How To Take Money Out Of Your Accounts In Retirement

September 22, 2016

Updated April, 2018

We typically spend most of our working life putting money in accounts for retirement, but how do we take them out after we retire? I recently received a question from a “long time reader, first time caller,” about how to order which accounts he will withdraw from when he retires soon. The conventional wisdom is to withdraw money first from taxable accounts, then tax-deferred accounts, and then tax-free accounts in order to allow your money to grow tax-deferred or tax-free as long as possible. However, there are a few other things you might want to consider too:

Will you need to purchase health insurance before you’re eligible for Medicare at 65? If so, your eligibility for subsidies under the Affordable Care Act is partly based on your taxable income. In that case, you might want to tap money that’s already been taxed like savings accounts and money that’s tax-free like Roth accounts to maximize your health insurance subsidy (but not so low that you end up on Medicaid instead). You can use this calculator to estimate what that amount would be.

Are you collecting Social Security yet? Withdrawing from tax-free Roth accounts can also reduce the taxes on your Social Security. That’s because the amount of your Social Security that’s taxable (either 0, 50%, or 85%) depends on your overall taxable income plus nontaxable interest (like muni bonds) but not tax-free Roth withdrawals.

How can you minimize your tax rate? First, you’ll want to withdraw (or convert to a Roth) at least about $12k a year from your pre-tax accounts because the standard deduction makes that income tax-free. If you have other deductions, you may be able to have even more tax-free income. Then take a look at the tax brackets and see how much income you can withdraw before going into a higher bracket.

For example, a married couple’s first $19,050 of taxable income is only taxed at 10%, with the next $58,350 is taxed at 12% according to 2018 tax brackets. Any long term capital gains at those levels are taxed at 0%. If you’re about to go into a higher bracket, you may want to use tax-free income to avoid those higher rates. Just keep in mind that pensions and taxable Social Security (see above) will also count as income in determining your tax bracket.

How do you put it all together? Your withdrawal strategy may change and adjust based on the situation. You may tap into savings accounts (including your HSA) and sell taxable investments to maximize your health insurance credits until 65. Then you may withdraw from taxable accounts until you collect Social Security benefits at age 70, which draws down your required minimums at 70 1/2 while maximizing your Social Security payment. At that point, you can continue withdrawing from your taxable accounts to fill in the lower tax brackets and then use tax-free accounts to avoid the next tax bracket.

Of course, this all assumes that you have investments in multiple types of tax accounts. Otherwise, it doesn’t really apply to you. But if you do, you might want to consult with a qualified and unbiased financial planner to help you sort it out and come up with the right strategy. If your employer offers that as a free benefit, it might be a good place to start.

 

Should You Contribute Pre-tax or Roth?

September 15, 2016

That’s one of the most common questions we get. For example, I recently received the following email: (My response follows.)

I am a 26 year old in my fourth year as a police officer. I’ve been contributing to my employers 401a and deferred comp programs for about 3 years. My contributions have been Roth and after reading your article, I’m wondering if that’s the best option for me. I have a part time job at the local mall that matches 5% of pre tax contribution and I max out there as well. I don’t plan on using the money until retirement, so should I switch my main employer to pre tax as well? This year I’ll make around 60-70k, but next year I’ll probably make around 80k. My goal is to save near a million dollars for retirement and I’m not quite sure how to figure my retirement income. Can you guide me in the right direction?

First of all, great job on contributing to all those retirement accounts at such a young age! The earlier you can save for retirement, the longer that money will be working for you. This will definitely put you in a much better position for retirement.

The basic decision is whether you’d rather pay taxes on your savings now (Roth) or when you take them out of your retirement account (pre-tax). Assuming you’re single, you would currently be in the 25% tax bracket so every dollar you put in those retirement accounts pre-tax is avoiding a 25% tax rate. If you retire with a million dollars, you could safely withdraw about 4% or $40k a year. In addition to the $28k of Social Security benefits you’re projected to receive at your normal retirement age of 67, your $68k of total retirement income would put you in the same 25% tax bracket at retirement.

Not all your retirement income would be taxed at 25% though. Based on your total retirement income, only 85% or about $24k of your Social Security benefits would be taxable. At least about $10k of your income wouldn’t be taxed because of the personal exemption and standard deduction so your taxable income would be no more than about $54k. Using today’s tax rates (which are adjusted for inflation), the first $9,275 of taxable income would be taxed at 10%, the next $28,374 would be taxed at 15%, and only the last $16,351 would be taxed at that 25% rate. As a result, your average or effective tax rate in retirement would actually be about 17%.

Of course, this assumes that you don’t have a lot of deductions like mortgage interest that would go away by the time you retire. It also assumes that the tax code stays the same. If your effective tax rate ends up being higher in retirement, you would be better off with a Roth account.

Confused? One simple solution would be to diversify by contributing pre-tax to your employer’s retirement accounts as well as to a Roth IRA. That’s because the Roth IRA has the additional benefit of the contributions being available anytime without tax or penalty. It may also be helpful to have some tax-free money in retirement to qualify for higher health insurance subsidies if you decide to retire before you’re eligible for Medicare at age 65.

Don’t overthink it though. Whichever option (or combination of options) you choose, the most important thing is that you’re contributing for retirement. The less optimal option is still much better than not saving at all.

 

 

 

4 Financial Moves I’m Glad I Made in My 20s

August 31, 2016

It’s easy to dwell on the shoulda, coulda, woulda’s of our past – those things we wish we’d done differently. But I’m also a big believer in reflecting on what went right! After all, if history is bound to repeat itself, wouldn’t we want the good stuff to repeat as well? So here are the financial moves I made in my earlier years that I would be glad to repeat.

Contributed to the match in my 401(k) since day 1. It’s worth noting that with my first two employers, I actually didn’t get to keep my full match as I left the companies before I was vested, but I still had the money I’d saved to start my nest egg. I also had the established habit of saving as I went on to higher-earning jobs, where I eventually qualified for and got to keep the match. So even if you’re quite certain you won’t be around long enough to keep matching dollars, you should still save enough to earn it. You never know when plans might change, and it’s silly to give up the chance at free money. Isn’t that why we buy lottery tickets?

Aggressively paid off credit card debt. There have been two occasions in my life when I used credit cards to get through times of income challenges. Both times I also reached a point when it was time to pay them off, and I committed to an aggressive monthly payment in order to eradicate the debt as quickly as possible. I also put any windfalls toward the debt, including things like tax refunds (Remember the “stimulus” checks we all received in 2001? Mine went straight to VISA), work bonuses and freelance income. I also made sure my spending reflected my desire to get out of debt and saved the luxuries as my reward for financial dieting. The Financial Finesse Debt Blaster calculator is a great way to make a debt pay-off plan.

Participated in my employee stock purchase plan. I’ve worked for three publicly traded companies that offered employee stock purchase plans, which basically allow employees to buy stock in the company at a discount through payroll deductions. This is another example of free money but was also a fun way to build up some side savings that made me care a little bit more about how my company did beyond just my own job. I never invested more than I could afford to lose, so in all three cases, I was just saving a small amount, but it was worth it to have that little investment nest egg that I could access before retirement. Caution though: make sure that your investment in any one company doesn’t exceed more than 15% of your total investments. If your employer match goes into company stock too, keep an eye on when you may need to diversify out of the stock.

Earned my BODYPUMPTM certification. What the heck does teaching a fitness class have to do with finances? Well, since I became a certified instructor in 2005, I’ve not had to pay for a gym membership, plus I get paid to work out. It’s not a ton of money, but it’s better than paying to work out! I try to make the most of it by transferring 50% of my BODYPUMPTM pay into a separate savings account. I can’t quantify the health benefits of teaching three times per week, but suffice to say, I probably wouldn’t make it to the gym more than once a week if I wasn’t paid to be there, so it’s worth it for the health benefits too.

How about you? What financial moves did you make early on that are paying off today? Please share them with me on Facebook or Twitter.

