One of the greatest concerns many Americans have about Roth IRAs is whether a change in the tax code can end up screwing us. Right now, you are taxed on contributions made into a Roth IRA but you are not taxed when you take distributions. This is different than the Traditional IRA where you get tax-deductible contributions but are then taxed when you begin taking distributions. There are plenty of other differences but that’s the biggest one when it comes to the two.

So, can Uncle Sam, in a pinch, decide to double tax Roth IRAs? Of course they can. If we moved to a Fair Tax/consumption tax where income tax is removed and we are taxed on what we spend, that’s essentially a double tax on the Roth IRA. The government could also lower tax rates, increase tax rates, or change the game completely (in the case of a consumption based tax).

The key is to diversify your tax profile so that you hedge your bets. Contribute to a 401(k) or 403(b) as well as a Roth IRA. You get tax benefits today as well as tax benefits in retirement.

Don’t put your eggs all in one basket! (unless it’s my basket!)

If you have children (or if you are a child under the age of 18 and reading personal finance blogs, kudos to you!), you might be thinking about what you could do to help give them a jump start on their retirement savings. Roth IRA contribution rules say nothing about age so anyone of any age, as long as they meet the other criteria, is eligible to contribute into a Roth IRA. So, your child is permitted to contribute as long as they have earned income and his or her adjusted gross income falls under the income ceilings and phaseouts.

What is earned income? Basically, if they get a W-2 or report income on a Schedule C, then they qualify.

If you’re close to retirement and have a lot of equity locked up in your home, consider downsizing as a means of supplementing your savings and reducing your overhead. The cost to maintain a large home in your later years can often be very high with increasing utilities, homeowners insurance, and property taxes so it might make sense to move into a smaller home with a more manageable space. A side benefit of downsizing is that you might be able to recapture the equity you’ve built up and put it into your savings to help combat outliving your nest egg.

When downsizing, consider renting rather than owning. In addition to lowering most of your recurring monthly costs, this puts the risk of repairs and maintenance on your landlord and not yourself. If something catastrophic happens, such as a pipe burst or electrical short, the landlord foots the bill. It’s a great way to offset that risk.

Finally, in downsizing, considering moving to an area with a lower cost of living. Consider one of the top 5 best places to retire as they are retiree friendly both financially and lifestyle-wise.

Buy low sell high, that’s the mantra of Wall Street (actually, it’s probably “Buy low very often, sell high very often,” but I digress), and one that you can achieve every single time you rebalance your portfolio. Rebalancing your portfolio is a task that no one likes to do because it’s so mechanical, it’s so unsexy, but it’s so necessary and one that can guarantee that you’ll be buying low and selling high. How is this guaranteed?

Rebalancing is the act of adjusting your portfolio such that the asset allocation is shifted back to your target asset allocation. Throughout the year, your various assets will rise and fall in market value, resulting in a shift of allocation. If stocks performed better than your other asset classes, they will comprise a greater percentage of your portfolio. If you had a conservative mix of 50% stocks and 50% bonds and stocks rose 10% while bonds rose only 5%, you now have 51.16% stocks and 48.84% bonds. In rebalancing, you’d be bringing both assets back to 50% by selling some stocks and buying more bonds.

How does this guarantee buying low and selling high? If your asset allocation remains the same, you will be selling the better performers for the weaker performers. In the above example, if stocks had fallen relative to bonds, you’d be selling bonds to buy more stock. As you saw above, both can appreciate and you would shift from the better performing asset to the weaker asset.

What if you’re worried about selling a shooting star midway in its path? Well, there’s always the risk of that but since you’re only rebalancing once a year (or twice), the other benefits outweigh the possibility of that happening. Also, consider yourself banking some of the earning all the way up. Plenty of dot com folks watched shooting stars fly… and then crash, with nothing to show for it.

