Sushi Money

Do you worry about how your IRA is doing these days? If so you’re not alone, but what exactly you do about that is an entirely different question. Walter Updegrave discusses one reader’s concerns about this very issue in IRA freefall: Cash out or hold pat? .

Basically the reader’s question showed that he/she really had no idea about what their IRA was even invested in, or what strategy they had for investing in the first place. This is not uncommon, especially for most people who begin an IRA without the help of a professional advisor. For many of us, the IRA is the second place we save money for retirement after the employer’s retirement plan at work. Because it is a retirement fund though, we often worry about how it’s doing. It’s not very much fun to get statements in the mail showing the IRA value has declined over several months, especially if you’re close to retirement.

Do You Really Want the Money Now? There are many better options than to simply liquidate the IRA, take the money and plunk it in a bank or CD account. Doing that could be a very costly mistake, and result in a bundle in taxes and penalties with the IRS next year if it’s a traditional, deductible IRA. First, if it’s not a qualified withdrawal or rollover, you’ll have to pay a 10% penalty on the amount withdrawn if you’re younger than age 59 1/2, and then you’ll have to pay taxes on the withdrawal amount as well. Depending upon the size of your account, that could be a lot of money, could set you back years, and basically you may be starting all over with far less than you had if you had just left things alone.

If it’s a Roth IRA, you should be able to take out tax-free distributions anytime, as long as you are only withdrawing contributions that you have made to the account. This is not true for a traditional, deductible IRA. But even with a Roth IRA, if you take out excess contributions or earnings, you may be taking an unqualified distribution, and may owe taxes or penalties. But the beauty of the Roth IRA is that you can take out money that you have put in just about any time you want. You just cannot take out any earnings or gains on the money you have deposited over time.

* If you are considering closing your Roth IRA or taking out earnings, there are special rules for distributions. And the distribution rules for Traditional (deductible) IRAs are different.

But I Want My Money! In either case, let’s say you became really worried and closed your IRA account- within the last 60 days. In that case you may be in luck- you’re entitled to one rollover each year, as long as you do so within 60 days. So yes, technically, you can take out all of your IRA money, look around for a good long while, and then re-deposit it in a new account in less than 60 days and you won’t owe any taxes or penalties. Some folks even do this as a short-term loan. But you better make sure to get that money back in a new account in less than 60 days!

But guess what? If you close your IRA outright, financial institutions are normally required to deduct 20% automatically for federal taxes. And if you get busy and don’t find or receive the new IRA paperwork in time to get that money back in a new account within 60 days, you just may have taken an unqualified distribution, and won’t be able to complete a rollover. But at least a good chunk of the taxes are paid already, right? Ugh. That’s a less than ideal way to loan yourself money or try to keep it from losing value in the market. And you just started over- while you do have most of the money, your IRA is gone. You’ll have to start a new one if you want another IRA.

What’s a rollover really for? Usually a rollover is used to move retirement money from an employer’s plan into your own IRA. Or from one compan’s retirement plan, to your IRA and then to a new company’s retirement plan. It can also be used if you are moving IRA money from one institution to a new IRA at another institution to develop a new or different portfolio and investing strategy. Keep in mind that IRA rollovers are reportable transactions for IRS tax purposes, and you can only do this once per year. Some professionals believe that employers retirement plans may offer better options than an IRA over the long term. But it’s too easy to say that one is better than another outright. If you are comfortable with your employer’s plan, that’s great. Just make sure it is diversified over time. I like the option of spreading the wealth around, and having my own IRA at another institution such as Vanguard. Plus if you have your own IRA established, it can serve as a transfer vehicle if you move from one job to another throughout your career.

If you are just trying to move your IRA from one place to another, there’s a better way. Simply work with the new institution first, and you can transfer your IRA to a different bank, brokerage company or other financial institution.  An IRA transfer is different from an IRA rollover. With a transfer you are simply moving some or all of your money to a different institution. This is often called a trustee-to-trustee transfer. You can make unlimited transfers each year, and a transfer is a non-reportable transaction for income tax purposes. The new institution will simply help you fill out the required forms and paperwork to transfer your IRA directly to a new account, and you will never see the money personally.  A little paperwork and you’re done!

