Several ways to overcome a lineup of expensive, lackluster mutual funds

In the past several years, retirement plans have been busy adding mutual funds and expanding investment options. But more isn't always better.

"There are still very few 401(k) plans with a lot of investment options we'd enthusiastically recommend," said Paul Merriman, of Merriman Capital Management, a registered investment adviser in Seattle.

So what if your defined-contribution plan at work features a lineup of mutual funds that seems lackluster?

"I've never run across a 401(k) plan so bad that I would discourage someone from using it completely," said Raymond Benton, a longtime Denver-based adviser. "You should at least be able to find one fund to invest in."

And that's important, as Merriman says, because "you want to take advantage of any matching contributions by your employer."

So rather than compound the problem by making lousy choices within a lousy 401(k) plan, you can make

When it comes to making crucial decisions about retirement payouts, you don't get do-overs. Instead of checking off boxes and signing forms before rushing off to your retirement party, take time to weigh your options. Making mistakes "can be a very expensive learning curve," says Mark Cortazzo, head of Macro Consulting Group, in Parsippany, N.J. Avoiding them can save you thousands of dollars in taxes.

MISSTEP #1: Withdrawing money too soon

If you tap your retirement funds before age 59 1/2, you'll owe a 10% early-withdrawal penalty on top of the federal and state income taxes you'll pay on each distribution. There are exceptions that let you withdraw your money early without a penalty -- but only if you follow the rules.

For example, if you are at least 55 when you leave your job, you can take distributions from your 401(k) without paying a penalty (but you will still owe income taxes on your withdrawals). The key is to keep your money in your employer's plan when you retire. If you transfer it to an IRA, you'll lose the "55-and-out" option.

Jim Conrad of Huntertown, Ind., planned to tap his 401(k) when he retired last fall after 33 years in the auto industry. But there's a catch: Although you qualify for penalty-free access to your money if you are

I gave a talk about retirement planning in Los Angeles in 2000. "Melanie," a widow who lost her husband to cancer five years earlier, was at that session and contacted me later to help her with a unique idea: She wanted to move to Tahiti and raise her son there.

Melanie had been a flight attendant for many years and had traveled the globe. "On my first trip to Moorea, French Polynesia, my mouth just dropped as I was struck by the natural beauty of the tropical vegetation and colors of the beach and lagoon; I fell in love with it immediately upon arrival and the Tahitians were exceptional, too. I went home to L.A. but became 'homesick' for Moorea. I flew back, two weeks later, with my only son Josh, who's 7 years old--he liked it, too. On my third trip, two months later, I made my decision to live there. And seven months later, I made that happen."

Caution: Do Your Research First!

Some of you may be thinking of retiring somewhere other than where you live now. When you are considering an exotic location like Tahiti or Mexico, it is especially important to do some homework first so you know what you're getting yourself into.

Melanie had the right idea when she spent time visiting the area where she wanted to relocate. She also

Question: I'm 59 years old, earn $125,000 a year and plan on working until I am eligible for full Social Security benefits. I have about $1.6 million that's invested in a number of retirement accounts (mostly tax-deferred, but I have a Roth IRA too) and I own an investment property worth about $390,000.

In addition to contributing to my company's retirement savings plan, I also save another $30,000 a year. I would like to retire with the same income I have now without going over a 4 percent withdrawal rate. Is this possible, assuming I invest in a conservative equity portfolio that earns a below average return? - Jim, Saute Ste. Marie, Mich.

Answer: I never like to say that something is a totally done deal. After all, we are going through a shaky period in the economy and the markets, and a lot can happen between now and the time you retire.

Based on the information you've given me, however, it seems you've got a very good shot at achieving your goal, although I do wonder whether you'll need the same income you have now in order to enjoy retirement.

But more on that point later. Let's do a few off-the-cuff calculations to see where you stand.

You say you invest in a conservative equity portfolio that earns a below-average return. Well, I don't

Come retirement, most of us will be faced with two important decisions: what to do with our 401(k) or IRA money and how best to spend an abundance of free time. Some dream of adventurous vacations or beachside villas, others want to devote their days to a favorite charity. Some, no doubt, will while away hours on the golf course. However, for a growing number weaned on CNBC, E*Trade and buoyant bull markets, retirement will mean a chance to finally pursue a “second career,” actively managing their own money.

Of course, playing money manager with one's nest egg is not without risks. Take Nancy Wells, 62, a former manager for Pacific Bell who said good-bye to her life as a “corporate road warrior” at age 54 after 28 years. In 1999, just as everyone around her was getting rich on Internet stocks, Wells opted for early retirement and rolled her 401(k) into an IRA, which she planned to parlay into a fortune.

