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Yahoo! has a top ten list for retirement planning. After yesterday’s story about the number of people having to retire early, it might be a good idea to look over the list and make sure we are on the right track. I will cover the first five today and the last five tomorrow.

1. Save as much as you can as early as you can.
2. Set realistic goals.
3. A 401(k) is one of the easiest and best ways to save for retirement.
4. An IRA also can give your savings a tax-advantaged boost.
5. Focus on your asset allocation more than on individual picks.
6. Stocks are best for long-term growth.
7. Don’t move too heavily into bonds, even in retirement.
8. Making tax-efficient withdrawals can stretch the life of your nest egg.
9. Working part-time in retirement can help in more ways than one.
10. There are other creative ways to get more mileage out of retirement assets.

Save as much as you can as early as you can

Albert Einstein was a pretty smart guy and he knew a little bit about the forces of the universe. So when he said that the most powerful force in the universe is compound interest, maybe we should listen. For instance, let’s say that you invest $5,000 per year and get a 10% return. If you do this for 30 years, you’ll have $1 million. After 20 years, you’ll have $357,000. After 10 years, you’ll only have $107,000. So, if you put off investing in a retirement fund when you’re 25 and start when you are 35, you’ll have a third of the money you’d have if you started earlier when you hit age 55.

Set realistic goals.

Most people need to replace a significant portion of the pre-retirement salary when they retire. It will help to be debt-free by then, but if you plan to move to retire, or have a winter/summer home, you will likely have a mortgage payment. Your car will not last 20 or more years you will be in retirement. Medical expenses will eat into your income. You’ll need to estimate all of these items to see how much you’ll need to earn in retirement. One quick way is to use the “Where am I heading?” calculator from Alliance Bernstein to see how much of your income you are on track to replace when you retire. The nice thing about this calculator is that it puts everything in today’s dollars so that you can see your retirement income. It’s better to actually go through the calculation of retirement needs and expected returns, but using this calculator can give you an idea if you are generally on the right path.

A 401(k) is one of the easiest and best ways to save for retirement.

A 401(k) is one of the easiest, but not necessarily the best. Depending on your situation, you may be better off with a Roth IRA than investing in your 401(k). If you get an employer match, you must save enough to get the match otherwise you are throwing away free money. Otherwise, if you are paying a low tax rate now, there is no incentive to paying taxes later when you may be in a higher tax bracket. Plus, you are limited to the funds in your 401(k). In my company’s old provider, we had a fund that lagged its benchmark by 30% annually over 5 years! How many people were invested in that fund because they set their investments and never checked it? A 401(k) is a wonderful tool for those that do not trust themselves to actually send a check to invest because the money is never in “your” pocket. But it isn’t right for everyone.

An IRA also can give your savings a tax-advantaged boost.

This is true. Like 401(k)s you can make tax deductible deduction to an IRA. The IRA limits are about $10,000 less than the 401(k) limits, so if you have a 401(k) that decision is a no-brainer. However, like I said above you should look into a Roth IRA, which doesn’t give a current tax break but does allow tax-free withdrawals in retirement.

Focus on your asset allocation more than on individual picks.

Most people miss this boat. Just because one set of stocks (*cough* tech) are shooting through the roof doesn’t mean all of your money should be there. Look what happened in 2001 for a sobering reminder of that. You should be well diversified amongst different classes of stock as well as bonds (if you are over 45), real estate, commodities, etc. You should own international stocks as well as domestic ones. The more diversified you are, the less likely a catastrophic drop will happen in your investments. Generally, US and international stocks don’t move in tandem. Commodities generally move in polar opposite to US stocks. Real Estate has different cycles than everything else. Diversification won’t necessarily provide you the best return from year to year, but it’s the clear winner in the long term.

The front page headline story in today’s USA Today is about retiring before you want to. McKinsey & Co. surveyed those that are at or near the traditional retirement age of 65 to see what their expectations are and what the reality is. The results should send a shiver down the spines of a lot of people that haven’t planned for retirement.