What Can I Do With My IRA?  So back to our original discussion: Why do people transfer IRAs and what else can we do with them? Even though IRAs have been around for many years, many people are just now realizing the power of an IRA. Your IRA can hold just about any type of assets in it. It’s just an account- and what you keep inside of it is up to you. You can have a money market fund for your IRA, or a mutual fund, or a basket of stocks. Your IRA can be with a bank, or a mutual fund company or as a brokerage account. Just because you opened the IRA with the bank down the street doesn’t mean you have to keep it there. You can move and re-establish that IRA with a new financial institution, and develop an entirely new strategy for investing for retirement.

Let’s say you completed the paperwork for the transfer- it may take a few weeks to get to the new institution. But once your money is in the new account, you can begin to implement your new goals and strategy.  For example, you may have transferred an IRA from a bank to a mutual fund company like Vanguard.  You can choose the type of mutual fund you want your money transfered to when you open the new account.  After the money is in that account, you can also re-allocate or direct some of that money to new mutual funds.

That’s basically how I approach it.  I prefer a well diversified portfolio of mutual funds in my IRA, along with a money market fund- what I call my Super Charged IRA. Why? Each year when I make my IRA contribution, it goes right into that money market fund. Then I can decide when and where I want the money in that money market fund to go. Then I divide it, or allocate that money into different mutual funds. All within my one single IRA. If I want to, I can even move money from the more aggressive stock mutual funds back into the money market fund. Normally I work on finding the right mutual funds, allocate the money, and then leave it alone. I try not to worry about the ups and downs of the market. It’s a strategy that works for me.

And that’s an important aspect of the article cited above: Implement an IRA strategy that builds upon a portfolio of diversified investments over time. And then leave it there to grow. As you get closer to retirement, that portfolio of stocks, mutual funds, etc, can be adjusted to fit your risk tolerance and other needs. Setting it up takes a little paperwork at first, but that’s about it.

What’s the hardest part? Having the patience and discipline to stick with it over time. Especially when the markets show the IRA as losing value. But if you’re having a hard time sleeping at night, that might tell you to think about changing your strategy, or maybe that you really don’t have a strategy to begin with and need one. You’re not alone- just read a few of the comments on that article. Most importantly however, it’s never too late to start.

* Investopedia has a great IRA information center for reference. There are countless different situations involving IRAs and retirement planning. If you are considering moving a lot of money around with IRAs, be sure to consult with your financial planner and tax professional. It might just save you a ton of money in taxes!

* Here’s a short review of some Common IRA Rollover Mistakes to avoid.

* Are you inheriting an IRA from someone? There are special rules for that too, and it may be time to sit down with a professional to review the best option for your situation.

* Here are some FAQ’s from the IRS regarding IRAs and Retirement Plans.

     I’m no economist… but I am a strong advocate of free markets and responsibilty for the choices we make in our lives.  The Wall Street Journal published a commentary today titled Fannie, Freddie and the Housing Bust that sums up the situation we face with the housing market, mortgage lenders and the government’s role.  I don’t disagree with the long-term value of Mr. Penner’s comments below, but let’s be honest… the question most of us have is “How is this going to affect ME?”  From the many economic commentaries I read … the end result ain’t going to be pretty.  Mr. Penner’s comments may be the Fed’s approach over time as well, yet the real result of this “healthy correction” may then be a tumultuous roll to recession with many long years before we recover.  Hence, I think dividend paying stocks and dividend-based funds are an increasingly essential part of any long-term portfolio in this climate, ideally in tax-advantaged accounts. 

“The current crisis is the result of the normal ebb and flows of credit cycles, and the free market will amply handle the correction that is already happening. Calls for Federal Reserve intervention or for other governmental involvement — including an increase of the Fannie Mae/Freddie Mac lending limits — must be rejected.”

