Questions and Answers on Retirement

Q: I am changing jobs to a company with no 401(k) plan and a $1,500 yearly contribution to a SEP-IRA. My previous employer had a 401(k) with a 3% matching contribution. Are there any choices out there with pretax benefits to save for my retirement?

A: Yuck. Start looking for a new job.

Here’s a little math to help you launch your search. If you had stayed at your old employer, contributed the $10,000 maximum to the 401(k) and gotten a 10% average annual return, you would have $2.1 million after 30 years.

At your current job, you would have about $246,000 after 30 years. Is what they’re paying you worth giving up $1.8 million in potential retirement benefits?

If you’re a regular employee--in other words, if you get a W-2 from your new company--you don’t have many other options. Because your employer is already contributing $1,500 to a simplified employee pension IRA, you’re considered an active participant in a retirement plan, which precludes you from deducting contributions to your own IRA.

Unless this new job pays enough for you to save plenty on your own, you should find an employer who knows that a decent retirement plan is a requisite for finding and keeping good people.

Q. In investing for retirement purposes, is it still advisable to consider the rule of thumb of 100 minus your age as the maximum percentage you should have invested in the stock market? I am 46, currently not working, and am considering moving my 401(k) from my former employer and investing in other choices.

I have the funds spread in a range of low-, medium- and high-risk stock funds, with about 20% in Treasuries and 20% in a balanced fund. I have been considering moving to a discount brokerage through my bank, where I know the investment representative. I would then get some expert advice and ongoing attention, which I don’t have with the 401(k). Your thoughts?

A. When it comes to personal finance, forget rules of thumb. There are many concepts that are true for most of the people most of the time, but there are so many exceptions to personal finance rules that you can’t expect one-size-fits-all standards.

The rule of 100 is a case in point. The idea was to shift people out of riskier investments (stocks) and into safer investments (bonds and cash) as they aged and their ability to recover from losses diminished.

As a general concept it’s not a bad idea, but it ignores too many variables to be truly useful. It doesn’t take into account your goal for the money, how long you might live, your employment prospects, your tolerance for risk and what other options you have.

A secure pension can allow you to take more risks with your other retirement funds, for example, whereas the lack of a guaranteed check in retirement should make you somewhat more conservative.

If you need some kind of starting point, look no further than the mix of stocks and bonds in a balanced fund: typically 60% stocks and 40% bonds. That gives you exposure to stocks’ long-term gains while softening the blows of stock market downturns with the bonds’ interest.

If you feel emotionally able to ride out wide market swings and you don’t think you’ll need to tap your retirement funds any time soon for living expenses (always a dark possibility during unemployment), you can increase the proportion of stocks and stock funds in your portfolio.

I wouldn’t go beyond 80% stocks and 20% bonds and cash at any age, though. Not many investors today have had experience with a real bear market in stocks; those of us who think we can stomach a 40% loss, or more, may feel different if and when it happens.

As for moving your money from your former employer’s 401(k) to a brokerage firm: If you do so, make sure you roll the money directly over into an individual retirement account to avoid a huge tax bite. Also, remember that “expert advice� and “ongoing attention� can translate into ‘making a lot of commissions by trading frequently in your account.’ Don’t let that happen.

Despite the boom of do-it-yourself and online trading, I have yet to see any evidence that trading a lot boosts returns. In fact, studies to date show it harms the average investor’s results. Investors also seem to have an uncanny knack for selling one stock to buy another that subsequently does worse than their original pick.

Besides, unemployment is no time to be taking extraordinary risks with your retirement funds. Although you probably will return to work at some point, every day that passes is another day you don’t have to earn money for retirement.

Q: I’m 48 and my husband is 51. We have unwisely run up more than $40,000 in unsecured credit card debt over a number of years. We have no equity in our house. We know it’s almost always a terrible idea to borrow from a retirement plan. With the interest savings, though, we wonder if we couldn’t get this debt paid off quicker and save ourselves more money overall by taking money out of my husband’s 401(k). What sort of formula should we use in deciding if this will help us or not?

A: How much a 401(k) loan will ultimately cost you depends on what kind of returns you would have earned on the money had you left the 401(k) alone. Under most scenarios, the “interest savings� you might get from refinancing your debt would be overwhelmed by the future returns you’d be giving up.

If you’re game for a few numbers, here’s how it might play out. Say your husband’s 401(k) savings earn an average annual return of 10%. If you borrow $40,000 from the retirement plan and pay it back at 8% interest, you would have about $3,000 less in your 401(k) at the end of the five years than had you left the money alone. You would also pay about $10,000 less in interest, assuming your credit cards charge an average interest rate of 16%. So far, it looks as if borrowing from the 401(k) is a good deal.

But wait. You would continue losing ground from there, because that missing $3,000 can’t earn future returns for you. In 15 years, you would be more than $13,000 behind.

The longer the time span from the time of the loan and the higher the returns you could have earned, the worse the damage becomes. In 30 years, you’d be nearly $60,000 behind on an account returning an average of 10% a year.

Now, you could come out ahead if you invested that $10,000 in interest savings, preferably by boosting your 401(k) contributions if possible, instead of spending it on more stuff. But most people don’t have the willpower to do that.

Trading your future security for immediate gratification is what got you in financial trouble in the first place. Don’t make things worse by raiding your retirement account.

Q: My husband is taking a new job shortly, and we will be moving to northern Virginia. We have the option of taking a full or partial lump-sum payment from his retirement account. Is it better to take part of our retirement to pay cash for a house and take a large tax “hit� now? Or to pay mortgage interest for 10 to 12 years (14 years at the most) until we retire and pay off our mortgage then?

The retirement account is worth about $520,000. We would take out about $400,000 to pay for a $250,000 house and the tax penalty, leaving us with about $120,000 in retirement funds. My husband is 51 and has a well-paying job; I am 41 and planning to work part time, so we have plenty of time and resources to rebuild our retirement account. We have a strong desire to have our mortgage paid off when we retire--this is a must.

A: It doesn’t matter how strong your desire is; you shouldn’t use that retirement money to buy a house. Besides the hideous loss you would suffer from taxes and penalties, you would be losing--forever--the ability of that money to grow for you tax-deferred. That’s something you can’t get back, and at 41 and 51 you don’t have “plenty of time� to make up the loss. In your own words, you have 14 years at the most before you will retire. That’s not much time to rebuild a nest egg to take you through 30 or 40 years of retirement.

Left alone, the money you want to withdraw could grow to nearly $3 million in 20 years, assuming a 10% average annual return. If you’re really hellbent on being mortgage-free, get a 15-year loan and make a few extra payments.

Q. In 1998 my salary was $80,000, and I contributed 9.5% of it to my 401(k) plan at work. I got a $4,000 raise the next year, of which I took home a whopping $120 a month after taxes. But because of the raise, the IRS says I’m now classified as a “highly compensated� person and can only contribute a maximum of about 7.2% a year to the 401(k)! So, because of this minor raise, I’ve had to reduce my 401(k) contributions. Do you know any way around this?

A. Ah, welcome to the world of the highly compensated employee, where your 401(k) contributions are held hostage by your lower-paid co-workers.

Here’s the scoop. Once you make more than a certain amount ($85,000 in 2000), your 401(k) contributions are generally limited to 2 percentage points more than the average contribution made by all eligible employees at your company who make less than that certain amount. So if the contributions by lower-paid workers averaged 5.2% of their pay last year, you can’t give more than 7.2% this year.

These seemingly arbitrary rules are actually designed to make sure that company bigwigs don’t use their 401(k) plans as a personal perk. The rules give employers a strong incentive to educate all their employees about the plan and encourage everyone to contribute.

In fact, you might urge your employer to boost its 401(k) outreach and education, because that is the way you are most likely to be able to increase your contribution. It won’t help you this year, but it might next year.

There are other ways around the limitation, but your employer may not go for them. That’s because they require employers to structure their programs in particularly generous ways, either with a high match or by making a contribution for every employee, regardless of whether the employee put his or her own money into the plan.

If your company did either, you and your better-paid peers could contribute up to the overall IRS maximum--$10,000 a year--without worrying about the rules on highly compensated employees. Not too many companies are willing to go to that expense, although you can always ask yours to consider it.

Finally, don’t let your 401(k) limit how much you save for retirement. You can put $2,000 into a Roth IRA. You can also save outside of any retirement accounts. A tax-efficient mutual fund, such as a fund that mimics the Standard & Poor’s 500 index, would allow you to continue putting away money outside your retirement fund while minimizing the tax bill.

Q. My old college roommate is starting up his own bank and is looking for investors to come up with the $3 million in seed money. I don’t have a lot of available cash, but I was planning to shift $25,000 of my 401(k) money into stock in his bank, because my 401(k) has a self-direct option that allows us to invest in individual stocks. However, the lady I talked to at the 401(k) administrator told me that I am not allowed to buy private stock with my 401(k) money. If it were a publicly traded stock, it would be no problem. I don’t think this is fair. I think the bank would be a great investment.

A. Uh-huh. In that case, can I interest you in some Florida swamp--er, wetlands?

If you don’t have a lot of available cash, you have no business gambling on a start-up, period, end of story. You’re not a highflying Silicon Valley venture capitalist with an eight-figure net worth and dollars to burn. You’re a working guy who needs that money for retirement.

