Last week Kiplinger's Personal Finance magazine and the National Association of Personal Financial Advisors (NAPFA) teamed up to offer free financial advice to thousands of Americans both by phone and online. Pretty exciting stuff, and I didn't want to miss out.
As a NAPFA Advisor, I volunteered to field questions in their online chat room for one hour. From 10:00-11:00am Pacific, I took questions like rapid fire. If you want to see the questions that I got and the responses that I gave, go to the Kiplinger site, click on "show all 93 entries" and scroll down about halfway. When you see questions answered by "Eric" you found me.
It was pretty exciting. The questions were thought provoking and challenging. I definitely would have gone into more detail given the time on a couple of them. I'll give you an example of one of the more interesting questions:
Gary: I have a mixture of standard IRAs, rollovers, a SEP-IRA, Roth IRAs, 403Bs, and brokerage accounts and am considering moving as many as I can into target funds. However, I know I can't put them all in one fund because of the tax considerations when I start taking distributions. What is the logical way to make this transition to target funds?
Here was my response:
Eric: Gary, your age and your risk tolerance are important here. However, without that, I will give you my answer that is not necessarily the most simple, but how I would approach it. Look at the accounts not as SEPs and 403b, etc., but as how they are taxed. They are taxable (brokerage), tax-deferred (IRA, Rollover, SEP, 403b), and tax free (Roth). Only the tax-deferred accounts have mandatory withdrawals, and those w/ds are fully taxed at your ordinary rate. The brokerage is currently taxable, but long-term cap gains and qualified dividends are taxed at a lower rate. And, if most target funds have low turnover, meaning that if you don't sell for a long time, you will effectively defer much of the taxation. The Roth is the best from a tax perspective. No mandatory w/d, tax free when you do take it out. I know the point of target funds is to pick a date, and apply it to everything, but that's not how I would do it. I would determine an overall allocation that makes sense for you, and put the most growthy allocation in the Roth, next most growthy in the brokerage, and the least growthy (most fixed income) in the tax deferred accounts. As I said, not the simplest way, but the most tax efficient way in the long term.
One of the things that was annoying was that I was not allowed to create more than one paragraph per response. So, this gets admittedly hard to read. But I scratched the surface with his tax considerations, and some cross account allocation issues. But I really had to approach the question with the premise that Target funds were the right investment for him. In fact, I could certainly make the argument that they are not.
Overall, I had a blast. The hour flew by, and I actually wished I could continue to field questions. But that's where you come in. I'm more than happy to answer reader questions about financial planning, investments, insurance, estate planning, retirement planning. The answers will be posted publicly, but your identity will remain anonymous. So, fire away!
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