Thursday, January 28, 1999

Q. I just retired. My savings include $180,000 in mutual funds, all earning 30 percent or more each year, plus $25,000 of Home Depot shares. To supplement Social Security ($14,500 a year), I will need to draw out about 10 percent from these funds each year. I don't want to move any of these over to bond funds for earnings, which would be so much lower.

In eleven years, a rental home I own will be paid for, and the income thereafter will pay the mortgage down on my recently purchased home. My wife will be eligible to collect her Social Security in 3 1/2 years. What are your thoughts?

—R.P., Wylie, TX

A. Don't relax just yet. While people are now impatient when their internet stock doesn't double every week, you simply cannot rely on that 30 percent return to continue, year in and year out, for the next 22 years which is about as long as your or your wife will live. There will be down years. A 10 percent withdrawal rate in a down year would have a devastating effect on your nest egg. Trust me, it would not be pretty.

(Readers with Internet connections can see the probabilities of portfolio survival at different rates of withdrawal, taken from the Trinity Study, on my website, www.scottburns.com.)

I think you've got some serious income and spending crunching to do. The same portfolio survival studies show that a 5 percent annual withdrawal rate gives you a very good shot at preserving your portfolio. That means you need to reduce your income expectations by about $10,000 taxable dollars a year, or an after-tax net of about $708 a month.

Your wife may receive a good portion of that when she starts to collect Social Security. So I suggest a "bridge" fund that will provide an amount equal to her expected Social Security. You would subtract this from your nestegg and withdraw at 5 percent from the remainder.

Another thing you might consider: selling the rental property and using the equity to pay off your home mortgage.

Q. Because of an emergency last year, I took out a loan against my 401k for $5,000. I am currently repaying the loan on a 60-month term at 9.5 percent, while still contributing 6 percent to my 401k. My company match is dollar for dollar up to 3 percent. My question is, should I take the 3 percent my company does not match and apply it to the principal balance of my loan to pay it off early? It seems logical because of the money will go into the big pot anyway?

—J.P., Lewisville, TX

A. Not really. What you are talking about is reducing your 401k contribution to repay a loan against your account. That means you are giving up tax savings and an increase in your account. With a loan balance of $5,000 this means you will lose the opportunity to contribute $5,000 to your account. If retirement is 25 years away, this will reduce your nest egg by $43,000, assuming a 9 percent annual return. Meanwhile, your Federal Income Tax bill will also rise, knicking you for another $1,400 if you are in the 28 percent tax bracket.

It's nice to think about "the big pot" as a great equalizer, but you'd really be cheating your retirement savings and gifting the Internal Revenue Service.

Q. I am a recent college graduate getting ready to start work. What type of investments should a 22-year-old professional engage in? I have heard about the benefits of a Roth IRA account and a 401k. My employer allows me to invest 15 percent of my earnings and matches 6 percent. If the 401k is a wiser choice, how should I split my investment?

—C.J., Carrollton, TX

A. The 401k account gets first priority because of the power of the employer match. It also gets you a tax deduction that will reduce your Federal Income Tax bill. That cash can be used to start funding your Roth-IRA. My suggestion: fund the 401k to the limit of the employer match. After that, there could be long arguments about how to split the remaining dollars. Some would suggest favoring the Roth-IRA because of its greater flexibility. If your 401k plan is run with modest expenses, I favor simplicity and keeping the money in one place.