It is getting easier and easier to gamble with 401(k) money--more companies are offering self-directed options that allow workers to invest in individual stocks and bonds instead of just mutual funds; many 401(k)s even allow daily trading. But most plans still have some safeguards in place to protect people from making a complete mess of their retirement funds.

Your plan’s rule against private stock is one such safeguard. Retirement plan providers are understandably nervous about letting employees invest in something that can’t readily be valued (since it doesn’t trade publicly) and that could disappear overnight.

Don’t try talking to me about borrowing money from your 401(k), either. Tapping retirement money for any other purpose is usually a bad idea. If you can’t come up with the cash outside your retirement kitty, you’re in no economic position to roll the dice on your buddy’s bank.

Q: While my husband and I are working to ensure a comfortable retirement for ourselves, I’m worried about how to help my 82-year-old father enjoy his final years. I’m scared about what will happen if he requires assisted living or, worse yet, nursing-home care. My mother’s lingering death from Alzheimer’s years ago took much of my father’s retirement savings. Should I consider borrowing against my retirement accounts if money is needed for Dad’s care, then hope the sale of his home could reimburse me? Is borrowing against such accounts ever wise? I want to keep my father safe and well-cared for, but I’m trying to find legal, ethical ways to preserve financial security for my husband’s and my later years.

A: You are a good daughter and your father is lucky that you care so much about his well-being. But please think carefully before you put your retirement savings at risk.

Ideally, all of us would have either enough money or long-term care insurance to provide in-home care so that we would never have to go to a nursing home. But many of us will not be in that fortunate position. Your father’s resources already have been depleted and he is probably too old for long-term care insurance to make much sense; the premiums would be prohibitively high at his age.

Many families in your situation decide that their parents’ resources will be used to provide either in-home care or placement in a good nursing home for as long as possible. Once those resources are exhausted, the parent would qualify for Medicaid, the government health program for the poor. (In California, the program is known as Medi-Cal.) The program does not cover in-home care, so your father would need to already be in or be transferred to a facility that accepts Medicaid/Medi-Cal.

If your father does need government help, the state could make a claim against his house, which would probably require that it be sold after his death to reimburse the government for his care.

No one wants to be indigent and in a nursing home. If your father needs such care, however, you can help ensure that he gets quality attention by carefully researching available facilities and then--once your father is admitted--by being a constant and cheerful presence in his life. Elder-care experts will tell you there’s nothing like an attentive family to keep a nursing home on its toes.

A book that can help you is “Beat the Nursing Home Trap: A Consumer’s Guide to Assisted Living & Long-Term Care� by Joseph L. Matthews ($21.95, Nolo.com). In addition to the alternative-care strategies referred to in its title, this book offers great advice about selecting a nursing home. Nolo.com’s Web site (https://www.nolo.com) also offers information about Medicare, Medicaid and long-term care.

You could cash in your retirement savings, rather than use the resources that are available and designed for people in your father’s position. You generally would have to take out about twice as much as you actually need, because taxes and penalties will whittle down the total available to give.

If you did tap your funds, you would risk someday being in exactly the same spot as your father--broke and needing care. You understand how difficult it is to worry about a parent, and you probably wouldn’t want to pass on that particular burden to your own children.

Q When I signed up for 401(k), my employer said I must designate a beneficiary and so I just put down my wife’s name, even though we have never actually lived together and I wasn’t sure then if we ever would. Now I no longer work at the company and have requested a withdrawal of my funds. My request was rejected because it required spousal consent and her signature. The trouble is I don’t even know her whereabouts. My landlady can attest that my wife has never lived with me from day one. Is there other way to get the money that belongs to me, or is it doomed to stay there forever? Should not truth carry more weight than rule technicality?

A How untidy of you to misplace your wife. And given that the “technicality� you refer to is a legal marriage, the short answer is no. Your “truth� should not cancel out the laws designed to protect spousal interest in retirement funds.

You’ll probably need to get a divorce decree to get your hands on the money. To get a divorce, you may need to share some of the 401(k) with your wife, since retirement accounts are generally considered shared property regardless of who made the actual contributions. If you can’t find your wife, the process is obviously going to be a lot more complicated and you’re going to need some legal help. Check with your local Legal Aid Society if you’re not able to afford an attorney otherwise.

Next time, you might consider marrying someone you actually want to see once in awhile.

SAVING ON YOUR OWN

Q I would like to start saving for retirement and other goals, but I work in the film industry and my income is very erratic--six figures one year, four figures the next. Well, maybe not quite that bad, but you get the idea. Last year I was out of work for almost six months, which really took its toll on my bank account and my credit cards. Now I’m making good money again, but I’m reluctant to use the cash that I’ve saved to pay off my credit card bills, fearing that I could be out of work again soon.

A Use your cash to pay off your credit card bills. If you lose your job tomorrow, you’ll be able to run up your credit cards again if necessary.

You don’t want to be paying interest when that money could instead be going toward building a solid financial situation.

Here’s the plan: Hunker down and live like a monk until you have savings equivalent to six months’ worth of basic expenses; a year’s worth would be even better. This pile will give you freedom from worry when your current contract ends and allow you to be choosier about your projects.

Even when times are good, it’s important to keep your overhead down. Don’t succumb to the temptation to lease a fancy car or to take on other debt, because you’ll face crushing bills when the paychecks stop.

If fact, when the money’s rolling in, stuff as much as you can into retirement accounts. If you’re self-employed, you can open a Simplified Employee Pension, and put in as much as 13% of your net earnings. Or you could open a Simple, or Savings Incentive Match Plans for Employees, another type of tax-favored retirement account, which lets you put as much as $6,000 a year aside. Or you could open a Keogh account, but if you decide to go that route, make sure you choose the type of Keogh that gives you flexibility to fund it or not in any given year. If you’re in a union, definitely check out its 401(k) or other retirement plans and contribute the maximum possible.

Your investments--especially ones outside retirement plans--should be on the conservative side, since you may well have to tap them should your career goes into an extended funk. (You want to avoid these at all costs--the funk and the tapping--but they may happen someday.)

Balance your stock investments with a hefty dose of bonds, bond funds and cash; a mix of 60% stocks, 30% bonds and 10% cash might be a good way to start.

Q: You recently advised someone who works in the film industry about saving for retirement, suggesting that he set up a Simplified Employee Pension or SEP-IRA. I am a film worker, and I got into trouble with the IRS last year because I have been putting my retirement savings into a SEP-IRA. Although most people who work in the film industry think of themselves as self-employed because they aren’t on the payroll of a studio or production company, they probably do not qualify for a SEP-IRA either. Most of the time, the production company pays the worker through a payroll company, which in effect is the “employer of record.� Any worker who isn’t set up as a company with employees--and most film industry workers are not--does not qualify.

A: Well, not quite. You don’t need to have employees to set up a SEP. As long as you’re self-employed, you’re eligible to put aside 13% of your net income each year into these tax-deductible, tax-deferred retirement accounts.

How to tell if you’re self-employed?

One good way is by the tax forms you get in January. If a company that has employed you sends you a 1099 form to report your pay for tax purposes, you’re probably an independent contractor and thus by definition self-employed. You’ll fill out a Schedule C to report your business income and expenses. (The SEP would be funded out of the resulting profit.) If you get a W-2, you’re most likely an employee, and you’ll report your wages on the front of your 1040 form. A few people who get W-2s can also fill out Schedule Cs if their employers have checked box 15 on that form; these folks, known as statutory employees, are usually traveling salespeople and insurance agents.

Which brings up the whole controversy of companies who treat their workers as independent contractors when in fact they really are employees--people who are closely supervised, who don’t get to set their own hours and methods of work and who are told what to do and when to do it. The IRS has cracked down on many companies that did this to save on payroll taxes and benefits, but it’s still going on.

That’s not your problem, of course. What is your problem is that you tackled your tax return with just enough knowledge to get into trouble. Perhaps next year you’ll consider consulting a qualified tax preparer; you can get a referral list from the National Assn. of Enrolled Agents at https://www.naea.org or the California Society of Certified Public Accountants at https://www.calcpa.org. Tax law is complex and constantly changing, so if you have anything more than a basic 1040-EZ to fill out, it often pays to pay for a little help.

Q: I assume that the two basic requirements for establishing a Roth IRA are a Social Security number and earned income. My problem is that I would like to establish a Roth IRA for a newborn child. Getting a Social Security number is not a problem since all children must get one to be claimed as dependents on their parents’ returns. Establishing an earned income for the child is another issue, however.

It must be possible because there are child actors who get income. I want to legally create earned income for the child and need to know what forms must be filed with the IRS.

A: Sorry, but there’s no legal way to commit tax fraud, which is what you seem to be proposing.

You’re right that child actors and child models have earned income. You also may hire your children to perform certain tasks in your own business, as long as you abide by appropriate child labor laws and file the appropriate wage and tax documents with the IRS and your local tax agencies.

Unless your newborn has already been spotted by a Hollywood talent scout, however, there’s not much chance he or she will have legitimate earned income any time soon. You can contribute to the child’s long-term financial security in many other ways. Just put the Roth IRA idea on hold until the kid is old enough to earn a paycheck.

