Life Insurance money- Is a Roth a good investment for this money?

[Guest connfamily]

Hi I recently received a $100,000 life insurance payment when my dad died. We used about 10,000 to pay off some bills. We would like to save some for emergency money and I would like to invest some.

I am 35 and my husband is 40. We have two kkids 12 & 6. I figure I will have collage costs in 6 & 12 years to worry about. We would like some of this money to be able to be used for collage, but we are also looking at retiring between 55-60. My husband has a 401k with 46,000 and mine is 3000 since I only started saving in mine recently (I realize this was a big mistake to wait now). Our house will be paid off in 13 1/2 years. We really want to start thinking and moving toward being able to retire. There is also the possiblity that I may get some money from the sale of my dad's property, but since I am not the executor of his estate (his two brothers are) and I have no idea what the will said I don't know if there will be anything left after paying his debts or if I would even get it. I am his only child. I make $46.000 a year and he makes about $52,000 a year plus between $5000-10,000 a year from his Air National Guard job (sometimes a lot of this is non-taxable when he goes on hazardous duty trips). He will have a retirement from the military & his government job. I will have a retirment from my company as long as there are no layoffs within the next 17 years. My husband currently has 10% of his income put in his 401, and I have 7%.

I really want to start investing this life insurance before it somehow gets spent over the next few years a little at a time. It seems to be too easy to get caught up in the "we have lots of extra money" spending. I want to pull a halt and get our savings in order before too much gets wasted.

Is an Roth IRA a good place to start? Since this money is tax free to us (since it is life insurance), it seems this is a good place to put this money so that we will not have to pay taxes on the interest in the future. It also seems like a good idea because we could take the contributions (not the earnings) out at any time if there is an emergency need for it.

Also where do I start. I looked at my personal bank (where the money is in a moneymarket) and at Fidelity (where my 401K is at). Where are the least expensive places to start a Roth IRA? How do I know I am chosing no-load mutal fund. Is it best to split my investments equally between a large cap, small cap and an international fund? I think I read about this strategy on the armchair millionare site.

Thanks in advance. I feel so lost as to what to do with this money.

[John G]

My summary of your key facts:

I am 35 and my husband is 40. We have two kids 12 & 6... seek to retire between 55-60. My husband has a 401k with 46,000 and mine is 3000. Our house will be paid off in 13 1/2 years. I make $46k a year and he makes $52k plus $5-10k a year from his Air National Guard job. He will have a retirement from the military & his government job. I will have a retirment from my company as long as there are no layoffs within the next 17 years. My husband currently has 10% of his income put in his 401, and I have 7%.

Lets put a pencil to some of the early retirement numbers looking out 15 years. The 50k that you currently have in the 401k accounts could grow to about 200k if you get an average annual return of 10%. If you keep funding the 401Ks at around 10k each year, you will add 150K which could grow to 317 thousand using the 10% annual return on investment. My back of the evelope calculation suggests that the 517k would yield in todays dollars pretax income of about 25% of your current income if in retirement you made about 7% and only took the earnings, leaving the principal alone. (This is a very rough calculation. I used 3% for inflation) You did not indicate what percent of your income you would get as a pension. You did not indicate if you or your husband participated in the social security program. Add my rough 25% to the percent of income you expect to be covered by these other two sources as a quick check on your plans. It looks a little thin if the other two items are not over 50%. You might need to make some downward adjustments for college costs, but this might be offset my the absence of a future mortgage payment. Even if the result looks OK to you, there is a lot of work to do between now and then, and the 10% annual return on investment is a target, not a given.

Your also said: "It seems to be too easy to get caught up in the "we have lots of extra money" spending. I want to pull a halt and get our savings in order before too much gets wasted.....Is an Roth IRA a good place to start? "

Response: Sure, you can improve your early retirment math by building Roths to complement your 401Ks. However, the maximum you can currently contribute would be $6K - 3,000 in two separate Roths this year. It would make some sense to draw upon the insurance funds to contribute the max to two Roths for many years. Adding 15 years of maximum Roth contributions (the max will increase periodically) will boost your retirement nest egg 15 years from now by more than 200K. That would boost your retirement assets to 717K and I would estimate that you could translate that to an income stream with buying power equal to 35% of your current income.

Since you can't just immediately flip the insurance funds into a Roth, consider a combination of taxable investments, annual Roth contributions and college savings.

Your other questions: "Also where do I start. I looked at my personal bank (where the money is in a moneymarket) and at Fidelity (where my 401K is at). Where are the least expensive places to start a Roth IRA? How do I know I am chosing no-load mutal fund. Is it best to split my investments equally between a large cap, small cap and an international fund? I think I read about this strategy on the armchair millionare site."

Fidelity, Schwab, Vanguard, T Rowe Price, Strong, Twentieth Century..... there are hundreds of places you can use for a Roth account. You can find them on the internet and in financial publications like Money, Kiplinger Financial and even Consumer Reports (March issues) magazines. No load mutual funds mention NO LOAD, if you don't see it, just ask. Since you would be just starting a Roth program, don't worry right now about different types of funds - you only need one each for a couple of years. Any broad based no load stock mutual fund could work. If you want to skinny out the fees, then consider an Index fund from Vanguard.

I have a huge concern that you did not mention anything about cash reserves. Part of what you just received should be set aside for emergency issues such as losing a job for 6 months. I would reserve at least 25K for that and keep those funds separate from your checking or usual savings.

Yes, you should start saving some funds for college. That is a huge topic and I will not get into it in this post. There are a variety of options, perhaps 10k and 10k would be appropriate.

