Financial Planning

Table of Contents

Financial Planning for Retirement — What's It All About?

Even the sound of the word "budget" is enough to make most of us want to leave the room. Fortunately, financial planning—as we will talk about it— is NOT about budgeting as such. And no, it is not about doing without the things you want. Instead, it's about financing a satisfying life style for your retirement.

Let's face it — you'll need money to be happy in the future. A little financial planning — the type an average person can do — can start earning you hundreds or even thousands of extra dollars each year. These earnings could start soon and amount to a sizeable sum over time.

How can financial planning help?

It is a fact that financial planning is even more important for the person with an average income than it is for someone with a very high income. The average person has to make his or her income stretch to cover many needs, and there is typically little money left each month after paying the bills.

Yet, despite current expenses, you need to look ahead to the time when work income will stop due to retirement. You want to feel that if you must stop or choose to stop working, you will be financially secure.

Financial Planning can help in a number of ways. It can:

 

Getting your financial records together: an essential first step

Do you have all of your important financial papers and records organized so that you can easily refer to them? If so, you are to be congratulated. If you are like most of us, though, you have your records spread all over the place, ranging from a drawer in the bedroom to a box in the attic.

Is it really important to have your records in one place? Well, it can cost you and your family money if you don't. A surprising number of important papers get lost, forgotten, overlooked, or just cannot be located when they are needed. Many insurance policies are never cashed. Under either government or private programs, if you don't file a claim for a benefit for which you are eligible, you won't get it. Bank books, military discharge papers, stock certificates, bonds, pension eligiility papers and deeds can easily get lost or overlooked, particularly when only one or two people know they exist.

TODAY is the time to gather all of your important financial records together. Include recent tax returns along with other important papers. By gathering them together, you will have done yourself (and your spouse) a service.

Some of the types of papers and records we are talking about include:


The chances are you will not be able to complete your records without checking with your employer, your insurance company, your Social Security Office, or perhaps some other source to get certain up-to-date information.

Once you have your records together

After you have rounded up your important financial papers and have made a record of them, put them in one safe place so that you and others will know where they are and will be able to find them when they are needed.

CAUTION: In some states, a safe-deposit box is sealed in the event one of its owners dies. No one can get into the box until a probate judge permits the box to be opened under the court's supervision. Therefore, if you use a safe-deposit box, you may decide to keep a copy of your will and other papers of importance in "one safe place" at home.

 

Potential sources of income

You may be pleasantly surprised about the total retirement income you can expect to receive from all sources combined. You may find that it will cover all of your estimated expenses. However, you should not leave this to chance. This section will help you to compare expected income with expected expenses. Get the facts now, so that you can plan on a solid basis.

Figuring the income you need

Each of us probably has a vague idea of how we want to live in retirement. Few people, though, have given much thought to what a satisfying retirement life style might really cost.

You might be pleasantly surprised to learn that you can afford to continue your present life style. Or you may find that only by taking decisive action now will you be able to achieve a satisfying, secure way of life in retirement.

None of us can afford to leave our future well-being to chance. Even if your employer has a most generous pension plan, you should determine if your income from this and other sources will provide the income you most likely will need when you retire.

Here's an important point: Your future income needs will depend partly on how you desire to live, what is acceptable to you, and what is realistically achievable.

Below are TWO METHODS for estimating your own (or family) retirement income target. IF YOU ARE MARRIED, YOU AND YOUR SPOUSE WILL NEED TO FIGURE YOUR EXPECTED INCOME NEEDS BOTH AS A COUPLE AND AS INDIVIDUAL SURVIVORS.

Method one: the Annual expense method

Using this method, a person or couple estimates what typical monthly and annual expenses will be in retirement. In making this estimate, look at what you are currently spending, estimate how this will change in retirement, and do a "retirement budget."

The form on the next page is helpful in using this method. Note that the form asks you to first estimate your current monthly and periodic expenses. Next, you are asked to estimate what your monthly and periodic expenses will be when you retire. If you are expecting to retire with a spouse, a relative, friend, etc., be sure to include his or her expenses as well as your own.

 Worksheet 1: Annual Expense Method

Method two: the three-fourths rule

Some experts suggest that monthly retirement income needs to be about three-fourths of pre-retirement income in order to satisfactorily meet expenses. For example if your income in the year before you retire is $32,000, you should consider planning a retirement income that adds up to $24,000 a year.

