This really only applies to people who are decades away from retirement.

This week started off rough. Merill Lynch agreed to be purchased by Bank of America, Lehman brothers filed for bankruptcy protection, and AIG looked about fifteen minutes away from also filing for bankruptcy protection. On Monday, the Dow Jones Industrial Average fell over five hundred points, it’s largest drop in six years. Five hundred points… or around 4%. It wasn’t alone though, all the other major indices posted huge losses too and were quickly followed by all the major Asian indicies who fell 5-6%.

That’s when I logged into my Vanguard account to check out my retirement accounts. They were all red. The sad thing wasn’t that they were red, they’ve been red since last year, but they were in deep.

That’s when I realized something… don’t look at my retirement account balances. Just don’t. I can’t touch those retirement account assets until I’m sixty, which is over thirty years away for me. I rebalanced them late last year and my target retirement date is around 2040, so these swings (even though they’re huge) shouldn’t affect my thinking.

Poverty Effect

The Wealth Effect is a phenomenon where people spend more because they are or feel richer. One of the ways people feel richer is when they see paper profits on their brokerage holdings lists. When a stock does well, people feel richer even though they haven’t realized the profits yet. Likewise, the reverse is also true (the Poverty Effect). If you look at your portfolio and see huge losses, it’ll have an effect on your thinking. You’ll do something rash like sell your holdings in the target retirement 2050 fund when you should really wait.

You Shouldn’t Do Anything Anyway

What happens if you retirement funds have a one day surge and you’re up big? Are you going to sell it? Of course not, you’ll smile, the wealth effect will make you feel warm and fuzzy, and you’ll go about your day. That’s the same way you should react when you see a big drop. You should do nothing. So, skip the poverty effect and save yourself some grief by not checking.

An important question you should ask yourself, as a couple nears retirement, is whether they should stagger retirement. It’s a topic that is worth exploring with your loved ones because there are many financial and relationship issues that accompany retirement and those can be, in part, alleviated if you opt to stagger your retirements. An article on TheStreet.com outlines some of the financial considerations but there are also relationship ones to consider as well.

Retirement Contributions

By keeping one spouse at work, he or she can continue to contribute towards IRA and 401(k) programs. Every extra year of contributions will help ensure a solvent and fruitful retirement because it’s adding more into the retirement nest egg. Plus, the one income acts as a source of money so that the retired spouse can turn to that, rather than his or her accounts, for funding - thus increasing the longevity of their retirement nest eggs as well.

Healthcare

One of the biggest costs of retirement is medical and health insurance. With one spouse working, you can have a company help alleviate that cost (or more depending on the generosity of the company), which can help the bottom line. By waiting, you can have one spouse retire before 65, when Medicare kicks in, and then have both retire once they reach that age limit.

Social Security

You can begin taking Social Security as early as 62 but to maximize your total gain from the program, you have to wait until “full retirement age,” which can be four years later. By keeping one income, you can put off taking SS payments and maximize your total payout.

Relationship

One of the biggest complaints about both couples retiring is that they now find themselves spending nearly every waking moment together. It can be difficult on a relationship to spend that much time together. By staggering, one spouse gets to try out retirement, find a rhythm and some hobbies, such that both aren’t sitting there watching TV and not knowing what to do. When one discovers a routine, the other can join or discover their own routine. There isn’t a case of two people not knowing what to do other than they have to do it together.

If you’re like me, you recently saw your retirement accounts take a pretty sizable hit. In fact, since October of last year, the markets have been down 20%. 20% puts it into bear market territory and something that probably makes you shudder to think about it (I know I do). You might be tempted to change directions, pull out of what you’ve invested in so far and going with something riskier to make up the losses. Please don’t.

Your retirement nest egg is your retirement safety net. You can gamble away your taxable investments, you can put your emergency fund into a hot new tech startup (I wouldn’t), and you can take your Latte Factor and blow it on the ponies - just don’t mess with your retirement accounts. Let them stay the course and you’ll be rewarded in the long run.

