01-When can I retire?
Like any good political/philosophical answer: it depends! The key question is how much is needed to meet you needs and wants in retirement. I’m reminded of a story from a podcast that I recently listened to of a client that was informed of an opportunity to take an early retirement pension due to a corporate buyout. When asked by the client how much the pension would be, the advisor responded: “about $540/month” thinking that the client would be disappointed with the answer. The response was the exact opposite – the client was elated because $540 was enough to live in their manufactured home on a piece of leased property deep in the woods and away from the hustle and bustle of life – the moral of the story: your goals in retirement inform what you need to save and how to be invested. For some: social security and perhaps a pension will suffice. For others, particularly those age 45 and younger, the combined likelihood of decreasing Social Security benefits and ever-more-seldom pensions implies that saving in retirement accounts (401(k)/403(b)/457/SIMPLE IRA, IRA, and Roth IRAs to name a few) will likely be the primary sources of retirement income. Some additional questions inform this answer as well: How much debt will you carry into retirement that may need to be serviced? Do you plan on any major purchases such as a retirement home, RV, or new cars? Do you have specific medical needs that should be accounted for, especially if the retirement age goal is before Medicare eligibility? What are your monthly discretionary expenses?
02-What should I invest in?
Most investors are aware of the standard considerations of “risk tolerance” and “proximity to use” i.e. how long until you need the money. There are some other important factors that come into play as well, some of which are psychological such as the perceived fear of loss (which studies have shown to be more influential that the hope for gain), as well the objective reality that equities (stocks) have outperformed fixed income (bonds) over virtually every meaningful period of time in the modern history of securities trading. The answer may be as simple as needing to take the risk of investing in equities to achieve financial goals, despite the perception of greater risk of loss in equity investing. Beyond this fundamental question, volumes can be written about asset allocation, diversification, cost-control, etc; all of which are important topics that should be considered, however, the basic question that needs to be answered is: what should be my exposure to the major asset classes of cash, stocks, bonds, real-estate, and commodities to identify a few.
03-Should I save for my children’s education and how should I do it?
There are few bad answers to this question. Like retirement accounts, Congress has created tax incentives for certain accounts that permit savers to invest after-tax dollars and be distributed without further tax consequence provided that the distribution is a “qualified” expense. Some of these vehicles are 529 Education Savings Plans, Coverdell Education Savings Accounts, as well as certain provisions within the parameters of “qualified distributions” for certain retirement accounts. Due to recent legislative changes, 529’s have expanded utility in providing for primary and secondary education for those currently enrolled in private, tuition-paying education. This new provision in 529 accounts largely negates the benefits of Coverdell accounts which were capped at $2,000/year/child. The mechanics of saving for higher education are fairly simple, however, the prima-facia question is whether or not parents should sacrifice their own retirement savings in order to either pre-fund a college savings account, or support a child through “cash flow” during university years. One way to consider the topic is that your child has a lifetime of earnings potential to either service debt related to college expenses, or to pursue higher education on a timeline and budget that makes sense for their budget…the timing on retirement planning and saving is unforgiving and very time-dependent. Another perspective is that when you reach your retirement years and may be dependent on your children to fill a financial void because your earnings potential has been reduced, may likely coincide with a time that they are in the throws of raising a family, and growing a career, with little remaining disposable income to support aging parents. In light of these realities, I urge great caution at the notion of saving for future college expenses for children at the expense of retirement saving and preparation.
04-Should I participate in an employer-sponsored retirement plan such as a 401(k)?
Most of the time, this answer is yes. There are several compelling reasons to take advantage of employer-sponsored plans: 1. Matching contributions. Many, but not all plans offer some form of matching employer contributions which has effectively taken the place of traditional, “defined benefit” or pension plans. I highly encourage clients to, at minimum, contribute to the limit of matching contributions. After all, you receive a 100% rate of return on each dollar that you contribute before the potential for market gains on top of it. 2. Tax deferral. While the potential for tax deferral is not necessarily unique to employer-sponsored retirement plans, having access to a ready-made plan that simply accepts your contribution then invests it, can be the difference in saving/investing for retirement or putting it off for a more convenient time that often never comes. Like an IRA, traditional 401(k), 403(b), 457, SEP, and SIMPLE IRA contributions offer the opportunity to invest “pre-tax” dollars through “salary deferral”. The net effect is lower reportable income at tax filing, and therefor more dollars working for you over the long-run. What’s the catch? The IRS requires that you start drawing off that account by age 70 ½, and on if you want/need access to that money before age 59 ½ (or age 55), without meeting some of strict parameters for “hardship withdrawals,” you are probably well-served to consider your contributions as inaccessible until you begin to systematically draw down that account in retirement. 3. Automated contributions when enrolled. Have you ever set-up a bill-pay service through your bank or other form of automated transfer from one account to another? Adapting to the reduced take-home pay in your pocket might sting for a while, but over time, you will probably adapt. Retirement savings is often very similar in practice. One great technique to implement is to contribute 50% of all raises to retirement saving, while enjoying the balance for other discretionary expenses or desires. So, what might be the downside of saving in an employer-sponsored retirement plan? Expenses. Plans can carry high fees that aren’t always completely, and transparently disclosed. Plan sponsors are required to disclose participant fees that often amount to the investment costs for the plan, however, plan administration and recordkeeping can be less transparent costs to participants, frequently exceeding 1% “all in” costs especially in small-balance plans.