Judgment must be exercised in using this method. Individuals with relatively low incomes may need more than three-fourths of their pre-retirement income to meet retirement expenses. Similarly, a couple with a high pre-retirement income might need less than three-fourths of that amount as their retirement income.

As with the first method, if you are expecting to retire with a spouse, relative, friend, etc., be sure to include his or her income if it will be used to meet your household expenses.

A SURVIVING SPOUSE will probably require a retirement income that is three-fourths of what the couple together required. For example, if the couple required $1,600 per month as retirement income, a surviving spouse might require $1,200 per month. Since the actual amount needed will vary with specific people and circumstances, consider your own case carefully when planning for your future.

 Worksheet 2: Currently Expected Retirement Income

 

Social Security—Count on it

The Social Security Trust Funds currently count reserves of nearly a trillion dollars and will have no problem meeting projected benefit outlays for over 30 years. Beyond the year 2040 — when seniors will grow to about 20% of the population — current payroll taxes will still be sufficient to pay at least 73% of benefits. But a shortfall is predicted.

Congress will need to address this problem in the near future and make corrections. But remember, for over 65 years Social Security has never failed to meet its monthly benefit obligations. It's a system Americans can count on, and reports of its impending demise have been greatly exaggerated.

But Social Security is designed to replace only a portion of a person's earnings prior to retirement: approximately 40% for average-wage workers. Clearly, it's desirable to supplement Social Security benefits with a pension and savings.

Applying For Social Security benefits

Normal retirement age under Social Security has always been 65. The age, however, is scheduled to rise gradually to 67 between the years 2000 and 2027 (see table). Early retirement benefits can begin at age 62, but retirees must accept a permanent benefit reduction.

To receive benefits, you must apply for them. Contact your local Social Security office when:

 Age to Receive Full Social Security Benefits

 Year of Birth  Full Retirement Age*
 1937 or earlier  65
 1938  65 and 2 months
 1939  65 and 4 months
 1940  65 and 6 months
 1941  65 and 8 months
 1942  65 and 10 months
 1943-1954  66
 1955  66 and 2 months
 1956  66 and 4 months
 1957  66 and 6 months
 1958  66 and 8 months
 1959  66 and 10 months
 1960 and later  67

*If you take monthly benefits before full retirement age, benefits will be reduced.

About Your Benefits

For information about your Social Security or Medicare benefits, or to request publications, call the Social Security Administration's (SSA) toll-free number (1-800-772-1213), visit the website or visit your local Social Security office.

The Social Security Administration has begun sending annual statements to workers age 25 and over who are not currently receiving benefits. These four-page statements include the worker's Social Security-covered earning history and estimates of future benefits. If there appears to be an error in your earnings record — this seldom occurs — notify SSA immediately.

[CAUTION: Under the legal statute of limitations, Social Security cannot be required to correct mistakes older than three years. After that period, it will be very difficult to correct mistakes in your record. Therefore, it's a good idea to check your earnings statement at least every three years.]

The actual amount of your retirement check will vary by your average earnings, the number of years you worked under the system and the age at which you begin collecting benefits.

Also, don't forget that Social Security benefits are fully indexed for inflation. The annual cost-of-living adjustment (COLA) guarantees that your last Social Security check will have exactly the same buying power as your first — a rare and valuable benefit. 

 

Est. Monthly and 1st Year Social Security for a Person Born in 1941 at Full Retirement Age (2006)

 Salary in Year Before Retirement

  Monthly

 First Year Social Security Income

 Approximate Replacement Ratio

 $20,000 

 $744 

 $8929 

 45% 

 $30,000 

 925 

 11,100 

 39% 

 $45,000 

 1,194 

 14,328 

 33% 

 $60,000 

 1,463 

 17,556 

 27% 

 $80,000 

 1,742 

 20,904 

 23% 




Work after retirement

If you continue working in covered employment after you begin receiving benefit checks, you may be subject to an Earnings Limitation for Employees. A law passed in 2000 ended the Social Security earnings limitation for persons once they reach full retirement age. For persons under that age receiving benefits, the limitation in 2006 is $12,480. Under current law, this limitation is scheduled to rise in future years.

