How An Indirect Retirement Account Rollover Can Go Wrong And How To Avoid It

September 11, 2018

Late last week I received a panicked phone call from my sister. She had received an unsolicited check from a financial institution with no letter explaining what it was for or why she received it.

After we did some investigating, it turns out it was a full distribution from her traditional IRA because the mutual fund it was invested in had been closed by the fund company. Because she did not want to take a distribution from her IRA, she will need to deposit that check into another traditional IRA within 60 days to avoid paying taxes and early withdrawal penalties (she is not yet age 59 ½) on the amount of her IRA.

While a hassle, that process is not difficult or time consuming. But here’s the rub: the fund company withheld 10% for federal income taxes. We’re not sure why 10% was withheld as it is not required to withhold from an IRA, but it is important to note that distributions from an employer plan, like a 401(k), require 20% mandatory withholding for federal taxes.

Why the unnecessary withholding is an issue

To avoid taxes and penalties on the amount withheld, she will need to come up with that 10% amount to make the indirect rollover a complete rollover. Otherwise, she will incur taxes and penalties for the amount withheld that won’t get into the new IRA within the 60 day deadline.

Let’s break it down further

The details

For simplicity sake, I am going to use round numbers to illustrate the problem.

  • The full amount of the distribution was $50,000.
  • $5,000 was withheld, so my sister received a check payable to her for $45,000.
    • If she were to simply cash that check, she’d have to include the full $50,000 as taxable income to her this year, including an additional 10% penalty for the early distribution (maybe that’s why they withheld? We’ll never know).
  • She is not able to come up with an extra $5,000 to complete the full $50,000 indirect rollover into an IRA, so her new IRA will start with a value of $45,000 – down from the $50,000 she had last week.
  • Come tax time, the $5,000 withheld will be included as income on her tax return. Even worse, she will have to pay a 10% early withdrawal penalty on that $5,000!
    • If she is in the 22% tax bracket, that comes up to $1,600 (22% times $5,000 plus 10% times $5,000) in tax and penalties.
  • She will get a refund of $3,400 since the tax and penalty on the $5,000 withheld is only $1,600. But she has now lost over 3% of her IRA value as well as the future tax-deferral on that $5,000.

A unique situation

This is a unique situation – having a distribution happen with no warning or chance to act beforehand (I suspect something was received and discarded on accident, but that is neither here nor there) – but I can only imagine that other recipients of such checks who did not have a financially savvy person to call may have just cashed the check and will find themselves with a big tax surprise in April.

What could’ve been done differently

Had she known this was going to happen, she could have initiated a direct rollover – where the funds move directly from one financial company to another – with no tax implications at all. And no need to worry about getting the funds into a new IRA within 60 days.

The moral of the story

Besides opening your mail and making sure you’re not missing important communications from your financial services providers, the important take-away here is that the simplest way to move retirement money is to avoid being the middle person. If possible, a direct rollover will always be much better than an indirect rollover if your intention is to keep all the funds in the IRA for the future.

This is especially true when rolling funds out of your 401(k) or other employer-sponsored retirement plan, as an indirect rollover does lead to a mandatory 20% tax withholding. When you do a direct rollover, there are no taxes to be withheld, so you don’t have to make up the difference (assuming you have the cash available to do so) or get stuck with unintended income.

The Pros And Cons Of In-Service Withdrawals From Your 401(k)

August 31, 2018

A solid financial plan requires the examination of all available opportunities to use financial resources to meet important life goals. Many 401(k) plans have a unique feature that can either create a world of opportunity for your retirement plans or create a tax and retirement planning nightmare. This 401(k) plan feature is known as an in-service withdrawal.

It is widely understood that distributions from a 401(k) plan that are made before you reach age 59 ½ are taxed as ordinary income. But the real kicker is the fact that minus a few exceptions, they are also subject to an additional 10% early withdrawal penalty.

The in-service withdrawal exception

In-service withdrawals or “in-service distributions” allow you to take distributions or roll your contributions over to an IRA after reaching age 59 1/2 while you are still an employee of the company. (It is important to note that not all 401(k) plans have the option to allow participants to take an in-service distribution while still actively employed. According to the Plan Sponsor Council of America, it has been estimated that up to 77% of 401(k) plans allow in-service withdrawals, so check with your 401(k) provider first.)

Typically, the only way to access elective deferrals to a 401(k) plan while you are still working is through a hardship withdrawal or 401(k) loan. Certain triggering events such as financial hardship must occur related to reasons such as unreimbursed medical expenses, buying a primary residence, paying for college tuition, funeral expenses, and to avoid eviction or foreclosure. Hardship withdrawals are subject to ordinary income taxes PLUS a 10% penalty if you are under age 59 ½. You also must prove that you have no other funds available.

In contrast, in-service withdrawals at age 59 ½ (if offered) that are not due to financial hardship are not subject to the 10% penalty and have no restrictions on how you use these assets.

Here’s how it works:

For example, let’s assume you’re still working for an employer and just reached age 59 ½. If your plan allows for an in-service withdrawal, you may choose to either rollover your 401(k) money to an individual retirement account (IRA) or you can even take a cash distribution. There are no penalties if you’ve reached age 59 ½, but withdrawals from a pre-tax 401(k) are still taxed as ordinary income.

This is where it gets tricky from a tax planning perspective. If your distribution is taxed as ordinary income, it will be added to your earned income for the tax year in which you take money out of the 401(k) plan. The distribution could potentially put you in a higher marginal tax bracket and may completely negate the benefits of making contributions to your retirement plan in the first place.

You can avoid having an in-service withdrawal become a taxable distribution by completing an IRA rollover. In fact, if you take a cash distribution and change your mind, there is a 60-day window to complete a rollover to an IRA. This will continue to allow for tax-deferred growth and could potentially give you more investment options to choose from and more flexibility with how your retirement portfolio is structured. This is why it’s the most common in-service distribution.

Reasons to consider an in-service distribution

The primary reason to consider an in-service withdrawal from your 401(k) is the added control and flexibility that comes with rolling assets into an IRA. If you are unhappy with the investment lineup within your 401(k) plan or have high administrative fees and expenses, it may be a welcome relief to know that you have an exit strategy while still remaining with your employer.

Individual retirement accounts may provide you with more (or different) investment choices than the ones offered in an employer sponsored retirement plan. They may allow for greater overall diversification through investments such as individual stocks, ETFs, individual bonds, no-load mutual funds, CDs, separately managed accounts and a number of other choices.

How to find out if your retirement plan allows in-service distributions

In-service distributions may potentially be available through a variety of qualified retirement plans in addition to 401(k)s. Profit-sharing plans, pension plans, employee stock ownership plans (ESOPs) and 403(b) plans are examples of other qualified retirement plans that allow for withdrawals while still working. Since each qualified retirement plan is unique, there are different withdrawal rules governing each specific type of contributions (salary deferral, employer matching contributions, profit sharing, rollover, etc.).

Check with your plan administrator or review a copy of your employer’s summary plan description (SPD) to find out if your plan offers an in-service withdrawal option. In addition to the age 59 ½ requirement, some plans may have a length of service requirement. You should also make sure that taking an in-service distribution will not hurt your ability to continue contributing to your employer’s qualified retirement plan and will not create any problems with your plan’s vesting schedule.

The potential downsides of an in-service distribution

Having more control and flexibility over how and when to access your retirement savings doesn’t necessarily mean this is the smartest financial decision. There are some compelling arguments against taking in-service withdrawals once you reach age 59 ½. Here are just a few of those downsides to consider:

  • Cash distributions may end up creating a greater tax burden than waiting until full-retirement to take money out of your 401(k) plan. As retirement nears, the urge to eliminate credit card debt or pay off a mortgage can be significant. You may even have a major purchase (e.g., boat, car, second home) that you want to make and your retirement plan would seem like a logical option. Unfortunately, you will likely pay significantly higher taxes if you take an in-service distribution while you are still working. Waiting until retirement to take out 401(k) assets is often a better alternative since your income level and taxes will likely be much lower.

IRA rollovers will allow you to continue to defer taxes until you choose to withdraw the funds in retirement. However, IRA rollovers also have potential drawbacks you must be aware of.

  • You will lose the ability to delay required minimum distributions (RMD) beyond age 70 ½. In reality, this one may not seem as big as a concern because who really wants to work into their 70’s? But with retirement confidence levels low, you may either work beyond the so-called “normal” retirement age out of necessity or because you want to work as long as possible (mind and body willing of course). There are no RMDs from 401(k) plans as long as you are still working (and you don’t own a 5% or bigger stake in the company).
  • You will not be able to use a net unrealized appreciation (NUA) strategy if employer stock is rolled into an IRA. This is important if you have highly appreciated company stock in an employer-sponsored retirement plan. Favorable NUA tax treatment allows you to pay income taxes only on the stock’s cost basis. When you eventually sell shares of stock, you are taxed at long-term capital gains rates, which could be significantly lower. Of course, you must weigh the potential tax savings of using the NUA strategy with the risk of having too much invested in any individual stock holding if you decide to hold on to company shares.
  • You will no longer have access to borrowing options once 401(k) assets are rolled into an IRA. While borrowing money as retirement approaches isn’t on the top of everyone’s list of potential goals, it remains an option within 401(k) plans if provided by your employer. IRAs do not have loan provisions and you would have to take a taxable distribution to gain access to your assets.
  • 401(k)s tend to have broader federal protection from creditors. IRAs have federal protection from bankruptcy protection, but that protection has limitations. General creditor protection is decided at the state level. As a result, 401(k) assets tend to have broader protection from potential lawsuits. If you have a pending lawsuit (or think there may be the possibility of one in your future) you should think twice about rolling assets from a 401(k) plan to an IRA.

It is possible that an IRA rollover may end up costing you more in the long run. Always compare the fees, costs, and services to make sure that a rollover fits your short and long-term financial plans. Also, keep in mind that conflicts of interest may exist if financial advisors stand to benefit from your IRA rollover decision. Financial services companies benefit from money in motion and view the IRA rollover market as a significant business opportunity.

There are plenty of valid reasons to consider an in-service withdrawal from your 401(k) plan. Just be sure that your financial advisor is operating in your best interests and not simply trying to generate assets under management (AUM) fees or earn commissions from the sale of investment or insurance products. Consult a fee-only financial planner or utilize the services of unbiased financial wellness providers to learn more about in-service distribution options.