• Nearly half of the Baby Boomers in the study expected to work past 65 to supplement their retirement income. The reality? Only 13% of current retirees worked past that age, a 35% difference in expectation and reality.
• 40% of retirees were forced to retire earlier than they had planned.
• The average age at retirement? 59!

Among those that were forced to stop working before they intended, it was split about evenly among those that were laid off and unable to find work and those that had a sickness or injury that forced them to leave the workforce. Both of these reasons are unforeseen and can really strike at any time.

What happens if you do get laid off? Most people would say “get a job” but are you really going to be able to find a job past 50? A study cited in the article says that a younger worker has a 40% better chance of being called for an interview than an older worker. Employers think that they can hire a younger worker cheaper and they will likely have fewer health issues that could affect employment are the main reasons that employers tend to prefer younger workers. On average, AARP found that workers over 55 spent 25% more time unemployed than youngers workers did after being laid off.

One way that older workers are getting around these hurdles is by going self-employed and become consultants in their professions. Consultants work on a contract basis, so the health and pay issues may be alleviated. Also, the experience of older workers is a goldmine for consultants rather than a perceived liability as an employee. Older workers are 60% more likely to be self-employed than younger workers and almost a third started their businesses after 50.

So, what can you do now to plan? Having an emergency fund helps, but having a 3-6 month fund won’t do much good if you are laid off and unable to find permanent work. As always, putting away as much as you can in a retirement fund as early as possible is a good idea. However, you can’t touch your IRA until you are 59 unless you meet certain critera. Getting laid off at 55 and having an IRA won’t help a whole lot. Buying long-term disability insurance is a good idea, but will only pay off if you are disabled.

That doesn’t leave a whole lot outside of taxable investment accounts to serve as an emergency backup. While I am loathe to suggest putting taxable money away when so many opportunities are available for tax-free income, it might not be a bad idea if you are in an industry prone to downsizing. Of course, how many GM employees in 1966 thought their industry would be in so much trouble now? That’s what I am looking at trying to plan for when I’m 65.

Any ideas out there?

It’s funny how emotional attachment can override the most basic rational thinking in humans. Whether it’s someone that runs up thousands of dollars on a credit card when they know they shouldn’t for the latest tech bauble or someone putting their entire 401(k) balance in company stock, an emotional attachment can overcome the basics that we all know are true.

The basic rule being violated here, obviously, is that we should all diversify our investments. According to a study referenced on CNN Money, company stock accounts for 25% of the value of all assets in companies that offer their own stock as an option. More than one in five people have at least half their assets in company stock!

Some of that obviously has to do with companies that make 401(k) matches in company stock and then refuse to allow employees to sell the match. If your company matches the first 3% of your salary and you only put in 3%, half of the value of your 401(k) will be in company stock. That is a situation you can’t get around (even though you should be putting in much more unless you’re investing elsewhere).

So, if you have more than say 10% of your 401(k) in company stock what do you do? First, check to see if you are really locked in or if your company just makes it seem like you are. If you are not locked in, I would sell all the stock you need to get to 5%-10% of your 401(k). If you can’t sell all at once, you can sell in chunks. But keep selling until you get to your goal. Use the proceeds from the stock sales to purchase other options in your 401(k) to diversify your investments.

If you are locked in, there’s not a lot you can do in your 401(k). In this case, I would limit the amount that you contribute to your 401(k) to maximize the company match. I would then take the money you would have contributed to your 401(k) and contribute it to an IRA instead. You will still get the tax break and you can diversify better than you could in a 401(k). I think that using an IRA to supplement a 401(k) is always a good idea to diversify, but many people either do not want to do the homework or cannot trust themselves to make the IRA contribution every month. In these cases, continue to invest in the 401(k) but make sure that your contributions stay far, far away from your company’s stock.

