Chances are that your retirement portfolio needs a major overhaul in 1994 to compensate for today’s sky-high markets and equally lofty income tax rates.
Let’s start with bonds and bond funds. Your problem here may be that you have too much money in them. When interest rates dropped 1.6 percentage points in 1993, bond portfolios made sharp gains (the total return on long-term Treasuries was 19 percent through Nov. 1).
So you may need to trim the fixed-income portion of your savings back to where you really want it to be. And with long-term rates poised to rise more than half a percentage point in ’94, you may want to tilt that fixed-income segment toward short- and medium-term bonds to protect against price declines.
As for stocks, you may have too much in one basket-or even in the wrong basket, when you take into account the powerful forces that will steer the markets in the year ahead.
To achieve the best returns today, financial adviser Paul Estbrook of Watchung, N.J., suggests dividing your individual stocks or equity funds earmarked for retirement evenly among blue chips, small and midsize companies, international and aggressive growth.
“Investors need to have a diversified stock portfolio,” he says. “Large, domestic stocks are not going to have the high returns they did in the 1980s.”
As you do your rebalancing, however, remember that you’re dealing with your retirement funds, the longest of long-term investments. And whether it’s money in tax-sheltered plans such as 401(k)s or other savings, you must keep your eye trained unswervingly on the long term. That means establishing broad allocations of your retirement portfolio based upon your age.
In your 20s and 30s, stocks or stock funds should make up as much as 70 to 80 percent of the mix, with the balance in fixed-income investments. And in your 50s, you will want to start gradually reducing the equity portion until it hits a still sizable 50 percent at retirement.
“With inflation and the long life expectancy of retirees,” says financial planner Isabelle Curtiss of Middlebury, Conn., “you must have growth built into your portfolio.”
Choosing the most tax-advantaged and cost-efficient vehicles in ’94 for your retirement needs will also help your nest egg grow faster, especially with the steep new top tax brackets of 36 and 39.6 percent.
“If you believe tax rates are going to stay high or go higher, as I do,” says Cincinnati financial planner Michael Chasnoff, “tax deferral is more valuable than ever.”
Someone setting aside $4,000 a year for 35 years in a company-sponsored 401(k) plan earning 8 percent on average will have $744,409 at retirement, compared with only $302,042 if he had put the same amount in taxable investments.
With capital gains still taxed at 28 percent, upper-income investors with sizable portfolios outside their tax-sheltered retirement plans might put income-producing investments into the plans and keep stocks that produce only capital gains outside.
But your first retirement savings dollars should go into workplace plans such as 401(k)s.
“What’s important for retirement is putting money away early,” says Andrea Markezin, a principal with the accounting firm of Ernst & Young, “and funding your 401(k) is a real no-brainer.”
Contributions of as much as an estimated $9,235 in 1994 are automatically taken out of your paycheck in pretax dollars, giving you the discipline of enforced savings and a tax cutter at the same time.
Better yet, 86 percent of companies offering 401(k)s match at least part of your contribution, producing an automatic gain. If you work for a non-profit organization or a school, your employer may offer a 403(b) pension plan or a tax-sheltered annuity in which you can stash up to $9,500 pretax in 1994.
If you are self-employed, you can set aside even higher amounts. For a sole proprietor, a tax-sheltered simplified employee pension (SEP) is the easiest and cheapest to set up.
Maximum 1994 contribution: 15 percent of self-employment income, or $22,500, whichever is less. A business owner nearing retirement can sock away the most money, though, with a defined-benefit Keogh, since you can fund an annual retirement benefit of as much as an estimated $118,737.
A small-business owner setting up a plan for employees as well may want to opt for a profit-sharing Keogh, whose annual contribution limit for the business owner is the same as in a SEP. The employer contributes to employees’ accounts according to a formula based on their income. A profit-sharing Keogh is far more flexible than a SEP, enabling you to vary contributions to employee accounts using such factors as age or length of service.
Ever since tax reform cut back the full deductibility of individual retirement accounts, IRAs have been overlooked by many investors. Don’t you overlook them.
IRAs should still be the second place for your retirement savings after completely funding company plans. You’ll qualify for a full or a partial IRA deduction if you don’t have a company pension or if your adjusted gross income falls below $50,000 for a married couple, $35,000 for singles. Even if you don’t get the writeoff, you can still put up to $2,000 into a non-deductible IRA every year and profit from its tax-deferred earnings.
Variable and fixed annuities are increasingly being marketed as retirement vehicles because their investment earnings are tax deferred, too. But unless you’ve already fully funded your workplace plans and IRA and are sure you will stay invested at least 10 years, think twice before putting money into these commercially sold annuities.
(Variable ones let you put money into portfolios of stocks, bonds or cash; fixed annuities pay a flat rate of interest, currently 5 percent or so.)
You must put in after-tax dollars, though. Plus you’ll be clobbered by surrender fees of as much as 8 percent of the amount you withdraw if you take money out within the first eight years, not to mention a 10 percent tax penalty on your accrued earnings if you want out before 59 1/2. And annual fees average slightly above 2 percent, versus the 1.2 percent average expense ratio of mutual funds.
“If you have other retirement plans, I don’t recommend annuities, because you’re locking up money,” says Westbrook. “You may need more flexibility for financial obligations you don’t foresee now.”