Q I want to know why, as a reader of two major newspapers, I managed not to know enough to make a simple, five-minute transaction that would have saved me a $20,000 tax penalty and the loss of my individual retirement account. I converted my IRA to a Roth IRA in 1998, not realizing that my income was too high to qualify for such a conversion. By the time I realized my mistake, it was past the Dec. 31, 1999, deadline to undo it. We had to pay the tax penalties and I was forced to liquidate the entire account. We did get a notice from the IRS, but it came during the holiday season and we put it aside, not realizing its importance. On one hand, I feel like an idiot; on the other, I believe what happened was unfair.

A I’d go with that first feeling.

Congress created Roth IRAs in 1997 as a way for people to save money that would not be taxed in retirement. People whose incomes were under certain limits ($160,000 for married couples, $110,000 for singles) were allowed to make a nondeductible contribution of up to $2,000 a year to a Roth IRA. Lawmakers also allowed people whose incomes were under $100,000, married or single, to convert traditional IRAs to Roth IRAs. People who converted their traditional IRAs paid income taxes, but not penalties, on the amounts they transferred to a Roth IRA.

A Roth conversion is indeed a complex transaction. That is why newspapers and personal finance magazines were filled with stories about who should and shouldn’t convert, and how to go about converting if you were eligible. The Los Angeles Times alone had dozens of stories about Roth conversions during 1998 and 1999, including 34 that specifically included the $100,000 income limitation. One of the stories, which appeared in March 1999, talked about the fact that many people were discovering their incomes were too high and were undoing their conversions. We also had three mentions of the Dec. 31, 1999, deadline.

The IRS itself tried to tell you about your mistake, to no avail. You’ve learned the hard way that it never pays to ignore an IRS notice.

Another lesson you might have learned is that you should never touch a retirement account until you get professional (that is, paid) tax advice on the transaction. A knowledgeable tax preparer could have saved you an enormous amount of grief and expense. Retirement accounts, and their tax-deferred status, are too valuable to throw away through a dumb mistake.

Q: I occasionally work for a temporary agency that offers a 401(k) plan, to which the agency contributes nothing. The plan does not offer any socially conscious funds, and I refuse to invest in ways that are contrary to my ethics. I have been investing instead in a traditional IRA. Are my contributions deductible?

A: People who are not covered by retirement plans at work are allowed to deduct their contributions to a traditional IRA, regardless of how much money they make. By contrast, those who are considered covered by a plan are only allowed to deduct contributions if their incomes are below certain limits.

The question is whether or not you would be considered covered by the plan. I asked your question of CPA Phil Holthouse, partner at Holthouse, Carlin & Van Trigt in L.A. He said if you don’t participate at all in the plan and your employer contributes nothing, you should be able to deduct your IRA contributions regardless of how much money you make. To make sure your employer isn’t reporting you to the IRS as someone who is covered by a retirement plan, check your W-2 to make sure your boss doesn’t check the ‘pension’ box. That’s how the IRS monitors who is and isn’t considered covered by a plan, Holthouse said.

401(k) or Roth Better Savings Tool?

Q. You recently suggested that a family consider contributing to a 401(k) only to the maximum matched by an employer, and then use any extra money to fund a Roth IRA. I have always thought that you should fund a 401(k) to the maximum allowed, even if you didn’t get a match and even if that meant not being able to contribute to a Roth. Am I wrong?

A. That depends on your situation.

It’s almost always best to contribute to a 401(k) at least up to the maximum matched by the employer. Typically, employers give 50 cents for each dollar you contribute up to some maximum percentage, such as 6% of your salary. That match means you get an immediate 50% return on your money. You can’t beat that with a stick. For people who expect to be in a lower tax bracket at retirement, continuing to fund the 401(k) to the maximum allowed before contributing to a Roth IRA is probably the better strategy. But the Roth IRA is an incredibly powerful savings vehicle for people who expect to be in the same or higher tax bracket in retirement, and for those who want to leave an inheritance for their kids. That’s because the Roth IRA is completely tax-free when withdrawn in retirement, and it doesn’t have the minimum distribution requirements of other tax vehicles, including 401(k)s and traditional IRAs. So if you expect to be well-off in retirement, it can make sense to contribute to a Roth IRA after you’ve set aside the maximum your company will match. If you still have money lying around after you fund your Roth, you could return to the 401(k) and contribute up to the maximum allowed.

Q: I am a 32-year-old attorney with a wife, two children and my own law firm. I am in the process of setting up some form of employer-funded retirement plan and my insurance agent (and family friend) is telling me I should buy variable life insurance. The way I see it, variable life insurance is silly because your investment is with after-tax dollars and, to make matters worse, part of your “investment� is used to purchase a term insurance policy (at higher rates than I’m paying now) with the rest put into a captive mutual fund. While I have pretty much convinced myself that variable life insurance is not for me, my wife, who trusts the agent, thinks I don’t understand the product and says our friend would not steer us in the wrong direction. What do you think?

A: I think even the best-intentioned insurance agents can get excited about a product and not realize that it isn’t the best fit for a client. Less well-intentioned agents might care more about the commission than about making sure you get something that suits your financial needs.

Variable life insurance--a life insurance policy that combines a death benefit with an account that can be invested in stocks, bonds and cash--can be a reasonable, if relatively expensive, option for high-income people who need life insurance and who have already exhausted other tax-deferred ways of saving for retirement. That means people who have contributed every dollar possible to a 401(k) or other retirement plan at work and invested $4,000 a year ($2,000 each for themselves and their spouses) into a Roth IRA--and who still want to save more.

The earnings in the investment portion of a variable life insurance policy are tax-deferred until withdrawn. That tax deferral comes with a price in the form of higher fees and costs than you would pay for equivalent mutual funds. And as with mutual funds, you bear the risk if your investments don’t perform well.

It’s not clear from your letter whether your agent is urging you to buy this policy in lieu of a retirement plan or in addition to it; if it’s in lieu of, thank him and resolve to restrict contacts with him to social events. Seek out a financial planner, preferably of the fee-only variety, who specializes in setting up retirement plans for help in getting a 401(k) or other savings program started at work.

If the agent is suggesting this policy in addition to a retirement savings plan, have the planner review it and see whether it meets your needs. If it’s as great a deal as the agent thinks, he should welcome the scrutiny.

RETIREMENT ISSUES

Q: I’m always reading articles about the “safe� withdrawal rate from a retirement fund. One study recently said withdrawal rates higher than 5% dramatically increased the probability of running out of money if the withdrawal period was longer than 15 years. That’s nonsense. If I have $100,000 and withdraw 5% ($5,000) every year, my nest egg will last 20 years, even if I keep it under my mattress. If I put it in a certificate of deposit at 6% annual interest, I could withdraw $5,000 per year until the Fed freezes over and would have more than I started with at the end. Even assuming a very conservative rate of return of 6% from a stock-dominated portfolio, one could withdraw 8% to 9% for a great deal longer than 15 years. The numbers don’t lie, so obviously I’m missing something, or the professors who do these studies can’t add (which seems somewhat less likely). So what’s missing?

A: Three rather crucial factors: inflation, taxes and the volatility of stock market returns.

Yes, you can keep your money in your mattress and pull out 5% a year. But by the end of 20 years, your $5,000 is going to be worth a heck of a lot less than when you started. Mild inflation of just 3% will reduce your buying power by nearly half in that time.

That’s why most retirement calculators assume that you will adjust your withdrawal amount upward for inflation each year. You might start with 5%, but the amount withdrawn will be increased by, say, 3% each year. Doing that means you run out of money during your 16th year of withdrawals.

On to your CD example. In addition to losing ground on inflation, you’re also going to have to pay taxes on the interest you earn. The higher your tax bracket, the more you’ll pay. In the 34% combined state and federal bracket, you’ll pay about $1,700 in taxes, reducing your withdrawal to $3,300. Adjusted for 3% inflation, your withdrawal would be worth about $1,800 in today’s money at the end of 20 years.

You’re right that an 8% to 9% annual return would put you in the clear and allow you to withdraw more than 5% over 15 years. Problem is, the stock market doesn’t guarantee steady returns. You might be up 20% one year and down 30% the next--and down 10% more in the third year. The biggest problem for retirees comes when the stock market dives and stays down shortly after they begin their retirements. They’re withdrawing from a shrinking pot, and if they don’t cut back sharply they risk running out of money much sooner than they expect.

The authors of these studies are trying to warn retirees and other investors not to count on stellar stock market returns throughout their retirements. Conservative withdrawal rates and a diversified portfolio are particularly important for people who can’t make up stock market losses with future earnings--and that includes most retirees.

Q: I was married for 24 years but divorced in 1984. I continued working, but my ex-husband has not had a tax-paying job since. I got a really good job in 1987. My question is: Can my ex get Social Security benefits based on my earnings after the divorce or just on what I earned during our marriage?

A: Let it go, dear.

He may be a shiftless bum, and you may resent that he will qualify for Social Security based on your earnings rather than his own. Any former spouse who was married at least 10 years can receive half of the ex’s benefit amount if both members of the erstwhile couple are at least 62. His benefit will be based on your lifetime earnings at that point, not just the earnings during your marriage.

Note, though, that whatever he gets will not reduce your Social Security check by one dime. This is one of the few cases in which an ex-spouse gets a benefit that’s not at the other’s expense. So concentrate on your good fortune at having “a really good job� and don’t begrudge him the few extra shekels in Social Security that your earnings will provide him.