Did you know you can sign up to receive my blog posts every week, delivered straight to your inbox? Just head over to our blog main page, enter your email address and select which topics or bloggers’ posts you’d like to receive. Obviously I suggest at least ‘Posts from Kelley.’ Thanks for reading!

 

 

The DIY Financial Checkup

August 08, 2016

When is the last time you had a financial checkup? Just like physical exams, regular financial exams lead to better overall financial health. While you can’t give yourself a thorough doctor’s exam, you can give yourself a comprehensive financial checkup with today’s abundance of useful online financial planning tools.

The first step in your diagnosis is to get all your important information organized in a central place. Some of this may be in paper form and some of it online. Gather these resources in advance so you have them on hand:

-your employee benefits such as retirement accounts, health/dental/vision insurance, disability insurance, HSA account, flexible spending accounts, commuter accounts, etc.

-the last month’s bank and brokerage account statements, including taxable accounts, IRAs and annuities

-a recent paycheck and your W4 (YTD cash flow statement if you are self-employed)

-estate planning documents, e.g., will, trust, power of attorney, healthcare directive

-additional insurance policies, e.g., homeowner’s, auto, umbrella liability, life, disability

-mortgage statement

-credit card statements, student loans, car loans, etc.

-financial plan, if you have one

-your budget, if you have one

What’s your financial position?

Pull together a summary of everything you own and everything you owe. (Download an easy net worth and budget worksheet here.) Subtract what you owe from what you own. That’s called your “net worth.”

Is your net worth positive or negative? Has it increased or decreased since the last time you calculated it and by what percentage? As my fellow planner Kelley Long says, “Your net worth is the ultimate measure of your ability to weather financial storms and maintain financial choices in life. The higher your net worth, the more financial freedom you can afford.”

Next, calculate your debt to income ratio by dividing your monthly gross pay by your total monthly recurring debt payments (mortgage, credit cards, student loans, car loans, etc.) The lower your debt to income ratio is, the better your financial position. FYI, mortgage lenders often look for a total debt to income ratio of no more than 36% of gross income.

Do you have sufficient cash reserves?

According to our 2016 Financial Stress Research, good cash management is the biggest differentiator between those workers who have no financial stress and those who have overwhelming financial stress. The foundation of cash management is a solid emergency fund to deal with inevitable unexpected events that happen to all of us. While the common guidance is to have at least three to six months in living expenses in savings or money market funds, it’s also important to make sure you have enough additional cash on hand to handle health, auto and property insurance deductibles as well as home and auto repairs. Bankrate.com has a helpful emergency savings calculator to figure out exactly how much you should keep in liquid savings. If your emergency fund could use some work, use this daily savings calculator to figure out how small savings, like $5 or $10 per day, can add up to a big cash cushion over time.

Could you survive a financial earthquake?

The purpose of insurance is to protect you and your family against catastrophic loss. The big idea behind insurance is that people pool their risks of catastrophic events. If you do suffer a loss and are adequately insured against it, you can be restored to your financial position before the loss. Do you have the insurance you need? Here are some guidelines for determining if you are sufficiently covered:

Health insurance – Everyone needs it, no excuses. If you don’t have health insurance, get it right away.

Disability income insurance – How would you pay the bills if you couldn’t work due to injury or illness? Many employers offer short and long term disability insurance. Make sure you take advantage of them during your next open enrollment period. This is particularly important if you are single or if you are the sole breadwinner in the family. To determine how much coverage you need and whether a supplemental policy is in order, use this calculator.

Life insurance – If someone else depends on your income for their living expenses, you need life insurance. There are different methods for determining how much insurance is ideal. For most people, the less expensive term insurance meets their needs. Use this calculator or download this worksheet to see if your coverage fits your situation. Subtract the coverage provided by your employer to determine what you need to purchase on your own.

Homeowner’s insurance – Per the Wall Street Journal, your homeowner’s insurance should provide enough to rebuild and furnish your home if it were wiped off the map. Does your policy reflect the current value of your home, any improvements you have made to it plus the cost to replace its contents? Basic homeowner’s policies do not cover you for things like floods and earthquakes. If those are common in your region, you may need to add specific coverage.

Renter’s insurance – Not a homeowner? When I was a young professional in Washington, D.C., my apartment was burglarized twice. Only then did I purchase renter’s insurance. Renter’s insurance covers the value of the stuff in your apartment that belongs to you like furniture, clothing and electronics. If the value of all those items exceeds the insurance deductible, consider renter’s insurance to cover your valuables.

Umbrella liability insurance – According to fellow planner Scott Spann, most people facing a judgment from civil litigation probably assume that their homeowner’s or auto policy would cover them. Low cost umbrella liability coverage provides an additional layer of protection in the case of a civil lawsuit. Consider policy coverage that is at least twice your net worth – more if you are a high earner.

Are you on track to replace 80% of your income in retirement?

Running a retirement calculator is like stepping on a scale. It is best done regularly in order to compare your results to your goal. Download our easy to use retirement estimator here.

While you may have run retirement estimates before, results can change depending on economic conditions. Review and update your assumptions about your savings rate, inflation and rate of return. For example, a recent report from McKinsey and Company suggests that investors may need to lower their sights, projecting that U.S. stock market returns over the next two decades could be between 4 and 6.5% annually.

If you’re not on track, what can you do to increase your retirement savings? Can you increase your contributions to a 401(k) or other employer-sponsored plan? Sign up for the contribution rate escalator. Contribute to a Roth or traditional IRA. According to our CEO, Liz Davidson, you can set yourself up for success by automating a process that would otherwise require a lot of effort and sacrifice.

How are you handling your taxes?

Did you get a big refund or owe a large sum on your most recent tax return? It may be time to adjust your withholding. This IRS withholding calculator can help you figure out the right number of allowances to claim.  Additionally, are you taking full advantage of tax-deferred retirement accounts, your health savings account, and flexible spending accounts? Make a list of what you need to change during your next open enrollment period.

Do your investments fit your situation?

Do you have a written plan to guide your investing decisions? If not, consider putting together an investment policy statement using this easy guide. Start by updating your risk tolerance by downloading this worksheet.

Has anything changed with your willingness or ability to take investment risk, your time horizon or your required rate of return? What about your inflation expectations or the kind of investments you are willing to make? Evaluate your current portfolio to see if it meets your updated goals and make changes if it doesn’t.

How much do your investments cost you in fees? Calculate your fees both as a flat dollar amount and as a percentage of your portfolio. Do you think you are getting your money’s worth?

Hint: if they are higher than 1%, consider changing brokerage firms or moving to lower fee alternatives such as index funds. Thinking about doing it yourself? Check out this blog post from fellow planner Erik Carter on how to save and invest on your own without getting eaten alive.

What happens to all this when you die?

Has anything changed since you first put together your estate plan? Take a look at all your retirement accounts and insurance policies and make sure your beneficiary designations reflect your current situation. Second, review your will and other estate planning documents such as a living trust, durable power of attorney, healthcare directive and guardianship provisions. Are the documents current and reflective of your wishes? What needs to be brought up-to-date?

Don’t have an estate plan? Follow these simple seven steps. Even if you do have a current estate plan, you may still need to develop a digital estate plan to express your wishes about what happens to your digital life.

Did you give yourself a financial checkup? How did it work out? Let me know by emailing me at [email protected]

7 Signs You’re Living Beyond Your Means Even If You Can Pay All Your Bills

August 03, 2016

I’m pretty sure most people understand that the first step in achieving financial security is to spend less than you make. Sometimes easier said than done, but it’s the only way you can save any money and avoid high interest credit card debt. What a lot of people don’t get though is that just because you’re able to pay your bills each month, it doesn’t mean you’re not living beyond your means. If your bank account balance gets dangerously close to zero right before payday, you’re not “getting by,” even if you don’t overdraw and are technically making ends meet. Here are 7 other signs you’re living beyond your means, even if you are able to pay all your bills on time, and what you can do about it:

1. You’re not paying off your credit cards every month or you don’t have a plan in place to pay them off. Use the Debt Blaster to get a plan going and then stick to it.