Those under 65 who exceed the earnings limitation in any year are subject to $1 reduction in benefits for each $2 of earnings over the limitation.

Taxation of Social Security benefits

For retirees with higher incomes, a portion of Social Security benefits is included as taxable income. This applies if a person's adjusted gross income, plus nontaxable interest and half of Social Security benefits, is more than a base amount: $25,000 for an individual or $32,000 for a couple.

The portion of the benefit subject to income tax will be whichever is less: 50% of benefits for the year or half the excess of the person's income over the base amount. If income as described above is more than $34,000 for an individual or $44,000 for a couple, 85% of benefits may be taxable.

People who get Social Security benefits should keep a record of benefits received to make figuring taxes easier.

Social Security's Government Pension Offset and Windfall Elimination Provision

In certain states and localities, public employees are not covered by Social Security. Some of these workers, however, may be eligible for a Social Security spouse or widow's benefit based on the covered employment of a husband or wife. Others may be eligible for Social Security based on pre- or post-government employment.

If you fall into any of these categories, be aware that you may be subject to Social Security/pension offsets that could significantly reduce your expected Social Security benefit. You will want to contact SSA to determine how the GPO (spouse offset) and/or WEP (employment offset) will affect you.

 

Retirement pension options

Nearly all AFSCME members can expect to receive an employer-sponsored pension if they participate in their plan for a minimum number of years. This minimum – called the vesting period – varies from plan to plan. It generally ranges from three to ten years.

Most public-sector pension plans provide for benefits to be paid in monthly installments over the course of retirement, along with a death benefit that's equal to the amount of a worker's contributions to the plan (if any), less the total of monthly pension benefits paid out before death.

In order to ensure that monthly payments will be paid to a spouse or other beneficiary after death, a worker must select an optional form of payment before retiring. If you select such an option, your benefit payments will be reduced during your retirement so that funds will be available to pay your survivor when you die.

It is vitally important to know how soon prior to your retirement you should notify the plan of your intention to choose an option. That's because most plans have something called an "option election period" or waiting period on options. This period may vary from six months to three years prior to the expected retirement date. If you fail to make a timely selection of an option, you may either be denied the right to select an option or you may be required to produce evidence of good health before selection is permitted.

If you select an option in a timely fashion, most plans will permit you to cancel the option just before retirement, if necessary. In this case, you may want to consider electing an option as soon as possible, regardless of your present age, in order to protect your spouse or other family members. Check with your employer to learn the rules of your specific plan.

Spousal protection is only one type of option that may be available. The most common optional forms of payment are described below:

  1. Life annuity with no death benefit. Some pension plans that require employee contributions allow employees to increase their monthly retirement benefits by forfeiting the death benefit. When all payments cease at death, the plan is called a "life annuity." Life annuities are also the standard form of pension payment when employers pay the full cost of a pension plan with no employee contributions.
  2. Years certain and life — 5, 10 or 15 years. This pension option guarantees that payments will be made to you as long as you live. If you should die prior to receiving payments for a prescribed number of years, the remainder of the guaranteed payments will be made to your beneficiary. For example, if you select a 10-year option, you will receive a minimum of 120 monthly payments. Even if you outlive the 10-year period, the plan is required to pay you benefits until your death, but your beneficiary will get nothing. On the other hand, if you should die after having received only 100 pension payments, the remaining 20 monthly payments will be made to your beneficiary.
  3. Contingent annuitant/survivor. This option, also referred to as "joint and survivor," provides for a continuation of your pension to a spouse or other beneficiary in the event you pre-decease that individual. Under this arrangement, you would receive reduced retirement payments, but your beneficiary would be guaranteed monthly payments upon your death — amounting to 50%, 66-2/3%, 100% or some other agreed upon percentage of your benefits. These payments would continue for the remainder of your beneficiary's life. If he or she dies prior to you, however, then all payments cease at your death.

Some plans offer a modification of this option if your beneficiary pre-deceases you. In this event, your previously reduced benefits would be restored to full-formula payments.

When you request an estimate of your pension benefit, be sure to furnish the plan with information on your spouse or other beneficiary, and get estimates of what your benefits will be, based on the various options offered by the plan. Remember that you must select an option before payments begin. After your pension benefits start, an option can be neither elected nor changed.