Conventional wisdom states that you should take risks when you’re younger, become more conservative when you’re older, and your finances will be better off for it. This is embodied in the typical advice for asset allocation - take 120, subtract your age, and you should have that value, as a percent, allocated towards equities in your portfolio. If you’re 20, you should be 100% in stocks. 40? 80% stocks, 20% bonds. Brokerage firms offer funds with this concept in mind, though their implementations vary slightly, by designing target retirement or lifecycle funds to this way. As the years progress, the allocation adjusts itself to meet the “rule of thumb” needs of the age group.

A recent study published in the Financial Services Review, an academic journal, shows that this isn’t necessary any advantage to his approach when looking at real-world portfolio returns. Professors Harold Schleef and Robert Eisinger of Lewis & Clark College ran simulations and discovered that such an allocation offered no advantage because of how random the stock market could be. They picked randomly a 30 year period across 80 years between 1926 and 2006 and created fictitious people with target retirement-like allocations (risky to conservative), seeing which stood the best chance of reading $1M. They found that there was only a 29% chance of making it.

Then they did the reverse (conservative to risky) and saw that there was a 45% chance of getting to a million. Going from conservative to risky was better historically! Of course they warn that you shouldn’t take this information and go all gangbusters but it’s certainly something that is noteworthy.

The Odds for a Retirement Nest Egg, Recalculated [New York Times]

If you just opened your 401(k) or are investigating where you should be invested, my advice to you is to keep things as simple as possible. If it’s your first 401(k), or your first time looking at it with this company, it can be a little overwhelming to figure out what you should be doing. If it’s not your first 401(k), you might be worried that your investments aren’t adequately diversified versus your other investments or that you simply haven’t picked the best ones for your financial situation. Regardless of your motivation to analyze your 401(k) fund offerings, the task is still the same and can seem monumental… so let’s keep things simple.

The two things you need to figure out are cost and performance. There are a lot of options, more if your company uses a traditional brokerage to manage the 401(k) because it opens up the full range of Wall Street’s products, but sticking with mutual funds can’t be wrong. Forget active versus passive or ETFs or individual stocks, stick with mutual funds, if you want a low maintenance 401(k), and you’ll be saner for it.

So, with cost you’ll want to see whether you’re getting a good bang for your buck. Passive funds generally have low expense ratios and likely low sales expenses (active funds usually have much higher because there is more activity) and trend with the market. If you’re happy with that, as many are, an index fund is always a good option. If you want the potential for greater gains, you can look at an actively managed fund. Past performance isn’t an indicator of future performance, but what else are you going to base your decision on if not the past?

Lastly, remember to use tools to see if your diversification is in line. Are you in too much stock? Not enough bonds? Too much international and not enough domestic? Or you could just go with a target retirement or life-cycle mutual fund, they can take care of those details for you (if you trust them!).

TradeKing.com is one of the leaders in the online discount broker business with their $4.95 market and limit equity trades and $4.95 option trades (+65 cents per contract). It was named Smart Money #1 Discount Broker in both 2006 and 2007 and likely will win for 2008 as well. While it’s certainly not as cheap as the likes of Zecco, it does give comfort to know that a reputable publication like Smart Money is willing to stake it’s reputation and name it #1 in discount brokers two years running (it also happens to be #1 in online discount brokers as rated by me!).

So, what are the specifics of their IRAs? Well first off, TradeKing.com does not charge an annual fee for maintaining an IRA account, which is relatively rare. By comparison, Vanguard has a sizable fee that can be avoided if you request all electronic notifications. TradeKing.com also charges a $50 fee for closing your IRA or transferring out funds but that’s a standard fee in the industry.

Lastly, another nice, and rare, feature is that TradeKing.com has no account minimums. If you want a Vanguard account, the minimum you need to open an account is $3,000. While you’ll always want to put as much as you can into your IRAs in the beginning, it’s always nice to know that you can start with $100 if you really want to. Of course you won’t want to begin trading yet because even at $4.95 a trade, each transaction costs you 5% of your portfolio if it’s only $100.