2. You don’t have an emergency fund. This is your first line of defense against long-term financial issues. Get started on this ASAP.

3. You say you can’t afford to do that thing you really want to do. This was actually the wake-up call for me to realize that I was living beyond my means even though I was making ends meet. I really, really, really wanted an iPad and a new bike, which added up to about $1,000. I said I couldn’t afford it and yet I was spending that amount monthly on dining out and booze. If you tell yourself you can’t afford something you really want, and that thing would be reasonable for someone of your income, lifestyle and life stage to have, that’s a sign you need to examine your spending and start living within your real means.

4. Unplanned expenses like a traffic ticket or a family member’s destination wedding send you into a tailspin. If the first thing you think of when you hear a cousin is getting married at an all-inclusive resort in the Caribbean is, “How rude! I don’t have the money for that!” you are not “making it” financially. There needs to be wiggle room in your cash flow for things like this. Here’s a good way to plan for it.

5. You’re taking out 401(k) loans to pay off other bills. Even though you’re paying interest to yourself, this is still a form of debt. If you’re borrowing against your savings, you’re not living within your means.

6. You’re not on track to retire at 65. Ideally, you’d be financially able to retire before you are mentally ready, but 65 is a good age to shoot for if you’re still in the earlier parts of your career. Here’s how to find out if you’re on track. If you’re not, the earlier you start saving, the sooner (and easier) you’ll get on track.

7. A job loss or medical emergency would severely alter your future. If going without even just one paycheck would send you into late fees with all your bills, it’s time to get a system in place that helps you save for these unexpected events.

The best and easiest times to escape the paycheck-to-paycheck lifestyle is when you experience any type of windfall like a tax refund, an unexpected bonus or even just your annual single-percentage increase at work. Be strategic with that money and use it to find some space in your finances, rather than just adjusting your spending to match. You don’t have to wait for a windfall to do this though. Even just a small change each day that you mindfully use to put away a little extra adds up.

 

Are You Taking Good Things Too Far?

July 29, 2016

The latest craze that has swept my family is the Pokémon Go app. My kids run around trying to “catch” Pokémon at different locations. I’m happy they are outside and active, but I have to admit that I don’t have the foggiest idea why they consider this even remotely fun. They walk around and occasionally ask me to take them to a nearby neighborhood so that they can catch these things. (I use “catch” liberally because it’s all virtual, with no one really catching anything.)

They can catch their Pokémon thingies while I sit at an outdoor table at a local coffee shop. I find it a little strange, and in a horrible twist to this silly game, criminals are now setting up shop near Pokémon characters and robbing unsuspecting game players. What started as a fun thing has turned into a fun thing that needs to be used with caution because of some unanticipated consequences. A lot of things that start out as a purely positive have some unintended consequences that create some negativity.

I’ve seen that with a few people recently. I’ve had two meetings with people who are doing a wonderful job of saving for retirement. They ran retirement projections and learned that they needed to pick up the pace as it relates to saving for retirement. They cranked their contribution percentage WAY up so that they could catch up to where they think they should be. That is 100% admirable, and they are operating with the best of intentions.

Their unintended consequences? Both of them are saving so aggressively in their 401(k) that they are struggling with day-to-day cash flow. One is depleting his savings account on a monthly basis just to cover basic living expenses, and the other is using a credit card for groceries in the last few days before her paydays. A noble effort to save for retirement has taken a somewhat sinister turn in these examples, and I’ve had to have a few “I applaud your effort, but maybe it’s one step too far….” conversations.

The good news is that they realized that they may have gone a bit too far, and when we talked about bringing the 401(k) contributions down just a bit in order to make day-to-day cash flow a bit more manageable, they were completely receptive. In each conversation, we had a nice laugh at how some good things can be taken too far. (If you don’t believe that, see how many chocolate chip cookies you can eat before you start to feel like it’s been one too many.)

The lesson here for all of us is that after a few cookies, it makes sense to stop and catch your breath. The other lesson is that some great financial behaviors can be taken to an extreme. Are you saving so much for retirement that you aren’t able to enjoy the here and now? I’ve heard so many stories about people depriving themselves of life experiences in order to save for retirement, only to die just prior to retiring. Are you spending so much in the here and now and enjoying life experiences that you are woefully behind the curve for your retirement goals?

Neither is a good place to be. What’s the old phrase? ”In all things, moderation.”

Even good financial behaviors should be used in moderation! If you’re wondering if you’re taking something just a bit too far, chances are that you are. Whether you ask a financial professional or just hit our Facebook page and ask, get another perspective on your situation to make sure that you have all of the moving parts in your financial life working together.

 

Anatomy of an Investment Mistake

July 22, 2016

I saw an email from a soon-to-be-retired employee recently, saying that he thought that he made an investing mistake and was looking for some help in correcting it. Here’s the mistake he made. When the stock market tumbled for a couple days because of the British exit from the E.U. (Brexit), he jumped out of the stock market. He moved his portfolio from 60% stocks/40% bonds and cash to 100% stable value because he was afraid the market would continue to drop like it did in 2008.

Well, after two days of going down, the market went back up and within two weeks, it was higher than it was the day before Brexit. The question he asked was “When should we get back in: when it drops to the level when we got out or lower?” There are a few flaws in his thought process.

Issue #1: Selling (or buying for that matter) based on emotions and news events usually ends poorly. In not too distant memory, we have seen the dot-com bubble burst, 9/11, Enron, the housing market collapse, the stock market collapse of ’08 and an economy that is 7+ years into one of the most lackluster recoveries ever, and the stock market is near all time highs! Markets go up. Markets go down. But over time, there has historically been an uptrend given enough time.

One of the things I tell people when they are worried about how the market will respond to a news event is “emotions are the enemy of good decision making.” Yeah, it’s not inspirational. It doesn’t rhyme, and it’s not all that compelling as a standalone statement. But it’s true, and I’ve seen it have horrible consequences for people time and time again.

If you are thinking about changing your investment mix based on a news event, don’t! Go take a nice walk, turn off the TV, play your favorite tunes and let some time pass. Markets overreact…in both directions. If there is a huge sell-off on Monday, chances are that logic and reason will come back into the market, and there will be a few up days after a massive sell off.

Cool your jets and maintain your long term asset allocation. Talk with a financial professional if you have one in your life. Don’t let your emotions be the enemy of your decision making process.

Issue #2: In his question, he assumes that the market will, one of these days, be lower than when they sold off the stock portion of their accounts.  It may never be that low again. People who sold in ’08 and wanted to buy back in when the market got that low again are still sitting around waiting for that to happen. Their wait may be eternal (or not).

The logical flaw in this argument is a lot like the “sunk cost fallacy.” You’ve already made the sell decision and are now tied to the results of that decision emotionally. Looking into the rear view mirror isn’t helpful in this case. Look forward. It’s a difficult skill to apply, but don’t allow yourself to fall into the sunk cost fallacy.

Issue #3: The reason he sold off a big chunk of his 401(k) and went to stable value is that he is considering retirement in the not too distant future. It makes sense to want to be more conservative in that case but it’s too drastic of a change. If he had been considering retirement for some time now, maybe a few years ago would have been an appropriate time to start making small changes to his long term asset allocation.

For instance, I meet annually with someone who has a retirement goal of 12-15 years. She was 100% stocks and 0% bonds and cash when we first met 5-6 years ago. Rather than selling her existing holdings, she changed her future 401(k) contributions to 75% bonds/cash and 25% stocks. She recently moved future contributions to 100% bonds/cash, and when she hears that the stock market hits a new high, she moves 1% of her account to stable value. Her goal is to be at 50% stocks, 50% bonds/cash at and during retirement.