After pulling out a chunk for emergency, smaller amounts for Roths, and modest amounts for college funds from the insurance amount.... you probably will have about 40K left. I would invest these in a mix of mutual funds. You will pull from this account each year to make your Roth contribution, so some of this should be considered short term investments that will be transfered each year. You might want to have between 4 and 8 mutual funds. This is where you might want a big cap, middle cap and small cap fund... one with a growth emphasis and another with a balance of stocks and bonds. Don't get too creative, it is easier to track a simple system. Because very large mutual funds have a substantial overlap in holdings, you don't get as much diversity from having a larger number of funds then you might first expect.

More comments on other issues raised in next post

[John G]

There is also the possiblity that I may get some money from the sale of my dad's property, but since I am not the executor of his estate (his two brothers are) and I have no idea what the will said I don't know if there will be anything left after paying his debts or if I would even get it. I am his only child.

I am troubled by the above. Has there been a reading of the will? As the only child, I would assume that you would be notified about the estate/will. At a minimum, the executors should respond to questions. You did not mention if your mother was still alive.

There are also public records that you can examine. Did you father own a house or any other property? If so, you can check with the county or city clerk about how the property was titled.

Adding to the prior question about early retirement:

If retirement at age 55 looks questionable, remember that adding a few more years of income (kids gone, house paid for, etc.) means you are banking more and delaying the drawdown. For example, adding 7 years to your retirement date means (if your assets are earning 10% per year) that you might be able to double the total nest egg - putting your retirement assets at something around 1.4 million.

Finally, a word of caution. If you are too conservative in your investment choices (such as relying on bank CDs or just bonds) you are not likely to achieve an average 10% annual return. To have a decent chance to achieve the 10% annual return, you probably need to have about 75% of your assets in stocks with a slight bias towards growth stocks, a maximum of 20% in long term bonds and no more than 5% in money market accounts.

If you are up to the task, you might want to create a spread sheet and a notebook to monitor your retirement progress. The spreadsheet would "model" the various pools of assets and attempt to project their growth. It should include all the income streams (based upon you best assumptions) such as pension, social security, 401Ks and Roths. At the end of each calendar year, you would monitor your progress. Did you contribute at the level you planned? Is your long term average gain around 10% per year? This is important feedback on your progress and may suggest some fine tuning of the strategy.

[Don't be surprised if you initial forecast is way off. I did this exact exercise in 1994 and get a good laugh over the assumptions I used and the number of unpredictable events that have occured since then. I completely replaced the spreadsheet in 2002 and two years later even that is dated. BUT, the exercise is vital to keeping our family on track. I retired early (more or less) and still had two kids to send to college. Now my wife is persueing her PhD and so I have three "kids" in college. ]

[Guest connfamily]

Hi John,

Thank you so much for your replies.

To answer some of your questions, yes my husband has participated in the SS program (hopefully there will be social security when we retire) and I have recently read that because he served in the armed forces he will get an extra amount of SS up to $1200 per year.

My pension uses the following formula:

1.6% of final average pay x years of credited service after July 1, 1995

Plus

2.0% of final average pay x years of credited service before July 1, 1995

Minus

1.6% of your Social Security benefit x total number of years of credited ( I need to find my last social security benefit form to see what I am predicted to get)

My husband will have two pensions. 1 from the Air National Guard (He just recently got his 20 year retirement letter) and 1 from the FERS Federal Employee program which is the plan that pays into the SS system.

I will also have one other pension that I didn't mention. My dad that adopted me (My mom and my birth father (the one I received the insurance for) were divorced when I was a baby. My dad that adopted me (my mom is not married to him anymore and my only sibling which was from my dad that adopted me was killed 8 years ago) has a pension plan where I am now listed as his survivor. He took reduced payments so that I would receive the money in payments of $800 per month from the day he dies till I die. My dad is in decent health and in his early 60's so I didn't include this amount in preparing for my retirement because I assume he will live for MANY MANY more years and it's not a guarantee that I would see this money for a long time.

My father that I got the insurance money from I had only met 12 years ago at the birth of my daughter. His wife left him (he was crippled and wheel chair bound and couldn't see due to a disease he had). They were never actually married though and she took his name. I know he took her name off the life insurance and added me and my kids. I thought he would have done that with the will but I am not positive. Because I only met his family 12 years ago, I don't feel comfortable being nosy and pushy about his estate. I trust that since both brothers have children that they would do the right thing as how they would want thier children to be treated.

Our cash savings has usually been about $10,000 dollars and sometimes dips below this amount. I will take your advise and keep $25,00 in liquid savings. Currently I have opened an ING Organge account that earns 2.20%. I want to look into the possiblity of finding something else that earns more. Not sure what % I should shoot for and what are the best savings avenues for an emergency fund.

So you think I should have a seperate fund for collage savings. I guess that makes sense since I have a lot to immediately invest. Should I open one of those state 529 plans? Should I open only one and let that grow and if there is money left in it then use it for my son 6 years after my daughter goes to college? Or should I open two 59 plans for $5000 each. I know you can change the child who uses the plan so it seems like 1 might be the way to go?

Thanks for your help.

[John G]

I do not have a lot of experience with the range of college savings plans, so I can offer no advice there.

I would suggest proceeding with the Roths as soon as you are ready, but take your time with the other decisions. Be sure to read all the materials involved as often the negatives or problems are in the details.

On interest rates - all interest rates are very low right now. Be wary of any marketing material that promises large percent returns as that is just not possible right now. While there are REITS and some stocks that promise dividend returns in the 6 to 14% range, these tend to be riskier options (often the underlying earnings are questionable or there is economic or interest rate risks) and I would not reccommend that approach.

[JAMES PATRICK]

There is a website run by an individual named Joe Hurley which has info on 529 plans in all 50 states. He is mentioned on numerous boards as being very knowledeable and I believe he has written a book.

the site is : savingforcollege.com