 

A version of this article was originally published on Forbes.

Working In The U.S. Temporarily? Here’s What You Need To Know About Retirement

August 17, 2018

We get many retirement benefits questions on our Financial Helpline from professionals who are working in the United States now but plan to return eventually to their home countries or take another ex-pat assignment. Frequent questions include: should I participate in my company’s 401(k) plan, and if so, should I choose to make a pre-tax, Roth or after-tax voluntary contribution? How can I access my savings when I leave the U.S.?

Get professional tax advice

If you’re a professional from another country working legally in the United States and do not have permanent resident status (e.g., a “green card”), the U.S. system of taxation can seem like a maze: one wrong move and you’re stuck in a corner. Do not try and navigate this yourself. Seek professional tax advice from a tax preparer who is experienced in ex-pat/non-citizen issues. You’ll need guidance on tax withholding, tax filing, benefits choices and what to do when you leave the U.S.

Ask ex-pat colleagues first for referrals to a tax professional who has experience working with people like you. It’s not expensive and could save you from financial and legal problems later. For a basic overview of types of U.S. tax preparers, see this post on How to Find a Good Tax Preparer.

What do I need to know about U.S. retirement savings programs?

The U.S. retirement savings system is made up of Social Security, defined contribution plans (401(k), 403(b) or 457), traditional pension plans (defined benefit), and individual retirement accounts (IRA and Roth IRA).

Social Security

This is the government-sponsored retirement system, similar to what’s often called a “public pension” in other countries. As a non-citizen employee, you will likely pay a mandatory 6.2% of your pay on the first $128,400 of your 2018 wages into the system while you are working in the U.S. You’ll also pay 1.45% of your wages into Medicare, which you will not recoup unless you continue to be a U.S. resident. Your employer will also make contributions on your behalf.

If you do not plan to live in the U.S. when you retire, you may or may not be able to receive Social Security retirement benefits. It depends on how long you paid into the system, your immigration status, your country of residence, and whether you started receiving payments before you left the U.S. See this Social Security Administration Guide for Your Payments While You Are Outside The United States as well as Can I Still Receive Social Security If I Move Abroad?

401(k), 403(b) and 457 plans

Most large employers offer employer-sponsored retirement savings plans, such as 401(k) and 403(b) plans. An employee may contribute a percentage of their gross pay each period to a tax-advantaged account. Frequently, the employer will match up to a set percentage of what you contribute or will sometimes make contributions regardless of whether you make your own contributions. You’ll get to choose how your contributions are invested from a menu of mutual funds or other investing vehicles.

You may also get to choose whether you contribute your money into a pre-tax (traditional), after-tax (Roth), or after-tax voluntary account. See tips below for choosing what works for you. In 2018, you may typically contribute up to $18,500 to your employer’s plan annually plus another $6,000 if you’re 50 or older.

IRA and Roth IRA

If you are considered a resident for U.S. tax purposes (have U.S. earned income, have a Social Security number and meet the substantial presence test), you may open a traditional or Roth IRA. However, if you are a non-citizen and don’t plan to seek U.S. citizenship or permanent residency, you may not be able to reap all the benefits of an IRA or Roth. If you’re eligible, you may contribute up to $5,500 annually to a traditional or Roth IRA plus an extra $1,000 if you’re 50 or older.

Traditional pension plans

These are no longer widely available to new employees, but some larger companies and state/local government jobs still offer them. A pension may be fully funded by employer contributions or with a combination of employer and employee contributions. Typically, it takes 10-20 years to be “vested” in a pension, where the employee is eligible to receive a fixed monthly payout at retirement.

Should I enroll in my 401(k)?

Saving in your employer-sponsored retirement plan has multiple benefits, even if you don’t plan to continue working and living in the U.S. later in your career. If there’s a match on your contributions, that’s like earning additional income. There’s the potential for tax-deferred or tax-free growth, depending on the type of contributions you make. Plus you really can’t beat the ease of contributions deducted automatically from your paycheck!

Always consider your future taxes

For non-citizens making decisions about which retirement contribution type to choose, you’ll need to consider where you will be living when you withdraw the money, how old you will be when you plan to withdraw it, and whether you think you’ll be a U.S. permanent resident or citizen at that time.

If you expect to still be a non-citizen when you withdraw the money, note that you are required to file a U.S. tax return in any year in which you have U.S. income, which includes retirement plan withdrawals. Additionally, according to the IRS, “Most types of U.S.-source income paid to a foreign person are subject to a withholding tax of 30%, although a reduced rate or exemption may apply if stipulated in the applicable tax treaty.” You may or may not owe that rate in taxes, but the funds will be withheld from the distribution regardless.

If you’ve overpaid through the withholding, you would get a refund after you’ve filed your tax return for that year.  See this IRS U.S. Tax Guide for Aliens for in-depth reading. Now do you see why I say you need a tax advisor if you’re an ex-pat working in the U.S.?

If by the time you withdraw the money, you have become a U.S. citizen or a permanent resident – but are living overseas – you won’t be subject to the 30 percent withholding. You will, however, have to file a U.S. income tax return every year, regardless of your income. This blog post reviews the rules for U.S. citizens or permanent residents living outside the U.S.

Pre-tax, Roth or After-tax voluntary contributions?

The financial planning goal, then, is to minimize taxes and penalties on your future retirement plan distributions. Remember – you’re going to pay income taxes on whatever has not been taxed before. Your company’s matching or profit-sharing contributions to your retirement plan are always pre-tax, so they will be taxed when you withdraw them. How much of your own retirement contributions will be taxed depends on how you contribute:

Traditional pre-tax contributions: They are deducted from your taxable income, so you’ll pay less in income taxes today. Earnings grow tax-deferred for retirement. After age 59 1/2, you may withdraw them without penalty, paying US income taxes on whatever you take out. Prior to that, you may withdraw them only if you a) retire b) leave the firm or c) have an extreme financial hardship. Pre-tax contributions up to your plan’s percentage are generally eligible to receive the match, which is also in pre-tax dollars.  See this blog post for more details.

Roth contributions: Roth 401(k) contributions are made after-tax and grow tax-free for retirement if withdrawn 1) after 5 years and 2) after age 59 ½. If you meet those requirements for a distribution, your Roth distribution would not be included in your taxable U.S. income. See this IRS tool to see if your Roth distribution could be taxable. However, your home country (or country of residence) could tax it, depending on the tax treaty with the U.S.

If your plan allows, you can leave the funds in the account until after age 59 ½. If you must take an earlier distribution after you’ve left the firm, you will only be taxed and penalized on the related growth and any company contributions, not your original contributions. See this IRS Guide to Roth 401(k)s for more information and this blog post for when a Roth 401(k) works best.

After-tax voluntary contributions: Many employer-sponsored plans permit after-tax voluntary contributions in excess of, or as a substitute for, Roth or pre-tax contributions. This will give you some flexibility, as you may withdraw those contributions at any time (although growth of your funds will be subject to tax). If you plan to withdraw contributions after leaving the firm, taxation is similar to the Roth 401(k). Your retirement plan may also permit you to convert after-tax voluntary contributions to the Roth account, which could come in handy if you end up staying in the U.S., or roll them over to a combination of a traditional IRA and Roth IRA when you leave the firm. (See this blog post for strategies.)

On the down side, you won’t receive an employer match on voluntary contributions. Your original contributions can be withdrawn at any time tax-free, but any earnings or growth made in the account will be taxed when withdrawn. (That means earnings which are withdrawn before 59 ½ will be taxed and subject to an additional 10 percent penalty.)

If you leave the U.S., are you required to take distributions?

If you leave to work and reside overseas, you would be able to take a distribution from your company’s retirement plan but are generally not obliged to take any until age 70 1/2.  If possible, leave it where it can continue to grow protected from taxes. Pre-tax contributions that are later distributed are included in your taxable income, and if taken prior to age 59 1/2, may be subject to an additional 10% penalty.

Ask for guidance

If your company offers a workplace financial wellness benefit, talk through the pros and cons of your choices with a financial coach. Your financial coach can help you understand the implications of your choices given your personal situation. Also, while you’re working in the U.S., don’t forget to use a tax advisor experienced in non-resident taxation., such as a certified public accountant or an enrolled agent. This is well worth the relatively low cost to get good tax advice.

 

A version of this post was originally published on Forbes.

How To Approach Investing As Retirement Draws Closer

August 15, 2018

One of the things I discuss quite a bit with employees that are approaching retirement is how they should structure their investments as retirement draws closer. Many times, they are considering becoming more aggressive over their last few years in the workforce to try and boost returns and maximize account values. This can be a recipe for delayed retirement if the timing is wrong.

The fundamentals

While the fundamentals of investing – being mindful of how long until you need the money and your risk tolerance – do not change as you approach (or enter) retirement, conventional wisdom says you should really want to take less risk as you approach retirement. The idea being you have less time to recover from market losses than you did earlier in your career.

It’s a (hopefully) long road ahead

But, you don’t want to just plow everything into a stable value fund or cash either. Retirement can last upwards of 30 years or more, so you want some aggressive investments to help that money grow and last. You may be thinking, “OK you’re telling me to be more conservative, but stay aggressive – which one is it?”

Well, like many things in financial planning, it depends. Let’s look at some strategies to help you decide how to best manage your own nest egg as you approach retirement.

Exploring the fundamentals

At any point in your financial life, sticking to the fundamentals is the best way to be a successful investor.

  • When do you need the money? Money you know you will need to spend in the next 5 years should be invested conservatively. Investments like a CD, money market mutual fund, or a stable value fund protect those funds from dramatic market movements.
  • What is your risk tolerance? Knowing how you feel about risk is crucial in setting up your investment allocation. There are investors in their 20s or 30s that are very conservative by nature, just like there are investors in their 70s and 80s that are aggressive. Staying true to your risk tolerance allows you to be comfortable with the risk you are taking, which makes you much more likely to stay with your strategy when markets are down.
  • Don’t react to market moves. This one is easier said than done because it contradicts our human nature. For most of us, the pain of losing value in our accounts is stronger than the joy we feel when our accounts are growing. Selling stock investments at low points locks in losses as we are often selling low after buying high. It’s best to resist watching the market on a day-to-day basis.
  • Rebalance regularly. At least once per year, make sure your allocation reflects your original strategy. If your goal is to have 60% in stocks, 30% in bonds, and 10% in cash, check to make sure that is how your funds are set up. In a year when stocks have done well, you may find yourself with 70% in stocks and 20% in bonds. It can be tempting to keep riding the wave of a bull market, but it’s better in the long run to lock in the gains and stick to your original mix. Rebalance by selling enough of the stock investments (sell high) to get back to your target, then buying enough of the bond investments (buy low) to get back to your target there.