Do you know your long term asset allocation preferences? Do you have a plan in place to shift from where you are now to where you want to be when you’re 98 years old? Review your asset allocation today, see if it’s consistent with your investment risk tolerance and then develop a plan to get from point A to point B over the course of time. Remain patient and don’t let emotions get in the way.

Over the course of time, we all make mistakes. I have, you have, and the odds are high that we’ll make even more in the future. But some mistakes are preventable, and we can hopefully learn from the mistakes of others so that we don’t make them as well. If you can remain emotionally detached from your investments when bad news is happening, avoid the sunk cost fallacy and have a clear vision about your long term investment strategy (and stick to it), you will put yourself in a great position for long term financial success.

 

 

Use These 5 Tricks to Keep Online Shopping in Check

July 06, 2016

When was the last time you indulged in a bit of retail therapy? Even the most financially savvy of us are prone to impulse buys at times. Considering the fact that we often end up regretting those splurges, it’s wise to explore this leak in our budgets and try to keep these guilty pleasures from turning very quickly into shameful regrets.

One way I avoid impulse buying is by shopping with a list and avoiding stores like Target when my emotions are high. I’ve noticed that even when I go into certain stores with a very specific buying mission, I find myself wanting to buy something else, even if I have zero needs. Marketing gurus have figured out how to trip our psychological need to consume and those stops are fully pulled out when you walk into any retail outlet. I’m mindful of this and it helps.

My Achilles heel of impulse buying, however, is the Internet. The “avoiding it” option doesn’t exist, so I’ve had to implement other techniques to quell the shopping. Here are a few tips I use to keep online shopping sprees in check:

1. Create a filter for emails. There’s a reason that stores are so generous with discounts offered via email. They work!

Just this morning, I found myself browsing skorts from Athleta because they sent me an email about their semi-annual sale, even though I didn’t wake up thinking, “Hey, I need a new skort.” I don’t want to give up on the opportunity to enjoy coupons and discounts when I DO need something, so I created a filter that directs all my shopping-related emails straight to a folder aptly titled, “Shopping.” Then when I actually do need to buy something, I just check that folder to see if there are any current coupons or discounts in effect (note to self to add a filter for Athleta).

2. Don’t save your card. Make it one step harder to complete a purchase by opting out of storing your credit card information on a retailer’s site. Not only does this hopefully make you think twice if you have to get up and get your card, it could potentially save your card number from hackers. Win-win.

3. Beware the lure of free shipping. If you find yourself going back to shop for one more thing to put you over the mark and qualify for free shipping, stop for a second and do the math. If the one extra thing you buy is less than shipping would cost, then it’s worth it. Otherwise, you’re just spending money on stuff you don’t need to avoid paying less total money. Pay the shipping or skip the purchase altogether.

4. Realize that Facebook isn’t all-knowing. It’s no coincidence that the pair of shoes you were contemplating on the Nordstrom website suddenly show up in your news feed on Facebook. That’s part of what you signed up for when you agreed to Facebook’s terms. They track everything you browse, not just on their site. For this reason, I try to remember to sign out of Facebook when I’m done so that I can both maintain my privacy and avoid temptations the next time I log in.

5. Only shop sober. Do I really need to explain why shopping online after a few glasses of wine is a great way to blow your budget? If you can’t resist the pull of shopping after happy hour, then at least make an agreement with yourself that you’ll leave everything in the shopping cart and complete the purchase in the morning. Deal?

I’m not suggesting that you cut out all online shopping, but if you spent more money last month on purchases that you don’t really need than you saved for retirement (assuming you’re not on track to have enough to retire by age 65), then a change in priorities is necessary. Consider increasing your savings and opening a separate shopping account where you direct deposit a set amount of money you can afford to spend on splurges each month. Just make sure you don’t go beyond that and find yourself in unnecessary credit card debt either.

 

 

How to Protect Your 401(k) After Brexit

June 27, 2016

Will the “Brexit” affect your 401(k)? Global stock markets fell on the news that voters in Great Britain voted narrowly to leave the European Union. Investors don’t like uncertainty, and there will be plenty of that during the next few years as Great Britain and the E.U. sort out the terms of their divorce. Employees are worried, calling our Financial Helpline to ask whether they should react now to protect their retirement savings. Here are some questions to ask to determine what action, if any, is needed:

Does my overall portfolio match my risk tolerance?

Does all the news about the Brexit have you compulsively checking your portfolio during the day? Are you tempted to throw in the towel and put everything in the lowest risk investment possible? If that’s the case, then maybe it would be a good time to double check your investment risk tolerance.

Try downloading our risk tolerance and asset allocation worksheet, a questionnaire which help you determine your risk tolerance and time horizon to get an idea of what investment mix is best for you. Compare the results to your current portfolio mix. If they line up, you don’t need to re-balance. If there is a big discrepancy, you may want to make some changes. This blog post from my colleague Scott Spann, PhD, CFP® offers some guidance on choosing the right investments in your 401(k).

Keep in mind that investing in stocks and bonds always involves some financial risk. Bad days or even years in the stock market are completely normal. However the risk of not investing in stocks and bonds means that the money you save will lose purchasing power over long periods due to inflation (the rising cost of living).

Is my stock portfolio well-diversified by sector?

My fellow planner Cyrus Purnell, CFP® noted that, “Even if you have the right mix of stocks, bonds and cash, it is worth checking to see if your holdings are sector heavy. The Brexit shock is beating up some sectors more than others. If you have stock funds that are focused on financials (banks, brokerage firms and investment managers), you may see more than the average downturn.” International funds focused on Europe are also likely to have some hiccups as Brexit gets sorted out. “If you are running into high concentrations of sectors, consider indexing,” he added.

When is the last time I ran a retirement calculator?

The reason you’re investing in your 401(k) is to build a nest egg for retirement. Measure your success against whether or not you are on track to achieve your retirement goals, not from the highest balance on your 401(k) statement. Now is a great time to run an updated retirement calculator to see if you are on track, given your savings and reasonable projections for your rate of return and inflation. You can use our Retirement Estimator for a basic check in to see if you are on track. You can also use the calculator to model different scenarios using different rates of return to see what happens.

Be realistic in your estimates: recent research from the McKinsey Global Institute suggests investors lower their expectations for average annual US stock returns to 4 to 6.5%. It’s better to use a conservative expected rate of return. If you’re wrong about it, you’ll be happily surprised, but if you’re right, you’ll be adequately prepared.

Do you have a personal finance question you’d like answered on the Monday blog? Please email me at [email protected]. You can also follow me on Twitter at @cynthiameyer_FF

 

3 Numbers That Matter More Than Your Credit Score

June 22, 2016

While knowing your credit score and the elements that impact it is important to your overall financial well-being, I sometimes find that people are overly concerned about it at the peril of other more important financial measurements. Your credit score only really matters when you’re applying for a loan, certain types of insurance and increasingly, when applying for a job. If none of those things are on your horizon, then your score is more like your high school ACT scores – perhaps a point of pride, but pretty irrelevant for the time being. Here are three more important numbers you should be focused on instead:

Net Worth

What is it: Assets (bank accounts, investments, home, car – basically cash or anything you could turn into cash) minus liabilities (credit card balances, car loans, student loans, mortgages, 401k loans – anything you owe).

Ideal number: As high as possible.

Why it matters: Your net worth is the ultimate measure of your ability to weather financial storms and maintain financial choices in life. The higher your net worth, the more financial freedom you can afford. There are countless cases of people who were millionaires on the asset side but broke on the net worth side as cautionary tales of neglecting this important number. Many of these people suffered during the last recession when their debts were called.

How to track it: I calculate my net worth on a monthly basis using Google sheets at the same time I sit down to set up any bill payments for the month. Here’s a snapshot of what it looks like:

Net worth snapshot

One nice side effect of this is the fact that I’m checking on all of my accounts at least once a month, so I can also do a quick check for anything fishy.

