February 28, (k) plans. IRAs. Roths. They all shield retirement money from taxes. But they aren't all the same.

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1 Personal Finance February 28, 2000 Shelter vs. Shelter 401(k) plans. IRAs. Roths. They all shield retirement money from taxes. But they aren't all the same. By JEFF D. OPDYKE There are more options than ever for sheltering your retirement cash from the tax man. How do you pick the one that works for you? If you're like Laureen Delaney, a 38-year-old advertising rep in Waltham, Mass., your retirement nest egg is spread across an abundance of accounts: a company-sponsored 401(k) plan, a rollover individual retirement account from a previous job or, maybe, a traditional IRA you've had for years. You might even have one of the new Roth IRAs. In short, you have a fistful of money in a gaggle of retirement accounts. But have you ever stopped to think how that money is invested? Sure, these accounts all offer certain tax advantages that have made them immensely popular and a fixture on the retirement scene. But the advantages, and the structure of the accounts themselves, differ slightly. Thus, to build the biggest buck while avoiding the most taxing bang, financial planners say, investors should step back and take stock of how they've allocated assets for their gray years. "I see people with accounts all over the place, and they're trying to figure out what goes where and if they're properly allocated," says Michael Rubin, vice president of the tax and financial-planning department at New York's Bessemer Trust Co. Mr. Rubin knows the situation well; he's a member of the gang, with a

2 profit-sharing plan, a Roth IRA, a rollover IRA and a traditional IRA. "I've got them all." Lucky for him, he deals with this for a living. But for people like Ms. Delaney, the landscape can be a "a maze," she says. "I didn't have a concept that there are special objectives investing in these things." There are. So, here's a simple guide to retirement-account asset allocation, from the ins and outs of the various plans to what those features mean for managing your money. What Do The Plans Offer? 401(k) Plans These provide tax-deferred investing and have the benefit of lowering your taxable salary by as much as $10,500 a year, the maximum contribution for Once you begin withdrawals, the money -- both contributions and profits -- is taxed as ordinary income based on your tax bracket. But these plans typically are limited in the investment choices they offer -- usually a few mutual funds from a single fund family, and often the employer's stock. Rollover and Traditional IRAs These provide tax-deferred investing, like 401(k)s, but offer broader investment choices, including the universe of mutual funds and individual securities. Rollover IRAs are for money transferred in from a 401(k) or other employer-sponsored plan when you retire or change jobs. Traditional IRAs allow contributions of as much as $2,000 a year per person, or $4,000 per couple as long as there's one working spouse, and may be tax-deductible for the year you make the contribution, depending on whether you -- or, if married, you and your spouse -- are covered by a retirement plan at work and, if so, your income. Withdrawals -- both any principal for which you take a deduction, and all investment income -- are taxed as ordinary income. Roth IRAs These relatively new creations allow no tax deductions on the way in, but the principal and profits compound tax free, meaning "what you see on your

statement is exactly the money you have to play with when you start pulling it out," says Michael Chasnoff, president of Advanced Capital Strategies Inc., a Cincinnati financial-planning firm.

3 statement is exactly the money you have to play with when you start pulling it out," says Michael Chasnoff, president of Advanced Capital Strategies Inc., a Cincinnati financial-planning firm. Like their traditional and rollover cousins, Roths are limited to $2,000 a year and $4,000 per couple with at least one working spouse, and are open to a world of investment options. Eligibility to contribute is governed by a wage test: Single people earning $95,000 a year begin losing access to Roths, and are completely cut off at $110,000. For married people, the phaseout range is $150,000 to $160,000. What Should Go in Each Account? 401(k) Plans Since these accounts typically are limited in their choices, financial planners such as Gregory Fenton, principal at Cambridge Cape Cod Advisors in Sandwich, Mass., usually start their decision making here, picking the one or two best choices available. That usually means U.S. equity growth or income funds and, maybe, a broad-based international fund. If so, Mr. Chasnoff says, consider a 75/25 split, with the bias on the domestic fund. That gives you large exposure to U.S. growth stocks, which have performed well historically, and a small dollop of exposure to growth outside U.S. borders. In recently reviewing Ms. Delaney's 401(k) account, Mr. Fenton, her adviser, moved her into a couple of T. Rowe Price funds available in her plan, including the Stable Value fund and New Horizons. Prior to that, she had 100% of her

4 401(k) in a Standard & Poor's 500 index fund, which Mr. Fenton considered a "bad idea" because index funds, for the most part, tend to be tax-efficient to begin with. Others argue that index funds "are fine for IRAs," says Jeffrey N. Mehler, an adviser in Centerbrook, Conn., who routinely earmarks part of his clients' IRA money for index investments. "I'm of the mindset," he says, "that you can't beat the market, you can only hope to do as well as the market." For those investing in company stock, "limit your exposure to no more than 25%," says Mr. Fenton. "People overinflate the value of their employer. If the stock crashes, you don't want it to destroy your retirement savings." Rollover and Traditional IRAs These are core accounts, so use the money "to complement what you've done in the 401(k)," says Peggy Ruhlin, a principal at Budros & Ruhlin Inc., a financialplanning and investment-management firm in Columbus, Ohio. Look to own mutual funds run by strong managers with long track records that you don't have access to in your 401(k). If, for example, your 401(k) is partly in the Templeton Fund, a widely available 401(k) offering and a solid, large-cap international value manager, "you might want to expand your exposure with a fund like Artisan International, which has more of a growth orientation, but is not as aggressive" as emerging-country funds, says Mr. Chasnoff. If you're going to own individual equities in this account, "own blue chips" you're going to hold or companies whose "product you like and use," says Mr. Rubin, the trust-fund adviser. In his IRA: Seattle coffee vendor Starbucks Corp., bought several years ago. Roth IRAs This, planners universally agree, should be home to your most aggressive assets -- shares of the next Microsoft, sector funds or emerging-market funds, for instance. The rationale: The Roth "is not taxed in the end, so you want the most