The bucketing strategy

When it comes to making investment changes as you approach retirement, one popular strategy is to think of putting your money in hypothetical buckets.

  1. The first bucket is your short-term funds – money you know you will spend in the next 5 years. This bucket can be thought of almost as a savings account and be very conservatively invested.
  2. The second bucket is your intermediate bucket and should be invested in things that generate income, like bond funds. This is money you’d anticipate withdrawing after 5 years, but before 10 years. This bucket is used to refill your short-term bucket as you spend from it.
  3. The third bucket is your long-term bucket and holds your aggressive investments (think stock funds) and is designed to drive growth. This is the bucket that can help your savings to last those 30+ years you’ll hopefully have in retirement.

Rule of thumb

Another way to look at it is by using a common rule of thumb that says the best balance is investing a percentage in stocks equal to 120 minus your age. So if you are 58, then 62% of your funds would be in stock funds. You may try this rule of thumb, along with the 5-year bucket if you find that simpler.

Final thoughts

As you approach retirement, it is a wonderful time to revisit your retirement accounts and make sure you are in line with your risk tolerance and following good fundamentals. Take some time to review your budget and spending needs over the next couple years, which will help you to clarify how much goes into each bucket. Having your money split into the different buckets can help make sure you have the right balance of safety, income, and growth. This will help your money last as your enjoy your retirement!

How To Find A Lost Retirement Account

August 14, 2018

This is a recent texting exchange I had with my 24-year old daughter who works in the medical field:

 

 

 

 

 

 

 

It got me thinking that if she hadn’t opened her statement or thought it was junk mail, would she ever know she had this plan at work? Since she’s not contributing, there’s a chance she may have never known about it, moved on to another job in the future, and missed out on potential thousands of retirement dollars in the future.

Many of us have changed companies over our careers, and I talk to people on a regular basis who think they might have an old retirement account somewhere, but have no idea how to go about tracking it down. Are you certain that you know where all of your old retirement plans are?

Here’s how to find an orphaned retirement account

First the easy steps:

  • If you remember the name of your 401(k) provider (Vanguard, Fidelity, TIAA, Voya, etc.), first contact them to see if your money is still there.
  • You can also contact the old employer. Look for the company online, and if it still exists, contact the HR department either by phone or email and ask them for your balance and account information.

Now the harder steps:

If the above two steps don’t yield any results, you’ll have to do a little more detective work.

  • You account may have been reported as “abandoned.” To search that, visit the US Department of Labor abandoned retirement plan database. It is searchable, so if you don’t know the Plan Name or exact Company Name, you can search by City and State to narrow the results.
  • Each state has an unclaimed property web site that is searchable as well – to find it, you can either search the name of your state and the term ‘unclaimed property’ or try starting here with a national database. If you have lived in multiple states, make sure you search each state’s site (and include your maiden name if appropriate).

Eureka! You’ve found something

If you are able to uncover old retirement accounts, you’ll have to take some steps to take back control. If it’s been reported as unclaimed property, go through the steps as directed to re-claim it as yours. If the money is still sitting at your old company or old plan, then getting started on re-claiming it may be as simple as updating the address on the account.

Once you’ve regained control of your account, you may want to transfer it to a place where you can keep better track going forward. Options include:

  • Transferring it to a rollover IRA (or existing IRA)
  • Roll it over to your existing retirement plan (if they allow rollovers)

Unless you’re over the age 59 1/2, resist the urge to just take the money and run — there are most likely tax consequences and penalties involved there, and since you didn’t know the money was out there, why not continue to “let it ride” for your future retirement? Happy searching!

How Will Your Social Security Income Be Taxed In Retirement?

August 13, 2018

Many of us dreamily envision the possibility of retiring someday; you know, making work optional, taking a permanent vacation, etc. While we can retire from the world of work, retiring from the world of taxes is typically not an option, as many retirees are surprised to learn.

Tax obligations may not be part of our retirement dreams, but perhaps they should be. The decisions we make about saving and investing for our retirement dreams while we are still working can help prevent a tax nightmare after we retire.

Your retirement income tax bite

As you might imagine, retirement is a popular reason for people to chat with a financial planner, and I have the pleasure of talking almost daily with people from all walks of life about their retirement concerns. Most people understand that pension income and distributions from traditional 401(k) and traditional IRA accounts will be taxed as ordinary income. One thing that surprises me though, is how many people are not aware that a significant portion of their Social Security retirement benefits will most likely be subjected to ordinary income tax as well.

Social Security is not (always) tax-free

If Social Security is your only or primary source of income in retirement, your benefit may not be taxable. However, if you have income from other sources as well (e.g., pension, distributions from a pre-tax IRA or 401(k), part-time work, self-employment, interest, dividends, etc.) that add up to a certain amount, then a portion of your Social Security will also be subject to income tax. Just how much of your Social Security is taxable will be determined by your combined income.

How to calculate whether you hit the income limits

Sometimes referred to as “provisional income,” your combined income figure is calculated as the sum total of adjusted gross income plus nontaxable interest (yes, that’s your municipal bond income) plus ½ of your Social Security income. Your combined income determines how much of your Social Security income is taxable, and the amount subject to income tax could be 0%, 50% or 85% (or even 100% in one special case). (Don’t panic – it’s not a 100% TAX, that’s the percentage of your SS that will be taxable!)

Adjusted gross income (line 37 on Form 1040)
+
Non-taxable interest (line 8b on Form 1040)
+
1/2 of what you received in Social Security (from Form SSA-1099)
_______________________________________________
Income for Social Security taxation purposes

A good rule of thumb is that if your other income is more than $44,000, you’ll be paying taxes on Social Security no matter what. Less than that (or if you’re not married), refer to the chart below.

 

Combined Income Limits for Taxation of Social Security Retirement Benefits

Taxable SS Amount Single, Head of HH, Widowed, Married Filing Separately IF apart entire year Married Filing Jointly
0% Less than $25,000 Less than $32,000
50% Between $25,000 – $34,000 Between $32,000 – $44,000
85% More than $34,000 More than $44,000

Note: If you are married and filing separately but you lived with your spouse even one day out of the year, all of your Social Security retirement benefit will be taxable for that tax year.

 

Roth to the rescue

If you think there isn’t much you can do about your taxes in retirement, you might be surprised to know that you have more control than you think. If you still have a few years to go until retirement, or if you plan to work part-time after you retire, a tax-free Roth IRA can help you keep the tax man at bay.

Here’s why: although the combined income calculation for determining Social Security benefit taxation includes non-taxable interest income (e.g., municipal bond interest), the calculation does not include Roth IRA or Roth 401(k) distributions.

You read that correctly.

Money you take out of a Roth account (assuming it has been in there at least five years) is not subject to income tax, nor does it affect how much of your Social Security is taxable. Accumulating Roth assets during your working years, including converting some traditional IRA/401(k) dollars to Roth accounts, can pay off hugely in retirement by giving you a source of tax-free income that reduces your combined income for Social Security purposes and potentially lessens the tax bite on that benefit.

Remember, you can even convert traditional/pre-tax retirement dollars to Roth IN RETIREMENT, although you’ll have to pay taxes on the amount you convert. However, that’s one way to plan ahead to hopefully avoid taxation of your Social Security in the future. If you want to read about more strategies for reducing your taxes in retirement, my colleague Erik Carter wrote about several strategies in one of his Forbes articles.

Should You Use The Brokerage Window In Your 401(k)?

July 27, 2018

Are you a hands-on investor seeking investments beyond your 401(k) plan’s core list of investment choices? If so, you may have an option available in your retirement plan at work that most retirement savers aren’t aware of – the self-directed brokerage account (SDBA). This “brokerage window” option available in some retirement plans gives participants the ability to invest in mutual funds, exchange-traded funds (ETFs) and in some cases individual stocks and bonds.

Who typically uses a self-directed brokerage account in a 401(k) plan?

According to Aon Hewitt, approximately 40% of employers offer self-directed brokerage account options, but participation rates remain low. Aon Hewitt found that only around 3 to 4 percent of retirement plan participants with access to SDBAs actually use this self-directed option.

The SDBA option has generally been more popular among retirement savers who have larger retirement plan balances or who work with an outside financial advisor. For example, Schwab recently reported that the average account balance of those using this option is just over $260,000. Compare this to Fidelity’s reported average balance of all 401(k) participants, which is just under $100,000.

What does a self-directed brokerage account offer?

The main benefit is that SDBAs give you more flexibility when it comes to the investment options available. Access to a wider range of investment choices than the default ones presented in your plan can be a refreshing alternative if you are generally unhappy with the investment options available in your plan.

For example, if your 401(k) plan does not include access to target date funds or asset allocation funds, you can use the SDBA to add this fund to your retirement portfolio. This can also be appealing if you are simply using the self-directed windows to gain access to asset classes not represented in your core investment lineup such as emerging market stocks, international small cap, and value or growth-oriented funds. SDBAs can even help you diversify with alternative asset classes such as real estate and commodities.

Beware of the paralysis of too many choices

But as behavioral finance studies on the paradox of choice have shown us, too many options can hinder participation rates in 401(k) plans. Choosing the right investments for your goals, risk tolerance, and time horizon also requires discipline. Most investors lack a written game plan or investment policy statement. As a result, many individual investors are prone to the “behavior gap” and underperform the actual funds they own due to mistakes related to emotional decision-making and market timing.  

Self-directed brokerage accounts are designed for advanced investors who know how to research and manage their investments. FINRA warns investors that the additional choices commonly associated with self-directed accounts require additional responsibilities. In order to follow a disciplined investment plan, you can start by focusing on things within your control such as asset allocation, contribution rates, minimizing costs, and asset location (i.e., pre-tax vs. Roth 401(k)).

