Costco Connection - November 2006

FINANCIALconnection

Advice on saving
for retirement
AskSuze
Orman

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Suze Orman’s latest book is The Money Book for the Young, Fabulous & Broke. The Suze Orman Show airs Saturday nights on CNBC. Suze can be contacted at www.suzeorman.com.

I am a senior and can’t afford investment risk. I have been investing in municipals the past few years, receiving a 5 percent tax-free return. But now that rates are favorable on short-term CDs, what return on them would be needed to make them preferable to municipals? Is there a formula? —Joan Coffey, Rockville, Maryland

KIE TH LATHROP

YES, THERE IS a simple calculation that will tell you the taxable equivalent yield you need to earn on a taxable CD to equal what you can earn on a municipal bond. Here’s what you need to know:

1. A = the tax-free yield

2. B = your federal tax rate, expressed as a decimal (add the state rate when applicable)

The calculation is A ÷ ( 1.00 – B).

Let’s run through an example. I will assume that you are in the 25 percent federal tax bracket ( expressed as 0.25) and that you own Maryland municipal bonds, which means you wouldn’t be hit with state tax. Subtract 0.25 from 1.00 to get 0.75. Then divide your 5 percent tax-free muni yield by 0.75, and here’s your answer: You would need to earn 6. 67 percent on a taxable CD to equal the 5 percent you are earning on your muni bonds.

Currently, you can earn about 5. 3 percent on a 10-year CD, so it appears that munis are the better move for you.

A good online calculator that will do the math for you is at www.adviserview.com/calculators/invest/ taxYield_default.asp.

I’m an employee of the U.S. Postal Service (USPS). I’m 45 and can retire at 56, and contribute to a thrift savings plan (TSP), which is employer matched up to 5 percent. I currently contribute 5 percent to the TSP, but can increase that to 15 percent. Should I contribute more to the TSP, or to something like a Roth IRA?

—Debbie Mochan, Wallace, California

GO WITH THE Roth IRA. Your TSP is great, and you’re smart to invest enough to qualify for the full match from the USPS. But as with a 401(k) or 403(b), you will owe income tax once you start making withdrawals from your TSP.

That’s where a Roth makes its mark: While it’s true that you will get no initial tax break when you invest in a Roth, you will not owe a penny of tax when you eventually make withdrawals, assuming you wait until you are least 59¹/2 and have owned the Roth for five years. This year you can invest a full $4,000 in a Roth IRA (it’s $5,000 for individuals over

50 who meet the income requirement: modified adjusted gross income below $95,000 for individuals and $150,000 for married couples filing a joint tax return).

If you invest $4,000 a year for the next five years and then invest $6,000 a year for the six years after you turn 50 (by that time, the contribution limit will rise to $6,000) and we assume you can earn an average of 8 percent a year and will keep the money invested until you are 65, you will have about $195,000 absolutely tax-free.

I also like the added flexibility that comes with a Roth: You can always withdraw any contributions you have made, regardless of your age. That can be handy in an emergency. Also, you will have many more investment options, rather than just the handful of funds available through your TSP.

I have several credit-card bills with balances due from 2000. What are the smart options to consolidate these debts and pay them off?

—Charles Weber, Twin Falls, Idaho

ALWAYS PAY THE MINIMUM amount due on every card by the due date. A timely payment history—even just the minimum amount due—is the single biggest factor in determining your FICO credit score. Then, use any extra money to add to your payment on the card you most recently ran up the debt on. Your newest debt has a bigger impact on your FICO score than older debt.

For example, let’s say you have $300 you can pay each month for all your cards and you need $150 to cover all the minimum payments. That leaves you with $150 more you can put toward paying down the balance. Use that extra money for the most recent debt, such as unpaid balances from charges you made in 2006.

Then when you get that balance paid off, concentrate on the next balance with the next freshest debt, say from 2005.

What’s your take on prepaying burial costs?

—Helen Deiches, Northport, New York

YOU ARE THOUGHTFUL to want to take care of these costs now. But I don’t like the prepayment route. You give up way too much money now for a service I sure hope you will not need for years.

I think it is smarter to keep the money invested in a safe savings account where you—not the funeral company—can earn interest. Then you can leave instructions in your will, and trust that this money will be used by your heirs to cover your funeral costs. C