Worth noting: I pay all my credit cards off each month, but I include them on this sheet because that’s money I still owe that is reflected in my checking account above. It’s the only way to have a truly clear picture of what I have. I keep things like my student loan and Mini Cooper loan on there both for historical accuracy as well as for the psychological thrill of seeing a big fat ZERO under old debts. It’s a little, “Yay me! Look how far you’ve come!” moment each month.

Retirement Readiness

What is it: The best way to measure whether you’re saving enough to retire comfortably when you want to, especially if you have many years to go until retirement.

Ideal number: On track to replace about 80% of your current income, unless you’re within 5 years of retirement (when you can be more specific about how much you’ll need each year).

Why it matters: Retirement, which really just means transitioning to living off your savings one day, is one financial goal that pretty much all of us share. Whenever anyone asks me what to do with extra money or if they can afford to take on an additional debt payment or savings goal, my first question is, “are you on track for retirement?” Even though it may be one of your longest-term goals, it should be in the top 3 in terms of priorities.

How to track it: There are countless calculators out there, but for people with a 401k or other workplace savings plan, I prefer this Retirement Estimator.

Worth noting: Many people who say they aren’t on track to retire have never run a calculator. Knowing is the first step!

Emergency Fund

What is it: A cash cushion in place to tap into in case of an unexpected loss of income due to job loss or extended illness or injury.

Ideal number: 3 months of expenses, minimum. For single income households or career fields that aren’t as certain, at least 6.

Why it matters: Life happens and when it does, having cash that’s easily accessible takes away much of the financial stress and allows you to focus your energy on finding a job, healing or adjusting to the new normal.

How to track it: If you’re starting from zero, start with a goal of setting three months of rent or mortgage aside. Then tack on three months of your next highest expense and so on until you have all essential expenses covered. Once you’re at three months, make sure you adjust for any changes such as a new home, new baby, etc.

Worth noting: It can be tempting to keep a credit card on hand instead of the cash or want to invest the cash for higher earnings, but resist. Should something happen, consider the probability that it could be due to an economic downturn when credit may not be as easily accessible and/or the stock market could be down. The best place for your emergency fund is in a high yield savings account.

These are the three numbers you want to focus on. Even if you’re not at the ideal numbers yet, you’ll be well on your way to financial freedom if you can find a way to track them on a consistent basis. And you just may find your credit score improving as well.

3 Things You Can Do About Student Loan Debt

May 27, 2016

One of the biggest things that we see not only in our research but also in day to day conversations is the impact that huge student loan balances are having on people of all ages, especially younger employees or those who went back to school during the “Great Recession.” My biggest piece of advice to anyone would be to avoid student loans as much as you can by working first and/or part-time, going to a less expensive state school or community college for the first couple of years, or any number of things. But for those that have already rung up a hefty student loan bill, there is still hope. Here are a few things that you can try with little or no pain involved.

1. Focus more on your student loans now but contribute just enough to get the company match to the 401(k) and sign up for the rate escalator feature if available. By putting the majority of your money towards your debt, you can focus your energy and efforts on the here and now but also have your 401(k) running on autopilot in the background. This way, if it takes you 10–15 years to pay off your loans, you are still in a great spot towards retirement instead of being debt free but with no savings.

2. Make your own “matching program” for your student loans. Look at each bill that you have and research to see if you can find a less expensive alternative and then set up automatic extra payments to your highest rate or smallest balance student loan equal to what you will be saving. So if you cut the cable and just use streaming services and it would save you $50 per month, “match” that saving to an automatic increase to one of your student loan payments. This could be a great project on an evening or weekend when rainy weather keeps you inside. If you don’t have the time, look at services like BillCutterz to do the work for you but you have to share the savings with them.

3. Ask your employer if they have any programs to help with student loans. While many employers do not currently have a student loan repayment plan, more and more companies are offering special deals on student loan refinance programs like SoFi or  actual repayment plans like Tuition.io or Student Loan Genius. There is even a bill before Congress to make a certain amount of student loan repayment tax free to the employee, similar to tuition reimbursement programs, so hopefully this will become a common benefit in the future.

Don’t get me wrong. There may not be a magic solution to your student loan issues. However, these steps can help you not just survive but thrive while you balance paying off the debt and engaging in life along the way.

Want more helpful financial guidance, delivered every day? Sign up to receive the Financial Finesse Tip of the Day, written by financial planners who work with people like you every day. No sales pitch EVER (being unbiased is the foundation of what we do), just the best our awesome planners have to offer. Click here to join.

 

 

3 Lessons Millennials Can Learn From Previous Generations

May 26, 2016

With the recent release of our research report on the generations, our current Think Tank Director and former Financial Finesse blogger Greg Ward makes a second appearance to discuss what millennials can learn from previous generations…

I recently received an interesting call from a young woman asking how much the average person her age has saved for retirement. She was 35, and while I understand the nature of the question, I think it is a very bad one to ask. You can search “how much has the average 35 year old saved for retirement” and you’ll find a variety of articles (e.g., The Motley Fool and Personal Capital), but comparing yourself to others is a recipe for creating false expectations. Not only that, but the average balance is based on the average American who makes an average salary, and this is a terrible benchmark when it comes to planning for retirement. As our latest retirement research points out, less than 20% of Americans are on track to achieve 80% income replacement—a reasonable goal for most people—so why on earth would you want to measure your progress to this?

I find it interesting that millennials feel the need to compare themselves to other millennials. Wouldn’t it make more sense to compare themselves to older generations or at least listen to them? Ask any pre-retiree what they wish they had done to be better prepared for retirement and most will tell you that they wish they had started saving earlier. So while some may think that saving money in your youth is a waste of time, older generations will tell you it is the best way to achieve financial independence. Here are three things I want the next generation to know when it comes to planning for retirement:

#1 Save early, save often, and save as much as you can.

Albert Einstein is known to have called compound interest “the eighth wonder of the world,” so what could be smarter than listening to one of the smartest people who ever lived? The more you start with, and the earlier you start, the more you’ll have later in life; pretty simple, huh? The more you save when you’re younger, the more you will have when you get closer to retirement, which gives you more flexibility in what kind of work you do, how long you do it, and what kind of lifestyle you’ll have when you are done.

#2 Be aggressive.

Piggy backing off of number one, don’t let youth be wasted on the young.  You may be nervous about stock market fluctuation and who can blame you? After all, you witnessed several of the most volatile stock and real estate market years in recent history. That said, you have the most opportunity to recover from these short-term events, so you must take advantage of your youth and save with the intention of keeping this money invested for a long, long time. The longer you can keep money in the stock market, the more likely you will see the types of returns that have been produced historically.

#3 Stop comparing yourself to others.

Some will make more and have to save more. Others will make less and not need as much. Some look forward to a simple lifestyle. Others plan to live the high life. Higher income earners will receive less from Social Security as a percentage of their income than lower income earners.

YOU are unique! You have to plan your life around who you are, how much you make and what you want your future to look like so the best thing you can do right now is decide for yourself what you want your retirement to look like and plan accordingly. Then use this retirement estimator to determine whether or not you are on track.

As my oldest of four children prepares for college, these are the things that I am teaching her. Now I offer them to you as well. If you, the next generation, adopts these principles, you will give my generation hope that the impending retirement crisis will likely be averted.

The 3 Most Important Things Resident Physicians Can Do With Their Money

May 25, 2016

Updated for 2019 numbers

You’ve made it through eight grueling years of schooling, been accepted into a residency program, and you finally have a salary. Even though the average salary for a first year resident is a little over $50,000, it can still feel like hitting the lottery. It’s easy to start thinking about how you’ll spend that money on luxuries you’ve postponed like a nice car or an apartment in an upscale neighborhood while deferring your student loans until you’re making real money in your chosen field. After all, your friends who chose business or law have been living it up through their 20’s and you’re ready to join them.