“In the free market, those that made bad credit decisions must be allowed to pay the price, and only by paying dearly can lessons truly be learned. Borrowers who were unwitting and took on too much debt must learn that there are consequences for their actions. Homebuilders that built too many homes or overpaid for land need to face the consequences. Wall Street firms that provided credit to all of these activities with too much laxity must also pay a price. This is all part of a healthy correction.”

“All of these players reaped benefits during the housing boom that preceded the current crisis. Certain homeowners were able to temporarily live above their means. Homebuilder and bank profits have been exorbitant, and shareholders and executives of these companies have profited mightily in the boom. To not permit losses now would be a direct violation of the free-market ideals at the foundation of our economy.”

Mr. Penner is a principal with the firm Lubert-Adler and is the managing partner of PGP, a real-estate investment firm. In the 1990s, as CEO of Nomura Capital, he helped pioneer the application of securitization technology to real-estate finance.

© Wall Street Journal, August 16th, 2007

That depends upon what you’re looking for of course.  Lets assume an individual’s overall debt situation is well under control, and their credit card debt, if not paid off monthly, is mild.  If an individual is trying to stay away from all market risk, and wants to keep cash readily available for a near-term use, then “safety” is defined by your need for the money, for a purpose close at hand.  

Having an “emergency fund” is important for unforeseen situations… the time you really need money for something.  Most advocates say 3-6 months savings in the amount of your monthly income needs should fit that bill.  I think 6 months is more appropriate, and should be a first priority, especially in a family. So bank savings, money market accounts and CDs will fit the bill (CDs for savings, not an emergency fund due to possible penalties upon early withdrawal… e.g. you need the money).   Next is the credit card situation… pay down the credit cards!   

But what about longer term?  Is a safe bank/money market account or CD really helping over time?  Aside from peace of mind for knowing the money is there if needed, it may not be a safe place to keep funds.  Why?  Walter Updegrave from CNN Money writes a nice overview on why stockpiling cash may be a bad idea in a recent article “A lot of cash- too much risk.”  In essence he shows how the bite of inflation can slow the interest rate growth of bank savings (or CD or money market accounts) to a crawl.  That just doesn’t provide the necessary growth for someone trying to save for retirement or some other longer-term goal.  Mr. Updegrave shows the better alternative of really using a 401(k), if you have one, to grow retirement funds.  

I can think of few reasons why someone should not take advantage of 401(k) opportunities.  Most of those reasons involve hassles with paperwork, or how long one expects to be with a certain company, etc, etc.  But most 401(k) plans offer amazing benefits, and can be portable to take to a new employer.  Best of all, most 401(k) plans offer some kind of attractive matching or other benefit to how much you countribute… why pass up free money?    If you don’t have one, or just don’t want to use it… start an IRA.  We all need some kind of tax-deferred savings vechicle.  There is no better way to build retirement funds over time than a long-term tax-deferred approach to savings.  What if that just doesn’t meet your goals and need?  Maybe it can for a part of your savings program, and you can still use bank savings, money market and CDs for another portion.  You don’t like stocks or mutual funds?  Historically they provide the best long-term growth opportunities.  What about U.S. Savings Bonds?  They can provide a safe investment with a decent return, and can be used to fund education needs for children at a later time. 

The point is that there are many opportunities to grow your money over time… the earlier we start, the better off we are in later years.  I had a water-softener installed a couple weeks ago.  I didn’t plan on making a large appliance purchase this month, but the old water-softener finally gave in.  We live on well-water, and a good water-softener is essential.  Good reason for having an emergency fund… but more interesting was the conversation with the installer.  Here’s a guy in his middle forties that has a construction business on the side.  He was an energetic guy with lots of ideas and a strong work ethic.  He built his own house, had no debt, purchased only used cars, and was helping his children pay for school.  What about his retirement needs?  He had over $100,000 in savings.  Where was it?  In the bank, in a passbook savings account.

 This hard-working family man had never invested, never started an IRA, never looked at stocks or mutual funds, and was not comfortable with anything but cash at hand.  He was proud of his financial accomplishments, and should be… but he was also taking on a lot of “risk” in terms of the long-term safety of the growth of his money over time.  He also didn’t have any life or disability insurance beyond what social security might provide, and a family member to run the business in case of his disability.  Lots more there to be concerned about.  He knew he needed to start some savings and investment programs that would give him a leg up on inflation, but he was very risk averse.   We talked about some options and I referred him to a Certified Financial Planner to help get started.  He didn’t seem inclined to really want to do more however.  I wished him well… and hope he looks at other options.  It’s never too late to start!