Estimating your pension income

If your pension is a percentage (x%) of your final average earnings (FAE), you can estimate what your pension will be at your normal retirement date as a percent of your gross pay.

Many public employee retirement systems use the following formula to calculate pensions:


x% x FAE x years of credited service=annual pension
Again, check with your employer to find out how benefits are calculated under your pension plan.

 

Sources of supplemental income

You'll need to determine whether your currently expected monthly retirement income will cover your expected retirement expenses. If you find that you probably won't be able to meet your expenses, you may want to consider alternative ways of supplementing your expected income.

For example, you may find that Social Security income plus pension income will provide you with $1,600 monthly, but you have estimated that you will need $1,900 monthly. You will need to supplement Social Security and pension income by $300 monthly, or $3,600 yearly. If you will need this supplement for 20 years, it will come to a hefty total of $72,000.

Of course, any supplement you need might come from a variety of sources, including your savings, your investments, part-time work and so on. You may have non-cash assets you could convert to cash if necessary. For example, a life insurance policy with a monetary value could be converted to a monthly retirement annuity.

Each person's situation is unique. You currently may have very few sources of additional income. If you need to create more assets and develop supplemental retirement income, here are some alternatives to consider.

  1. Increased savings: Perhaps it would be possible to increase your savings each month, in order to enlarge your retirement nest egg. Many employers offer workplace savings plans, such as 457 or 403(b) plans, that allow your nest egg to grow tax-deferred. This means you won't have to pay taxes on your investment and interest until after you retire. These plans generally offer a variety of savings and investment vehicles, depending on your tolerance for risk.
  2. Employment of spouse: In some cases, one spouse — usually the wife — does not now have a paid job or is not working on a full-time basis. Consideration could be given to finding paid employment or switching from part-time work. The additional earnings could be used to increase the nest egg available for retirement.
  3. Work after retirement: Many individuals supplement their retirement income through work. It may be part-time as an employee, a hobby that has been turned into a small but enjoyable business, or any one of numerous other possibilities. Be sure to plan ahead, however. Employment opportunities should be thoroughly explored well before you retire.
  4. Better financial management and investing: Perhaps you are too conservative in your current savings habits. There are many relatively safe investments that a person with an average income can make in order to obtain higher returns.
  5. Borrowing on your life insurance policy: Many people have life insurance policies with a savings feature as well as a death benefit. Generally called "ordinary life" or "whole life" insurance, this type of policy often allows the holder to borrow some of the value of the policy at low interest rates. This money can then be reinvested or used for cash emergencies. The other standard form of life insurance, called "term insurance" has no savings feature and cannot be borrowed against. It provides a death benefit, however, that can be important if others depend on your income.
  6. Using the equity in your home: Often people are able to borrow against their home, or use what is termed a "Reverse Annuity Mortgage." In other instances, retirees sell a home that may be larger than they need for retirement and use the proceeds to purchase a smaller home and provide some needed cash. Factors to consider in using the equity in your home are included in Section V of this handbook.

 

Inflation: a major problem

One of the biggest problems in planning retirement finances is price inflation — the continuous increases in the cost-of-living over the years. Many wonder how financial planning is possible when future costs and income levels seem so unpredictable. Even relatively low rates of inflation can cause prices to more than double in the 15-20 years most of us can expect to be retired.

For example, if the annual inflation rate is 4%, the purchasing power of your income is reduced by 50% in 16 years. In 30 years, the purchasing power of that income is reduced by 75%.

No one, of course, can forecast future prices and income levels. However, it is possible to take steps to avoid some of the financial difficulties inflation can cause.

Purchasing power and retirement planning

Preserving or building purchasing power for retirement means that savings and investments should produce an after-tax annual return or growth that equals or exceeds the annual rate of inflation.

If the current rate of inflation is 4% annually, then the money you are saving or have invested is:


Of course, it's not always easy to stay ahead of the current inflation rate. An investment that is producing a return that exceeds the rate of inflation today may have a lower rate six months from now. This is why experts recommend that savings and investment programs be periodically reviewed.