That’s the focus of this week’s Ask the Expert column over at CNN Money. The reader is asking if they should turn over their $1.5 million savings over to a professional to run for a fee of $2,500 per quarter.

Basically, the question comes down to how much you want to do. The fee the financial advisor is charging is equivalent to 0.67% per year. That is on top of the fees that the mutual funds will charge. As the “Expert” points out, that’s cheap for a financial advisor but can it be avoided entirely?

As I’ve said before, I believe it can. Even if you have no idea of where to invest (if you have $1.5 million in savings you’ve done pretty well already) you can go to a fee-only financial planner that suggest where to put your money without specifically trading for you. It will be much cheaper than having the financial advisor trading for you, even if you go back every year.

Additionally, they could put their funds in a “lifestyle” fund such as Fidelity’s “Freedom” funds, Vanguard’s Target Retirement funds or T. Rowe Price’s Retirement funds. I’ve discussed these funds before (another time when the “Expert” slammed financial advisors rather than softly recommending them here) and I think they are good funds for those that don’t want to mess with portfolio allocation and similar concepts, but I believe people can do better by either researching on their own or going to a fee-only advisor.

I always suggest going with T. Rowe Price’s fund because it is more aggressive and puts more of the money in equities at every stage. Historically, returns are higher on stocks so T. Rowe Price’s fund will put people in a better position to retire than the other funds will.

Let’s face it. There are very few people that are truly wealthy. While it is a worthwhile goal (and dream) it’s one that is not likely to be realized. The goal for most people, especially in retirement is to aim for financial security rather than true wealth. CNN Money has four tips for reaching financial security, even if wealth is not achieved.

Build a cushion

This is the most important thing that everyone should do. You must have a savings account in case of emergency. As Americans, we have gotten away from having a rainy-day fund. The US savings rate has been negative for two years, meaning we are spending more than we are earning. While some of that is cashing out of home equity, how many people truly have the 3-6 months salary saved away somewhere accessible? That means not in a 401(k) or IRA, but in a savings account.

How are you going to get there? Budget, budget, budget. Pay yourself first. When you budget, have a line item for “savings”, or if you can’t fill that line every month simply lower your income at the top for what you put into savings. The article also suggests using gifts and direct deposit from your paycheck as ways to build up an emergency fund.

More esoteric suggestions include using flexible spending account money or the two extra checks you receive if you are paid every two weeks to boost savings. Both of those suggestions are much harder to implement. We do use our flexible spending account money because we pay about $500/month for daycare, not an insignificant sum. I do get paid every two weeks and we budget monthly, but the extra two checks are our vacation fund and Christmas fund respectively.

One great suggestion is to use a higher paying money market savings account to build a cushion quicker. This is one suggestion I have been unable to convince my wife to do. There are several online banks that are FDIC insured and offer rates as high as 4.75% on money market funds.

Live on less than you make

The easiest rule to building an emergency fund, but the hardest to follow. How do you do this? Budget, budget, budget! Schedule out all of your planned expenses for the month and compare it to your income for the month (which is generally fixed). If you go over on expenses because of a large unexpected expense one month make up for it the next month or the next few months depending on the size of the expense. As I said above, pay yourself first by having a line item in your budget to put into savings.

The goal is always to put 10% of your take home pay into savings. We have a hard time with this because of our child and other expenses. I do manage to put 10% of my gross income into my 401(k) to save for retirement, but we’re only at about 3-4% of take-home pay into savings each month. But, it is better than nothing!

Adopt a pay-go, pay-off strategy

Basically, this means pay off your credit cards every month. This is something we do religiously. It makes zero sense to pay the outrageous (usurious?) rates that credit cards charge to carry a balance. If you currently have a balance, this should be your first challenge, even diverting money from an emergency fund to pay off credit card debt. This is a huge debate in the financial blogging community right now, but I am firmly on the side of paying off credit cards then saving.

