Q-and-A With Jonathan D. Pond: Family and Money Issues
By: Jonathan D. Pond | Source: AARP.org | February 17, 2009
I am a college senior and set to graduate this June. I landed a great job at a top-tier firm for next year. I recently had a conversation with my father about the family's finances. His business is not doing as well as it was with the economic crisis. My mother is a teacher, and with the budget crisis in California, that's hardly secure. My parents are in their mid-50s. From our discussion, I don't believe they have saved nearly enough for retirement. They have spent all their income providing a great life and a great start for me and my three siblings, including private school and college for all of us.
I want to start to save and invest some money and give it to my parents when they decide to retire (or need it). I can't simply give them money now, because it would embarrass them. What is the best way to save for your parents' retirement? Are there any tax-advantaged ways of saving, not counting tax-advantaged mutual funds? Are there any plans or government subsidies like IRAs? Should I just buy a major brokerage Target 2020? –Charles, California
Charles, you are the child every parent dreams of, and I’ll certainly show your letter to my three daughters.
There are a number of ways you could help your parents financially, ranging from setting money aside in a brokerage or savings account in your name to be used later on as needed to making annual gifts to them if their situation becomes dire. The current annual limit is $13,000 per recipient.
But before you set aside money for your parents, give them the satisfaction of knowing that you are making progress in your own financial future. If your own “savings portfolio” (an emergency fund, retirement account, debt reduction, etc.) is off to a good start, you will be on your way to achieving financial independence. That’s one less financial concern for your parents. You’d be surprised at the number of retirees who are burdened financially by providing support to their children.
Finally, don’t dwell on your parents’ current financial challenges. Many parents who have invested in their children’s upbringing and education find themselves in straits similar to your parents. But once the children leave the nest, they can make great strides toward their own retirements. The greatest financial gift you and your siblings can give your parents is becoming financially self sufficient.
Jonathan, would you be kind enough to write me a little note that I could pass on to my aunt Kitty? She has about $20,000 in her annuity and 401(k), is already retired with $1,900 in monthly income. She has given much of her savings to her grandsons and continues to think she will not need any money in the future. She is 63. I have asked and asked her to save. She basically lives like a bag lady. She just recently sent $4,000 to the boys, who are in their 20s, instead of getting her teeth fixed. Is it wrong for me to want more for her? I don't want to be the one to have to support her down the road. –Karen, North Carolina
Karen, you are to be congratulated for your concern about your aunt’s misguided generosity. Unfortunately for her and many others, the impulse to help needy family members in the younger generation can cause older relatives to lose sight of the importance of providing for their own secure financial future. It’s one thing to help out a family member in genuine financial need if you can easily afford to do so. But all too often, whether affordable or not, this can lead to an ongoing transfer of money.
After all, if the recipients begin to rely on regular cash infusions from other family members, they have less incentive to take the actions necessary to become financially independent. This may sound insensitive, but the long-term budgetary implications of this generosity can be significant. Financial planners tell me that they commonly encounter seniors who are struggling financially because they have given far too much of their money to younger family members. Once the pattern is established, it can be difficult to curtail.
Your aunt has worked for decades to get to a position in which she can manage a modest lifestyle. But she’s not thinking about the future. The foregone dental work could cause serious—and far more expensive—problems later on. While she thinks she can get by on her monthly income alone, it will probably lose ground to inflation. At age 63, there’s a good chance that her cost of living, even living modestly, will more than double later in life. Unexpected expenses, like the dental work, inevitably arise in retirement. If she gifts away her retirement nest egg, there will be no cushion.
Young adults often complain that they have little or no money. In fact, they have an abundance of the most valuable asset there is: time—time to earn and time to save. Your aunt, like all retirees, has neither.
I would appeal to your aunt Kitty’s pride of being independent. The best thing she can do to avoid herself becoming a burden on her family is to become a good steward of her resources.