To put our current difficulties in perspective, consider that since the 1920s, the S&P 500 has returned a historic 11% year over year. That’s through numerous bear markets, including the recession in the 1980s and the tech bust the few years after 2001.

If you can’t stomach it and want to pull out, pull out. Just don’t gamble it on a potential shooting star.

###

My Retirement Blog was included in this week’s Carnival of Personal Finance at Greener Pastures.

If you have a Traditional IRA or 401(k), you are required by tax rule to start taking required minimum distributions (most of the major brokerages have tools to help you manage this) by April 1st of the year after you turn 70 1/2. One of lesser known benefits of a Roth IRA is that there is so such similar requirement to take required minimum distributions. You are in total control when it comes to RMDs and Roth IRAs.

Granted, you can begin taking distributions at 59 1/2 on 401(k)s, so by the time you reach 70 1/2 you may need those distributions. However, it’s always nice to know that you can take out your funds on your terms, especially since the government won’t have let you touch it without penalty (outside some generally negative situations, first home excluded).

###

My post on Naming Beneficiaries on Retirement Plans was selected as an Editor’s Choice at the Money Hacks Carnival #17 - Music of the ’80s hosted at Mrs. Nespy’s World. Thanks!

I had a reader Wallace send in this question:

What is the law regarding premature IRA CD withdrawals by senior citizens without penalty?

Wallace,
The law regarding premature IRA withdrawals depends on the type of IRA you have. If you have a Roth IRA, you can withdraw your principal without penalty as long as it’s been in the account for five years.

If it’s a Traditional IRA, you pay a 10% penalty in addition to your marginal tax rate if you are under the age of 59 1/2.

There are a few exceptions to the 10% early withdrawal penalty that may apply to your situation:

• You are permanently or totally disabled,
• You are unemployed and are paying for health insurance premiums,
• You are paying for college expenses for yourself or a dependent,
• You are paying for medical expenses exceeding 7.5% of your AGI,
• Or the IRS has levied your retirement assets to pay off your tax debt.

If you fit any of those categories, you avoid the 10% penalty but you still have to pay your income tax on those funds.

Please consult with a tax professional before making any decisions, rules are constantly changing and this information may be out of date.

Every retirement plan you own has a spot for you to designate a beneficiary. It seems like a simple problem right? Just pick someone you trust and everything will be okay. Couples name their spouse, singles name their parents or their children, everyone can think of at least one person they’d want to leave their money to and simply put them. Some people neglect to put anyone. Either scenario can be dangerous for numerous reasons and here are a few things to consider.

Beneficiary Rules

The rules of naming a beneficiary are not as simple as they may seem. A prime example is that many pensions and employer sponsored retirement plans (401Ks, etc) require that you name your spouse unless your spouse waives that right in writing. If the plan doesn’t require it, the state might. Other accounts will not let your assets directly transfer to a minor and will require the funds be given to a trustee or guardian instead. Be sure to check those first because they will hold precedence.

Here’s where the fun begins. Selecting a beneficiary, once you get past the laws and rules of the program, comes down to the mechanics.

Selecting a Beneficiary for Employer Retirement Plans

Spouses: If your spouse is the beneficiary, he or she will inherit the assets without paying federal estate or income taxes. However, starting at age 70.5, the spouse will have to start taking the required minimum distributions as mandated by his or her life expectancy. Those required distributions are taxed as income, as they would if you were taking it.

Everyone Else: Any nonspousal beneficiary (that’s what they call everyone else) must cash it all out (bad) within one to five years or roll the funds over to an IRA in a trustee-to-trustee transfer (same thing that happens when you rollover a 401k into an IRA). The rollover option was added effective 2007 but many plans haven’t changed their rules to allow this option, it’s best to double check.

Selecting a Beneficiary for IRAs

IRAs differ slightly from employer sponsored retirement plans.

Spouses: Spousal beneficiaries can just designate themselves as the account owner. There are no additional taxes.

Everyone Else: Everyone else has to cash out over the next five years or take annual distributions determined by life expectancy of either the beneficiary or the decedent, whichever would’ve had the higher life expectancy.