05-When should I take my pension (if applicable)?
It’s no mystery that private pensions are dying a quick death, and that the public sector (federal, state, & municipalities) is one of the few vestiges remaining for defined benefit plans. DB plans, provided that they are sufficiently funded, provide the unique benefit of “guaranteed” income for the lifetime of the beneficiary, and possibly that of the surviving spouse if a reduced “joint survivorship” option is chosen. The decision as to when to take the benefit is typically informed by the financial planning process. For example, eligibility and maximum benefit are typically two separate ages that can span a decade. As with social security, it is tempting to default to the age with the highest benefit, however, careful consideration should be given to a few factors: 1. Does health or other circumstances factor into the retirement decision? 2. Are other retirement assets including social security benefits (if eligible) sufficient to provide for shortfalls in projected benefits and cash flow needs taken at an earlier than maximum benefit age? 3. If the decision is made to retire and begin pension benefits prior to age 65 (age of Medicare eligibility for most Americans), are healthcare benefits available in retirement? 4. Does work satisfaction play into the decision and is partial retirement an option?
06-Should I invest in a Roth or Traditional IRA/401(k)?
This is a common question and offers a wonderful tax-planning and opportunity when the appropriate qualified retirement is utilized. Below are some key questions to consider before funding either of these types of retirement accounts: 1. Are you covered by an Employer-Sponsored Retirement Plan such as a 401(k) and does it offer a “Roth option”? 2. Do you expect to be in a higher or lower tax bracket in retirement, and do your income needs allow for a tax-optimized distribution strategy? 3. What is your current Adjusted Gross Income (line 37 of the IRS Form 1040)? 4. How concerned are you about legislative risk such as tax code changes or means-testing of other benefits? 5. What are the primary sources of income that you will draw from in retirement? 6. Are you subject to state income taxes? Participating in Traditional IRA/401(k) plans is akin to “taking the bird in the hand” – you’re receiving the benefits of tax deferral in the current tax year as your net, reportable income is lower – hence “deferral”. The risk is that no one knows what your income tax bracket will be when the IRS requires you, or you decide to begin withdrawals from these deferred accounts. Conversely, taking advantage of the Roth option solidifies the tax burden on that investment by paying it “once and for all time” in the current year with a promise that it will never be taxed again provided that distributions are “qualified.” The counterpoint, however, is that there is no guarantee that legislative risk won’t impact Roth accounts in the future. Proposals have already been circulated in past administrations to reduced some of the benefits of Roth investing
07-Should I payoff my house with retirement funds?
It’s not uncommon for clients who are at or near retirement to have a negligible, if any mortgage balance. The notion of entering into retirement debt free is a noble endeavor, and buried deep into the lexicon of American thinking that financial freedom is directly correlated to a paid-off home. I can’t argue with the sense of peace that clients feel when the final payment is made and they own their home outright, however, I have seen the opposite fixation on accelerating principal reduction or even drawing down retirement savings in order to achieve this goal. The latter option is easier to deal with at face-value: consider the tax consequences of significant and early withdrawals from a portfolio: a basic understanding of compounding concludes that when interest is earned upon interest, the result is parabolic growth provided that returns are consistent, and also that time is the biggest determinant of that growth. Retirement can last 20-30 years or longer, especially in an era of ever-increasing life-expectancies. When we make significant draws on retirement early in retirement, we may jeopardize the ability to sustain future distributions because of the eroding effect of principal distributions can have. The former option of rapidly paying down principal through additional payments can have a negative effect on the accumulation of “liquid” assets. Another way to consider this point: investing in tax-deferred retirement savings provides the opportunity to earn a rate of return in excess of the long-term rates of real estate. Additionally, you likely won’t be looking to your home to tap equity in retirement if you have a funding shortfall, and if so, what was the point of paying off the mortgage of your biggest asset simply to have to turn-around and sell it in order to access the capital? The result is a very tax-inefficient savings mechanism. In conclusion, I wholeheartedly support the idea of entering into retirement debt-free. A reputable financial advisor I subscribe to states it this way: “money not going out the door is the same thing as money coming in.” If we can control and minimize our expenses in retirement, we will likely experience more peace, our retirement will be more enjoyable, and we significantly reduce the likelihood that we will outlive our savings and investments. We need to count the cost in achieving that goal, however, especially when nearing retirement.