Q My husband and I are planning to retire in our mid-50s. We will have just enough money to squeak by until we can withdraw without penalty from our investments. However, do you know what we can do for medical insurance? I know we can use COBRA for 18 months after retirement, but what is available and how much does it cost before Medicare kicks in?

A You may be working a little longer than you had planned.

If you’ll have only enough money to ‘squeak by’ until 59 1/2, you probably won’t have enough money to pay for health insurance, which is likely to run you several hundred dollars a month.

The Consolidated Omnibus Budget Reconciliation Act of 1985, known in benefits shorthand as COBRA, generally requires companies to extend health coverage for up to 18 months, but you’re required to pick up the bill. Once COBRA expires, you’ll need to find individual coverage, which may be even more expensive than what your employer provided. You might want to talk to an experienced insurance broker for an idea of what coverage is likely to cost in your area.

Alternatively, you might choose ‘catastrophic’ coverage, which protects you from disastrously high medical bills and typically has a low monthly cost--usually between $20 and $150, although premiums can be higher depending on your age and health. But these policies come with a large deductible--typically $2,000 per person each year. Again, that’s money that will need to come out of your own pocket.

You won’t be eligible for Medicare until age 65, so you could be facing 10 years of picking up some pretty hefty bills. Going without health insurance isn’t an option, by the way--one serious illness could wipe out all you’ve put aside and turn your early retirement into a long-term nightmare.

Q. I’m 49 and my wife is 42. We hope to retire in six or seven years. Our retirement funds are mostly in tax-advantaged accounts. If we retire in six years, we can live for a while on personal assets until I start drawing on my retirement accounts. However, it would be quite helpful if we could also draw on my wife’s generous retirement accounts at that time. If one spouse is older than 59 1/2 and the other spouse is younger, can a couple draw on the younger spouse’s retirement account without penalty--particularly considering that our state (California) is a community property state? Or, if my spouse changes jobs, could she transfer her existing retirement assets to a new account under our joint names, thus allowing us to draw on those assets when I turn 59 1/2? Or could she deposit her retirement assets into one of my existing individual retirement accounts, thus commingling our community property, and would we then be allowed to draw on her assets as well as mine when I turn 59 1/2?

A. Darn, you’ve been trying to work this out every which way, haven’t you?

Community property has nothing to do with it. If you divorced, you would be entitled to half of the retirement money earned during your marriage, but it would still have to be kept in separately titled accounts. There’s no such thing as a joint individual retirement account or 401(k), and you normally wouldn’t be able to tap your wife’s money without penalty until she reached the minimum withdrawal age of 59 1/2.

There are exceptions, though. She could begin taking what’s called “substantially equal periodic payments�--that is, withdrawals in equal annual amounts, based on her life expectancy--at any age from her IRA. (She can also make such withdrawals penalty-free from a 401(k) if she no longer works for that employer.) The IRS has strict rules about how to figure these payments, though; if your wife runs afoul of the rules, she’ll owe the early-withdrawal penalty.

For more details, talk to a tax professional and read up. One guide is the Nolo Press book “IRAs, 401(k)s and Other Retirement Plans: Taking Your Money Out.�

If your wife leaves her employer after age 55, her 401(k) distribution wouldn’t face the early-withdrawal penalty. Finally--and I almost hate to mention it, given your creative mind--if she dies and you inherit her retirement accounts, you could opt to treat them as your own, using your age to determine withdrawal amounts.

Q. My job was transferred to New York early this year, and I opted not to relocate there.

If I start to work for a new company, I would expect to be paid at least 30% less than I was in my old job. I will be 50 years old late this year, and my friends tell me that Social Security uses the average of the last five years’ salary to compute the retirement benefit. I am afraid to go back to work because of this situation. I do not want to reduce my benefits based on a lower new salary.

Would it be beneficial for me just to apply for retirement benefits at the minimum age? My husband is still working and will try to earn at least 50% of my net pay in the stock market if I decide to stay home until I am 59 1/2, when I can tap into my 401(k), which has about $120,000. Do you think this will be a better plan than working again at a much lower salary?

A. In answering your question, I will try not to use the phrase “harebrained scheme.�

Oops! Oh, well.

Listen, your friends are dead wrong, your husband is deluded, and I shiver to think how much damage you could do to your finances if you proceed with your plan.

Your Social Security benefit will be based on a calculation that includes your 35 highest-earning years--not the last five. Right now, those 35 years include your summer job in high school. Surely even with a 30% pay cut you would make more now. (If you want to know more about how Social Security works, visit https://www.ssa.gov on the Internet or call (800) 772-1213.)

Your husband’s plan is a fool’s game. You don’t put money you need to live on in the stock market. It’s hard to remember this with this long-lived bull market, but stocks do go down, and sometimes they stay down. Then where will you and hubby be?

As for your 401(k): You may or may not have enough right now to get you through retirement; it depends on how much your account earns, how long you expect to live and how much money you need to live on.

If you earn 8% a year on your money until you tap it and 7% afterward, for example, it looks as if you could take about $22,000 a year until you were 85, when the money would be exhausted. Of course, that doesn’t take into account the effect of inflation. If inflation averages 3%, by the time you take your last payment, it will be worth about $7,500 in today’s dollars.

The truth is that your greatest asset is your earning power, and there’s no reason to toss it away. Even with a salary cut, you will be able to continue building your retirement funds and making yourself more financially secure.

Q: We gave our granddaughter $10,000 from my wife’s Keogh this year. We had already started taking annual distributions from the account, although for a smaller amount. Our income tax preparer said the gift is not deductible. Our son, who is very knowledgeable about income taxes, says this is a one-time gift to a relative and is deductible. Who is right?

A: Well, not your smarty-pants son, that’s for sure. Gifts to individuals are never tax-deductible, one time or any time. This makes me wonder what other nonsense he’s been feeding you that could be injurious to your financial health.

If he were really smart about taxes, he would have warned you not to take the money from the Keogh. Keoghs are tax-deferred retirement savings accounts for the self-employed. That means you have to pay taxes, at your regular income tax rate, on every dollar you withdraw. And any withdrawn dollars are thus no longer earning tax-deferred returns. So in one fell swoop you’ve added hundreds of dollars to your tax bill while giving up hundreds or even thousands of dollars in tax-deferred future earnings.

Generally speaking, you should delay tapping your retirement funds for as long as possible to prolong the time you have to earn tax-deferred returns. Any gifts should be made from money that’s already been taxed.

I’m guessing your son confused the gift-tax rules with rules about deductibility. Gifts of $10,000 or less aren’t subject to gift-tax reporting rules, and financial planners often recommend such gifts as a way of reducing the size of your estate and thus any future estate taxes. This only becomes an issue when your estate is worth more than the exemption amount, which is currently $650,000. (And it may not be an issue at all if you don’t care how big a bite Uncle Sam gets after you’re gone.)

Next time, consult your tax advisor before you make a gift or take any other action involving a retirement fund. You’ll save yourself some grief at tax time.

Q: You have told people in the past that using savings or a retirement distribution to pay off a mortgage is not a good idea. But I have heard that people nearing retirement should pay off their debts. We’re close to retirement and have more than enough savings to retire our mortgage at the same time.

A It’s an excellent idea to be out of debt by the time you retire. That’s why some people increase their mortgage payments as they near retirement, to pay down the principal more quickly and make sure they don’t have that monthly albatross around their necks when they kiss their paychecks goodbye. If you can afford to pay off the whole mortgage without tapping tax-deferred retirement money, and you want to do so, then go for it.

You’re probably not getting much tax advantage from your mortgage anyway, since only mortgage interest--not the whole payment--is tax deductible. In the early years of a mortgage, you get to write off nearly all of your mortgage payment, because nearly all of it is interest. Over the years, however, the proportion of the payment that represents the principal slowly (verrrry slowly) rises. In the last years, most of your payment will be nondeductible payments toward the principal.

Q Until 1991, my minimum required distributions from my individual retirement account were based on joint life expectancy. That year I became a widow, and reverted to calculating the distributions based on my age alone. I recently read about a federal rule that allows retirees to use the joint life expectancy of themselves and their oldest child to calculate the required minimum distribution, which has the effect of reducing the pay out and thus reducing taxes. May I now change to a joint life expectancy using the age of my oldest child?

A Oh, dear. Not only may you not change the way you calculate your distributions now, but it’s possible that you shouldn’t have done so earlier.

The IRS set up minimum required distribution rules for retirement accounts to make sure that Uncle Sam gets his share of the money that’s been growing tax deferred all these years.

Although you have options in how you calculate your minimum distributions, the IRS rules require that once you pick a method, you stick with it for the rest of your life.

The rules are somewhat different if you inherited the IRA from your spouse. In that case, you had the option of rolling the assets over into your own name and choosing another calculation method. But again, once chosen, you’re required to use the same calculation method until death.

You can learn more about required minimum distribution rules by reading “IRAs, 401(k)s and Other Retirement Plans: Taking Your Money Out� by Twila Slesnick and John C. Suttle (2000, Nolo Press). But it’s also a good idea to discuss your distribution plans with a qualified tax professional before making any decisions, because as you can see your choice is supposed to be irrevocable. Your best move at this point may be to hire a tax preparer who can review your situation and advise you what to do next.Questions and Answers on Retirement

By LIZ PULLIAM WESTON

SAVING FOR RETIREMENT

Q: I am changing jobs to a company with no 401(k) plan and a $1,500 yearly contribution to a SEP-IRA. My previous employer had a 401(k) with a 3% matching contribution. Are there any choices out there with pretax benefits to save for my retirement?