Pay attention to the fees

Minimizing your overall investment costs is one thing you have some control over as an investor. That’s why it is just as important to understand all fees and expenses associated with a self-directed brokerage account as it is to know your core 401(k) plan expenses.

Some 401(k) plans charge an annual maintenance fee for using the mutual fund or brokerage window. It is also necessary to identify if there are any commissions and transaction costs associated with trades made through SDBA accounts. You can check your plan’s fee disclosure to better understand the actual costs related to your 401(k) plan.

Check mutual fund expenses

In some cases, you may also see an increase in mutual fund expenses when you go outside your core investment options. This is because most funds available in the SDBA are retail share classes which tend to be much more expensive than the institutional funds many large retirement plans provide access. On the other hand, if your 401(k) plan has expensive mutual funds, the self-directed brokerage account is a potential remedy.

How does its performance compare?

Finally, it is important to note that there is a reason self-directed brokerage accounts are underutilized. The average investor is often better served simplifying their investments as much as possible. That is why it is important to establish benchmarks to track your performance.

Self-directed brokerage accounts give you an opportunity to try to outperform or diversify your plan’s core options. But if you choose to take the self-direct route and find that your investment performance consistently lags the core investment portfolio, you may need to take a simpler approach to your retirement savings plan.

 

A version of this post was originally published on Forbes.

What Are Your Health Insurance Options If You Retire Before Medicare?

July 20, 2018

Early retirement is a very common goal, although how exactly do you define “early?” For most people, early means stopping work before the availability of benefits that are used by retirees like Social Security and Medicare. Uncertainty over whether retirement savings can stand up to several years without these programs is often the reason people put off retirement.

If you have dreams of sleeping in or traveling the world before you’re eligible for retiree benefits, all is not lost. As is the case with any goal, you must decide to face it head-on and find ways to make it work within your financial plan. Here are a couple of ways to address meeting your medical care needs if you choose to retire prior to age 65.

Option 1: Obtaining insurance through the federal marketplace

Pros

  • You have the possibility of finding health coverage similar to what you have with your employer – Due to the implementation of the Affordable Care Act, coverage from your employer and coverage through healthcare.gov offer similar coverage benefits, deductibles and premiums.
  • You may be eligible for subsidies depending on your income – The cost of coverage for health insurance through the federal exchange is correlated to how much income you report. In some cases these subsidies  can bring the cost of coverage in line with what you are currently paying through work.

Cons

  • Coverage can be very expensive – Without the subsidies, you are exposed to the full brunt of the cost of healthcare. Depending on where you live and the size of the deductible you choose, costs can approach $1,000 or more per month. While you may want to maintain the deductible you have through your employer, you may need to increase it in order to make premiums affordable.
  • Changes in laws pertaining to the Affordable Care Act can make it difficult to plan – The laws that govern the plans that are available on the exchanges have changed substantially over the past year and there is reason to believe that there are more changes to come. This can make it very difficult to plan the cost for this line item in your budget going forward.

Option 2: Use COBRA coverage

Pros

  • You can maintain your same coverage – The Consolidated Omnibus Reconciliation Act or COBRA is a rule requiring employers to offer you access to coverage after separation of service for a certain amount of time. So rather than searching for a similar plan, you can use the same plan.
  • It may still be at a lower cost than coverage through healthcare.gov – The cost of coverage is essentially what you would normally pay in premium plus what your employer pays. If you work for a large company, the total cost can still end up being cheaper than going it alone in the Exchange because of the cost savings the employer may have negotiated.

Cons

  • Coverage is available for only 18 months in most cases – Because the coverage only lasts 18 months in most cases, COBRA is only a temporary fix for an early retirement. Once the coverage goes away, the exchange may become your primary option.
  • It is still substantially more expensive than what you probably pay today – If your employer covers a large portion of the cost of your insurance benefit, you may experience sticker shock.

Start planning now

As you can tell, both options have some drawbacks but you have no way of knowing how much of a drawback unless you do some research. Here are some things you can do to plan now:

  • Contact HR: If you think COBRA is a likely option, reach out to your benefits department to find out how much it costs today. In the case of insurance on the Federal Exchange price it now. Yes, there is a reasonable likelihood the pricing will change, but it will give you a baseline to plan.
  • Beef up your HSA: If you have an HSA, make sure you’re maxing out your contributions to the account now. You can use the account to pay for COBRA tax-free. HSAs cannot be used to pay health insurance premiums from the exchange, but they can be used to offset out of pocket medical expenses. (and they can also eventually be used to pay for Medicare premiums)
  • Consider investing in vehicles that will not show up as future income: By investing in accounts like Roth 401ks and IRAs, you can lower the amount of taxable income you generate in a year when you withdraw from these accounts. This may help you to qualify for Healthcare Exchange subsidies and will eventually allow you to keep your Medicare premiums down as well.

 

 

 

What To Do With Your Old Employer’s Retirement Plan

July 16, 2018

Have you ever had to leave a job and couldn’t decide what to do with your retirement plan? I recently got a Helpline call from a woman who was about to leave her company and had to make that exact decision. Let’s look at the pros and cons of the options:

Option 1: Cash it out

This is generally the worst decision since you have to pay taxes on anything you take out and possibly a 10% penalty if you’re under age 59 ½ and left your employer before the year you turned age 55. If you’re still working at a new job, the tax rate you pay is likely to be higher than it would be if you waited until retirement and if the balance is large enough, it could even push you into a higher tax bracket. You also lose the benefits of future tax-deferred growth.

That being said, if you absolutely need the money to get caught up on bills or to pay off debt, it may be your only choice.

Option 2: Roll it to an IRA

This option generally provides the most flexibility. It allows you to continue deferring the taxes while giving you more investment options than you may have in your current retirement plan. You also have the ability to use the money penalty-free for education expenses and for a first-time home purchase (up to $10k over your lifetime) or to convert it into a Roth IRA to grow potentially tax-free.

Option 3: Roll it into your new employer’s plan

If you want to keep things simple and consolidate everything into one account, this may be the choice for you. Just make sure the new plan allows it. It can also be the best choice if the new plan provides unique investment options that you’d like to take advantage of with this money or if you’d like to have the option of borrowing against it.

Option 4: Leave it where it is

As long as you have at least $5k in the account, most plans will allow you to keep the money there. If you have company stock or any unique investment options that you’d like to keep, this may be the best option for you. It also gives you time to decide during what is likely to be a hectic time in your life. After all, you can always roll it into an IRA or your new employer’s plan later. Just keep in mind that having too many retirement accounts in different places can make it harder to manage them.

In this particular case, the woman decided to simply leave it where it was because she had turned 55 and wanted to have the option to take penalty-free withdrawals if she needed to. If she rolled it into an IRA or a new employer’s plan, she would have had to wait until age 59 ½ to avoid the penalty.

That doesn’t mean it’s the best choice for everyone. Every situation is different. The key is to understand your options so you can make the best choice for you.

Can You Contribute To A 401(k) And SEP-IRA At The Same Time?

July 13, 2018

One trend I’ve noticed in recent years is people with full-time jobs starting a business on the side. Some folks are looking to earn some extra cash and some are passionate about a hobby or pursuit and want to try to make a business from that passion.

If you have a side gig such as catering, photography, or blogging in addition to your “real job,” it’s important to know that there are distinct types of retirement plans that you can use for each. Being aware of how they work together can allow you to save more for retirement, while possibly saving on taxes today.

What is a SEP?

First, a quick review of what a SEP-IRA is. Most of us are familiar with our 401(k) plans at work – in order to contribute, you have to work for the company that’s providing it. Similarly, a SEP-IRA is a retirement plan tied to a company, but it’s specifically designed for self-employed individuals and small businesses.

How do contributions work?

Unlike the 401(k), where both the employer and employee are able to contribute to the account, all contributions to a SEP-IRA are considered employer contributions. For 2018, you can contribute the lesser of 25% of your gross salary (or 20% of your net adjusted annual self-employment income) up to a maximum of $55,000. You have until your tax filing deadline to make your contribution, so many people with SEPs choose to wait until then so that they know exactly how much they can put in (your CPA and most tax prep softwares will calculate this amount for you).

Keep in mind that if you employ anyone to help out with your business, you also have to put the same amount in their account as you save for yourself. You can adjust your contributions each year, so if your business is having a great year, you can save more. You can also save less (or not at all) in years that are tight. However, you do have to have self-employed income to make any contributions.

Can I use a SEP-IRA if I also contribute to my 401(k)?

If you are an employee of the company you work for (aka you receive a W-2 at tax time) and you also have a side business that you own, you can actually make contributions to your employer’s 401(k) plan and contribute to a SEP-IRA for your business. That means that having a side gig can allow you to save beyond the 401(k) annual limit of $18,500 (or $24,500 if you’re over age 50)!

Here’s an example of how it might work:

  • Let’s say you are already maxing out your 401(k) at work.
  • Now let’s say you also do a little wedding photography on the weekends, which brings in another $20,000 this year.
  • You could open a SEP-IRA and contribute $5,000 (25% of $20,000) for this year.
  • Because the 401(k) and SEP-IRA are with two different companies with no common control, saving in your 401(k) does not impact how much you can save into a SEP-IRA.
  • It’s important to note that if you have two jobs where you work for someone else and have 401(k)’s at both, that the $18,500/$24,500 limit applies to both across the board; the SEP-IRA, however, could be in addition to the 401(k).

As you can see, the potential to reduce your taxable income and save for retirement becomes very powerful!

Other things to consider

  • It is crucial to run your situation by your tax professional to make sure your strategy is best suited to you.
  • I also suggest reviewing this FAQ site from the IRS to get additional information.
  • My colleague, Scott has also written a great piece about SEP IRAs that can help if you’re looking to set one up.

Understanding your options and having a well-coordinated plan can help you manage your taxes and do some serious savings for retirement!

Common Mistakes To Avoid When Starting A New Job

July 10, 2018

This month marks my 2-year anniversary of joining Financial Finesse. Prior to making the move, I was with my previous employer for 17 years. It was my first change in employer since college. While I am a seasoned veteran at my job, I was a rookie at changing companies.

Transitioning from one company to another can be an exciting time but it also presents many opportunities for costly financial mistakes. Here are some areas you will want to focus on if you recently made a change of employer.