08-When should I take Social Security benefits?
“While the precise answer is unique to each individual and household, the good news is that the financial planning process can demonstrate the pros and cons of taking benefits now, or waiting for some point in the future.”
Similar to question #5: if you can tell me how long you’re going to live, I can give you an exact answer, however, we know that the answer is completely unknown. The premise of the question does, however, imply some credence that should be given to life expectancy. If longevity runs in your genes, perhaps waiting to maximize Social Security benefits at age 70 may make the most sense. However, a recent study conducted by the Wharton School of Business found that the Social Security Trust Fund will be insolvent by 2032 without significant and immediate reductions in benefits starting NOW with current recipients. Furthermore, if you are currently retired and have immediate cash flow needs, the obvious answer is to take benefits as they are likely more tax-efficient than drawing that same benefit from retirement savings and investments. While the precise answer is unique to each individual and household, the good news is that the financial planning process can demonstrate the pros and cons of taking benefits now, or waiting for some point in the future. Specifically, a savvy planner can deduce the age at which the decision to take benefits vs. waiting is reached; commonly referred to as the “crossover age.” This should incorporate the tax consequences of each decision as well as the alternatives for forgoing vs. taking the benefit.
09-How should I pay for an expected large purchase?
In financial planning vernacular, we refer to these as “interim financial goals”. While indirectly related to the question at hand, “Grandma’s advice” of delaying gratification comes to mind as we attempt to reconcile the difference between a “need” and a “want.” On one hand, we can be miserly and pinch each penny in a desperate attempt to control an unknown future, and on the other hand, our culture of immediate gratification makes a compelling case for the latest fashion, newest car, and biggest house. While we need clothes, vehicles, and shelter, it is easy to get caught in the trap of needs vs. wants, and the effect that can have on retirement planning can be devastating. A mortgage is a good example of the exception of “good” debt in that a home is typically an appreciating asset, and it is also categorically a “use” or “tangible” asset as opposed to a liquid asset such as a brokerage account or IRA. The key consideration is counting the cost in terms of debt service and available, discretionary cash flow. We habitually underestimate our expenses, so the confirmation bias we bring into large purchases can have a double-negative effect: we don’t typically factor all of the additional taxes, maintenance, insurance, or other costs that large purchases carry with them, but can have real impacts to budgets. Despite the Federal Reserve’s recent monetary policy moves in hiking interest rates, the cost of borrowing is still low by historical standards, which may imply that provided that cash flow is adequate to support a large purchase, a mathematical case can be made for financing debt, and deploying cash into the financial markets may be a better opportunity than sinking it into lower appreciating, or even depreciating assets such as a new car. That said, minimizing debt service through reasonable down-payments not only controls our cash outlays, it also aids in making wise financial decisions on a psychological basis. Consider the notion that systematic savings for a financial goal lends towards a much more informed and diligent decision-making process as opposed to simply “putting it on the card” which can lend towards impulse-driven buying decisions.
10-I don’t have a will; where should I start?
The good news is that for most Americans, estate planning can be a relatively straight-forward endeavor, especially in community-property states such as Washington and Idaho. Most assets can effectively be divided into two categories: probate and non-probate. Non-probate assets such as IRA’s, 401(k)’s, and life insurance proceeds pass to beneficiaries by way of “designation.” This means that the individual, charity, or trust that is named as beneficiary to these accounts of policies receives the proceeds without a court-overseen probate process. On the other hand, most other assets are considered “probate assets” which implies that an executor or personal representative has to inventory, then distribute those assets in accordance with the deceased’s last will and testimony, as well as settle any creditor claims. This can, but does not have to be a messy process. Thankfully, when beneficiary designations are accurate, having documents such as a simple will, durable power of attorney, living will/medical directive, and community property agreement cover most, if not all of the potential gaps in estate planning. One alternative is establishing a living trust which, provided that trust intent and execution is adhered to, bypasses the probate process. Finding a competent estate-planning attorney to prepare documents does not have to be a costly or time-consuming endeavor, but the consequences of passing intestate (not having a will in place) can be cumbersome to surviving heirs and beneficiaries. High profile celebrity deaths such as Aretha Franklin in 2018 highlight the nightmarish situation that estate beneficiaries go through in such situations.
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