So, TradeKing.com looks like a pretty good place to put your IRA if you haven’t yet picked a spot for it yet. Smart Money can’t be wrong two years in a row, can they?

If you’d like to learn more, he’s a far more in-depth TradeKing review at Blueprint for Financial Prosperity.

Consumerist offered this gem up the other day, a forty-page document released by the AARP called “A Financial Professional’s Guide to Working With Older Clients” (PDF).

The first 18 pages were written for financial professionals and you can probably skip them. As a potential client, on the service provider-client side of the relationship, you could read the first 18 pages if you want to know what you need to be asking someone advising you. If you don’t plan on working with an adviser, you can skip it entirely.

On page 19, it starts discussing the issues that concern retirees and older clients. Not all of these will apply to you but it’s good to know what your peers are concerned about because you might be concerned too and just not know it! It covers social issues, family issues, generational issues, physical impairments (hearing, vision, disability), mental impairments, as well as written & online communications.

It’s a very quick read and gives you something to think about.

A self-directed IRA is a type of Traditional or Roth IRA in which you’re allowed to invest in things other than stocks, bonds, or mutual funds - such as investing directly in a hot new biotechnology or traditional technology startup. In fact, it’s the only way you’d be able to invest your IRA dollars into anything non-traditional to include but not limited to real estate, race horses, and basically anything else (as long as you follow a few rules).

Disqualification

The biggest rule is that you can’t do anything that makes it appear as if you’re using deferred funds for current use. The biggest example is in real estate investing. If you use your IRA funds to “invest” in a property that you end up using and the IRS finds out, then your entire IRA could be disqualified, considered distributed, and you’ll have to pay any associated taxes and withdrawal penalties if you’re under 59 1/2. The disqualification aspect is the biggest danger associated with self-directed IRAs because it can sink you.

There are some categories that are explicitly not allowed and the two biggest are life insurance and collectibles. The “current use” rule regarding life insurance is clear, you’re technically always using it, right? With collectibles, it appears that the rule exists simply because there’s no way to enforce the “current use” rule otherwise. If the IRS ever asks, you could simply give your cousin the piece of art and say they were using it.

How To

This part is pretty simple, just head on over to your bank’s trust department or open an account with a custodial firm (many traditional brokerages, such as Vanguard, also handle self-directed IRAs). They handle all the accounting from disbursing the funds to collecting the profits but they stay mum on all other issues, they are not allowed to give advice. The fees are typically higher than your normal IRA account but that’s because they do a lot more work handling all those esoteric investments you’re thinking about.

Coming from a Chinese family, the thought of having my parents live in a retirement home was never appealing to me. In Chinese culture, unlike American culture, there’s a sense that family, rather than government (Social Security, pensions?), takes care of the elderly members of the family. That’s not to say all Americans send their grandparents to the retirement home, just that it happens more often. However, as I’ve been reading about retirement communities (and also homes), I see there’s a tremendous benefit to living with people who are in the same age demographic as you, rather than with children. It still hasn’t changed my mentality but it certainly opened my eyes to the benefits.

Events
Since a retirement home or community is full of folks in the same age demographic, it likely has events that cater to those individuals. Bingo nights, dancing nights, and movie nights really increase the level of social activity ones experiences and, to be honest, would be fun for almost anyone not looking to get drunk at a bar. This level of social activity is crucial when you reach retirement because it gives you something entertaining to do.

Quiet
A community without the younger demographic is one that will naturally be quieter! A quiet lifestyle, if that’s what one prefers, is one you’ll generally find in a retirement community and not necessarily find in a “regular” community.

Affordable
If you look up housing pricing for retirement communities, you’ll find that the homes there are affordable because they are catering to the fixed income crowd. So not only do you get the events and the peace and quiet, but you get a more affordable home too!

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