Not so fast

Before you find room in your budget for things you may not be able to enjoy to the max while working 80+ hours per week, first make sure you’re setting yourself up for optimal financial success. I’m not saying you shouldn’t treat yourself to that luxury car you’ve been dreaming of ever since that first day of class, but first make sure you’re making the most of the savings opportunities you may not have available after residency.

I ran these past my physician husband just to make sure I wasn’t being unrealistic and he agrees. Here are three really important things you should set up before you make your residency budget.

1. Max out your Roth IRA. Take advantage of your lower salary by contributing the full $6,000 allowed into a Roth IRA. There are income limits that could eventually prohibit you from depositing to this account (they start at $122,000 for single people in 2019), so use it before you lose it. A Roth gets money into savings after tax, then allows the money to grow tax-free for life. For eventual high income earners, it’s especially critical to contribute while you can and you’re young, when the money has lots of time to grow.

2. Start paying your student loans. It can be tempting to postpone those payments as long as you can, but I caution against waiting until you feel like you can better afford it. First of all, you’re probably going to be working so much over the next three to four years that you won’t really miss the money, but second of all and more importantly, you’ll avoid throwing money away on interest. It’s all about making your money work harder for you, and using it to pay down loans with an interest rate of 6% or more in some cases can even exceed what you might earn investing the money.

3. Contribute at least to the match in your hospital’s 401(k) or 403(b) plan. Just because you don’t plan to stay at your residency hospital for the rest of your career doesn’t mean you can’t or shouldn’t participate in their retirement savings plan while you’re there. You get to take that money with you when you leave.

Most hospitals offer some type of match for employees who contribute and unless they have a longer than average vesting schedule, that match will be yours when you’re done as well. That’s free money, so don’t pass it up. If you can afford to save more than the match, consider doing so. Time is on your side right now and the more you can save while you’re young, the more the effect of compound interest will have on your future savings.

Becoming a physician in the first place is a great way to ensure a prosperous future for yourself and your family. But even doctors are prone to over-spending and under-saving, especially as the competing costs of real life (buying a house, kids, college, travel, etc.) set in after residency. By buckling down for these last few years, you can doubly ensure your long-term financial security. After all, I’ve never had anyone tell me they regretted saving more money.

 

 

Can You Save Too Much For Retirement?

May 09, 2016

Is it possible to save too much for retirement? Isn’t that a bit like eating too many green vegetables? Recently, I read an article by journalist Constance Brinkley-Badgett, Are You Actually Putting Too Much Money Away for Retirement?, challenging the common financial planning guideline of using a generic “replacement rate” for retirement savings. Brinkley-Badgett quoted David Blanchett, CFA, CFP®, of Morningstar regarding his research into retirement income replacement rates. Do people really not need to save as much for retirement as they think they do?

The simplicity of this message worries me – a lot. According to a study by the Federal Reserve, 31% of American households don’t have any retirement savings at all…not one dime. Even if it’s true that some higher net worth households are “over-saving,” the far more urgent national problem is that most Americans are not saving enough.

There are two common, interrelated retirement planning guidelines. The first is that you should target replacing 70-80% of your pre-retirement income. Why 70-80% and not 100%? Primarily because you no longer have to save for retirement or contribute to Social Security.

However, Blanchett asserts that 80% may be inaccurate, and that based on his research the replacement rate range is a wide 54-87%. “The true cost of retirement is highly personalized based on each household’s unique facts and circumstances,” he wrote in the report summary, “and is likely to be lower than amounts determined using more traditional models.” It’s a thought-provoking piece of research, and if you are interested in financial planning, it’s worth a read.

Another general guideline is known as the 4% rule for retirement account withdrawals. Based on a 1994 article by William Bengen, CFP® in the Journal of Financial Planning, the idea is if you withdraw no more than 4% from your retirement accounts the first year of retirement, then adjust your withdrawals in subsequent years for inflation, a portfolio of 50% stocks and 50% intermediate Treasury notes should last at least thirty years. The two work in conjunction: save as much as you need to generate an annual 4% inflation-adjusted withdrawal from principal over thirty years to cover 70-80% of your pre-retirement income.

While it is true that the 80% and 4% rules are “one size fits all” generalizations that can be improved by personalizing them based upon your health, your expected monthly expenses, your total savings and your expectations for activities in retirement as Blanchett correctly notes, not everyone can afford to have a personalized retirement plan made for them. What does this mean for someone who’s saving for retirement in their 401(k) plan and does not have access to the ongoing services of a financial planner? It is tempting to listen to the “save less” recommendation. After all, if you save less for retirement, you’ll have more money to enjoy life now. However, when we consider the basis for the 80% and 4% rules, we can see how even if your personalized replacement rate was 50 to 60%, you might still want to save for the 80% replacement rate (or higher).

A 95% success rate still means running out of money 5% of the time.

These rules were developed based upon studying how people could spend money in retirement in such a way that they can feel a level of confidence that they will not “outlive their money.”  If one followed the 4% withdrawal rule, then you would have about a 95% chance of being able to live on your savings for 30 years. 95% confident sounds like a lot, but is it enough?

To see what this means, consider what would happen if you lived the same retirement over and over again thousands of times. In some of those lives, you’d get lucky and retire in a bull market, where stocks rise significantly, so your portfolio would always be enough. In others, you’d retire and the markets would fall 30% in the first year. The bottom line: during 5 out of every hundred lives you would run out of money before your thirty year retirement is up.

Past performance does not indicate future results

The model in Bengen’s original paper used long term historical rates of returns and inflation. However, the future may be different. While that could work out in your favor, with higher rates of return during retirement and lower than expected inflation leading to your savings lasting longer than predicted, the opposite could also be true. Rates of return could be much lower, and/or inflation could be higher, which means your money could run out sooner. You could also have the bad luck of retiring at the beginning of a bear market, with a few years of successive negative returns leaving you with a smaller portfolio to generate retirement income.

You could live much longer

According to the Social Security Administration, “a man reaching age 65 today can expect to live, on average, until age 84.3. A woman turning age 65 today can expect to live, on average, until age 86.6. And those are just averages. About one out of every four 65-year-olds today will live past age 90, and one out of 10 will live past age 95.”

Even if your needed retirement replacement ratio were lower, perhaps because you paid off your mortgage or otherwise had significantly lower expenses, there is still a chance that you’ll outlive your savings. What if your money has to last you 40 or 50 years? One way to address that is to save more before retirement, but not spend more afterwards, so you have something left in your nineties. Aim for a 99% confidence level that you won’t outlive your money over a long retirement period.

When you consider that poverty is the price for outliving your money, you can see why financial planners generally want you to oversave for retirement. I don’t know about you, but I plan to live longer than 30 years. Since I can’t change what happens in the economy, I’m planning to save more – not less — than the 80% and 4% rules tell me.

How about you? What do you think are the ideal rules for saving and spending in retirement?  Email me at [email protected] or follow me on Twitter at @cynthiameyer_FF

 

Retirement Planning Shouldn’t Be Like Counting Jelly Beans

May 06, 2016

When I was growing up, there was a local store that would “give away” a huge stuffed animal to a person who could guess the exact number of jelly beans in a gigantic jar. I think that stuffed animal was still in the store when my kids were about the age I was when I first saw it. There may not be a right answer to that question. After all, did someone spend most of a day painstakingly counting jelly bean after jelly bean and keeping a running tally? Is the number that the store owner believes is correct an actually correct number?

After this long, I’m sure some of the jelly beans have merged together and that might change the correct number anyway. I don’t know if people have actually won the stuffed animal and there are lookalikes that keep getting placed where the old one was…or if it’s one constant big bear sitting there taunting everyone who guesses at the number of jelly beans. But it is certainly a source of entertainment and mystery for kids and for that, I’m thankful that it’s there.

Entertainment and mystery…that’s how many of the people I talk to view their financial lives. They see the “game” of planning for retirement a lot like the jar of jelly beans. “How many are in the jar?” Who knows? “How many will it hold?”

