How do I figure out whether I’m saving enough for retirement?  What’s the impact of one bad year in the stock market?  How much can inflation erode my nest egg?

These are the types of questions that can be addressed by financial modeling.  I’ve written a program that lets you enter data for two people (presumably you and your significant other), and it calculates the probability that you will have enough money to last both of you.

You can use Quicken or other retirement calculators, but they usually do not include a Monte Carlo simulation.  Monte Carlo does not mean you take your life’s savings to Monaco and let it ride on roulette red.  A Monte Carlo simulation is used to model systems that have some random elements and for which the outcome can’t be expressed by a simple formula.  The return on your investments fluctuates from year to year.  Low investment returns are worse if you are close to retirement than if you are just starting out.  So the timing of the market highs-and-lows relative to your time-to-retirement is an important factor.  A Monte Carlo simulation calculates a lifetime of savings and expenses, letting the investment returns vary.  Then it repeats that calculation many times, simulating many possible lifetimes. Continue Reading »

There are three types of retirement investment accounts for employees: 401(k), Roth IRA, and the traditional IRA.

If your employer offers a match to your 401(k) contributions, then your first priority should be to contribute enough to the 401(k) to maximize any employer match. For example, your employer may offer to match 50% of the first 6% of your salary that you contribute. If your salary is $50,000, and you contribute 6% ($3,000), your employer will match half, or $1,500, for a total of $4,500 in your retirement account. You don’t pay income tax now on either the contribution or the match, but you will when you take it out (plus any gains) during retirement. The idea is that you’ll then be in a lower tax bracket, so you save on taxes. (I’m not sure I believe we’ll be at a lower tax bracket in retirement, but I’ll leave that argument for another post).

Fewer companies are matching these days, and it may be a benefit on the way out, but as long as it’s there, take full advantage of it — it’s free money.  Continue Reading »

If your employer offers a match to your 401(k) contributions, then your first priority should be to contribute enough to the 401(k) to maximize the match.  Fewer companies are matching these days, and it may be a benefit on the way out, but as long as it’s there, take advantage of it.  It’s free money; don’t leave any on the table. Continue Reading »

Congress passed a law at the end of 2008 letting seniors off the hook for mandatory withdrawals from IRAs in 2009.  Normally, seniors 70 1/2 and older are required to take part of their money out of the IRAs each year (so that Uncle Sam can get his cut).  Failure to do so levies a hefty penalty of 50% of the amount that was supposed to be distributed.  But at least for 2009, seniors won’t have to worry about it.

Article in USA Today

It’s a good time to convert an IRA into a Roth, if you have the cash to pay the tax.  This is true for two reasons: 1) the value of the IRA is deflated (since the market is so low) and 2) tax rates are likely to go up (this is just my humble opinion since someone’s gotta pay for bailing out the bankers).

Converting your IRA into a Roth is considered a distribution, and adds to your taxable income, so don’t get too crazy and convert the whole thing, or you’ll end up in a higher tax bracket.  Consider converting a chunk – say, $10k or 20k – this year and perhaps more the next year, if the market is still down.  If you’re in the 28% tax bracket, you’ll owe $2,800-5,600 in tax in 2009, so this is not exactly cheap, but since the Roth grows forever tax-free, you may save in the long run, if the market recovers significantly.

If you expect to retire in a substantially lower tax bracket, then this is probably not a good strategy for you.  It works best if you happen to have a low income year, but that also makes it a tough year to pay the tax.  At any rate, you may want to consult a financial advisor to see if this makes sense for you.  There are income limits for IRA conversion that are currently scheduled to disappear in 2010.

IRS pub 590  IRAs