Question: I am fortunate to have a six-month emergency fund but I know I must save more for my retirement. I am currently investing in my company 401k plan but know I also need to be investing more into something like a Roth as well. I don’t know anything about investing so I’ve tried reading various books on the subject but I get discouraged because they all seem to assume I have more to invest than I actually do. I don’t have $10,000 to fund say 5 different mutual funds so that I can diversify and limit my risk. If I attempt this on a smaller scale, all the associated fees have a much greater impact on my small nest egg. Given that I have roughly $2,500 a year to invest, could you recommend a strategy that is better suited for my situation than the ones I keep reading about in these investment books? L.M.
Answer: First, you should pat yourself on the back for both having a significant emergency reserve account and focusing on your retirement planning. Too many folks have done neither. You have also learned that diversification is very important for reducing risks. Many investors like you want to diversify appropriately but run into the problem of mutual fund companies requiring a high minimum investment or excessive trading fees for smaller investments. Here is an excellent solution…one we use for clients who have small accounts. Open an account at Charles Schwab (www.schwab.com) and invest through their Fundamental Index funds. This is an index oriented strategy that uses a unique quantitative methodology to choose stocks based on solid fundamentals rather than company size as is the case with most index funds. They offer equity funds in U.S. Large Cap; U.S. Small Cap; International Large cap; International Small Cap; and International Emerging Markets. Best of all, there are no transaction fees and a minimum initial investment of only $100. After that, the minimum is $1 so you can easily divide your $2,500 among these five choices. If you want to ‘automate’ your investment program, you might, for example, initially invest $100 in each of the five funds then automatically invest $200 divided up anyway you choose…all without any fees! Schwab also has a similar investment program using their own proprietary traditional index funds. For your bond allocation, consider Schwab’s intermediate government bond fund, Schwab GNMA (SWGSX).
Question: I’m 66 and started investing in a tax deductible IRA back in 1984 with $2,000. In the years that followed, I made additional non-deductible contributions to add to my retirement savings. So now this $25,000 account has both deductible and non-deductible contributions plus earnings. I think I have to start withdrawing money at age 70½. What can I do to get this into a Roth IRA or some other non-taxable account? I know I messed up by not opening separate accounts but I do have all of my tax records. P.C.
Answer: A lot of people have IRA accounts that include both deductible and non-deductible contributions. When you do, it’s important to maintain tax records since the non-deductible contributions will not be subject to income taxes when withdrawn, or in your case, converted to a Roth IRA. Using your tax records, determine the total of non-deductible contributions then convert the entire account to a Roth using IRS Form 8606. All monies, excluding your non-deductible contributions, will be treated as ordinary income in the year of the conversion. It’s important that any taxes due are paid from sources outside of your IRA in order to maximize the benefit of the conversion. Income tax rates may rise next year so this year may be a good year to do a Roth conversion. Unlike traditional IRAs, Roth IRAs are not subject to Required Minimum Distributions at age 70½.