What do you see as the best investment choices for my 401(k)? I am 58 and plan to retire at age 66. –Sandra, Ohio
Making the most of your 401(k), which for most working-age persons will be their single-largest investment account, is always a challenge, but that is even more important amidst the economic turmoil. Here are four considerations to help you make wise 401(k) plan investment choices:
- Evaluate fund performance. Rare is the 401(k) plan that offers consistently outstanding funds. Usually, there are some stars and some duds. Some offer many more duds than stars. But whatever the situation with your plan, you should invest your 401(k) money in the better-performing funds. You can always round out your investments by investing in a particular fund category in your IRA or other investment account in sectors in which your 401(k) plan is lacking. For example, if your 401(k) fund has poorly performing small cap stock funds, don’t waste your money investing in small cap stocks inside the plan. Instead, invest in a top-notch small cap fund in another account—an IRA account or your spouse’s retirement plan, for example.
- Avoid a common 401(k) plan trap. While most employees don’t realize it, most 401(k) plans and other workplace retirement-savings plans offer primarily stock mutual fund choices. It’s not unusual for 80 percent or more of the choices to be stock funds. Many plan participants think they’re well diversified if they spread their money among a variety of funds in the plan, but they end up with far too much money invested in stocks. As a result, employees report that they have lost as much as half or more of their workplace retirement-plan money as a result of the stock market meltdown. In essence, they had far more money invested in stocks than they had imagined. To avoid this trap, pay more attention to how your money is allocated between stock and interest-earning fund choices rather than simply putting money blindly into a bunch of stock funds—investments could result in further big losses if the stock market continues to stumble.
- Consider all-in-one funds. All-in-one investments are the perfect antidote for investors who are concerned that they’re going to make mistakes in their investing, especially when the investment markets are so troubling. All-in-one investments are available in an increasing number of 401(k) and other workplace retirement plans. They allow you to invest money in a single fund that diversifies across several important investment categories. These “set it and forget it” investments are ideal if you don’t want to be bothered with the chore of selecting and monitoring your investment holdings. All-in-one investments hold mutual funds with solid performance histories or individual stocks and bonds that are actively managed. They also regularly and automatically rebalance your holdings, so you avoid the temptation to keep pouring more money into hot investment sectors. The main attraction, though, is the simplicity of a single, all-purpose fund, as opposed to your having to pick from among a long list of retirement-savings plan choices. Here are the two kinds of all-in-one funds that are prevalent in workplace plans:
- Lifestyle funds diversify your money across several investment categories according to how comfortable you are with investment risk. They are usually offered as a series of mutual funds under such names as “income,” “conservative,” “moderate,” and “growth.” Each individual fund is managed using a designated allocation of stocks, bonds, and temporary investments. For example, a “growth” fund would hold a much higher percentage of stocks than a “conservative” fund, which would be more heavily invested in bonds. One of the beauties of lifestyle funds is that if you want to invest a bit less or more in stocks, you can simply move your money among the categories. For example, if you hold a moderate fund but are becoming concerned about stock losses, you could move to a conservative fund that will hold a lower percentage of stocks compared with the moderate fund.
- Target-date funds diversify and gradually adjust your diversification according to a fund’s target date. While most people select a target-date fund based upon the year they expect to retire, they can also move money between target-date funds in order to adjust the overall investment allocation. The closer the target date is to the present, the lower the percentage of stocks that are held in the fund. For example, a typical 2015 target date fund would hold about 20 percent less stocks compared with a 2025 fund.
- You may be able to move out of a poorly performing plan after age 59 ½. It’s really a shame how many workers are stuck with pitiful 401(k) plans. If you’re stuck with a “subprime” plan, one that offers primarily mediocre choices, there may be a glimmer of hope. Many, but not all, plans allow workers who are age 59 ½or over to roll their 401(k) plan investments into IRA accounts of the employees’ choosing while continuing to participate in their company’s 401(k) plan. If you have a poor plan and you’re comfortable with the greater number of choices available in an IRA, when you reach age 59 ½, ask your plan administrator whether or not the plan allows you to do an IRA rollover.
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