Tuesday, February 3, 2015

Retirement and College Savings

     Saving enough for retirement and kids' college expenses are two of the three things (the other being affording long-term health care insurance) virtually impossible for average middle class Americans with multiple children to do.
     For this and other financial topics I draw upon my college and professional training, which has helped us with these impossible tasks. Here's what I've found: 
     Believe the oft stated advice that the earlier you start the better because of the “magic” of compounding. Simply stated, invested money grows more money the longer it is kept invested. Socking away a little at a time is all it takes.
     Have a cash bank account or equivalent emergency fund that will cover at least two months of living expenses. (For me, that's far too little. I keep a disproportionate share of non-retirement and non-college savings in credit union CDs 'cause I hate the thought of losing fifty percent if it's all in stocks come the next stock market crash.)
     Saving for retirement is a far higher priority than saving for kids' college educations. My friend Norm took a huge financial hit by cashing out all his accumulated 401K retirement savings to pay for college tuition (plus other current expenses) to pursue his second career as a nurse. I asked what are your plans to retire (he's almost fifty) and he said I'm in a work-until-you-die plan. His health is less than stellar so in essence he's saying “I don't care right now about my long-term finances, I'll deal with it at a later date.” He's a smart guy and knows the realities of what he might one day face (as he's witnessed in his nurses' training—he's on the verge of graduating), even so, I'm concerned (though comforted about his education, engineering background, and loving, smart, and hard-bitten tough kids and siblings that could help out if necessary).
     Take advantage of employer 401K matches, or even better, employer defined benefit pension plans that guarantee lifetime payments upon retirement (I am blessed with just such a plan with the state). Be sure to first consider life expectancy and expected rates of return to determine reasonableness of cost. Also consider the financial health of the payer—whether employer or annuity insurance company. Some annuities contracts, especially those offered by independent agents, are blatant scams. Ask lots of questions, get everything in writing, and hire a CPA if necessary.
     For middle class Americans with kids, ROTH IRAs are a good alternative if the above are not available or as additional investments 'cause current federal income tax rates are so low and seem likely to me to rise. For such ROTH IRAS (that you contribute to after-tax, but get to withdraw tax-free) it's wise to invest in diversified portfolios such as mutual funds that hold stocks of lots of different companies or bond funds that can substantially lower risk, though current returns are exceedingly low. (Deanne and I both have ROTH IRAs with investments in stocks and bonds mutual funds.) 
     Avoid high fees, loads, and all other trading and holdings costs that'll steal your investments' earnings.  
     Avoid get rich quick schemes that'll steal your investments even faster.
     Avoid trading individual stocks and bonds unless your employer offers great discounts (or employer matches) on company stocks.  
     Avoid derivatives such as futures, options, hedges, swaps, short sales, and other complex instruments. Banks, cities, and tons of “smart” investors have gone broke thinking they knew what they were doing when in fact they didn't. 
     For higher earning tax-payers, invest in tax-deferred 401K plans, regular IRAs, or deferred compensation plans. These may also be attractive to average income tax-payers for lowering current federal and state taxes or because of investment options not available elsewhere. (We have a substantial portion of our retirement savings in our state's deferred compensation plan because of a stable value option that has given us steady returns.) The downside of these is that withdrawals upon retirement are fully taxed at a time when tax rates may be a lot higher (especially if retirement income exceeds working income, which my retired uncle and Mom suggest are quite likely, improbable though it seems to me).
     Select investments based on what you're willing to lose as opposed to what you hope to make. This is a way to stay within your risk tolerance profile. The riskier an investment, the more it's price will tend to bounce around. If such price jumps bother you, find less risky investments. For some, even the S&P 500 is far too nerve wracking. (When I first started saving after college, I put all my funds into bank savings accounts, than CDs. Only slowly after I had a huge cushion did I venture into mutual funds, the minimum thousand dollars investment at a time. I still approach stocks by adding a little at a time and waiting and seeing before making larger moves to, say, rebalance my portfolio. It's served me well through the years with slow, steady gains and no spectacular losses.)
     When an adequate retirement cushion is established so that perhaps forty to sixty percent of retirement needs will likely be met, not counting Social Security benefits, start saving for college right away! (I told you it's impossible, but try we must, I suppose. Maybe our kids will get rich and cover all our retirement needs?) One of the best deals for this (which isn't even that great) is 529 college savings plans offered by all states for residents of any state. (It's weird, it doesn't make much sense, but it's legit and works.) Money goes in after-tax and gets withdrawn tax-free. In essence, tax-free earnings is its main direct financial benefit. Some states (not Hawaii) offer plans that allow before-tax contributions that may be far better deals. Be sure to research and crunch numbers before deciding. 
     When comparing states' 529 plans and investment options (almost unlimited choices in unlimited states may be held—I told you it's weird) consider costs and fees, your risk profile, and expected returns as described above (as saving for college is similar to saving for retirement, only shorter term in outlook meaning we hope to far outlive the day all our kids graduate college, right? If so, college funds ought to be depleted far before retirement funds). 
     Vanguard (I rarely do endorsements) is one company with terrific offerings and ultra low (I especially like their index funds) fees and their funds have done super for all my ROTH IRAs and my kids' 529 college savings plans, though some much better than others. (I own 529 plans in three states (that begin with the letters U, O, and V), each with some of the lowest admin. fees around. Hawaii's 529 plan stinks so they get zilch from me.) 
     My Hawaii State Federal Credit Union is fantastic, by the way, far superior to any of the local banks, so they get virtually all my personal financial banking business. (I don't dare venture to Internet banking because it just feels far too sketchy to me.)
     Impossible though the task to average middle class Americans may seem, saving sufficiently should be approached like exercise whereby in general, the more the better, every little bit helps, and small steps can lead to big gains.

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