“How much money will I need to live the rest of my life?” “When should I take Social Security?” “How much should I contribute to my 401(k)?” “What will taxes look like in my retirement period?”

These questions aren’t that much different from the jelly bean question, but they certainly are a LOT more important in the grander scheme of life. The good news is that with some thought, some preparation and some planning, you’ll be able to get much closer to the “right answer” with your retirement questions than I ever got with the jar. I am a big fan of simplicity, so when I meet someone who is completely baffled by the concept of retirement planning, I go through a quick retirement reality check with them. It’s a two stage process and I’ll share it here:

Step 1: We use this Retirement Estimator calculator to see if their current course of action will get them close to reaching their goals. If they are on track, we check in annually to make sure they’re staying on track and to see if anything new has developed. If they aren’t on track, we tweak some things to see what it would take.

What happens if they increase their 401(k) savings rate? What if they work a few more years? What if they change their investment strategy and shoot for more growth?

During this step, we make sure they have current statements from any and all investment accounts, including their 401(k). We also talk about and enter any income streams like Social Security, pensions, rental income, etc. It’s a pretty straight forward calculator and we can usually build it in less than 15 minutes as we talk through the inputs.

Step 2: This is my “real world” sanity check of the numbers from the calculator. We look at their take-home pay based on their last few paychecks and figure out a monthly amount that they’re living on today. We can even shrink that number if they are regularly saving money, because those funds aren’t being spent now. We add back about $1,000 for medical coverage and some inflation, since that’s usually being deducted from net pay today.

Then we look at Social Security and pension income and come up with a gap that would be needed from investments. If it’s $1,000/month, I like to annualize that and call it $12,000 per year. Divide 12,000 by 3% (a fairly low withdrawal rate from a portfolio) to get to the amount of money they’d need in their investment accounts ($400,000 in this case – in today’s dollars). This is far from an exact way to calculate retirement needs, but it can help validate the results of the calculator. And, it’s a very easy and understandable way to see what retirement might look like.

Once people know the results, that’s when the real work begins. Sadly, not nearly enough people have ever run a retirement calculator. According to our 2015 Year In Review research, only 22% of the population knows that they are on track to replace 80% of their current income in retirement. That means there is a lot of work to do! Most people have never even run a retirement calculation.

Doing this quick two-step process puts you ahead of the game because at least you know where you stand. Only then can you knowingly make progress. Use the calculator – today! And use my way-too-simple sanity checker as a backup. If you do those two things, you’ll move from hoping you can retire at some point to knowing what it will take to retire when you choose and you’ll end up with a lot more than a stuffed animal.

 

 

3 Reasons To Make After-Tax Contributions To Your Retirement Plan

April 25, 2016

Updated for current tax figures

Are you lucky enough to have the option to save after-tax money in your employer’s retirement plan? Most employees probably haven’t given it a thought, and not many utilize the option to save more than the current $18,500 pre-tax annual employee contribution limit (plus another $6,000 if you are 50 and older).

In fact, many people are not even aware that they may be able to save additional money in their employer-sponsored retirement plan, in some cases up to the annual total defined contribution limit (from both employee and employer) of $55,000 (plus $6,000 catch up if 50 and older) or 100% of your compensation, whichever is less. Sure, the likelihood of saving that much for many people might be small.

However, if you are already contributing the maximum in pre-tax and Roth contributions, here are some reasons to save more after-tax:

Automatic savings

Saving for an early retirement or financial independence? Let’s face it. It’s unlikely you’d save that much or invest on such a consistent schedule if you had to write a check every two weeks to a mutual fund company.

That’s one reason your employer can be your best financial services provider. Saving after-tax money in your retirement plan can be as easy as clicking a button or signing a form to choose what percentage of your salary you want to save. Every paycheck, you’ll defer money into after-tax savings and invest them in plan funds, just like your regular contributions. Little by little, you’ll save and grow that extra money without having to think about it.

Ability to withdraw contributions

You should generally be able to withdraw after-tax voluntary contributions, subject to the plan guidelines on withdrawals, even before you’re 59 1/2 and without meeting a specific need like you often do for a hardship withdrawal. That means if you have an emergency, you will be able to access those funds.

However, you may not be able to withdraw associated earnings growth, and if you are, those earnings – but not your original contributions – would be subject to taxes and a 10% penalty if withdrawn prior to age 59 1/2.

Tax-free rollover to a Roth IRA

You’ll reap the biggest rewards from your after-tax contributions when you leave your company or retire. Assuming you’ve been saving for a while, your after-tax balance will contain two components: your original after tax contributions and the tax-deferred earnings growth on those contributions. The IRS allows you to separate those two components out during the rollover process, so you can do a direct rollover into multiple destinations: rolling the tax-deferred earnings growth into a traditional IRA and rolling your after-tax contributions into a Roth IRA.

That’s right. You read that correctly. Your after-tax voluntary contributions can be rolled into a Roth IRA, where any future earnings growth will then be tax-free (assuming you leave the money in the Roth for at least five years and until after age 59 ½ ). You may even be able to convert your after-tax contributions immediately to Roth and have all future growth tax-free (but then you give up the ability to withdraw it early).

Here’s an example: Jane is already contributing the maximum $18,500/year to her pre-tax 401(k) plan at XYZ Company. She wants to save extra for retirement, so she saves an additional $10,000 annually in after-tax voluntary contributions in the plan.

After 10 years, Jane has about $144,000 from her after-tax contributions ($100,000 in contributions and $44,000 in growth). She also has about $260,000 in pre-tax savings and growth from contributing the maximum. When she leaves XYZ to take a new job, she can roll her plan balances into multiple destinations: $100,000 into a Roth IRA and $304,000 into a traditional IRA or her new employer’s 401(k) plan.

Fast forward another 15 years to when Jane retires. Without adding any more money to her Roth IRA and receiving a 7% return, her account is now worth about $285,000. That’s an additional $185,000 of tax-free growth, all because she originally saved after-tax money in her 401(k) plan.

 

 

Delaying Social Security May Still Make Sense Under the New Law

April 21, 2016
At the end of this month, two strategies (often called “claim now and claim more later” and “file and suspend”) to maximize total Social Security benefits between spouses will be going away. Under current rules, you could file for a spousal benefit equal to one half of your benefit at full retirement age and then switch to your higher benefit later. Under the new rules, it will be much simpler. When you file, you’ll either get your benefit or the spousal benefit, whichever is higher. Although you will no longer be able to collect a spousal benefit in the meantime, there are still several good reasons why delaying your benefits may make sense:
 
1) You’ll probably collect more over your lifetime. The Social Security benefits are supposed to be calculated so you get the same amount if you live until the average life expectancy. (A 65 yr old woman can expect to live to age 87 and a 65 yr old man can expect to live to age 84.)You’d be better off collecting earlier if you live to less than life expectancy and later if you live longer. However, those calculations were based on older life expectancy numbers that were lower and people are continuing to live longer and longer.
 
2) It’s probably a better investment. Your Social Security benefits grow by about 8% for each year you delay. That’s more than your investments can be guaranteed to earn and more than they’re likely to earn, especially if you’re more conservative in your retirement years. You might as well use your lower earning investments to cover your expenses and let your Social Security benefits continue to grow until age 70.
 
3) You may reduce the taxes on your Social Security. Since you won’t need to withdraw as much from taxable accounts to supplement the higher Social Security checks, less of those checks may be subject to taxes. Drawing down your taxable accounts while you delay will also mean smaller required minimum distributions when you turn 70 ½.
 
4) You can reduce the risk of outliving your money. One of the greatest risks retirees face is outliving their savings. In that case, you’ll be glad you have that higher Social Security check in your later years.
 
5) Your surviving spouse will be better protected. If you don’t live quite as long as you hope, you won’t miss not getting those Social Security checks but your spouse will be able to collect a bigger survivor benefit.
 
