Top Six Financial-Planning Tips for 2010

Volunteering in your community. Putting a regular workout schedule in place--and sticking to it. Tackling that pile of books that is fast taking over your nightstand.

If you're like many people, your 2010 to-do list is rapidly growing unwieldy. So the last thing you need is a long and unrealistic list of financial to-dos thrown into the mix.

But getting a grip on your finances needn't be a massive undertaking. In fact, you can accomplish many key tasks in a half-hour or less. (In fact, I coach you on completing 36 such tasks in my upcoming book, 30-Minute Money Solutions.) So go ahead and get a jump-start on your 2010 plans by tackling some of the key issues below. You'll be done before you know it.

1) Rebalance. (Or don't.)
When it comes to your investments, a strategy of benign neglect is often more fruitful than a more active approach. That’s why I'm a big believer in making changes to your portfolio on an infrequent basis, mainly when your allocations to stocks, bonds, or cash are more than 5 or even 10 percentage points different from your targets--a process called rebalancing. As you rebalance, pay the most attention to your exposure to broad asset classes; those allocations are going to be the biggest determinant of how your portfolio behaves. But also consider how your investments are arrayed across various subasset classes. Following this year's rally, aggressive holdings such as emerging markets, technology, and commodities are apt to be in need of a trim, whereas tamer positions such as high-quality bonds and dividend-paying stocks may be consuming a smaller portion of your portfolio than you intended them to. (Eyeballing the Sector Valuation graph in the top right-hand corner of the Stocks cover page gives you a quick view of where our analysts think the bargains are--and are not.)

This article details how to rebalance.

2) Check withdrawal rates.
If you're already retired and taking distributions from your portfolio, check up on whether your withdrawals are realistic given the size of your nest egg. A 4% annual portfolio withdrawal rate is often considered "safe," but that may not be a livable amount for those who aren't superwealthy. T. Rowe Price's free Retirement Income Calculator enables you to play around with the variables, such as changing your asset allocation, to help determine how much you can safely withdraw in retirement. The calculator is also helpful for those who are still in accumulation mode: You can model the effects of continuing to work part-time in retirement, deferring Social Security for a few years, or increasing your equity position.

3) Build liquidity if taking distributions.
On a related note, those who are over age 70 1/2 and taking required minimum distributions from company retirement plans or IRA portfolios will have to resume distributions in 2010, after being allowed to skip them last year. Thus, you'll want to make sure that your portfolio includes adequate liquidity to help you meet your distributions. If you don't have cash on hand, it's time to think about what to sell to raise it.

4) Consider an IRA conversion.
I've been extolling the virtues of IRA conversions for more than a year now, and all savers, regardless of income level, will get their chance beginning in 2010. Those who heretofore have not amassed any IRA assets because they earn too much will also be able to get into a Roth through the back door next year. Although income limits on IRA contributions will remain in place, higher-income savers can make a nondeductible IRA contribution in 2009 and again in 2010, and then convert those assets to Roth status in 2010. It's possible that Congress may close this loophole down the line, given that it doesn't make sense to leave the income limits in place for initial contributions but not conversions. But for now it looks like an opportunity.

The key benefit of converting to a Roth is that you'll pay taxes now in exchange for tax-free withdrawals in retirement, which seems like a pretty good trade-off given that taxes are widely expected to drift upward in the years ahead. (Some of you have been worrying that Congress could decide to tax Roth IRA withdrawals. There are no certainties, but in my view this would be a politically precarious step to take given that the Roth has been the province of middle-class investors for much of its existence.)

The Roth also makes sense from the standpoint of estate planning. Unlike traditional IRAs, the Roth doesn't require mandatory distributions, thereby allowing your assets to compound and increasing the amount you can pass to your spouse or heirs. Your heirs, in turn, will be able to receive tax-free distributions on those assets, and they'll also be able to accept distributions over an extended period, further stretching out the tax benefits and enabling those assets to compound on a tax-free basis.

The second key estate-planning benefit relates to estate taxes. Because you've already paid tax on Roth assets, the overall nest egg that you pass to your heirs will be smaller under the estate tax system, and therefore could help to reduce your estate-tax liability. The traditional IRA assets, by contrast, will be included in your estate-tax liability, even though your heirs will have to pay taxes on those assets. (Of course, the estate tax is another issue that will probably be revisited in Washington in the coming years.)

5) Earn a higher guaranteed return on your cash.
With interest rates way down, investors in search of a guaranteed rate of return on their cash are really getting squeezed. CDs and money market funds are hardly yielding anything, but the risks of venturing into higher-yielding investments were laid bare by colossal blowups at funds like Schwab YieldPlus (NASDAQ:SWYSX - News).

Assuming you have ample cash in your emergency fund to cover any additional expenses you anticipate within the next year or two, one of the best possible uses of your cash is to prepay your mortgage. Of course, you won't have the same access to your capital that you would have by parking your cash in a money market fund or even stocks and bonds. But by prepaying your principal on a more aggressive schedule than your lender requires, you'll earn a guaranteed return on your cash that's far higher than what you can earn in safe investments. Those who are nearing retirement or are paying private mortgage insurance will be particularly good candidates for this strategy; ditto for those who have had their mortgages for awhile and don't have much in the way of deductible interest. This article discusses the ins and outs of prepaying your mortgage.

6) Strategize in preparation for 2011.
All's quiet on the tax front for 2010, meaning that dividend and long-term capital gains tax rates will remain relatively low: 15% for most investors. However, that favorable tax treatment is set to sunset in 2011, meaning that most long-term capital gains would be dunned at 20% and dividends would again be treated as ordinary income.

Basing your investment decisions on taxes alone is invariably a mistake; it's also possible that Congress could extend the currently favorable dividends and capital gains tax rates. But if you were thinking about selling something anyway and the security is trading well above the price you paid for it, you're better off doing so in 2010 than waiting until 2011 or beyond.

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