Common mistake: lack of budgeting for new cash flow

There is nothing more fundamental to your finances than your cash flow. Understanding the method in which you are paid is essential to your budgeting habits. While most job changes are made to increase cash flow, you have to plan for how it may differ from the previous employer.

You may be switching from a company that paid biweekly to now getting paid bimonthly. Or there may be a lag between your starting date and your first paycheck. In my case I went from a job that was primarily salary based compensation to a job that had a larger performance based component.

We had to readjust our monthly budget to accommodate for those changes. We adjusted to using the performance based compensation to save for our “big wants” like vacations, which freed up the regular compensation for our week-to-week needs.

How to avoid it

If you’re fortunate enough to receive a signing bonus, don’t “pre-spend” it, but instead keep it on hand for the first couple months in case you need to adjust to a change in cash flow. If you don’t receive a signing bonus, try to cut back on spending for a few weeks leading up to your job switch so that you’ll have an extra cushion.

Common mistake: choosing the wrong health insurance

When changing jobs mid-year, you have an opportunity to re-enroll for health care. Even if the coverages are administered by the same provider, the coverage options can still differ greatly. In our case the insurance company remained the same so there were a lot of similarities all the way down to the insurance cards looking the same, but when we looked under the hood the coverage was different.

How to avoid it

Be sure to download your coverage details from your former employer and compare it to your new company’s offerings. Get the information from your new plan options to make sure your preferred doctors and hospitals are available in the plan you are choosing, even if you are staying with the same insurance company.

Common mistake: keeping your retirement planning on auto-pilot

Not all retirement planning benefits are equal, so it is not safe to assume you should contribute to your retirement plan the same anywhere you go. Before you just go with the default at your new company, take some time to understand how the new retirement plan works.

How to avoid it

Get the match – At the most fundamental level, you need to understand if your new employer offers a match and when you are eligible to start receiving that match. This ensures you are not leaving free money on the table.

Pick your investment – Next up review your investment options and choose one. I have seen cases where no investment choice was made and the default option wasn’t the best fit. If you are unsure which investment is the best fit, many plans offer several hands-off investment options.

Pre-tax or Roth – Your new plan may also offer options that may not have been available at your previous employer like Roth 401k and after-tax savings. There are resources that can help you determine which option may work best.

Common mistake: missing out on unique benefits

Perform a deep dive into your benefits beyond the basics. Sometimes you can find hundreds of dollars of savings in your employee benefits, but you have to take some time to read up and maybe do some digging.

Here are some examples of unique benefits you may want to explore:

Student loan assistance – Some employers aid with managing your student loans. Some programs offer to pay a portion of your loan after a reaching a certain level of tenure. Other companies offer student loan experts to help you refinance.

Legal benefits – If getting a solid estate plan in place is one of your goals, investigate your new company’s Employee Assistance Program or EAP. These programs sometimes offer free legal document preparation software. They also may offer discounts on local attorney services.

Your company may also offer a pre-paid legal program that will allow you to have the cost of will or a trust covered by you making small monthly payments. In many cases you can enroll in the program with a single year’s commitment and have a large amount of legal work done at a significant discount than you would pay otherwise.

Financial wellness benefits – Last but certainly not least, your company may offer financial wellness benefits. I spoke to someone recently who said they were having a hard time finding a financial advisor that would help them with their plan to pay off debt but had just learned that their company added a Financial Wellness benefit. She was excited because her family has likely saved hundreds of dollars because of her company’s benefit.

How to avoid it:

Take some time in your first 60 days or so to peruse your company’s benefits website and/or brochure. Ask around to see what benefits your colleagues value the most. Finally, when the annual enrollment period rolls around, don’t just go on auto-pilot — it’s a great chance to assess whether you made the best choices and to switch things up as necessary. Your employee benefits are a valuable part of your compensation, so make the most of them.

5 Ways You May Be Sabotaging Your Financial Independence

July 02, 2018

Take a moment to think about what you would do if you were financially independent. Would you travel, volunteer, spend more time with family or friends and “treat” them or yourself more often? Is financial independence something you want to achieve and life keeps getting in the way?

This month, take a stand and start choosing the financial lifestyle you want. When the people who founded the United States of America declared the nation’s independence, their biggest interest was in achieving each individual’s freedom to determine his or her own financial destiny. Here are some things you may be doing wrong, and the keys to setting yourself up for financial independence:

  1. NOT writing down your financial goals or action plan. It’s easy to procrastinate your way to financial mediocrity or even financial ruin, but studies show that people who just write down their goals and action plans are significantly more likely to achieve them. You’ll be thanking yourself later. Create a S.M.A.R.T. (Specific, Measurable, Attainable, Relevant, and Timely) goal plan using the S.M.A.R.T. Goals worksheet, and use online calculators to figure out the savings or payment rates you’ll need.
  2. NOT using a spending plan to guide your financial decisions. Look at your transactions over the first six months of the year, and compare them to the plans you made. Can you see where you need to reign some things in, and where you’ve done a good job sticking to your plan? Keep up the good habits, and change the ones that aren’t working now.
  3. NOT paying off debts quickly and wisely. Include a plan to pay off credit cards every month, automate the payment of low interest debt, and eliminate high interest debt.
  4. NOT keeping an emergency fund. Lacking a cushion of funds to pay for the occasional car repair or veterinary bill can repeatedly sabotage the best of financial plans. Use a separate savings account or a Roth IRA, whatever works best for you, to stash some cash that you will not touch unless it’s for an emergency.
  5. Making poor investment choices. Don’t leave your financial dreams to chance! Invest for the long run and not like a day trader (unless you ARE a day trader). Take advantage of the tax benefits offered by retirement accounts to set up a diversified, long range portfolio. Then put money into those accounts consistently and generously to accelerate your achievement.

It’s never too early, or too late, to start matching your financial decisions up to your goal of financial independence. You might even enlist your friends to help you stick to the plan and avoid poor choices that will sabotage your success. Keep with it and soon you will be enjoying your financial freedom.

How Your Social Security Benefit Is Calculated

June 18, 2018

Most people know that the amount of your Social Security benefit depends on two things:

  1. The age you are when you elect to begin receiving payments
  2. The highest 35 years of your earnings

However, there is a lot of confusion around how your benefit is affected if you work past age 62, especially if you’re in your highest earning years.

Here’s what you need to know

Your earnings are indexed for economy wide wage growth

In other words, you may be making the most total dollar amount of your working years right now, but that might not mean it’s your highest year for SS purposes.

What that means is that Social Security plugs your annual earnings into a table over all of your years of working and multiplies the earnings by an index to get everything in current dollars. Then they take the 35 highest years from that table to calculate your benefit.

Figuring out your 35 highest earning years

To figure out your 35 highest years, go to this website, then enter the year you will first become eligible to receive payments (the year you turn 62). I was born in 1977, so will turn 62 in the year 2039. Once I have the index factors, I can pull out my earnings report (which you can access through your SS account) and multiply each year’s earnings by the indexing factor.

For example, the first year I had wages was 1992, when I earned a whopping $136. The indexing factor for 1992 is 4.8442967, which means that $659 is the amount used in figuring my highest 35. Do this for each year, then add up the highest 35 (or for me, since I don’t yet have 35 years, I just add them all up), then divide by the total number of months in those years. This is your average indexed monthly earnings (AIME).

If you have 35 years of earnings, you just divide by 420. Since I’ve only had 26 years to date, I’d use 312 for now. So if you add up all your indexed years and get $3,000,000 and divide by total months of 420, your AIME would be $7,143.

Plugging your 35 highest years into the formula

Once you’ve added up the highest indexed 35 years and divided by the total months you’re counting to get your average earnings, you plug it into a formula. Using the example above, here’s how the formula works:

90% of first $885 of earnings: ($885 x .9) =$796.50 Remaining earnings: $6,258
32% of earnings above $885 up to $5,336 ($4,451 x .32) =$1,424.32 Remaining earnings: $922
15% of everything above $5,336 ($992 x .15) =$138.30 TOTAL: $2,359.12

 How to use this information

The good news is that the Social Security Administration does this work for you, but knowing how the formula works can help you if you are trying to figure out whether continuing to work will actually increase your benefit and if so, by how much.

In order to figure it out, you basically have to take a look at your indexed earnings so far, then make sure you’d be able to out-earn your 35th lowest year.

You may be surprised to find that your lowest earning year in actual dollars may NOT be your lowest indexed year. Likewise, your highest indexed year could very well have taken place many years ago, even though you’re earning more in actual dollars today.

Is it worth it?

Finally, even if your projected earnings are substantially higher than your lowest 35th year, you may find that the increase to your benefit would be minimal. When I ran a few examples of a worker just matching highest actual dollar years in continuing to work, the monthly benefit increased by less than $15.

Depending on your projected monthly retirement expenses, that additional $180 per year could make a difference, but most people I know in their 60’s would pay $180 per year in order to retire sooner, no?

 

Ways To Delay Social Security While Maintaining Your Lifestyle

June 14, 2018

Financial planners generally agree that delaying your Social Security retirement benefits can be an excellent way to maximize your available retirement income and potentially stretch your savings over your lifetime. As you are probably aware, each year past full retirement age that you wait to file your claim, your Social Security retirement benefit increases by as much as 8%. Where else are you going to find a guaranteed 8% return on an investment these days?

Where else are you going to find a guaranteed 8% return on an investment these days?

On the other hand, if you are thinking about waiting until after you reach full retirement age to claim your Social Security retirement benefit, you might also be wondering where you are going to get the income that Social Security will not be paying you during those years when you delay this benefit. Fortunately, making a few little changes to your retirement spending plan in the near term could result in some big benefits in the long run.

How to plug the gap

Continue working a little longer

This is probably the most obvious alternative for generating income in place of a delayed Social Security retirement benefit and what most people choose to do. Working full-time or part-time provides immediate cash flow, but there is also another benefit that may not be quite so obvious.

Each year that you continue to work past your full retirement age, you also continue to accrue Social Security credits. These additional earnings and credits might begin to replace those from some of your earliest working years when you worked for significantly lower wages, fewer hours, or both. As a result, the formula used by the Social Security Administration to calculate your retirement benefit could generate an even larger benefit check than if you chose not to work a few more years.