A: Yuck. Start looking for a new job.

Here’s a little math to help you launch your search. If you had stayed at your old employer, contributed the $10,000 maximum to the 401(k) and gotten a 10% average annual return, you would have $2.1 million after 30 years.

At your current job, you would have about $246,000 after 30 years. Is what they’re paying you worth giving up $1.8 million in potential retirement benefits?

If you’re a regular employee--in other words, if you get a W-2 from your new company--you don’t have many other options. Because your employer is already contributing $1,500 to a simplified employee pension IRA, you’re considered an active participant in a retirement plan, which precludes you from deducting contributions to your own IRA.

Unless this new job pays enough for you to save plenty on your own, you should find an employer who knows that a decent retirement plan is a requisite for finding and keeping good people.

Q. In investing for retirement purposes, is it still advisable to consider the rule of thumb of 100 minus your age as the maximum percentage you should have invested in the stock market? I am 46, currently not working, and am considering moving my 401(k) from my former employer and investing in other choices.

I have the funds spread in a range of low-, medium- and high-risk stock funds, with about 20% in Treasuries and 20% in a balanced fund. I have been considering moving to a discount brokerage through my bank, where I know the investment representative. I would then get some expert advice and ongoing attention, which I don’t have with the 401(k). Your thoughts?

A. When it comes to personal finance, forget rules of thumb. There are many concepts that are true for most of the people most of the time, but there are so many exceptions to personal finance rules that you can’t expect one-size-fits-all standards.

The rule of 100 is a case in point. The idea was to shift people out of riskier investments (stocks) and into safer investments (bonds and cash) as they aged and their ability to recover from losses diminished.

As a general concept it’s not a bad idea, but it ignores too many variables to be truly useful. It doesn’t take into account your goal for the money, how long you might live, your employment prospects, your tolerance for risk and what other options you have.

A secure pension can allow you to take more risks with your other retirement funds, for example, whereas the lack of a guaranteed check in retirement should make you somewhat more conservative.

If you need some kind of starting point, look no further than the mix of stocks and bonds in a balanced fund: typically 60% stocks and 40% bonds. That gives you exposure to stocks’ long-term gains while softening the blows of stock market downturns with the bonds’ interest.

If you feel emotionally able to ride out wide market swings and you don’t think you’ll need to tap your retirement funds any time soon for living expenses (always a dark possibility during unemployment), you can increase the proportion of stocks and stock funds in your portfolio.

I wouldn’t go beyond 80% stocks and 20% bonds and cash at any age, though. Not many investors today have had experience with a real bear market in stocks; those of us who think we can stomach a 40% loss, or more, may feel different if and when it happens.

As for moving your money from your former employer’s 401(k) to a brokerage firm: If you do so, make sure you roll the money directly over into an individual retirement account to avoid a huge tax bite. Also, remember that “expert advice� and “ongoing attention� can translate into ‘making a lot of commissions by trading frequently in your account.’ Don’t let that happen.

Despite the boom of do-it-yourself and online trading, I have yet to see any evidence that trading a lot boosts returns. In fact, studies to date show it harms the average investor’s results. Investors also seem to have an uncanny knack for selling one stock to buy another that subsequently does worse than their original pick.

Besides, unemployment is no time to be taking extraordinary risks with your retirement funds. Although you probably will return to work at some point, every day that passes is another day you don’t have to earn money for retirement.

Q: I’m 48 and my husband is 51. We have unwisely run up more than $40,000 in unsecured credit card debt over a number of years. We have no equity in our house. We know it’s almost always a terrible idea to borrow from a retirement plan. With the interest savings, though, we wonder if we couldn’t get this debt paid off quicker and save ourselves more money overall by taking money out of my husband’s 401(k). What sort of formula should we use in deciding if this will help us or not?

A: How much a 401(k) loan will ultimately cost you depends on what kind of returns you would have earned on the money had you left the 401(k) alone. Under most scenarios, the “interest savings� you might get from refinancing your debt would be overwhelmed by the future returns you’d be giving up.

If you’re game for a few numbers, here’s how it might play out. Say your husband’s 401(k) savings earn an average annual return of 10%. If you borrow $40,000 from the retirement plan and pay it back at 8% interest, you would have about $3,000 less in your 401(k) at the end of the five years than had you left the money alone. You would also pay about $10,000 less in interest, assuming your credit cards charge an average interest rate of 16%. So far, it looks as if borrowing from the 401(k) is a good deal.

But wait. You would continue losing ground from there, because that missing $3,000 can’t earn future returns for you. In 15 years, you would be more than $13,000 behind.

The longer the time span from the time of the loan and the higher the returns you could have earned, the worse the damage becomes. In 30 years, you’d be nearly $60,000 behind on an account returning an average of 10% a year.

Now, you could come out ahead if you invested that $10,000 in interest savings, preferably by boosting your 401(k) contributions if possible, instead of spending it on more stuff. But most people don’t have the willpower to do that.

Trading your future security for immediate gratification is what got you in financial trouble in the first place. Don’t make things worse by raiding your retirement account.

Q: My husband is taking a new job shortly, and we will be moving to northern Virginia. We have the option of taking a full or partial lump-sum payment from his retirement account. Is it better to take part of our retirement to pay cash for a house and take a large tax “hit� now? Or to pay mortgage interest for 10 to 12 years (14 years at the most) until we retire and pay off our mortgage then?

The retirement account is worth about $520,000. We would take out about $400,000 to pay for a $250,000 house and the tax penalty, leaving us with about $120,000 in retirement funds. My husband is 51 and has a well-paying job; I am 41 and planning to work part time, so we have plenty of time and resources to rebuild our retirement account. We have a strong desire to have our mortgage paid off when we retire--this is a must.

A: It doesn’t matter how strong your desire is; you shouldn’t use that retirement money to buy a house. Besides the hideous loss you would suffer from taxes and penalties, you would be losing--forever--the ability of that money to grow for you tax-deferred. That’s something you can’t get back, and at 41 and 51 you don’t have “plenty of time� to make up the loss. In your own words, you have 14 years at the most before you will retire. That’s not much time to rebuild a nest egg to take you through 30 or 40 years of retirement.

Left alone, the money you want to withdraw could grow to nearly $3 million in 20 years, assuming a 10% average annual return. If you’re really hellbent on being mortgage-free, get a 15-year loan and make a few extra payments.

Q. In 1998 my salary was $80,000, and I contributed 9.5% of it to my 401(k) plan at work. I got a $4,000 raise the next year, of which I took home a whopping $120 a month after taxes. But because of the raise, the IRS says I’m now classified as a “highly compensated� person and can only contribute a maximum of about 7.2% a year to the 401(k)! So, because of this minor raise, I’ve had to reduce my 401(k) contributions. Do you know any way around this?

A. Ah, welcome to the world of the highly compensated employee, where your 401(k) contributions are held hostage by your lower-paid co-workers.

Here’s the scoop. Once you make more than a certain amount ($85,000 in 2000), your 401(k) contributions are generally limited to 2 percentage points more than the average contribution made by all eligible employees at your company who make less than that certain amount. So if the contributions by lower-paid workers averaged 5.2% of their pay last year, you can’t give more than 7.2% this year.

These seemingly arbitrary rules are actually designed to make sure that company bigwigs don’t use their 401(k) plans as a personal perk. The rules give employers a strong incentive to educate all their employees about the plan and encourage everyone to contribute.

In fact, you might urge your employer to boost its 401(k) outreach and education, because that is the way you are most likely to be able to increase your contribution. It won’t help you this year, but it might next year.

There are other ways around the limitation, but your employer may not go for them. That’s because they require employers to structure their programs in particularly generous ways, either with a high match or by making a contribution for every employee, regardless of whether the employee put his or her own money into the plan.

If your company did either, you and your better-paid peers could contribute up to the overall IRS maximum--$10,000 a year--without worrying about the rules on highly compensated employees. Not too many companies are willing to go to that expense, although you can always ask yours to consider it.

Finally, don’t let your 401(k) limit how much you save for retirement. You can put $2,000 into a Roth IRA. You can also save outside of any retirement accounts. A tax-efficient mutual fund, such as a fund that mimics the Standard & Poor’s 500 index, would allow you to continue putting away money outside your retirement fund while minimizing the tax bill.

Q. My old college roommate is starting up his own bank and is looking for investors to come up with the $3 million in seed money. I don’t have a lot of available cash, but I was planning to shift $25,000 of my 401(k) money into stock in his bank, because my 401(k) has a self-direct option that allows us to invest in individual stocks. However, the lady I talked to at the 401(k) administrator told me that I am not allowed to buy private stock with my 401(k) money. If it were a publicly traded stock, it would be no problem. I don’t think this is fair. I think the bank would be a great investment.

A. Uh-huh. In that case, can I interest you in some Florida swamp--er, wetlands?

If you don’t have a lot of available cash, you have no business gambling on a start-up, period, end of story. You’re not a highflying Silicon Valley venture capitalist with an eight-figure net worth and dollars to burn. You’re a working guy who needs that money for retirement.