Having read Jane Bryant Quinn's Making the Most of Your Money in the mid 1990s, Wells's plan was to live off of her investments until her defined benefit pension kicked in. However, like thousands of other investors in Internet bubble stocks, Wells's plan backfired. By mid-2002 she had lost 40% of her IRA

Dear Dr. Don,
I have worked in the trade industry all my life for small outfits that never offered a pension. I am 43 years old and recently inherited $250,000 from my mom. I have this money in CDs. How do I start saving for retirement with this money? I have no clue!
-- Vinny Vicissitude

Dear Vinny,
I always have mixed emotions when I hear someone has received an inheritance because I know the windfall most often comes about because the inheritor has lost a family member or friend. I'm sorry for your loss.

When saving for retirement, you can invest in tax-advantaged retirement accounts or taxable investment accounts.

Your ability to move money into tax-advantaged retirement accounts is limited because your employer doesn't have a retirement plan, but you can fund either a Roth or traditional IRA account. Which one is right for you depends on several different variables. Use Bankrate's IRA comparison chart or look on Vanguard's Web site to help you make an informed choice.

At your age, the annual limit is $4,000. You have until April 15, 2008, to make contributions for the 2007

If you're saving for a retirement decades away, Thursday's big drop in the stock market shouldn't worry you too much.

But something did happen this week that you can't afford to ignore: the Federal Reserve's rate cut.

The Fed's actions could very well be ushering in a new era of inflation - and that is horrible news for your retirement portfolio.

When you save for retirement, you're saving for a lifetime supply of food, shelter and golf fees. Over time, the prices for these things only go one way: up.

The risk is that the value of the investments you're now stockpiling to pay for them may not increase at the same pace - leaving you with only enough money to pay for nine holes' worth of green fees.

With its rate cut this week, the Fed has made it clear that staving off recession is more important than reining in inflation.

But while the typical recession has lasted 18 months on average (not including the Great Depression),

For employees of educational institutions and certain nonprofit organizations, the 403(b) plan can be a key element in their retirement-saving strategy. Employer-sponsored 403(b) plans allow participants to contribute pretax dollars into a retirement savings account, then withdraw funds when they retire, permitting account earnings to grow on a tax-deferred basis. Similar to their private sector counterparts, 401(k) plans, 403(b) plans have a variety of rules that govern contributions, withdrawals, and other factors that current and potential participants should be aware of.

Eligibility

403(b) plans are available to employees of educational institutions and certain nonprofit organizations that offer a plan. Plan participants include teachers, school administrators, professors, and doctors and nurses, among others.

Contributions

Contributions to a 403(b) plan can consist of pretax employee contributions, after-tax employee contributions, and employer contributions. Amounts contributed to a 403(b) plan and earnings thereon are not subject to income tax until withdrawn. For 2007, participants in a 403(b) plan can contribute up to

The Roth IRA, available since 1998, presents a potentially attractive alternative to the regular IRA long favored by many Americans as a cornerstone in their retirement planning efforts. That's because a Roth IRA may allow you to avoid future taxation of your retirement funds by making nondeductible contributions now.

Rules of the Roth IRA

Following is a summary of the rules for Roth IRAs:

Unlike the traditional IRA, contributions to a Roth IRA are nondeductible regardless of your income level or participation in a company-sponsored retirement plan.

Your contributions are limited to $4,000 a year ($8,000 for couples) in 2006. The contribution limit begins to decline or "phase out" for single taxpayers with adjusted gross incomes (AGIs) of more than $95,000 and for married couples filing jointly with AGIs of more than $150,000. Individuals with AGIs in excess of $110,000 ($160,000 for married couples filing jointly) are not eligible for a Roth IRA. Married taxpayers filing separately are not allowed to contribute to a Roth IRA. An individual's total contributions

Many of you who have been loyal Morningstar readers for some time are at least somewhat comfortable choosing funds. However, many investors need help creating appropriate portfolios that incorporate those fund choices.

To that end, I've created five model portfolios specifically designed for retirees. In this week's column, we're going to take a closer look at two of them, the Preservation and the Conservative Portfolios. (Next week, I'll discuss the Balanced, Growth, and Aggressive Growth Portfolios.) Unlike in portfolios appropriate for those still employed, preservation of principal plays a key role in the investment strategy. So, you'll see a heavier allocation to cash and bond investments in these portfolios than you might in portfolios for those who are still working.