Spend a little more of your retirement savings in the early years

I’m always surprised by the number of people who just assume they have to start collecting Social Security just because they are done working. Many of us have been coached during our working years not to touch our retirement assets and to make them last as long as possible once we do retire. Consequently, spending a little extra on the front end of retirement might seem like the wrong thing to do.

However, according to research by William Reichenstein and William Meyer, if your retirement portfolio is somewhere between $200,000 and $600,000, this strategy might be a good way to minimize taxes and stretch your retirement savings. Keep in mind, the additional spending only happens until you turn on your delayed – and larger – Social Security benefit. At that point, you would then begin spending substantially less of your retirement savings.

What it looks like

Let’s say your monthly Social Security check at a full retirement age of 67 would be $1,800. If you delay filing for three years until the maximum claiming age of 70, your check would increase to $2,232 (not counting any cost of living adjustments or additional credits for working during those years) or a flat 8% for each of three years, giving you 24% more Social Security income.

Since you would not be receiving the $1,800 in monthly Social Security between the ages of 67 and 70, you would have to withdraw an additional $21,600 from your retirement savings each year ($1,800 x 12). However, at age 70, not only would you be able to stop taking out the annual $21,600 from your savings, you would also begin receiving an additional $5,184 each year from Social Security, thanks to the delayed retirement credits paid to you by Social Security in return for delaying your benefit until the maximum claiming age of 70.

Convert a little of your investment portfolio to an income annuity

Everything you’ve heard about annuities is generally true: they can be expensive, complicated, and very difficult (as in even more expensive) to unravel if you change your mind. However, not all annuities are the same. An income annuity (also known as an immediate annuity) is about as plain vanilla and inexpensive as these products can get.

Assuming you have a pretty good idea of what your retirement budget may look like, converting a portion of your retirement portfolio to a lifetime stream of income by purchasing an immediate annuity at or a few years before you retire can help take some of the unpredictability out of your future retirement income.

There are many ways to slice and dice this strategy, and the free immediate annuity calculator at ImmediateAnnuities.com can help you see how much income can be generated from various investment amounts. Another great feature about this site – no sales pressure. You do not have to enter any personal contact information.

Think a little longer before you choose a reverse mortgage

If you are at least age 62 and have a considerable amount of equity in your home, you might be considering a reverse mortgage as another way to bridge the income gap between the date you retire and the date you elect to claim your delayed Social Security benefit. However, caution is advised with this particular strategy.

The Consumer Financial Protection Bureau (CFPB) recently issued a report advising older consumers that the relative costs and associated risks of taking out a reverse mortgage loan may not be worth the additional increase in delayed Social Security retirement benefits. The report points out that consumers should be fully aware of how this strategy may significantly reduce available home equity and limit retirees’ ability to handle future financial needs. The CFPB also makes available a helpful “Reverse Mortgage Decision Guide,” as well as an informative video for those who wish to know more about reverse mortgages.

A few more ideas

Finally, a few more ideas to help you bridge that retirement income gap include these:

  • Encourage your spouse to work a little longer to prolong income and benefits.
  • Live on less for a few years (or forever – tiny houses are popular!).
  • Take pension benefits (if you have a pension).
  • Convert some of your assets to cash (sell some stuff).

Whichever strategies or approaches you choose, a well-worn and familiar expression reminds us, “A little goes a long way.” With this in mind, a little change here and there in the way we manage our retirement assets just might go a long way toward making the most of our savings and enjoying retirement just a little bit more. Which one will you choose?

 

This post was originally published on Forbes

How One Financial Decision Changed Everything For This 35-Year Old Single Mom

June 06, 2018

As a financial wellness coach, I have the unique opportunity to dive deep into the finances of many different types of people with many different situations. Most financial advisors don’t have this perspective because they only work with “qualified prospects,” people with enough investable assets for them to manage. Because of our business model, we are able to deliver guidance to employees on every aspect of their finances from crisis situations to wealth building.

I want to share a recent client story about re-thinking your assumptions about the best way to handle what may appear to be a “little thing” that turns out to be a really big thing.

Borrowing from retirement to buy a car – good idea or bad?

A recent coaching relationship, Susan, originally contacted me because she was looking to take a loan from her 401(k) account to purchase a new car. Susan (35) works for a large corporation and earns around $80,000 annually plus bonuses. She is a divorced single mom with an 11 year-old daughter.

She was planning to buy a new brand Buick Enclave, which is a very nice SUV that would provide reliable, safe transportation for her and her daughter. It can carry up to 7 people, ideal for soccer carpool duty. Sticker price after trade-in: $40,000.

Susan’s plan was to take the $40,000 as a loan from her 401(k) because she would get a low interest rate, pay herself back the interest instead of to a bank, and have cash to buy the car, which would enable her to negotiate with the dealer for a better price. She had calculated the loan payment of $375 per paycheck (Susan is paid bi-weekly) for 5 years. On the surface, that sounds like a good plan. But I wanted her to dig a little deeper.

What’s your 5 year plan?

I asked Susan if we could take a step back for a minute to discuss her other financial goals and she agreed. Here’s how our conversation went:

Me: “What does your ideal financial situation look like in 5 years?”

Susan: “I haven’t really thought about it.”

Me: “Let’s break it down to make it more tangible and talk about some other common goals:

  • How much would you like to have in an account in case an emergency comes up?
  • Would you like to be debt-free besides your mortgage?
  • Do you want to put some money away for your daughter’s education?
  • You should have a plan to be on track for retirement some day.
  • How about travel or vacations?”

Setting 5 year goals

After discussing further, Susan decided to put her 5 year goals down on paper:

Me – “How does the car fit into this plan? Can you afford to be your ideal 40 year-old Susan if you buy this car?”

That got her thinking.

Financial psychology side note

As humans, we are constantly making intertemporal choices (inter – between, temporal – time periods), basically deciding to act on impulses (instant pleasure) or for the future (delayed gratification). The brain is an amazing organ. It has the ability to learn and remember, but that can work both ways. The more we make impulse decisions, the more inclined we might be to act on impulses in the future. The more we stop and think about how decisions impact our future, the stronger this part of brain gets.

The more we make impulse decisions, the more inclined we might be to act on impulses in the future. The more we stop and think about how decisions impact our future, the stronger this part of brain gets.

Why visualizing your future makes a difference in today’s choices

If we can’t visualize what we want the future to look like, we don’t have the context for what we could be giving up in the future. Susan’s car decision was impulsive — she was thinking about how it would make her feel good in the present but she wasn’t considering how it would impact her future. After understanding what she would have to give up (retirement preparedness, her daughter’s college plans, the trips she loves), her impulse turned into a thoughtful decision.

What she decided to do

So, what did Susan decide to do? After researching Consumer Reports and other publications, she purchased a 3 year-old Honda CRV for a little under $18,000. She gave up the dream car with room for the entire soccer team, but her new car rated better in safety ratings with less than half the payment.

She weighed the financing options with facts. The dealer offered her a better rate than her local bank with the option to make extra payments. Because her 401(k) loan did not allow this pre-payment option, she decided to use the dealer financing.

Now, she is able to fund her other goals. With the remaining $380 she would have paid every month, she did the following:

  • Opened an emergency fund and set up a $150 auto-deposit per month
  • Opened a separate vacation fund at the same online bank with another $150 going in each month
  • Opened up a College Savings account for her daughter with a monthly contribution of $50
  • Signed up to increase her 401(k) contributions every year by 1% to get her on track for retirement

It’s amazing how one seemingly small choice to drive a different car can make such a huge difference, but it did. What are you giving up in your future with the choices you’re making today?

Do We Really Have A Retirement Crisis In America?

June 05, 2018

Since my early days in the financial services industry, around 1997 or so, the industry mantra has always been, “Save more money for retirement; you never know how long it may last.” I’m not sure if we were talking more about time or money, but most people assume the money won’t last as long as retirement might, which is a scary thought.

The idea that we aren’t saving enough conjures up a pervasive image of an elderly grandma eating cat food because she is now unable to afford groceries in retirement. This thought always bothered me some, though not so much from the imagery as the skewed economic priorities. Have you seen the price of canned cat food lately? From what I’ve seen, it’s actually less expensive to buy whole chicken than some of the premium brands out there.

At least we can now put to rest that image of grandma eating cat food because she went broke. Unless grandma is also housing and feeding 20 or 30 felines, in which case her retirement savings are taking a severe beating.

Are we actually saving enough though?

This story is more about grandma than her cats, however, so let’s get back to her. How much has the average grandma (or grandpa) been saving towards retirement? According to a recent article, many workers contribute sporadically to their 401(k)s and similar retirement plans at work, only to see their savings eroded by subpar returns and high administrative expenses.

Other sources suggest that workers in their 40’s have saved only around $14,000 or so in their 401(k) plans, and the middle 40% of wage earners have socked away only $60,000 or so for retirement. Our own Financial Finesse 2015 research report on Retirement Preparedness shows that just 19% of workers surveyed believe they are on track with their retirement savings.

When the wolf says the sky is falling

Most of us are probably familiar with the children’s stories of Chicken Little and the Boy Who Cried Wolf. I can’t help but think about these tales when I see all the doom and gloom reporting about retirement savings in the media and from the lips of some of my financial industry colleagues.

Of course, creating a crisis mentality can be a good way to sell investments and annuities. Who wants to end up in poverty when there was something we could do about it, if we only acted now, you know, before it’s too late; before rates go up, or down, or Congress does this or that, or blah, blah, blah.

Think about who you know

Despite hearing the cries that we aren’t saving enough and will end up retiring in poverty, how many people do you know that ended up in that situation? As a practicing middle-market financial planner for the past 20+ years, I’ve seen this happen to exactly – zero people. I’m sure there are exceptions out there. There are certainly people who ended up working longer than they originally intended or scaled back their retirement expectations for various reasons. But by and large, Americans seem to find a way to make do, even when their retirement reality doesn’t turn out quite as they imagined it might.

It’s not just rich people I’m talking about

And no, I haven’t been working exclusively with high net worth clients. I’ve also started taking a very close look at exactly who is sounding the alarm about a so-called retirement savings crisis. Often the message comes from someone connected with the financial industry and with a vested interest in the sale of investment and insurance products. Politicians also get in on the message by proclaiming how the private sector has failed and how Social Security and similar programs must be expanded to save people (i.e., voters) from certain doom.