How inflation affects retirement income

Financial planning, as we've already stressed, should result in maintaining or improving the purchasing power of your money. Being able to retire with the assurance of adequate purchasing power for the next 10, 20 or 30 years is important. Here are some typical sources of retirement income and a description of how they are affected by inflation:

Social Security: By law, Social Security benefits are tied to increases in the Consumer Price Index (CPI). If a person's Social Security benefit is $850 a month at the time of retirement, that amount will be adjusted each year with full cost-of-living ajdustments (COLAs). In other words, the purchasing power of the benefit remains exactly the same from the very first check to the very last.

Pension Plans: The majority of pension plans provide a fixed payment — that is, the same amount of money each month for the life of the retiree. But some employers agree to increase pension amounts as the cost-of-living rises – either through periodic adjustments (requiring legislative action each time) or automatic annual cost-of-living adjustments. Even the latter, however, are almost never full COLAs. They are generally capped at a certain percentage (commonly 3%), regardless of how high inflation may rise in a year.

Annuities: A "fixed" annuity guarantees a fixed income for a specified period, such as 10 years or life. A person may purchase an annuity that pays $200 a month for life beginning at age 62. If the person lives until age 92, the $200 would be paid monthly for the entire period. There would be no adjustment for changes in the cost-of-living over the 30 years. There are also "variable" annuities that vary the amount of income with changes in living costs. These are usually much more costly.

Savings and other investments: Savings accounts and some forms of investment tend to pay a fixed- percentage rate of interest. Keep in mind that if the annual rate of return (the yield) is less than the inflation rate, the purchasing power of these savings and investments will be eroded over time. Stocks and commodities often deliver the highest rates of return in the long term. As a result, these types of investments may turn out to be a good hedge against inflation. But they also carry higher risks, which must be recognized by any potential investor and weighed against potential returns.

 

What's an "Investment"?

Investment. Here's a good, basic definition of the word: An investment is an outlay of money to produce income or profit. It's simple language, but it fails to clear up much of the confusion about the where, when and why of investing. You owe it to yourself to find out what investment options are available — so you can make educated choices about what will be best for you.

All of us are investors of one sort or another. Some invest through savings bonds, an account at the local bank or credit union, or equity gained by buying a home. Others put money into stocks, bonds, precious metals or similar investments.

Though we are all investors, many of us are not getting as much as we can out of our investments. Perhaps we are not sure about certain types of investments: Are they really safe? Can we believe the promises being made? These are realistic concerns that sometimes cause us to stay away from good savings and investment opportunities.

The key to bettering yourself financially is to gain some understanding of the alternatives available to you. By first reading up on basic terminology and investing concepts, you'll be in a better position to understand and evaluate advice you get from experts.

Financial experts may include someone at your local bank, a benefit specialist with your employer or union, insurance agent, stock broker, savings and loan officer, credit union manager and so on. While they can be excellent sources of information, their recommendations or information should never automatically become your decisions. Keep asking questions and getting information until you feel you understand the facts. Then you will feel confident to make educated choices.

Financial Planners

When considering the services of a professional financial planner, keep in mind that there are different types. Some financial planners charge a flat fee for their services. Others collect a commission on the products they sell (and may be tempted to push investment products that pay higher commissions). Some do both.

Financial advisors often specialize. Be aware that these specialists tend to be biased toward, and advocates of, their specialties. The stock expert is likely to recommend investment in stocks; the insurance expert will probably suggest strengthening your insurance program (with whole life policies and annuities).

When the experts work for stock brokerage firms or insurance agencies, they will probably try to sell the investment products marketed by their companies.

Independent planners that charge a flat-fee for their services are not connected to a specific brokerage firm or insurance agency, so they are not trying to sell the products of any one company. For a list of such planners in your area, contact the National Association of Personal Financial Advisors at 1-888-333-6659. For a list of independent planners that include those who receive commissions, call the Financial Planning Association at 1-800-PLAN (7526) or check its website (http://www.fpanet.org/)

Ultimately, each investor must make his or her own final decisions, balancing the often-conflicting advice of some of the experts. There are many investment options to choose from and you should feel comfortable with the decisions you make.

Questions a Financial Planner Should Ask


REMEMBER: The people who represent themselves as financial experts have the obligation to communicate the facts, pro and con, in a way that is clear, accurate and understandable to the average person. Some have great communication skills; others do not. If necessary, shop around to find advisors you can talk to easily.