Each person's retirement situation is unique. One size really doesn't fit all when it comes to retirement investing. You need to consider all sources of income--Social Security, pensions, dividend income, annuity payouts, etc. You also need to think carefully about how much risk you can tolerate. Use the following model portfolios to jump-start your investing strategy for retirement, but make sure you tailor these portfolios to fit your own individual circumstances.

I am going to talk only about mutual funds that are still open to retail investors today. But if you own a

Four years ago, after an almost three-decade-long career at the accounting firm McGladrey & Pullen, Ambrose Jones did some soul searching, crunched the numbers - generously padded by a buyout he received after H&R Block acquired part of the firm in 1999 - and decided, at the age of 55, to retire.

His next step? Go back to school to pursue his lifelong dream of getting a PhD in accounting and, ultimately, teach.

Now a professor at the University of North Carolina at Greensboro, Jones teaches several advanced auditing classes. His work has been published in academic journals and six new research projects are underway. To be sure, he brings home a fraction of what he earned as a partner at McGladrey, but he couldn't be happier. "There's a lot of enjoyment in teaching and research," he says. "It makes me feel like I'm 25 years younger."

If the retirement surveys that almost every financial company is conducting these days are to be believed, this is a scenario that millions of adults dream of. For instance, nearly three quarters - 71% -

A couple of weeks ago, I invited readers to take part in my 401(k) savings challenge, and promised to keep the momentum going with more articles about making the most of your retirement plans.

401(k) Rollovers Uncovered

One of the topics many of you wanted to learn more about is how to make smart rollover decisions when changing jobs. Well, you're not alone. According to consultant Deloitte's most recent 401(k) Benchmarking Survey, 22 percent of employers surveyed revealed that their employees find rollovers to be the most confusing part of their retirement plan.

"Rollover" is the term used to describe moving money from one type of tax-advantaged account, like your 401(k) plan, to another, such as an individual retirement account (IRA) or a different 401(k) plan at your next job.

The goal here is simply to ensure that your money continues to grow tax-deferred and that the government is aware of its status. Otherwise, you're likely to get hit with a tax bill for funds you didn't

With the stock market as bouncy as a beat-up couch, you may be thinking it's time to focus on a small number of stocks that you know really well. What better way to keep returns up and risk down?

Conventional wisdom and new academic research certainly seem to suggest that this is the way to go. Many financial planners and brokers will tell you that a portfolio of as few as 12 stocks (and up to 30) will sufficiently diversify your holdings.

And three recent studies have found that individuals who own fewer stocks do better than those who own many.

However, as is often the case with conventional wisdom (and academic research), there's a lot more to the story. Fact is, if you build your portfolio entirely on the principle of "less is more," you're a lot more likely to end up with less than more. Here's why and what to do instead.

Those were the days

The idea that 12 to 30 stocks are all you need dates back at least to the 1960s, when academics, including Burton Malkiel, author of the classic "A Random Walk Down Wall Street," concluded that that's what it took to eliminate most of the risk from a portfolio. (They

Many of us will spend 20 years or more in retirement. That's about half the time of our working years. For some, retirement might be working less but having more time to take advantage of outside hobbies and leisure activities... or start that new business venture. For many, it may mean moving to a different part of the country or traveling. The choice is up to you. Proper planning will allow you to live the retirement lifestyle you desire. How you handle your personal and financial affairs today will determine what you can do tomorrow.

Like it or not, a greater portion of your retirement income will come from what you've saved. If you're not a saver, you may be putting your future financial security in jeopardy. Where will your retirement income come from?

Retirement sources of income have often been compared to a three-legged stool. The first leg of that stool is your Social Security. The second leg is your employer's pension plan. And the third leg is your personal savings. How much you depend on the third leg depends on the strength of the other two. But one thing is for sure. Your future financial security will depend on all three.

The strength of each leg may change, and then you'll need a new plan of action to reinforce the retirement stool. Specifically, it will require you to be more

Dear Tax Talk:
Can I roll over money from my traditional IRA to a money market account without tax consequences? I don't plan on touching the money. I just want to move it to a location less vulnerable than the stock market, like a money market fund because this will be more stable. I will turn 58 this year. Thank you in advance for your help.
--Larry

Dear Larry,
It is understandable that you would want to change your investment strategy. As we age, our investment time-frame changes, decreasing our tolerance for risk.

When you're in your 30s, your investment time frame for retirement savings is probably well over 20 years. This will allow you to recover from most downturns in the stock market. At 58 years of age, you may be thinking of early retirement and want to be assured your capital will remain intact. Hence,