It is getting easier and easier to gamble with 401(k) money--more companies are offering self-directed options that allow workers to invest in individual stocks and bonds instead of just mutual funds; many 401(k)s even allow daily trading. But most plans still have some safeguards in place to protect people from making a complete mess of their retirement funds.

Your plan’s rule against private stock is one such safeguard. Retirement plan providers are understandably nervous about letting employees invest in something that can’t readily be valued (since it doesn’t trade publicly) and that could disappear overnight.

Don’t try talking to me about borrowing money from your 401(k), either. Tapping retirement money for any other purpose is usually a bad idea. If you can’t come up with the cash outside your retirement kitty, you’re in no economic position to roll the dice on your buddy’s bank.

Q: While my husband and I are working to ensure a comfortable retirement for ourselves, I’m worried about how to help my 82-year-old father enjoy his final years. I’m scared about what will happen if he requires assisted living or, worse yet, nursing-home care. My mother’s lingering death from Alzheimer’s years ago took much of my father’s retirement savings. Should I consider borrowing against my retirement accounts if money is needed for Dad’s care, then hope the sale of his home could reimburse me? Is borrowing against such accounts ever wise? I want to keep my father safe and well-cared for, but I’m trying to find legal, ethical ways to preserve financial security for my husband’s and my later years.

A: You are a good daughter and your father is lucky that you care so much about his well-being. But please think carefully before you put your retirement savings at risk.

Ideally, all of us would have either enough money or long-term care insurance to provide in-home care so that we would never have to go to a nursing home. But many of us will not be in that fortunate position. Your father’s resources already have been depleted and he is probably too old for long-term care insurance to make much sense; the premiums would be prohibitively high at his age.

Many families in your situation decide that their parents’ resources will be used to provide either in-home care or placement in a good nursing home for as long as possible. Once those resources are exhausted, the parent would qualify for Medicaid, the government health program for the poor. (In California, the program is known as Medi-Cal.) The program does not cover in-home care, so your father would need to already be in or be transferred to a facility that accepts Medicaid/Medi-Cal.

If your father does need government help, the state could make a claim against his house, which would probably require that it be sold after his death to reimburse the government for his care.

No one wants to be indigent and in a nursing home. If your father needs such care, however, you can help ensure that he gets quality attention by carefully researching available facilities and then--once your father is admitted--by being a constant and cheerful presence in his life. Elder-care experts will tell you there’s nothing like an attentive family to keep a nursing home on its toes.

A book that can help you is “Beat the Nursing Home Trap: A Consumer’s Guide to Assisted Living & Long-Term Care� by Joseph L. Matthews ($21.95, Nolo.com). In addition to the alternative-care strategies referred to in its title, this book offers great advice about selecting a nursing home. Nolo.com’s Web site (https://www.nolo.com) also offers information about Medicare, Medicaid and long-term care.

You could cash in your retirement savings, rather than use the resources that are available and designed for people in your father’s position. You generally would have to take out about twice as much as you actually need, because taxes and penalties will whittle down the total available to give.

If you did tap your funds, you would risk someday being in exactly the same spot as your father--broke and needing care. You understand how difficult it is to worry about a parent, and you probably wouldn’t want to pass on that particular burden to your own children.

Q When I signed up for 401(k), my employer said I must designate a beneficiary and so I just put down my wife’s name, even though we have never actually lived together and I wasn’t sure then if we ever would. Now I no longer work at the company and have requested a withdrawal of my funds. My request was rejected because it required spousal consent and her signature. The trouble is I don’t even know her whereabouts. My landlady can attest that my wife has never lived with me from day one. Is there other way to get the money that belongs to me, or is it doomed to stay there forever? Should not truth carry more weight than rule technicality?

A How untidy of you to misplace your wife. And given that the “technicality� you refer to is a legal marriage, the short answer is no. Your “truth� should not cancel out the laws designed to protect spousal interest in retirement funds.

You’ll probably need to get a divorce decree to get your hands on the money. To get a divorce, you may need to share some of the 401(k) with your wife, since retirement accounts are generally considered shared property regardless of who made the actual contributions. If you can’t find your wife, the process is obviously going to be a lot more complicated and you’re going to need some legal help. Check with your local Legal Aid Society if you’re not able to afford an attorney otherwise.

Next time, you might consider marrying someone you actually want to see once in awhile.

SAVING ON YOUR OWN

Q I would like to start saving for retirement and other goals, but I work in the film industry and my income is very erratic--six figures one year, four figures the next. Well, maybe not quite that bad, but you get the idea. Last year I was out of work for almost six months, which really took its toll on my bank account and my credit cards. Now I’m making good money again, but I’m reluctant to use the cash that I’ve saved to pay off my credit card bills, fearing that I could be out of work again soon.

A Use your cash to pay off your credit card bills. If you lose your job tomorrow, you’ll be able to run up your credit cards again if necessary.

You don’t want to be paying interest when that money could instead be going toward building a solid financial situation.

Here’s the plan: Hunker down and live like a monk until you have savings equivalent to six months’ worth of basic expenses; a year’s worth would be even better. This pile will give you freedom from worry when your current contract ends and allow you to be choosier about your projects.

Even when times are good, it’s important to keep your overhead down. Don’t succumb to the temptation to lease a fancy car or to take on other debt, because you’ll face crushing bills when the paychecks stop.

If fact, when the money’s rolling in, stuff as much as you can into retirement accounts. If you’re self-employed, you can open a Simplified Employee Pension, and put in as much as 13% of your net earnings. Or you could open a Simple, or Savings Incentive Match Plans for Employees, another type of tax-favored retirement account, which lets you put as much as $6,000 a year aside. Or you could open a Keogh account, but if you decide to go that route, make sure you choose the type of Keogh that gives you flexibility to fund it or not in any given year. If you’re in a union, definitely check out its 401(k) or other retirement plans and contribute the maximum possible.

Your investments--especially ones outside retirement plans--should be on the conservative side, since you may well have to tap them should your career goes into an extended funk. (You want to avoid these at all costs--the funk and the tapping--but they may happen someday.)

Balance your stock investments with a hefty dose of bonds, bond funds and cash; a mix of 60% stocks, 30% bonds and 10% cash might be a good way to start.

Q: You recently advised someone who works in the film industry about saving for retirement, suggesting that he set up a Simplified Employee Pension or SEP-IRA. I am a film worker, and I got into trouble with the IRS last year because I have been putting my retirement savings into a SEP-IRA. Although most people who work in the film industry think of themselves as self-employed because they aren’t on the payroll of a studio or production company, they probably do not qualify for a SEP-IRA either. Most of the time, the production company pays the worker through a payroll company, which in effect is the “employer of record.� Any worker who isn’t set up as a company with employees--and most film industry workers are not--does not qualify.

A: Well, not quite. You don’t need to have employees to set up a SEP. As long as you’re self-employed, you’re eligible to put aside 13% of your net income each year into these tax-deductible, tax-deferred retirement accounts.

How to tell if you’re self-employed?

One good way is by the tax forms you get in January. If a company that has employed you sends you a 1099 form to report your pay for tax purposes, you’re probably an independent contractor and thus by definition self-employed. You’ll fill out a Schedule C to report your business income and expenses. (The SEP would be funded out of the resulting profit.) If you get a W-2, you’re most likely an employee, and you’ll report your wages on the front of your 1040 form. A few people who get W-2s can also fill out Schedule Cs if their employers have checked box 15 on that form; these folks, known as statutory employees, are usually traveling salespeople and insurance agents.

Which brings up the whole controversy of companies who treat their workers as independent contractors when in fact they really are employees--people who are closely supervised, who don’t get to set their own hours and methods of work and who are told what to do and when to do it. The IRS has cracked down on many companies that did this to save on payroll taxes and benefits, but it’s still going on.

That’s not your problem, of course. What is your problem is that you tackled your tax return with just enough knowledge to get into trouble. Perhaps next year you’ll consider consulting a qualified tax preparer; you can get a referral list from the National Assn. of Enrolled Agents at https://www.naea.org or the California Society of Certified Public Accountants at https://www.calcpa.org. Tax law is complex and constantly changing, so if you have anything more than a basic 1040-EZ to fill out, it often pays to pay for a little help.

Q: I assume that the two basic requirements for establishing a Roth IRA are a Social Security number and earned income. My problem is that I would like to establish a Roth IRA for a newborn child. Getting a Social Security number is not a problem since all children must get one to be claimed as dependents on their parents’ returns. Establishing an earned income for the child is another issue, however.

It must be possible because there are child actors who get income. I want to legally create earned income for the child and need to know what forms must be filed with the IRS.

A: Sorry, but there’s no legal way to commit tax fraud, which is what you seem to be proposing.

You’re right that child actors and child models have earned income. You also may hire your children to perform certain tasks in your own business, as long as you abide by appropriate child labor laws and file the appropriate wage and tax documents with the IRS and your local tax agencies.

Unless your newborn has already been spotted by a Hollywood talent scout, however, there’s not much chance he or she will have legitimate earned income any time soon. You can contribute to the child’s long-term financial security in many other ways. Just put the Roth IRA idea on hold until the kid is old enough to earn a paycheck.