We do use credit cards for every purchase we make, but we use our Chase Rewards or Costco/American Express cards to do it. We get rewards for using these cards rather than simply using our checking account. The rewards added up to over $500 last year. If you can control spending, and write down every single purchase on your budget, I cannot stress highly enough to use reward cards for everyday spending. But you have to pay it off every month, otherwise the rewards are useless and you are better using your debit card.

Take cover

Insurance is a must for being financially secure. Health, disability, and life insurance are all good to have to blunt the effects of a catastrophe. However, they won’t keep your financial life from being ruined by a catastrophe all by themselves. Half of all bankruptcies in 2004 were at least partially due to health costs. 68% of those that filed partially or primarily because of health costs had health insurance. Review your policy to see what exactly is covered. Get disability insurance if you do not have it. My extended family has been lucky that health catastrophes that resulted in permanent disability didn’t end up in bankruptcy because of fantastic health and disability insurance. Replace as much of your income as you can for long-term disability insurance. Inflation will eat at whatever amount you are able to replace (prices double every 20 years) and you will want to keep the same lifestyle as long as possible.

Life insurance is necessary if anyone relies upon your salary to survive. If you have children, make sure to get enough to take care of them until they will no longer rely upon you for their primary means of support. If your spouse relies upon your salary for primary support, get enough to pay off any debt that the two of you have accumulated along the way: mortgage, student, cars, etc. Consider getting term rather than whole life as it is often cheaper (especially if you are young) and you can therefore afford to get more insurance. You can never have too much life insurance.

MSN Money has a topic on four common retirement blind spots. I think it’s more about how we kid ourselves when it comes to planning for retirement. I admit to using at least one in my retirement planning and I think we all do. It may be overly pessimistic to uninclude all of these, but we should be prepared if our plans don’t work out.

I can work until I’m 70 or older 

I don’t have working until 70 in my plans, but I do plan on working into my 60s. The reasons that she cites are age discrimination in the workplace and the need to quit working for health reasons (your own or your family). I plan on eliminating the first possibility by being out on my own well before I am that age. The second is impossible to eliminate entirely and can only be offset by saving more earlier, which is always good advice.

I can count on Social Security 

Bwahahahahahaha! I don’t even have Social Security in my retirement plan as I indicated when I wrote about planning for my own retirement. I think anyone under the age of 40 should not expect to receive much, if anything, from Social Security. People who are on Social Security are surprised by how far it really goes (in a bad way). How far does it go?

Right now, accounting for taxes and Medicare, Social Security benefits replace about 39% of the average wage earner’s salary, says Sass. By 2030, that will drop to about 29%. “That’s a huge, huge cut.” 

So, even if you plan to include Social Security, plan to still replace 70% of your salary in retirement (you will use less, but it never hurts to save too much).

I’m saving for a better future

This one really hurts. You’re not saving for a retirement filled with monthlong jaunts to Costa Rica. You’re saving for a retirement where you’re not eating dog food. Most people have a romantic vision of retirement as a time of endless vacation and fun. Take a look at your parents or grandparents that are retired. Are they retreating to Rome for their yearly vacation?

Thank goodness for my inheritance  

If you are counting on your inheritance for retirement planning, you may want to look again. A study cited by MSN states that “only 1.6% of heirs will get $100,000 or more”. You can hope to be one of the 1.6%, but counting on it is another matter entirely. More and more people will have to spend down their assets to qualify for Medicaid in order to get medical costs paid for. Long term care isn’t getting any cheaper either.

Yes, this article is quite negative, but I think people need a wake-up call when it comes to retirement. Better now than when you’re 70.

Fidelity’s Investors Weekly has a nice roundup of how long to keep various types of documents. The piece mainly focuses on how long to keep the records for tax purposes, which may or may not be the most important function of these documents based upon circumstance.

