Q. I am going to retire in 2009. The financial adviser for my company has told me that he doesn't like index funds for retirement. He says they are fine in the accumulation phase but not good in the distribution years because of volatility. My index funds--- Vanguard 500, Total International, Total Bond and Total Stock Indexes--- have all performed well in the past. I have other securities in my portfolio as well. What do you think? Is there a better alternative to index funds in retirement?
---M. A., by email
A. Ask your adviser for the source of his research. You might also ask him if he can spell B-O-G-U-S. Index funds have the volatility of the asset class they represent. Managed funds may have more, or less, volatility than their asset class, depending on manager luck/skill. But managed funds are not a reliable route to reduced risk.
The best way to reduce risk, whether you use managed or index funds, is to diversify across multiple asset classes. This is what you have been doing, while reducing the cost of investing.
You can reduce the overall risk of your retirement portfolio further in several ways. The easiest is to shorten the average maturity of the fixed-income fund in your portfolio. An extreme case would be to replace your total bond market fund with a money market fund. You can also add other asset classes, such as REITs. And, finally, you can convert a portion of your portfolio to a lifetime annuity. This will increase your immediate cash flow at the expense of your eventual estate--- but it will increase the odds that your remaining invested assets will survive a long period of withdrawals. The source of the research that supports these suggestions is Ibbotson Associates, now owned by Morningstar.
Q. My wife and I, both 65, are very close to retiring. Between us, we have over $200,000 in 401(k) accounts in three different employers’ plans. What is the best way to for us to handle these funds without losing a great deal of it to taxation? Additionally, I would like to use some of the money for remodeling work in our mortgage-free home.
---T.M., by email from Austin
A. Unless you are unusually fortunate and have very low-cost 401(k) plans, your first step should be to consolidate your plans so that each of you has a single IRA rollover account on a low-cost investing platform such as Vanguard, Schwab or Fidelity. At Vanguard you will be able to choose between low-cost index mutual funds and low-cost exchange-traded fund versions of the same index funds. At Schwab or Fidelity, you’ll need to use a combination of their index funds and ETFs to build a well-diversified but low-cost portfolio.
All of this can be done without exposing your assets to taxation. You have a “taxable event” only when you withdraw money from your tax-deferred account. You can build one of my simple Couch Potato Building Block portfolios at any of these firms. (To learn more about Couch Potato investing, visit my website, www.scottburns.com.)
Unless you have large pensions as well as Social Security income, it is unlikely that $200,000 of qualified plan money will expose you to a big tax hit. Here’s why: For 2008 a couple filing a joint tax return can have up to $65,100 in taxable income before they exceed the 15 percent tax rate. That’s after they take off $7,000 for two $3,500 personal exemptions, $10,900 for their standard deduction, and $2,100 for their two $1,050 elderly exemptions (when eligible). In addition, a significant portion of their Social Security benefits may be excluded from taxation.If you want your qualified plan savings to last as long as you do, you should limit annual withdrawals to between $8,000 and $10,000 a year--- about 4 percent to 5 percent of the original account value. Odds are you won’t be paying income taxes at a high or punitive rate.