Clarifying Your Objectives: Balancing Risk and Return

In general, a higher return goes hand in hand with a higher risk. You'll need to minimize your risk if you feel that you cannot afford to lose the money you are investing. If you wish to take almost no risk, be prepared to receive a lower return on your investment (such as you might get with passbook savings or a Certificate of Deposit at a bank or savings and loan).

Whatever the amount of risk you are willing to take as a younger person, reducing risk as you get older and closer to retirement is usually a good idea. Keep in mind that the facts of your specific situation are most important in considering how much risk you can reasonably afford.

Income Versus Growth

You can look at an investment as a means of producing either current income or growth in your "capital" (the amount for which you can sell your investments). Usually, you need to give up one in order to get the other.

Growth-oriented investments, such as stocks, generally involve more risk than income-oriented investments. Some people invest their money in some of both to balance income and growth and to control the amount of risk taking.

A good general strategy is to: (a) grow as much capital as you can before you retire, since the more capital you have, the more income it will produce in retirement; and (b) begin switching from capital growth investments to income-producing investments about five years before retirement, so you have time to pick and choose the best income producers at the most advantageous times.

Liquidity

This is a term you need to know because financial specialists use it a lot. Liquidity refers to how fast you can convert an investment into cash if you want to do so. For example, a U.S. government bond is considered "very liquid" because you can redeem it for cash by simply taking it to a bank. On the other hand, an investment in real estate is usually not very liquid. It may take months to sell a piece of real estate before you can get your money.

Liquidity is good, since it allows you to convert an investment to cash whenever you want. However, if you wish to have high liquidity, you will generally have to settle for a lower return. For example, if you keep money in a passbook savings account, you can convert it to cash quickly. Your money will also be earning the lowest interest rate paid by that savings institution. A Certificate of Deposit can pay a much higher return, but it is less liquid than a passbook savings account because it must be invested for a set period of time.

Taxation

Did you know that the income from some investments is not subject to federal or state income tax? Did you know that some other investments are taxed at a reduced rate, or do not require tax payments until some future date?

Taxes take a big bite out of most people's income. When you make out your federal (or state) income tax return, the percentage used in calculating the amount of tax you owe is your "tax bracket." If a married couple is in the 25% federal income tax bracket, for example, the couple will have to pay a 25% tax on any additional taxable income. Any additional non-taxable income, though, is free and clear.

Here is a comparison of the income to the investor from both a taxable and a tax-free investment, using the identical rate of interest.


 

 Taxable Investment

 Tax-Free Investment

 Amount invested

 $6,000 

$ 6,000 

 Annual rate of return

 8% 

 8% 

 Annual income from investment

 $480 

 $480 

 Less federal taxes (25%)

 -120 

 -0  

 Net return

 $360 

 $480 



You can see from this example that income taxes are an important factor in considering investment possibilities. Potential investors should be aware, however, that tax-free investments generally carry a lower rate of interest than those subject to taxation. Still, for someone in the 25% tax bracket, it would take a taxable interest rate of 8% a year to equal the return on a tax-free interest rate of only 6% a year. Since the return will vary with the investor's tax bracket, be sure to compare rates of return based on your own tax bracket before investing tax-free.

A "net" return — the after-tax return — should equal or exceed the rate of inflation; otherwise, you are losing ground financially.

Putting Your Objectives Together

We have identified the major categories of financial objectives that you need to think about. These are:

  1. Degree of risk or safety.
  2. Growth of your fund versus income.
  3. Amount of liquidity.
  4. Tax advantages.


Since no investment is perfect, you need to be able to answer the question "What are my specific objectives in each of these four categories?" Of course, each individual's case will be different.

Investment Vehicles

These are a few of the more common types of investments:

  1. Passbook Savings: These regular savings accounts involve little risk if guaranteed by a government agency (the Federal Deposit Insurance Corporation – FDIC - guarantees most bank accounts up to $100,000). Earnings take the form of income, but interest rates tend to be relatively low. You can get your cash out quickly, but the interest earned is subject to same-year taxation. This is true even if the interest earnings are left in the account.
  2. Buying A Home Or Other Property: There are many tax advantages to real estate investment. Risk can vary, however, depending on the specific property and its location. While return can be high, economic conditions do affect the real estate market. Some homes may offer only a modest return. Liquidity varies, since it could take months to sell a property.
  3. Stocks: When you buy stock in a company, you are buying part ownership. Income or growth in the value of your stock will depend on company profits. How much of your savings should go into the stock market? That depends on how much risk you are willing to take, since stocks can carry a relatively high degree of risk. Some experts offer this guide: The percentage of long-term savings that you can afford to keep in stocks equals 100 minus your age. For example, at age 30, you can afford to keep 70% of your savings in individual stocks or common-stock mutual funds. At age 48, however, only 52% should be in stocks. The theory is that, as you get closer to retirement age, the percentage of your money that is in riskier investments should be steadily reduced.
  4. Bonds: When you buy a bond, you are lending money to the issuer of the bond. Companies issue bonds and so do governments. The issuer promises to pay you a fixed rate of return on your investment, such as 6% per year. Risk will vary. Essentially, a bond is an IOU, and it must be paid back to you on a specific date. There are many types of corporate bonds and government bonds, and many municipal government bonds are tax-free.
  5. Certificates of Deposit (CDs): A Certificate of Deposit is a special kind of savings account. If you agree to leave a certain amount of money in a savings account for a given period of time (such as $5,000 for 18 months), the savings institution will guarantee you a specific rate of interest. These are called Time Deposits, and they generally offer higher interest rates than passbook savings accounts. The savings institution will issue you a Certificate of Deposit that describes your deposit arrangement. Investment rates vary by type of certificate and length of time you agree to leave your money in the account. Penalties are generally charged for early withdrawal. These accounts are usually government-insured up to $100,000.
  6. IRAs: Individual Retirement Accounts, IRAs, allow you to invest in a variety of options—mostly stock and bond mutual funds. Depending on the option you choose, safety and growth can vary widely. There are two basic types of IRA: traditional and Roth. In a traditional IRA, contributions to an account are tax deductible. The interest accrues tax-deferred, meaning taxes don't have to be paid until retirement, when tax brackets may be lower. In a Roth IRA, contributions are not tax deductible, but the income earned from the account is free of all taxes at time of withdrawal. Both types of IRAs limit the amount of annual contributions, set minimum ages for withdrawal, and require payment of significant penalties if funds are removed early.
  7. Mutual Funds: Mutual funds, which pool the resources of a large group of investors, are a way of buying stocks, bonds, real estate or other securities. Benefits to buying securities through a mutual fund include the services of a professional fund manager, who purchases a variety of stocks or bonds for the group. There's less risk than with individual stocks because the fund is diversifying your holdings. There are enough different types of mutual funds to match almost anyone's investment objectives.
  8. Riskier Investments — Precious Metals and Commodities: Some people invest in precious metals, such as gold and silver. These investments can be very risky, because their value can fluctuate wildly. So be sure you understand the risks ahead of time. You also take a chance with commodities. These are generally agricultural products such as wheat, coffee or potatoes. A person signs a contract to buy a specific quantity, at a given price, at a set time in the future. He or she then tries to sell the contract at a higher price, before the deadline for purchase. But remember the risk involved: some traders have had to take delivery of carloads of goods, as they could not sell their contracts in time.
  9. Payroll Savings: Many employers have special payroll savings plans for employees, often known as 457, 403(b) or 401(k) plans. These are similar to traditional IRAs, but tend to have even better tax advantages. Payroll savings plans are an excellent way for working people to invest for retirement. Your employer's benefits administrator will be able to explain a plan's tax advantages and investment options.


The rule of 72

The Rule of 72 is a simple way to find out about how long it will take to double your investment. Assume that the investment's earnings are paid annually and re-invested in the same account. Simply divide the number 72 by the investment's interest rate.

For example, if you put $1,000 in an investment that pays 8% interest, divide 72 by 8 and you'll see that it takes about nine years to double that investment.

The advantage of starting early

It pays to start saving early. If you contribute $1,000 a year for just 10 years to a tax-deferred IRA or employee savings plan, starting at age 21, your nest egg will grow to $137,858 by the time you reach age 65. But if you wait until age 41,and then contribute $1,000 a year until age 65, you will have only $58,176 – even though you invested nearly two-and-a-half times as much money for almost two-and-a-half times as long. Both examples use an annual interest rate of 7%.