Q I want to know why, as a reader of two major newspapers, I managed not to know enough to make a simple, five-minute transaction that would have saved me a $20,000 tax penalty and the loss of my individual retirement account. I converted my IRA to a Roth IRA in 1998, not realizing that my income was too high to qualify for such a conversion. By the time I realized my mistake, it was past the Dec. 31, 1999, deadline to undo it. We had to pay the tax penalties and I was forced to liquidate the entire account. We did get a notice from the IRS, but it came during the holiday season and we put it aside, not realizing its importance. On one hand, I feel like an idiot; on the other, I believe what happened was unfair.

A I’d go with that first feeling.

Congress created Roth IRAs in 1997 as a way for people to save money that would not be taxed in retirement. People whose incomes were under certain limits ($160,000 for married couples, $110,000 for singles) were allowed to make a nondeductible contribution of up to $2,000 a year to a Roth IRA. Lawmakers also allowed people whose incomes were under $100,000, married or single, to convert traditional IRAs to Roth IRAs. People who converted their traditional IRAs paid income taxes, but not penalties, on the amounts they transferred to a Roth IRA.

A Roth conversion is indeed a complex transaction. That is why newspapers and personal finance magazines were filled with stories about who should and shouldn’t convert, and how to go about converting if you were eligible. The Los Angeles Times alone had dozens of stories about Roth conversions during 1998 and 1999, including 34 that specifically included the $100,000 income limitation. One of the stories, which appeared in March 1999, talked about the fact that many people were discovering their incomes were too high and were undoing their conversions. We also had three mentions of the Dec. 31, 1999, deadline.

The IRS itself tried to tell you about your mistake, to no avail. You’ve learned the hard way that it never pays to ignore an IRS notice.

Another lesson you might have learned is that you should never touch a retirement account until you get professional (that is, paid) tax advice on the transaction. A knowledgeable tax preparer could have saved you an enormous amount of grief and expense. Retirement accounts, and their tax-deferred status, are too valuable to throw away through a dumb mistake.

Q: I occasionally work for a temporary agency that offers a 401(k) plan, to which the agency contributes nothing. The plan does not offer any socially conscious funds, and I refuse to invest in ways that are contrary to my ethics. I have been investing instead in a traditional IRA. Are my contributions deductible?

A: People who are not covered by retirement plans at work are allowed to deduct their contributions to a traditional IRA, regardless of how much money they make. By contrast, those who are considered covered by a plan are only allowed to deduct contributions if their incomes are below certain limits.

The question is whether or not you would be considered covered by the plan. I asked your question of CPA Phil Holthouse, partner at Holthouse, Carlin & Van Trigt in L.A. He said if you don’t participate at all in the plan and your employer contributes nothing, you should be able to deduct your IRA contributions regardless of how much money you make. To make sure your employer isn’t reporting you to the IRS as someone who is covered by a retirement plan, check your W-2 to make sure your boss doesn’t check the ‘pension’ box. That’s how the IRS monitors who is and isn’t considered covered by a plan, Holthouse said.

401(k) or Roth Better Savings Tool?

Q. You recently suggested that a family consider contributing to a 401(k) only to the maximum matched by an employer, and then use any extra money to fund a Roth IRA. I have always thought that you should fund a 401(k) to the maximum allowed, even if you didn’t get a match and even if that meant not being able to contribute to a Roth. Am I wrong?

A. That depends on your situation.

It’s almost always best to contribute to a 401(k) at least up to the maximum matched by the employer. Typically, employers give 50 cents for each dollar you contribute up to some maximum percentage, such as 6% of your salary. That match means you get an immediate 50% return on your money. You can’t beat that with a stick. For people who expect to be in a lower tax bracket at retirement, continuing to fund the 401(k) to the maximum allowed before contributing to a Roth IRA is probably the better strategy. But the Roth IRA is an incredibly powerful savings vehicle for people who expect to be in the same or higher tax bracket in retirement, and for those who want to leave an inheritance for their kids. That’s because the Roth IRA is completely tax-free when withdrawn in retirement, and it doesn’t have the minimum distribution requirements of other tax vehicles, including 401(k)s and traditional IRAs. So if you expect to be well-off in retirement, it can make sense to contribute to a Roth IRA after you’ve set aside the maximum your company will match. If you still have money lying around after you fund your Roth, you could return to the 401(k) and contribute up to the maximum allowed.

Q: I am a 32-year-old attorney with a wife, two children and my own law firm. I am in the process of setting up some form of employer-funded retirement plan and my insurance agent (and family friend) is telling me I should buy variable life insurance. The way I see it, variable life insurance is silly because your investment is with after-tax dollars and, to make matters worse, part of your “investment� is used to purchase a term insurance policy (at higher rates than I’m paying now) with the rest put into a captive mutual fund. While I have pretty much convinced myself that variable life insurance is not for me, my wife, who trusts the agent, thinks I don’t understand the product and says our friend would not steer us in the wrong direction. What do you think?

A: I think even the best-intentioned insurance agents can get excited about a product and not realize that it isn’t the best fit for a client. Less well-intentioned agents might care more about the commission than about making sure you get something that suits your financial needs.

Variable life insurance--a life insurance policy that combines a death benefit with an account that can be invested in stocks, bonds and cash--can be a reasonable, if relatively expensive, option for high-income people who need life insurance and who have already exhausted other tax-deferred ways of saving for retirement. That means people who have contributed every dollar possible to a 401(k) or other retirement plan at work and invested $4,000 a year ($2,000 each for themselves and their spouses) into a Roth IRA--and who still want to save more.

The earnings in the investment portion of a variable life insurance policy are tax-deferred until withdrawn. That tax deferral comes with a price in the form of higher fees and costs than you would pay for equivalent mutual funds. And as with mutual funds, you bear the risk if your investments don’t perform well.

It’s not clear from your letter whether your agent is urging you to buy this policy in lieu of a retirement plan or in addition to it; if it’s in lieu of, thank him and resolve to restrict contacts with him to social events. Seek out a financial planner, preferably of the fee-only variety, who specializes in setting up retirement plans for help in getting a 401(k) or other savings program started at work.

If the agent is suggesting this policy in addition to a retirement savings plan, have the planner review it and see whether it meets your needs. If it’s as great a deal as the agent thinks, he should welcome the scrutiny.

RETIREMENT ISSUES

Q: I’m always reading articles about the “safe� withdrawal rate from a retirement fund. One study recently said withdrawal rates higher than 5% dramatically increased the probability of running out of money if the withdrawal period was longer than 15 years. That’s nonsense. If I have $100,000 and withdraw 5% ($5,000) every year, my nest egg will last 20 years, even if I keep it under my mattress. If I put it in a certificate of deposit at 6% annual interest, I could withdraw $5,000 per year until the Fed freezes over and would have more than I started with at the end. Even assuming a very conservative rate of return of 6% from a stock-dominated portfolio, one could withdraw 8% to 9% for a great deal longer than 15 years. The numbers don’t lie, so obviously I’m missing something, or the professors who do these studies can’t add (which seems somewhat less likely). So what’s missing?

A: Three rather crucial factors: inflation, taxes and the volatility of stock market returns.

Yes, you can keep your money in your mattress and pull out 5% a year. But by the end of 20 years, your $5,000 is going to be worth a heck of a lot less than when you started. Mild inflation of just 3% will reduce your buying power by nearly half in that time.

That’s why most retirement calculators assume that you will adjust your withdrawal amount upward for inflation each year. You might start with 5%, but the amount withdrawn will be increased by, say, 3% each year. Doing that means you run out of money during your 16th year of withdrawals.

On to your CD example. In addition to losing ground on inflation, you’re also going to have to pay taxes on the interest you earn. The higher your tax bracket, the more you’ll pay. In the 34% combined state and federal bracket, you’ll pay about $1,700 in taxes, reducing your withdrawal to $3,300. Adjusted for 3% inflation, your withdrawal would be worth about $1,800 in today’s money at the end of 20 years.

You’re right that an 8% to 9% annual return would put you in the clear and allow you to withdraw more than 5% over 15 years. Problem is, the stock market doesn’t guarantee steady returns. You might be up 20% one year and down 30% the next--and down 10% more in the third year. The biggest problem for retirees comes when the stock market dives and stays down shortly after they begin their retirements. They’re withdrawing from a shrinking pot, and if they don’t cut back sharply they risk running out of money much sooner than they expect.

The authors of these studies are trying to warn retirees and other investors not to count on stellar stock market returns throughout their retirements. Conservative withdrawal rates and a diversified portfolio are particularly important for people who can’t make up stock market losses with future earnings--and that includes most retirees.

Q: I was married for 24 years but divorced in 1984. I continued working, but my ex-husband has not had a tax-paying job since. I got a really good job in 1987. My question is: Can my ex get Social Security benefits based on my earnings after the divorce or just on what I earned during our marriage?

A: Let it go, dear.

He may be a shiftless bum, and you may resent that he will qualify for Social Security based on your earnings rather than his own. Any former spouse who was married at least 10 years can receive half of the ex’s benefit amount if both members of the erstwhile couple are at least 62. His benefit will be based on your lifetime earnings at that point, not just the earnings during your marriage.

Note, though, that whatever he gets will not reduce your Social Security check by one dime. This is one of the few cases in which an ex-spouse gets a benefit that’s not at the other’s expense. So concentrate on your good fortune at having “a really good job� and don’t begrudge him the few extra shekels in Social Security that your earnings will provide him.