Tax records: Keep three to seven years

I would push for closer to seven years because the IRS has a sneaky habit of using the “we have six years if you underreport your income by 25%” rule if you’ve pitched your records. And this means all tax records: W-2s, mortgage deduction statements, charitable contribution records, child care expense backup, etc.

Investment records: Keep until you sell the security, plus seven years

This is primarily for tax purposes. You need all of your historical records to calculate the cost of the investment, which can be changed by dividends and stock splits. If you don’t have the records the IRS will assume a zero cost and you will pay tax on the entire sales price.

Retirement account records: Keep indefinitely

I hadn’t heard that the IRS was requiring all retirement statements to be kept until all the amount is drawn out. For me, that could be 70 years (!) if I live into my 90s. I’m not sure of the reason for this, but I will definitely start keeping records.

Home improvement records: Keep until you sell your house, plus seven years

For the same reason as investment records. Major home improvements increase the “cost” of your house for tax purposes. They don’t cover closing records, but have those as well. Again, the IRS will assume zero cost if you don’t have these records.

Bank and cash management account: One year to indefinitely

I’m not sure why they say “indefinitely” since their description says seven years. Again, for tax purposes you should keep any checks that go on your tax return (deductions, etc.). Your bank statements can help with an audit if you no longer have W-2s, etc.

Personal bills: Until you have proof of payment

We don’t do a very good job of this. We usually shred as soon as they are paid. By the time you get notified you didn’t pay it’s too late anyway.

So, there you have it. A brief primer on document retention.

Today is the Major League Baseball amateur draft. The top draft pick 15 years ago was an 18 year old 6′4″ lefthanded pitcher. A lefthanded pitcher that averaged 2.5 strikeouts per inning his senior year of high school. A lefthanded pitcher that could throw 95 mph without effort and could dial it up close to triple digits when he needed to. A pitcher that was the ultimate can’t-miss prospect. He was called the best amateur pitcher ever. His name was Brien Taylor.

Haven’t heard of him? You’re not alone. Except to those that obsess over the game the name means nothing. But his tale is a cautionary one. What is this doing on this website? Well, other than my love of the game his is mostly a cautionary tale in how to handle a windfall.

Brien Taylor was a poor black kid from rural North Carolina. The son of a crabber and a bricklayer, his shoulder was his family’s ticket out of poverty. The Yankees drafted him and offered him $300,000 to sign. That was more money than the family ever had, but it was nearly a million dollars less than the #1 overall pick from the prior year received (Todd Van Poppel for those wondering). His mom became famous in her quest to get him more money. He ended up getting a signing bonus of $1.55 million.

Taylor went to the minor leagues and continued his brilliance. He struck out more than a hitter an inning in Class A and AA ball over the next two years. He was headed straight for the majors and a big payday.

Then fate intervened. His brother got into trouble and got beaten up (partially because he was Black and Brien was his brother). Brien later went to defend him and got involved in a fight. He fell on his shoulder, his golden shoulder, and tore it up. His surgeon called it one of the worst shoulder injuries he had ever seen. Surgery was performed but Brien was no longer golden. His fastball dropped into mortal territory and he became hittable. His career was over. He became the second player ever drafted #1 overall to never reach the majors.

Brien made over $2 million during his brief career (including his signing bonus). That windfall likely could have set Brien up for life. Using the retirement principle of taking no more than 4% of your savings to ensure it won’t run out, he would have started at $48,000/year ($2m * (1-40%) * 4%), a fortune in rural North Carolina. And that would have only increased as his investments compounded. Instead, Brien went home and worked as beer distributor. He is now 34 years old and is working with his father as a bricklayer to support his five daughters and living in the trailer he grew up in with his parents.

Brien is a cautionary tale, but hardly the only one from the world of major sports. If you come into a windfall, make sure to take care of yourself first. You never know what will happen. When Brien signed for that $1.55 million, he didn’t know that two years later his career would be all but over and his future windfall would never come. This is why it is important to have savings and an emergency fund. If you get a windfall, don’t buy a new house and a shiny car. Put it away and let it take care of you for the rest of your life. Don’t become the next Brien Taylor.