 

Addressing legal issues

Legal Documents and contracts

For most everyday legal matters, you don't need the services of a lawyer. You've probably signed insurance applications and taken out loans without legal expertise. There are certain situations, however, where it is too risky to act as your own lawyer; this section will discuss some of those circumstances.

Keep in mind that if your signature is required on a form, it is probably a legal document or contract of some sort. Before signing any contract, there are several rules that you always should follow:

 

Getting help from a lawyer

Whenever you are signing a document involving a lot of money or a risk of significant liability (which could result in a lawsuit), or establishing a trust or making a will, you may want to consider using a lawyer.

A "do it yourself" will or trust is a difficult undertaking and probably shouldn't be left to chance. By employing a professional, you will gain security from knowing that everything will go according to plan after your death.

One of the first steps in finding an appropriate lawyer is to get suggestions from friends, relatives, or your local bar association. When someone you know suggests the name of a good lawyer, you should ask for specifics, such as:


Before you decide to hire a particular lawyer, arrange to interview him or her. If you are considering a "legal clinic" (many of which are low cost or even free), visit the clinic and talk to one of its representatives before making a final decision. Talk services, fees and schedules with the lawyers you interview. The relationship between you and the lawyer that you select should feel comfortable.

 

Estate planning: your will and your heirs

Do you have an estate? Most likely, you do!

A person's estate consists of everything he or she owns, minus what is owed. Your estate might include a home and furniture, a car, personal items such as jewelry, some savings, one or more insurance policies, and similar items of value. Many individuals are surprised to learn that they have estates that exceed $100,000, $200,000, or even more.

What is estate planning?

Estate planning is the process of deciding what you want to happen to your estate and taking the action necessary to insure that these wishes are or will be implemented. The purpose of an estate plan is to insure that what you own will be passed on to loved ones in the manner you wish without too much of the estate going to pay for death taxes and probate costs.

Since a person can begin to pass on an estate while he or she is still living, thus reducing the tax bite for heirs, estate planning is a lot more than preparing a will, which takes effect only after a person dies. Once you have a clear picture of what your estate is, you may want to ask your lawyer about possible ways to start distributing assets in your lifetime, using such vehicles as trusts and gifts.

Before an estate can be settled and its assets distributed following your death, it must first be reviewed by the probate court. This process often takes six months to a year, so estate planning should include such provisions as emergency cash, insurance that pays directly to survivors, joint bank accounts that carry survivors' names, and other devices that will assure survivors of needed income before they can take possession of your estate.

What you should know about wills

A valid will is basic to effective estate planning. You've probably heard a thousand times that "everyone needs a will." No one likes to think about making a will because it reminds us too much of the end, but it is really a great gift to survivors, since it can eliminate many problems they may be unprepared to handle or should not have to face.

A will is an official declaration of how a person wishes to have property, cash and personal items distributed at death. A will may also be used to name someone to serve as your estate's executor (the person who oversees the distribution) or as the guardian of any minor children.

Most things you own can be passed to another by a will, but there are a few exceptions:


Dying without a will

If a person dies without a will, the probate court will appoint an administrator for the estate and, in the event there is no surviving spouse, appoint a guardian for any minor children. The assets of the estate will then be distributed as specified by state law, regardless of the situation of each dependent or relative. If a person leaves no heir or next of kin, his or her property will be forfeited to the state.

How to make a will

Each state has laws setting forth the formal requirements that must be met before a will becomes legally effective. Such laws generally require that:


Cost of Preparation

Simple wills usually cost between $100 and $400. If the provisions are complicated, or if you are not totally prepared with all the information you need about what you want to pass on and to whom, the cost can be higher. The taxes and probate costs that may be saved and the knowledge that your assets will be distributed according to your desire may more than offset this expense.

Keeping It Safe

The will should be kept in a safe place where it can easily be found by the executor. Be aware that safe deposit boxes are sealed, in many states, upon the death of their owners, and can only be opened either after their contents are inventoried or by court order. For this reason, it is best to keep an original of the will in an attorney's safe and to give another original to the executor. Keep a third original at home for access by beneficiaries.

 

Additional legal considerations

If your estate is fairly large, you should discuss estate taxes with your lawyer.

Resources

There are many resources available on financial planning and estate planning. Here are some that you may find helpful:

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