Q My husband and I are planning to retire in our mid-50s. We will have just enough money to squeak by until we can withdraw without penalty from our investments. However, do you know what we can do for medical insurance? I know we can use COBRA for 18 months after retirement, but what is available and how much does it cost before Medicare kicks in?

A You may be working a little longer than you had planned.

If you’ll have only enough money to ‘squeak by’ until 59 1/2, you probably won’t have enough money to pay for health insurance, which is likely to run you several hundred dollars a month.

The Consolidated Omnibus Budget Reconciliation Act of 1985, known in benefits shorthand as COBRA, generally requires companies to extend health coverage for up to 18 months, but you’re required to pick up the bill. Once COBRA expires, you’ll need to find individual coverage, which may be even more expensive than what your employer provided. You might want to talk to an experienced insurance broker for an idea of what coverage is likely to cost in your area.

Alternatively, you might choose ‘catastrophic’ coverage, which protects you from disastrously high medical bills and typically has a low monthly cost--usually between $20 and $150, although premiums can be higher depending on your age and health. But these policies come with a large deductible--typically $2,000 per person each year. Again, that’s money that will need to come out of your own pocket.

You won’t be eligible for Medicare until age 65, so you could be facing 10 years of picking up some pretty hefty bills. Going without health insurance isn’t an option, by the way--one serious illness could wipe out all you’ve put aside and turn your early retirement into a long-term nightmare.

Q. I’m 49 and my wife is 42. We hope to retire in six or seven years. Our retirement funds are mostly in tax-advantaged accounts. If we retire in six years, we can live for a while on personal assets until I start drawing on my retirement accounts. However, it would be quite helpful if we could also draw on my wife’s generous retirement accounts at that time. If one spouse is older than 59 1/2 and the other spouse is younger, can a couple draw on the younger spouse’s retirement account without penalty--particularly considering that our state (California) is a community property state? Or, if my spouse changes jobs, could she transfer her existing retirement assets to a new account under our joint names, thus allowing us to draw on those assets when I turn 59 1/2? Or could she deposit her retirement assets into one of my existing individual retirement accounts, thus commingling our community property, and would we then be allowed to draw on her assets as well as mine when I turn 59 1/2?

A. Darn, you’ve been trying to work this out every which way, haven’t you?

Community property has nothing to do with it. If you divorced, you would be entitled to half of the retirement money earned during your marriage, but it would still have to be kept in separately titled accounts. There’s no such thing as a joint individual retirement account or 401(k), and you normally wouldn’t be able to tap your wife’s money without penalty until she reached the minimum withdrawal age of 59 1/2.

There are exceptions, though. She could begin taking what’s called “substantially equal periodic payments�--that is, withdrawals in equal annual amounts, based on her life expectancy--at any age from her IRA. (She can also make such withdrawals penalty-free from a 401(k) if she no longer works for that employer.) The IRS has strict rules about how to figure these payments, though; if your wife runs afoul of the rules, she’ll owe the early-withdrawal penalty.

For more details, talk to a tax professional and read up. One guide is the Nolo Press book “IRAs, 401(k)s and Other Retirement Plans: Taking Your Money Out.�

If your wife leaves her employer after age 55, her 401(k) distribution wouldn’t face the early-withdrawal penalty. Finally--and I almost hate to mention it, given your creative mind--if she dies and you inherit her retirement accounts, you could opt to treat them as your own, using your age to determine withdrawal amounts.

Q. My job was transferred to New York early this year, and I opted not to relocate there.

If I start to work for a new company, I would expect to be paid at least 30% less than I was in my old job. I will be 50 years old late this year, and my friends tell me that Social Security uses the average of the last five years’ salary to compute the retirement benefit. I am afraid to go back to work because of this situation. I do not want to reduce my benefits based on a lower new salary.

Would it be beneficial for me just to apply for retirement benefits at the minimum age? My husband is still working and will try to earn at least 50% of my net pay in the stock market if I decide to stay home until I am 59 1/2, when I can tap into my 401(k), which has about $120,000. Do you think this will be a better plan than working again at a much lower salary?

A. In answering your question, I will try not to use the phrase “harebrained scheme.�

Oops! Oh, well.

Listen, your friends are dead wrong, your husband is deluded, and I shiver to think how much damage you could do to your finances if you proceed with your plan.

Your Social Security benefit will be based on a calculation that includes your 35 highest-earning years--not the last five. Right now, those 35 years include your summer job in high school. Surely even with a 30% pay cut you would make more now. (If you want to know more about how Social Security works, visit https://www.ssa.gov on the Internet or call (800) 772-1213.)

Your husband’s plan is a fool’s game. You don’t put money you need to live on in the stock market. It’s hard to remember this with this long-lived bull market, but stocks do go down, and sometimes they stay down. Then where will you and hubby be?

As for your 401(k): You may or may not have enough right now to get you through retirement; it depends on how much your account earns, how long you expect to live and how much money you need to live on.

If you earn 8% a year on your money until you tap it and 7% afterward, for example, it looks as if you could take about $22,000 a year until you were 85, when the money would be exhausted. Of course, that doesn’t take into account the effect of inflation. If inflation averages 3%, by the time you take your last payment, it will be worth about $7,500 in today’s dollars.

The truth is that your greatest asset is your earning power, and there’s no reason to toss it away. Even with a salary cut, you will be able to continue building your retirement funds and making yourself more financially secure.

Q: We gave our granddaughter $10,000 from my wife’s Keogh this year. We had already started taking annual distributions from the account, although for a smaller amount. Our income tax preparer said the gift is not deductible. Our son, who is very knowledgeable about income taxes, says this is a one-time gift to a relative and is deductible. Who is right?

A: Well, not your smarty-pants son, that’s for sure. Gifts to individuals are never tax-deductible, one time or any time. This makes me wonder what other nonsense he’s been feeding you that could be injurious to your financial health.

If he were really smart about taxes, he would have warned you not to take the money from the Keogh. Keoghs are tax-deferred retirement savings accounts for the self-employed. That means you have to pay taxes, at your regular income tax rate, on every dollar you withdraw. And any withdrawn dollars are thus no longer earning tax-deferred returns. So in one fell swoop you’ve added hundreds of dollars to your tax bill while giving up hundreds or even thousands of dollars in tax-deferred future earnings.

Generally speaking, you should delay tapping your retirement funds for as long as possible to prolong the time you have to earn tax-deferred returns. Any gifts should be made from money that’s already been taxed.

I’m guessing your son confused the gift-tax rules with rules about deductibility. Gifts of $10,000 or less aren’t subject to gift-tax reporting rules, and financial planners often recommend such gifts as a way of reducing the size of your estate and thus any future estate taxes. This only becomes an issue when your estate is worth more than the exemption amount, which is currently $650,000. (And it may not be an issue at all if you don’t care how big a bite Uncle Sam gets after you’re gone.)

Next time, consult your tax advisor before you make a gift or take any other action involving a retirement fund. You’ll save yourself some grief at tax time.

Q: You have told people in the past that using savings or a retirement distribution to pay off a mortgage is not a good idea. But I have heard that people nearing retirement should pay off their debts. We’re close to retirement and have more than enough savings to retire our mortgage at the same time.

A It’s an excellent idea to be out of debt by the time you retire. That’s why some people increase their mortgage payments as they near retirement, to pay down the principal more quickly and make sure they don’t have that monthly albatross around their necks when they kiss their paychecks goodbye. If you can afford to pay off the whole mortgage without tapping tax-deferred retirement money, and you want to do so, then go for it.

You’re probably not getting much tax advantage from your mortgage anyway, since only mortgage interest--not the whole payment--is tax deductible. In the early years of a mortgage, you get to write off nearly all of your mortgage payment, because nearly all of it is interest. Over the years, however, the proportion of the payment that represents the principal slowly (verrrry slowly) rises. In the last years, most of your payment will be nondeductible payments toward the principal.

Q Until 1991, my minimum required distributions from my individual retirement account were based on joint life expectancy. That year I became a widow, and reverted to calculating the distributions based on my age alone. I recently read about a federal rule that allows retirees to use the joint life expectancy of themselves and their oldest child to calculate the required minimum distribution, which has the effect of reducing the pay out and thus reducing taxes. May I now change to a joint life expectancy using the age of my oldest child?

A Oh, dear. Not only may you not change the way you calculate your distributions now, but it’s possible that you shouldn’t have done so earlier.

The IRS set up minimum required distribution rules for retirement accounts to make sure that Uncle Sam gets his share of the money that’s been growing tax deferred all these years.

Although you have options in how you calculate your minimum distributions, the IRS rules require that once you pick a method, you stick with it for the rest of your life.

The rules are somewhat different if you inherited the IRA from your spouse. In that case, you had the option of rolling the assets over into your own name and choosing another calculation method. But again, once chosen, you’re required to use the same calculation method until death.

You can learn more about required minimum distribution rules by reading “IRAs, 401(k)s and Other Retirement Plans: Taking Your Money Out� by Twila Slesnick and John C. Suttle (2000, Nolo Press). But it’s also a good idea to discuss your distribution plans with a qualified tax professional before making any decisions, because as you can see your choice is supposed to be irrevocable. Your best move at this point may be to hire a tax preparer who can review your situation and advise you what to do next.