5 growth you can possibly get to happen in this account," says Steven Enright, president of Enright Financial Advisors Inc., in River Vale, N.J. The Roth also is the best place to temper the otherwise encouraged buy-andhold strategy, for those who are so inclined. If you're confident in your or your adviser's stock-picking skills, this is the account where you might own shares of glamour stocks, such as Internet or tech issues, or small-cap companies primed to soar. Mr. Rubin has his Roth invested in souped-up funds such as Janus Global Technology, up about 180% in 1999, while Ms. Delaney owns some of the Street's favorite tech belles: Cisco Systems Inc., Sun Microsystems Inc. and 3Com Corp. What About Other Investments? Well, if you're buying taxable bonds, such as Treasurys or corporate obligations, "you want those in your traditional or rollover IRA," Mr. Enright says, "because you want to shelter the income from taxes while it grows." Municipal bonds, meanwhile, should go into a standard taxable brokerage account since they're already kicking off tax-free income. Likewise for annuities, which are structured as tax-free investments to begin with. Many people these days are buying variable annuities in their tax-deferred accounts, "and that's just ridiculous," says Steven Norwitz, a vice president at Baltimore fund family T. Rowe Price. "You're buying a tax shelter within a tax shelter, and that's not very efficient." That's what Marge and Charles Valentino, a husband and wife team in Clinton, Conn., faced. She's a 49-year-old child-care administrator for a nonprofit organization; he's a 52-year-old state social worker. They moved their 403(b) accounts -- essentially a 401(k) for government and nonprofit workers -- into a rollover IRA, loaded with variable annuities. Their adviser, Mr. Mehler, has been moving them out of those investments and into diversified international equity funds such as Artisan, a Vanguard

6 intermediate bond fund and, to a small degree, the Scudder Gold fund, "just as an inflation hedge," Mr. Mehler says. Funds that track the S&P 500 or some other broad stock index can be an excellent choice in a taxable investment account. As Ms. Delaney learned from her adviser, Mr. Fenton, turnover in those funds is limited, so they're going to kick off minimal taxable income. The same holds true for funds such as Vanguard's Tax-Managed Capital Appreciation fund, designed to limit the government's tax bite. And don't overlook one clear advantage of taxable accounts. If you sell an investment at a loss, you can use that loss to offset gains realized from the sale of other investments. Losses that exceed gains can be used to reduce taxes by offsetting up to $3,000 of wages and other ordinary income. What if You're Already Retired, or Close to It? Individual securities should be in a taxable brokerage account, says Christine Fahlund, a senior financial planner at T. Rowe Price. When those securities are passed to heirs, they're subject to "step-up" rules, meaning the cost basis (the cost used as a basis for calculating capital gains) is adjusted to current market values. That, for instance, would allow heirs to sell stock in a taxable account immediately, if they wanted, and escape taxes on accumulated capital gains. In an IRA, the cost basis remains at its original level and capital gains are taxed at the heirs' ordinary rate. For retirees already taking minimum required distributions from a traditional IRA, Ms. Fahlund recommends keeping two years' equivalent of distributions in fixedincome instruments such as a short-term bond fund to "cushion the impact of any downturn in the stock market that might occur." Intermediate-term money, she says, is best funneled into equity-income and intermediate bond funds, where it can grow. Meanwhile, Ms. Fahlund says, higher-risk investments "that you need only as a last resort" should be in a Roth IRA. That way, heirs inherit a tax-free pot of money from which they can withdraw money tax-free over the course of their

7 lives. (A note for heirs: Do not take a lump sum, Ms. Fahlund urges -- you'll have to park it in a taxable account. In the Roth, "it continues to grow tax-free for the rest of your life.") If you're approaching retirement and you have a 401(k) loaded with company stock, Ms. Fahlund says, consider rolling your 401(k) into a rollover IRA, and in the process moving your company stock into a traditional brokerage account. This maneuver, so long as it's a lump-sum distribution, is legal and generally doesn't trigger any taxes typical when you move assets into a taxable account from a tax-deferred one. You do have to pay taxes at ordinary income rates on the stock's original cost basis, but that is likely substantially less than its current value. And you or your heirs ultimately have to pay capital-gains taxes when you sell the stock, but, because the shares are subject to the step-up rule, the taxes are based only on the appreciation prior to moving the stock into the brokerage account. For example: If you have one share of stock, with a cost basis of $1 and valued at $20 when you move into a taxable account, on the move you're taxed on the $1 cost. When you sell or your heirs inherit the share, say at $30, the capitalgains are levied on the original $19 gain. "It's a darn good deal," Ms. Fahlund says. -- Mr. Opdyke is a staff reporter in The Wall Street Journal's New York bureau. Write to Jeff D. Opdyke at jeff.opdyke@wsj.com 1 URL for this Article: Hyperlinks in this Article: (1) mailto:jeff.opdyke@wsj.com Copyright 2000 Dow Jones & Company, Inc. All Rights Reserved. Printing, distribution, and use of this material is governed by your Subscription Agreement and copyright laws. For information about subscribing, go to

SOCIAL SECURITY INFORMATION

1. Tax Rates SOCIAL SECURITY INFORMATION The FICA tax is 6.2% of the first $97,500 of wages (the wage base) for both the employer and employee; in 2007, the maximum contribution is $6,045 for the employer