There are a couple of reasons I can think of not to delay. One is if you simply don’t have enough assets to cover your expenses while you wait. The second is if you think you have a below average life expectancy and no spouse to collect your survivor benefits. In that case, you might prefer to leave more of your assets to your heirs. But if neither of those apply to you, just remember that good things come to those who wait.
 
 
 
 

How The Self-Employed Can Defer Taxes On Retirement Savings Too

April 14, 2016

Updated March, 2019

In our CEO’s book, What Your Financial Advisor Isn’t Telling You, Liz Davidson writes about understanding the importance of taxes to your investing returns. After all, it’s not just what you earn but what you actually keep. In honor of National Retirement Planning Week, I thought I’d write about one of the best ways to reduce taxes on your investing: qualified retirement plans.

By allowing you to defer taxes on your contributions and earnings until you withdraw the money, these plans benefit you in a couple of ways. First, you’re likely to pay a lower average tax rate on the withdrawals than on the contributions. (Even if you retire in the same tax bracket, a lot of your withdrawals will probably get taxed at lower rates because of how the tax code is structured.) Second, your investments will grow faster since the money that would otherwise be going to taxes is instead being reinvested.

Savings options for self-employed

But what if you or your spouse is self-employed? You can contribute to an IRA but you’re limited to only $6,000 a year or $7,000 if you’re over age 50. (One advantage to not having a retirement plan at work is being able to deduct all of your traditional IRA contributions regardless of your income.) Here are some other options if you’d like to put away a bit more in a tax-advantaged retirement account:

Individual 401(k). Also called a uni-401(k), solo 401(k) or a 401(k) for one, you’re only eligible if you have no partners or employees (other than maybe your spouse). The main advantage is that you can contribute up to $19,000 per year plus 25% of your earned income (there’s a special calculation of this) up to a total annual contribution of $56k plus an additional $6k if you’re over 50. Withdrawals are limited and subject to a 10% early withdrawal penalty but you can also set it up to allow you to borrow from the plan.

SEP-IRA. With a SEP-IRA, you can contribute 25% of your earned income (up to a total annual contribution of $56k plus an additional $6k if you’re over 50) but you have to contribute the same percentage of pay to each of your eligible employees. However, you can vary the percentage each year. Withdrawals are subject to a 10% early withdrawal penalty.

Simple IRA. With a Simple IRA, you generally cannot have more than 100 employees. Employees can contribute up to $13,000 per year (or $16,000 if over age 50) and you must either contribute 2% of income for each eligible employee (up to $5,600 a year) or provide a dollar-for-dollar match (up to $13,000 per year) of employee contributions of at least 3% of their income.  The penalty for early withdrawals is increased to 25% in the first two years and then 10% after that.

When I was self-employed, I chose the SEP-IRA since the individual 401(k) was too expensive for my needs (fees have come down a lot since then) and I couldn’t contribute as much to the Simple IRA (also didn’t like that higher penalty on early withdrawals).

If you or your spouse is self-employed, the individual 401(k) will allow you to contribute the highest amount and take a loan if necessary. If you have employees, it all depends on how much you want to contribute for yourself and for them. In any case, being self-employed is no excuse not to save for retirement and reduce your taxes in the process.

Why You Need to Start Saving Money RIGHT NOW

March 30, 2016

Pretty much every personal finance resource will tell you that the earlier you start saving, the better off you’ll be due to the effect of compound interest. It’s a bit of a, “well, duh,” thing, but there’s more to it than just the fact that you’ll have longer to save if you start early. The thing is, the earlier you start, the earlier you can actually stop saving if you want to. Continue reading “Why You Need to Start Saving Money RIGHT NOW”

Can Life Insurance Be a Retirement Plan?

March 28, 2016

Listen to the radio these days and you’re likely to hear a commercial promising tax-free retirement income with no stock market risk. If you call a toll-free number or sign up on a website, you will probably get a follow up contact from a life insurance agent who wants to show you how you can use whole life or universal life insurance for tax-free retirement income. Doesn’t that sound too good to be true? Can permanent life insurance really be a retirement plan?

Be very, very cautious. Life insurance is not designed for retirement savings. Permanent life insurance is primarily designed to protect people in your family who rely on your income to maintain their standard of living. The “permanent” aspect means that this insurance protection stays with you for your life, as long as you pay the premiums.

Both major types of permanent insurance — whole life or universal life — include a death benefit component and a savings component. The savings component consists of a policy cash value, the amount of accumulated policy value which would be paid out to the insured if the policy were surrendered early. The “life insurance as retirement cash flow” strategies are based on the insured person borrowing against the cash value of their policy. While it is correct that you may borrow against the cash value in some circumstances without taxes, and that invested premiums grow tax deferred, there are some significant disadvantages.

A Loan is Not Income

A policy loan uses the cash value of the policy as collateral, and the insurance company charges the borrower interest on the loan. The interest is paid to the insurance company, not back to you. The interest rate may be the same, higher or lower than the rate you are crediting on the growth of the policy cash value. Financial planning expert Michael Kitces aptly calls this borrowing strategy, “nothing more than personal loan from the life insurance company.” That’s not real income.

Policy Dividends Helpful But Not Guaranteed

What about dividends? While certain types of insurance companies pay dividends to policyholders (who hold a “participating” policy) when their annual results are good (those dividends can be applied towards future premium payments or used to purchase additional coverage), they aren’t always likely to make profits every year. You may or may not receive dividends.

Potential Tax Problems

If you are eligible to receive policy dividends from a participating policy, they are not taxable. However, strategies that recommend borrowing against cash value life insurance have potential tax problems.  Should you borrow enough of your cash value so that the basis in the policy goes down to zero, you would have to put in more cash or risk a lapse of the policy and having the total outstanding loans included in your taxable income.

No Free Lunch

Another disadvantage of using life insurance as retirement savings are the fees. You’re paying for the insurance component. If you died early, your beneficiaries would receive the full death benefit, so you’ll be charged underwriting costs and mortality charges, etc. Plus you are paying for the distribution of the policy, in other words, commissions.  Someone’s getting paid, and those fees and charges eat into the type of returns you might otherwise earn if you invested the money into buying and holding tax-efficient index funds.

The Bottom Line: Do You Need Permanent Life Insurance?

Consider a life insurance proposal primarily in the context of your estate plan, not your retirement plan. Lifehappens.org has an overview of insurance basics and a helpful calculator to figure out how much insurance you actually need. Does the proposed policy meet your needs of providing for your family should something happen to you? Are you comfortable with/interested in having insurance protection you can’t outlive? How do the costs of this policy compare to costs of policies from other companies with the same face value?

If the life insurance meets those needs on its own merits, then your ability to borrow from it later on is an extra bonus. If paying premiums on this kind of life insurance policy are preventing you from other, more effective types of retirement savings, such as maxing out your tax-deferred retirement plans like your 401(k) and IRA/Roth IRA, that could do serious damage to your financial wellness. If you are on track for retirement, have low/no debt and need permanent insurance, then there may not be any harm. Don’t think of it as a retirement income strategy, however. Think of it as life insurance with access to a personal loan.

Do Your Homework

If you are considering one of the currently popular life insurance cash flow strategies, here are some questions to ask the insurance agent about your proposal:

  • How do you get paid?
  • What are the other fees involved — mortality, underwriting, surrender charges, investment management, etc.  Where can I see them reflected on your proposal?
  • What is the interest rate I’d be charged if I borrowed against my cash value?
  • What is the rate I’ll be credited on my cash value?
  • If I borrow from my cash value, can I repay that at any time? Are interest payments deducted from the cash value, or do I write checks for them?
  • What happens to the policy if I borrow the entire cash value?
  • What is the actual return net of all fees?
  • What’s the worst case scenario? Are there any circumstances in which I could be taxed? Lose money?  Lose my insurance?

How about you? Do you have a personal finance question you’d like answered on the blog? Email me at [email protected] or follow me on Twitter @cynthiameyer_FF.