Dear Liz: What is the difference between ETFs, mutual funds and index funds?
Answer: Index funds are a type of mutual fund. Mutual funds and ETFs both allow you to buy a diversified mix of investments, but they’re structured differently.
Mutual fund shares are usually priced once a day, based on the value of their underlying assets minus liabilities. Investors buy and sell without knowing precisely what the share price will be, since that’s calculated after they place their orders with the mutual fund company. ETFs, or exchange-traded funds, by contrast, trade throughout the day on stock exchanges and can be worth more or less than the underlying investments, depending on demand.
Most mutual funds are actively managed. That means the underlying investments may frequently change as the fund manager tries to “beat the market” and get a better return than a market index or benchmark such as the Standard & Poor’s 500. All that trading increases a fund’s costs and usually doesn’t result in a higher return.
By contrast, index mutual funds just try to match the market benchmark. This is known as passive management. Less trading leads to lower costs and typically better returns.
Most ETFs are passively managed and have even lower costs than typical index mutual funds. ETFs are the investment of choice for robo-advisors, which offer automated investment management, but they also can be an inexpensive way for individuals to invest. Also, ETFs don’t have the investment minimums that can sometimes be a barrier to start investment with mutual funds.
Ask a tax pro before Roth conversion
Dear Liz: I’m almost 70, still working, and I’ve got a decent-size IRA as well as a 403(b) that I plan to move to an IRA when I retire. Because I have a pension and other investments, I don’t think I’ll ever need the money in the IRA and 403(b). Should I convert to a Roth now so my kids (31 and 28) won’t have to pay taxes when they inherit it? I’ve got the cash to cover the taxes for the Roth conversion.
Answer: That would be a generous move, but you should consult a tax pro to make sure you understand the implications.
As you know, converting a pre-tax retirement account such as an IRA, 401(k) or a 403(b) to a Roth IRA can generate a sizable income tax bill. Such conversions can push you into a higher tax bracket and, if you’re on Medicare, also may increase your premiums.
You may want to spread the conversion over several years, converting just enough each year to “fill out” your tax bracket and avoid Medicare surcharges. A tax pro can help with those calculations.
When to start spousal benefits?
Dear Liz: At what age do Social Security benefits stop for dependents? My child is 17 and is currently getting half of my Social Security amount. When her benefits stop, can I sign up my nonworking spouse to receive half of my benefits?
Answer: A minor child can receive up to half of a retirement-aged parent’s Social Security benefit. Child benefits typically end when the child turns 18, or up to 19 if the child is still a full-time high school student. If your child turns 18 during her senior year, for example, the benefits would stop when she graduates. If she turned 19 during her senior year, the benefits would end then.
Spousal benefits can begin as early as age 62, but the amount would be permanently reduced if started before the spouse’s full retirement age (which is 67 for people born in 1960 and later). Technically a spouse does not have to wait until child benefits stop before applying, but there is a limit to the total amount a family can receive based on one person’s work record. The amount varies from 150% to 180% of the worker’s full retirement benefit.
Part D premiums can vary widely
Dear Liz: Regarding Medicare, there is one more point I think you need to tell readers, and that is the high cost of Part D prescription drug coverage for people who choose original Medicare. For example, if you need just a few expensive drugs that are “Tier 3″ or higher, and coupled with the monthly fee, you can easily pay $3,000 a year or more. I am not saying original Medicare is bad. On the contrary, it gives you great freedom of health choice. However, Part D is expensive.
Answer: Part D coverage, like Medigap supplemental plans and the all-in-one Medicare Advantage plans, is offered by private insurers. Part D premiums and coverage can vary tremendously from insurer to insurer. Even with the same insurer, which drugs are covered and how they’re covered can change from year to year. That’s why it’s so important to shop around every year and to be prepared during open enrollment (which starts Oct. 15 and runs to Dec. 7) to switch to a better plan.
Liz Weston, Certified Financial Planner, is a personal finance columnist for NerdWallet. Questions may be sent to her at 3940 Laurel Canyon, No. 238, Studio City, CA 91604, or by using the “Contact” form at asklizweston.com.