Like different types of Makizushi, or simply “Maki”, an IRA can be an amazing combination of many assets all rolled into one. We’re going to talk about mutual fund investing and increasing the power of your IRA! This discussion is not about what an IRA is, or if you are qualified to open one- we will assume you have some idea of the basics (if not, look here!). Personally I favor the Roth IRA if you’re eligible. Most taxpayers are, and the beauty is that qualified future withdrawals will be tax free under current law.

My analogy with Maki is simple: Your IRA does not have to be comprised of one or two stodgy funds that you remain committed to, or change every few years after gut-wrenching analysis. And why should it be? Your IRA can hold nearly any combination or flavors of investment vehicles. Asset allocation and diversification are not only relevant to your entire portfolio, but should also be used as a tool within your IRA. Common sense to some, but many people are under the assumption that IRA’s are not very flexible for the type or combination of assets they hold within the IRA. Perhaps because of confusing jargon and legal descriptions, many people are also hesitant to make changes to their IRA due to potential tax consequences. But you don’t have to be hesitant, as long as you are not withdrawing funds from the IRA itself. (If you are making a qualified, intentional withdrawal then this obviously doesn’t apply). Even if you do take money from the IRA by mistake- if you “rollover” the funds back into the IRA within 60 days you should not incur tax penalties.

The strategy I prefer for managing an IRA is simple. Find a good low cost mutual fund or brokerage company like Vanguard, and over time diversify your IRA contributions to different funds you believe will achieve your objectives. In either case, let’s say you are adding to your Roth IRA with a $4000 contribution for 2006 or 2007 (you still have until April 17th to make a contribution for 2006!!!). Do you need to put that money directly into the same fund you already have? No! Consider other funds that will meet your current or long-term objectives and put the money into a new fund. Many funds have minimum requirements of anywhere from $500 to $3000 or more to be opened, so choose carefully. You can even open a different IRA at a different institution if you desire- there is essentially no limit to how many IRA’s you have. The real limits are established by law in terms of an annual contribution maximum for how much you can contribute in total to any or all IRAs in a given year. I like to keep my IRA with one institution to minimize administrative issues.

But here’s the key to the strategy: Use one of your IRA contribution years to fund and open a good money market fund within your IRA such as the Vanguard Prime Money Market Fund (VMMXX). Now that you have this money in the money market fund, within your IRA, you can choose to sweep that money into any other fund, at any time that you desire, based on the institution’s minimum investment requirements! And vice versa… let’s say you are uncomfortable with the market’s direction at some point- you can sell all or a portion of a fund held within your IRA and “sweep” the cash back to your money market fund, also held within your IRA. Or you can move or re-balance other funds within your IRA at a later date… what a great tool for re-balancing a portfolio over time! There are no tax consequences because all funds and transactions remain within your IRA. (There may however be fund company or brokerage firm consequences- if you sell all of a given fund, or reduce a fund below a certain balance, the fund or brokerage company may close you out of that fund and not allow transactions to the same fund within a period of time. Look at the company guidelines for your fund before doing this.) But in general, you now have increased your flexibility within the IRA for how you manage your assets.

I’m not advocating market timing in any sense, and I strongly believe in long-term investing for an IRA. However there are times when we may need the flexibility of having choices… and using a money market fund as a placeholder within your IRA can be a very helpful tool. So that’s it- supercharge your own IRA with flexibility! You can then a) know that you are not stuck in a fund or asset allocation that makes you uncomfortable, b) do your IRA investment research in a thoughtful manner over time, and c) choose the funds or assets that are most appropriate for your objectives. Talk with your financial planner or investment advisor if you want more information. Moving mutual fund investments around frequently is not a good strategy to achieve long-term returns. But you can do more with your IRA than at first glance!

For more news about the Roth IRA.

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