My wife works at a relatively small startup-type company that has a 401(k) plan but offers no employer match. One of the things I had researched was whether it was a good idea to put funds towards a 401(k) plan or if other options were better for her and broke it down to several considerations.

$15,500

That’s how much money you can put, tax-deferred, in a 401(k). What that means is that you don’t pay tax on it today, you defer the tax until you start taking withdrawals in retirement. When you make a $1 contribution, it reduces your income by $1 and you don’t pay tax on that money. The benefit from the 401(k) is that you can invest your tax-deferred money and avoid taxes until retirement. There is no other investment vehicle like that for an employee in terms of magnitude.

The only other similar option would be a Traditional IRA but that has some downsides. First, depending on the rules of your 401(k), you may not even be able to deduct contributions to a Traditional IRA. Second, it shares the same contribution limit as a Roth IRA, which grows tax-free (you pay taxes on the contributions). I recommend taking advantage of the Roth IRA, so a Traditional IRA is almost never an option unless you’ve exceeded the income limits.

Fund Options

If your employer lets you pick from a nice healthy basket of mutual funds or stocks, that’s the ideal. If your employer, such as my first employer, only offers their own private versions of funds then you may be in a tough situation. You might want to investigate what types of funds you have available as well as the expense ratios associated with them. Also, be sure to review the administrative fees associated with your employer’s plan. A mere 1% in fees can take a huge chunk out of your retirement savings.

Now, are fees reason enough to stop contributing? No, but if you have multiple options, it’s good to investigate each one. Not all of us are going to have $15,500 to contribute, or even $5,500, so you’ll want to make sure you get the most bang for your buck.

Ultimately, she participated because the tax benefits were significant enough and because her employer offered a nice selection of funds. Despite not having an employer match, the tax-deferred status of earnings and the amount she could contribute was simply too good to give up.

Plus, nothing says you can’t ask your employer to start offering a 401K match!

Catching up is hard to do, unless you’re talking retirement savings and you have the power of the US Government behind you. The contribution limits for various retirement accounts are increased if you are over the age of 50 and you can use them to your advantage if you didn’t contribute as much in your younger days. Below is a table listing the contribution limits for each account as well as the catch-up amount for the 2008 tax year.

So, if you’ve considered increasing your contributions to either account, know that you have a little extra breathing room if you want to contribute more and “catch up.”

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. It is comforting 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.

Sharebuilder, owned by is one of the best online banks, is a popular broker that has offered a handsome new account promotional bonus for as long as I can remember (current bonuses run in the $50 range). This begs the question, would they make a good place to hold your IRA’s?

Sharebuilder made a name for itself for $4 trades if you were willing to wait until Tuesday for the transaction to execute. For many years, a real-time trade was not an option until recently, when the price was set at $9.95 a trade (which is still pretty cheap but not $4.95 at TradeKing). That being said, if you’re buying for the long haul or you’re buying on a set schedule, you don’t need real time trades because the Tuesday buying schedule will work just fine.

Here are the other benefits of Sharebuilder:

• Free dividend reinvestment - This is where they got their name, share builder, and one of the best reasons to join Sharebuilder. Rather than having the dividends sit in cash after they’ve been paid out, you can elect to have free dividend reinvestment and build your holdings. This is a feature that many offer nowadays but was novel back in the days Sharebuilder started.
• Fractional ownership - When they first started, it wasn’t possible to buy fractional shares and Sharebuilder gave you that option. In fact, back in the days before the internet, you couldn’t even buy odd lots (shares that didn’t number in round 100’s); however Sharebuilder gave you the option to buy 1.5 shares or 100.3 shares.
• Scheduled purchases - The $4 trade fee applies to transactions schedule on that Tuesday, likely to assist in bulk purchases, but it also let you de facto schedule your purchases every month at a set time.

Overall, Sharebuilder, now a subsidiary of ING Direct, is certainly a great place to turn to if you are of the buy and hold mentality and have little to invest.

###

The 151st Carnival of Personal Finance is up at the Alpha Consumer, please check it out! My post about the difference between lifestyle and life-cycle funds was listed this week.