The real cost of retirement

Not the kind to take many things at face value, I began a search for some unbiased (or less-than-biased) information that might suggest exactly how Americans do spend their retirement savings. Perhaps the most telling story comes from a longitudinal study performed by the Employee Benefits Research Institute (EBRI). Following a group of households for several years, this study showed that median household spending actually dropped by as much as 12.5% in the first four years of retirement, and by the sixth year a majority of households were spending less than 80% of what they spent during their working years. (Note that these retirees were living on less than 80% of preretirement spending, not 80% of preretirement earnings.)

Other studies have confirmed this finding, like this one and this one. Most interesting to me were discoveries regarding just how frugal retirees tend to be when it comes to spending down their retirement savings:

  • People who had accumulated less than $200,000 in non-housing assets at retirement had spent only about 25% of their savings, on average, during the first 18 years of retirement.
  • Those with assets between $200,000 and $500,000 generally had spent around 27.2% by year 18 of retirement.
  • Wealthier retirees with nest eggs in excess of $500,000 had spent less than 12% of their savings by the 20th year in retirement.
  • Even though some retirees had spent down their savings significantly in the first 18 years of retirement, almost one-third of retirees in the study actually grew their assets during that period. Those with access to pensions were much more likely to fall into this group.

The most important question is: are you saving enough?

The most important question is not so much are Americans saving enough but are you saving enough to fund your retirement? Even though there is substantial research out there suggesting that our retirement years are likely to be more affordable than we might fear, we don’t want to become lulled by false hope and fall behind in our savings efforts. The fact remains that the majority of people we work with don’t think they are on track, and the only way to get there is to save.

At the very least, contributing to one’s retirement plan at work at whatever rate the employer will fully match is a powerful move. Why leave free money on the table, right?

Beyond that, saving at a higher contribution rate may be needed in order to replace 70% – 80% or so of your preretirement income. You can use our retirement estimator calculator or a similar online calculator to measure your progress. If you are able to replace 80% of your income, then the odds are very good that you will have little trouble replacing at least 80% of your pre-retirement spending, which appears to be the true cost of your future retirement.

Should You Use Your Retirement Savings To Buy A Home?

May 01, 2018

First-time home-buyers are often surprised by the requirements of obtaining a mortgage, especially when it comes to the down payment. One way you can improve your chances of getting a home loan is by putting at least 20% down at the time of purchase. For existing homeowners like me, coming up with a 20% down payment usually starts with selling the home I’m in right now and using the equity to make a down payment on my next home.

But what about someone that may be buying a home for the first time? Coming up with a $50k down payment on a $250k home may take several years of aggressive saving, but your retirement account may not be a bad place to go for the additional funds needed to get you on the path to home ownership. In fact, the IRS offers certain breaks for taxpayers that choose to use retirement assets to purchase a first home. Here’s how it works.

Who qualifies as a first-time homebuyer?

Interestingly enough, you don’t actually have to be buying a home for the first time in your life to be considered a “first-time” homebuyer.  IRS publication 590 defines a first-time homebuyer as any homebuyer that has had no present interest in a main home during the 2-year period ending on the date of acquisition of the new home.

In other words, as long as you haven’t lived in a home you owned for the last two years, you are considered a first-time homebuyer even if you owned a home previously. If you are married, your spouse must also meet this no-ownership requirement.

Using your IRA

Most people know that when you take money out of a traditional IRA prior to age 59½, there is usually a 10% penalty tax for early withdrawal. However, the IRS offers an exception for first-time homebuyers that allows first-time homebuyers to withdraw up to $10,000 over a lifetime without penalty for first-time home purchases. Keep in mind that while the distributions are not subject to penalty, they are still subject to income taxes. $10,000 probably won’t be enough to cover your full down payment, but it can help.

Does it make a difference if I use a Roth IRA?

It does. If you’ve owned a Roth IRA for at least five years, any distributions used for a first-time home purchase (subject to the $10,000 lifetime limit) are treated as qualified distributions. That means the amount distributed will not only be exempt from penalties, but also income taxes. If you have not owned a Roth IRA for at least five years, your distribution may still avoid penalties but some or all of it may be subject to income taxes.

How to use more than $10,000 from your Roth IRA

One thing you should understand is that Roth IRA distributions are subject to ordering rules, which basically means any money you put in comes out first and is therefore not subject to taxes or penalties (since you already paid taxes on the money before it went in). Therefore, the exception described above is really only applicable after you have withdrawn all of your contributions, so many people find themselves withdrawing all of their initial contributions PLUS $10,000 of growth, with no tax consequences.

Using your 401(k) or 403(b)

The same exception doesn’t apply to your retirement account through work — the only way to withdraw money from you employer-sponsored retirement plan (e.g. 401(k)) for a home purchase while you are working is through a hardship withdrawal. Buying a home is one of the reasons allowing for a hardship withdrawal, but you will pay that early withdrawal penalty if you’re under age 59 1/2 and any pre-tax withdrawals or growth in your Roth 401(k) will be taxed as well.

Using a plan loan instead

Some people use the 401(k) loan provision to access those funds to buy a home without the tax consequences, but it’s important to factor in that you’ll have to pay the funds back in order to avoid taxes and penalties. Many companies give you longer than the standard 5 year pay-back period to repay a residential 401(k) loan, but you may have to prove that you actually closed on a home in order to maintain the longer pay-back period. Also, if you leave work before paying off the loan, many plans require you to pay off the balance within a few months of separation or risk defaulting on the outstanding balance.

So is it a good idea to use retirement assets to purchase a home?

That depends. If you plan on using the equity in your home as supplemental income in retirement, some investors may consider this a good way of diversifying your retirement portfolio. However, if you have trouble making payments on the loan, not only could you end up losing your place to live, but you may also jeopardize part of your retirement nest egg. Read this Forbes article for more things to consider and like with all financial decisions, you should weigh your options carefully before deciding which approach to take.

 

Why You Should Max Out Your HSA Before Your 401(k)

April 25, 2018

Updated for 2021 limits

Considering that most employers are offering a high-deductible HSA-eligible health insurance plan these days, chances are that you’ve at least heard of health saving accounts (“HSAs”) even if you’re not already enrolled in one. People who are used to more robust coverage under HMO or PPO plans may be hesitant to sign up for insurance that puts the first couple thousand dollars or more of health care expenses on them, but as the plans gain in popularity in the benefits world, more and more people are realizing the benefit of selecting an HSA plan over a PPO or other higher premium, lower deductible options.

For people with very low health costs, HSAs are almost a no-brainer, especially in situations where their employer contributes to their account to help offset the deductible (like mine does). If you don’t spend that money, it’s yours to keep and rolls over year after year for when you do eventually need it, perhaps in retirement to help pay Medicare Part B or long-term care insurance premiums.

Not just for super healthy people

But HSAs can still be a great deal even if you have higher health costs. I reached the out-of-pocket maximum in my healthcare plan last year, and yet I continue to choose the high-deductible plan solely because I want the ability to max out the HSA contribution. Higher income participants looking for any way to reduce taxable income appreciate the ability to exclude up to $7,200 per year from taxes for family coverage (plus another $1,000 if turning age 55 or older), even if they end up spending the entire amount each year. It beats the much lower FSA (flexible spending account) limit of $2,750 even if out-of-pocket costs may be higher

Even more tax benefits than your 401(k)
Because HSA rules allow funds to carryover indefinitely with the triple tax-free benefit of funds going in tax-free, growing tax-free and coming out tax-free for qualified medical expenses, I have yet to find a reason that someone wouldn’t choose to max out their HSA before funding their 401(k) or other retirement account beyond their employer’s match. Health care costs are one of the biggest uncertainties both while working and when it comes to retirement planning.

A large medical expense for people without adequate emergency savings often leads to 401(k) loans or even worse, early withdrawals, incurring additional tax and early withdrawal penalties to add to the financial woes. Directing that savings instead to an HSA helps ensure that not only are funds available when such expenses come up, but participants actually save on taxes rather than cause additional tax burdens.

Heading off future medical expenses
The same consideration goes for healthcare costs in retirement. Having tax-free funds available to pay those costs rather than requiring a taxable 401(k) or IRA distribution can make a huge difference to retirees with limited funds. Should you find yourself robustly healthy in your later years with little need for healthcare-specific savings, HSA funds are also accessible for distribution for any purpose without penalty once the owner reaches age 65. Non-qualified withdrawals are taxable, but so are withdrawals from pre-tax retirement accounts, making the HSA a fantastic alternative to saving for retirement.

Making the most of all your savings options

To summarize, when prioritizing long-term savings while enrolled in HSA-eligible healthcare plans, I would strongly suggest that the order of dollars should go as follows:

  1. Contribute enough to any workplace retirement plan to earn your maximum match.
  2. Then max out your HSA. (For 2021, the maximum annual contribution, including employer contributions, is $3,600 for single coverage and $7,200 for family coverage, plus a $1,000 catch-up contribution for HSA holders age 55 and older.)
  3. Finally, go back and fund other retirement savings like a Roth IRA (if you’re eligible) or your workplace plan.

Contributing via payroll versus lump sum deposits
Remember that HSA contributions can be made via payroll deduction if your plan is through your employer, and contributions can be changed at any time. You can also make contributions via lump sum through your HSA provider, although funds deposited that way do not save you the 7.65% FICA tax as they would when depositing via payroll.

The bottom line is that when deciding between HSA healthcare plans and other plans, there’s more to consider than just current healthcare costs. An HSA can be an important part of your long-term retirement savings and have a big impact on your lifetime income tax bill. Ignore it at your peril.

6 Ways To Make The Most Of Your Workplace Financial Wellness Benefit

April 17, 2018

As an unbiased financial wellness coach, one of my personal missions is to help people realize that much of what they need to make the most of their finances is available through work by using their financial wellness benefit. Many of the employees I talk with via the Financial Helpline aren’t even aware of the full suite of benefits they have. Even if you don’t work for a company that offers our programs, chances are you have some type of benefit that can help.

What can you do with a workplace financial wellness benefit? A lot – and it doesn’t cost you a dime to get help tackling your debt, getting ready to buy your first home, running a retirement projection or understanding the difference between a Roth and Traditional 401(k). You may have access to a wide range of resources, including financial coaching, workshops, webcasts, peer-to-peer groups and online learning tools, all paid for by your employer.