MSN Money has a section for twentysomethings in order to keep them from messing up their financial lives. Liz Pulliam Weston has a quiz on how you stack up compared to your peers.

1. The median income for families headed by people aged 20 to 29 was just under $28,000 in 2004
2. Twentysomethings were more than twice as likely as older folks to have a negative net worth…The median net worth in this age bracket was just $7,901
3. Thirty percent had education loans. The median amount owed to student lenders was $9,200.
4. One out of 10 families headed by twentysomethings was at least 60 days late on a bill.
5. Thirty-two percent of twentysomething families had no health insurance

My answers:

1. We do beat this statistic
2. Negative net worth? Yikes! We do have positive net worth greater than the median, but likely because of #1.
3. Check and we wish.
4. Nope. I’m fanatical about paying on time. I hate penalties.
5. Luckily my wife and I both have jobs that provide health insurance.

If you’re twentysomething take a gander at the new (to me, at least) section and see how you stack up to your peers. She also has six suggestions to run with if you don’t stack up.

• Live cheaply as long as you can
• Get health insurance
• Shovel money into your retirement funds
• Take a chance
• Be strategic about debt
• Pay attention to your credit score

Fidelity’s listed their five top tax strategies that you can use right this minute to “fix” your taxes for 2006 (not “fix” like this guy, but fix potential problems).

1. Take a look at your payroll withholding
2. Consider increasing contributions to retirement savings accounts
3. Get more energy efficient
4. Keep better records of charitable contributions
5. Consider taking advantage of stock losses

Take a look at your payroll withholding 

A lot of people overlook this tip on purpose. If you’re getting a refund, you are giving the government a free loan, but it’s a saving trick a lot of people use. As interest rates rise, people may take a second look at this “saving” strategy. It makes a lot more sense to adjust withholding when you’re giving up more than half a percent of interest.

Consider increasing contributions to retirement savings accounts

Everyone should be saving for retirement and increasing those savings whenever they can. I put it to people this way, if you can sacrifice a little bit now you won’t have to work as long when you get older. Or, the more you put into retirement the quicker you can quit your job. That argument seems to work with my peers (late 20s) that don’t want to think about being in their 60s anytime soon.

Get more energy efficient

There were a myriad of tax credits passed late last year dealing with energy efficiency, from the hybrid car credit to credits for improving the energy efficiency of your home. The easiest way to determine what products are eligible is taking a gander at the IRS fact sheet on energy tax credits. And make sure that the store/manufacturer proves you are eligible for the credit before you buy. If they tell you they’ll show you the docs after you purchase, it’s likely not eligible.

Keep better records of charitable contributions

Fidelity’s tip is all about documenting charitable donations over $250. I would posit the majority of lost charitable deductions are actually smaller dollar amounts that people never bother to write down. Donations to churches or money dropped in the Salvation Army kettles are the most likely lost deductions because people don’t note the amount donated when they make the donation and then forget to later. We keep a notecard in my wife’s purse that she uses to note any cash donations and we try to write checks for as many as we can so that we can flag donations in Microsoft Money for easy year-end recordkeeping.

Consider taking advantage of stock losses 

Harvesting tax losses to offset capital gains is a time honored tradition to reduce taxes. You can also use it to reduce normal income as $3,000 can be offset against non-capital income and the rest can be carried forward. Though, with stock markets around the world up by double digits in the past year, it may be slim pickings when it comes to tax losses. You also need to be aware that re-purchasing the stock you sold within 30 days before and after the sale will cause the loss to be disallowed even if purchased in a separate account.

These are five relatively easy tax strategies that can either reduce your tax or reduce the over or under withholding of taxes so that a surprise (good or bad) doesn’t happen next April.

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