Even just using your benefit may put you in better financial shape

What’s the upside of participating over time? Our research found that those employees who were repeat users of their workplace financial wellness programs had higher overall financial wellness, were better prepared for retirement, managed their cash flow more effectively and were more comfortable with their debt levels. Here’s a summary of the progress participants made between taking their first financial wellness assessment and their most recent one:

1st assessment Last assessment
I have a handle on my cash flow. 67% 77%
I have an emergency fund to cover unexpected expenses. 51% 59%
I check my credit report on an annual basis. 54% 71%
I am on track to reach my income goal in retirement. 18% 39%
I feel confident that my investments are allocated appropriately. 31% 51%
I have taken an investment risk tolerance assessment. 43% 65%
I rebalance my investment accounts to keep my asset allocation plans on track. 33% 58%
I carry enough life insurance to replace my income. 46% 60%
Average overall Financial Wellness score 4.85 5.96

6 ways you can take advantage of the benefit

1. Find a financial mentor

Navigating financial issues has become increasingly challenging, with employees facing more and more complex decisions about health insurance, tackling debt and student loans, saving for retirement and balancing competing priorities. A workplace financial wellness coach can help guide you through all that “life stuff,” helping you understand your options, weigh the pros and cons of each and assess the impact on your financial trajectory.

Depending on your company’s financial wellness program, you may be able to talk to someone on the phone and/or in person. That coach becomes your financial mentor – someone to cut through all the jargon and help you clarify the actions needed to move you towards your most important goals.

Mentoring from a financial coach is different from advice. A financial mentor empowers you to make wiser, more confident financial decisions for yourself. Questions to ask your financial coach/mentor include:

  • Can I speak to you on the telephone, in person, or both?
  • Can I email you my questions?
  • Is there any limit to how many times we can work together?
  • Do you have a professional designation, such as the CERTIFIED FINANCIAL PLANNER™ designation or CPA credential?
  • Is this completely unbiased with no sales pitch?

Heads up: make sure that your financial coach is truly unbiased and isn’t just trying to use the phrase “financial wellness” to sell you investments, insurance or anything else. A real financial wellness program won’t sell you anything.

2. Grab a life line

If you are living paycheck to paycheck or feeling overwhelmed by bills, your financial wellness program can help. Debt and cash flow issues are primary drivers of financial stress. Reach out to a financial coach, who can brainstorm with you on ways to get a handle on your cash flow to free up resources to tackle debt and save for emergencies.

Many companies who offer workplace financial wellness programs encourage employees seeking retirement plan loans and hardship withdrawals to talk through the advantages and disadvantages with a financial coach and work through alternatives, if there are any. You’ll find that your financial coach or credit counselor listens without judgment, offers a practical process for coping with financial stress and anxiety as well as achievable action steps. That can be a lifeline when financial stress has become unmanageable.

3. Maximize your benefits choices

If you aren’t taking full advantage of your employer-sponsored benefits, you could be leaving as much as $1 million on the table over the course of your career. Before you make your benefits elections during open enrollment this year, schedule some time with one of your workplace financial wellness program’s financial coaches to do a complete benefits review with you, asking these kinds of questions:

  • Am I earning the full employer match in my 401(k) or 403(b) plan? How can I contribute more? Should I sign up for the automatic rate escalator?
  • What health insurance plan makes the most sense for me? How can I get the most out of it?
  • Am I leaving any money on the table in benefits I could be using?
  • Am I taking full advantage of all the ways to minimize my taxes?
  • Am I making the best use of the insurance benefits my employer offers?
  • Should I put more in a health savings account and/or a flexible spending account?
  • Can you help me understand all my voluntary benefits (e.g., legal, commuter, tuition, etc.)?
  • Can you help me calculate the value of my benefits as part of my overall compensation?

4. Run a retirement projection

Have you run a retirement projection yet? If not, you’re not alone. Half of all employees (51 percent) in 2016 didn’t know if they were on track or not for a comfortable retirement and only about one in four (27 percent) knew they were on track to reach their goals. Those who interacted with their financial wellness program over time, however, were nine percentage points more likely (58%) to have run a retirement projection and 11 percentage points more likely to be on track (38 percent).

The single most important step

The simple act of running a retirement projection may be the single most important step you can take to reach your retirement goals, per our research. If you find out you’re on track, this will reduce your financial stress and increase your confidence that you can meet your retirement goals on time or sooner. If you find out you’re not on track, you have the opportunity to change your saving or investing or adjust your assumptions, such as your target retirement date and how much you’ll need for expenses.

5. Get an unbiased second opinion on your investments

There are lots of great financial advisors out there, but there is also a small percentage that just wants to charge you high fees or worse, make off with your money. An unbiased financial wellness benefit – where there is zero selling of products or services – offers you the opportunity for a second opinion on your financial plan or investment proposal.

A financial coach can help you work through questions to ask your financial advisor and help you evaluate if your advisor’s recommendations fit your risk tolerance, time horizon and financial circumstances. They can help you check the credentials of any financial advisor you are considering hiring. Plus they should be able to help you understand the investment choices in your retirement plan in light of your financial goals and situation.

Remember, most financial wellness providers cannot offer you investment advice. They can’t tell you what to do. Rather, they can assist you in understanding your options and empower you to make the wisest choice for your situation.

6. Measure your progress

Making financial progress is a lot like losing weight. Getting physically or financially fit are both about making small changes in your behavior which you can sustain over a long period of time – preferably for life. The people who are the most successful are those who set a benchmark and track their progress.

If your financial wellness program offers you a tool for assessing where you start and a mechanism for tracking your progress, make sure to use it at least once per year. Check if your employer offers peer-to-peer learning opportunities (e.g., women and money, new employees group, etc). These offer accountability and encouragement. Having the support of a group of like-minded people is like having your personal cheerleading squad, and you’ll be more likely to “weigh in” on a regular basis.

Not every workplace financial wellness program is a true workplace financial wellness benefit, but it still may be able to help. Some companies only offer online tools, while others offer comprehensive programs which include unlimited 1 x 1 coaching. Check with your HR department on what’s available to you and how you can take advantage of it.

What’s The Difference Between Roth IRA And Roth 401k?

April 04, 2018

We’ve recently received several calls on our Financial Helpline from people who entered their Roth 401(k) contributions as Roth IRA contributions in tax software and were told that they had over-contributed. Since Roth 401(k) plans are relatively new, it’s easy to get these mixed up but the differences are important and not just when filing your taxes.

What’s the same?

Let’s start with the similarities.

  • Both accounts allow you to contribute after-tax dollars that can grow to be tax-free after age 59 ½ as long as you’ve had the account for at least 5 years.

The differences

Now let’s take a look at the subtle, but important differences.

1. Can you contribute?

Roth 401k:

A Roth 401(k) has to be offered by your employer. If your employer offers one and you’re eligible to contribute to the 401k, you’re good to go.

Roth IRA:

A Roth IRA has income limits. (However, there is a way to get around them.)

2. How do you contribute?

Roth 401k:

If your employer offers you a Roth 401(k) option, the contributions are deducted from your paycheck for that tax year.

Roth IRA:

With a Roth IRA, you have to open the account and make the contributions yourself, either by writing a check or having an automatic transfer from your bank account. You also usually have until April 15th (April 17th this year) to make a contribution for the previous year. Not sure where to open a Roth IRA? Here are some low cost options.

3. How much can you contribute?

Roth 401k:

The total limit for employee traditional and Roth 401(k) contributions is $18,500 ($24,500 if you’re over age 50 this year) for 2018.

Roth IRA:

For IRAs, the total limit is a much lower $5,500 ($6,500 if you’re over age 50 this year). The Roth IRA contribution limit can also be reduced if your income is in the phase-out range.

Contributing to one doesn’t affect how much you contribute to the other so you can do both if you’re eligible, which means for 2018 you could feasibly be putting a combined $24,000 into Roth accounts ($31,000 if you’re over age 50).

4. What can you invest the accounts in?

Roth 401k:

With a Roth 401(k), you’re limited to the choices your plan offers but this can often include options not otherwise available like higher-yielding stable value funds and mutual funds with reduced fees.

Roth IRA:

With a Roth IRA, you can invest in almost anything, including stocks, bonds, mutual funds, annuities, and even gold coins, real estate, and your own business if you have a self-directed Roth IRA. The choices (and their fees) will depend on which financial institution you choose to use.

5. How can you get the money?

Roth 401k:

With a Roth 401(k), you’re generally limited to loans and/or hardship withdrawals before age 59 ½ if you’re still employed there and if the plan allows them. Many plans also allow you to take withdrawals at age 59 ½. You can withdraw money after you leave your employer as well.

Roth IRA:

You can take money out of a Roth IRA anytime. (that doesn’t mean there won’t be penalties or tax consequences, so keep reading)

6. Are there penalties on withdrawals?

Roth 401k:

For both types of account, Roth earnings withdrawn before age 59 ½ are subject to taxes and a 10% penalty unless you meet certain exceptions. With a Roth 401(k), withdrawals are considered contributions and earnings in the same proportion as they exist in your account. This means that if you have a balance of $20,000 but $10,000 is the amount you contributed (called the “basis”) and you withdraw $10,000, the IRS will consider 50% of that withdrawal to be earnings and you’ll be taxed and/or penalized accordingly.

Roth IRA:

One of the big differences is that with a Roth IRA, your withdrawals are considered contributions first, which is important if you need access to the any of the money before age 59 1/2. That means you can withdraw the sum of your contributions at any time without tax or penalty. Unlike with a Roth 401(k), Roth IRA earnings can also be withdrawn penalty-free for education expenses and up to $10k (lifetime limit) for a home purchase if you haven’t owned a home in the last 2 years.

7. Can you roll money from one to another?

You can roll money from a Roth 401(k) to a Roth IRA but not the other way around.

What’s the bottom line?

Roth IRAs generally provide more flexibility, both in terms of how the money is invested and withdrawn. However, Roth 401(k) accounts offer greater convenience and allow you to contribute more (and may allow you to contribute at all if you make too much money). They’re both excellent ways to shield your future income from taxes so if you’re eligible, you may want to contribute to both!