5 New Year’s Resolutions for the Almost Retired

The start of a new year is always a good time to check in on your finances.  Here are five resolutions to help you get on track if you’re thinking about retiring soon.

1) Think about what you want to do in retirement.  Do you want to travel the world? Do you want to turn a hobby into a small business? In my experience, the happiest retirees are the ones who had a clear picture about what they wanted to do once they retired.  Spend some time thinking about what you want to do when you have the time to do whatever you want.

2) Finally create a budget.  To successfully transition into retirement you need to know what you spend now and how that might change in retirement.  If you plan to travel more extensively in retirement you must accountant for that.  The same goes if you pay off your mortgage and are only responsible for taxes and insurance in the future.  Consider using an automated service like Mint.com or Quicken® to help determine your yearly expenses. Knowing your budget helps you determine if you are financially ready for retirement.

3) Review your potential income sources in retirement.  Go to www.ssa.gov to register for a username and password to review your Social Security benefits.  Pull any pension estimates from your current or past employers.  Add in any income you may earn from part-time work in retirement. Determine the value of your nest egg by adding together all your retirement and investment accounts.  If your savings totals 20-25 times the size of your current income you are probably in good shape.

4) Max out your 401k/403b/IRA contributions.  As you approach retirement it is likely you are at your highest earning years and once you retire you will fall to a lower tax bracket.  Now is an ideal time to max out contributions to retirement accounts to avoid paying taxes today and instead pay taxes in retirement at a potentially lower rate.  For 2015, those over age 50 can contribute up to $24,000/year to a 401k and/or up to $6,500/year to an IRA if they qualify.

5) Talk to a professional.  While you may have a good handle on your financial readiness, it may still be worthwhile to check in with a CERTIFIED FINANCIAL PLANNER™ professional.  Often a professional can identify holes in your financial plan that you weren’t aware of such as: 

·         Determining the most tax efficient withdrawal strategies after you retire which could save you thousands in taxes. 

·         Identifying potential risks in your portfolio that could jeopardize your retirement.

·         Determine the optimal strategy for claiming Social Security (very important for married couples!) 

A professional can help you answer many if not all of the questions you need to answer as you transition into retirement.

4 Ways to Reduce Your 2014 Taxes

Few things are as painful as filing your tax return in the spring and realizing you owe the government even more money.  Fortunately, the 2014 tax year is not over yet and there are some ways you can potentially reduce your tax bill.  Here are some ideas to lessen the tax bite:

1.  Make a traditional IRA contribution.  You can make a traditional IRA contribution all the way up to April 15^th 2015 and still have it count for the 2014 tax year. Those under age 50 can contribute up to $5,500/year and if you’re over age 50 you can contribute an additional $1,000/year for a total of $6,500/year.  The contribution will be tax deductible as long as your AGI (adjusted gross income) is below the limit. 

Here is a nice recap of the 2014 AGI limits*:  http://www.schwab.com/public/schwab/investing/retirement_and_planning/understanding_iras/traditional_ira/contribution_limits

Example: You make a $5,500 traditional IRA contribution and you fall in the 25% Federal tax bracket.

$5,500 X .25 = $1,375 in tax savings

The tax savings may be even greater since a deductible traditional IRA contribution will reduce your AGI, which may potentially affect other tax credits and deductions.  Also, this example doesn’t even include the potential state income tax savings.  I once advised a couple to make full traditional IRA contributions and they reduced their tax bill by over $3,800!

*Source: Charles Schwab & Co.

2.  Make a donation to charity.  If you itemize your deductions, you can claim donations to a qualified charity as a tax write off.  You can donate cash, used goods, clothing and your car. 

For those in high tax brackets with investments in a taxable brokerage account you can even donate shares of mutual funds/stocks and avoid paying taxes on the capital gains!  This can be substantially better than giving cash in many instances. 

If you aren’t sure which charity you want to give money to or when you want to donate but would like the tax deduction immediately you could set up a Donor Advised Fund (DAF).  This helps separate the time of the tax deduction from the time of the gift.

Make sure to keep receipts, records and appraisals so you can prove the donations if the IRS ever audits you.

3.  Capitalize on any tax losses you have.  If you bought a stock or mutual fund through a taxable brokerage account and the value of the investment has declined it may be worthwhile selling the security to be able to write off the loss.  The loss will offset any other capital gains you have potentially saving you 15% or more.  If you don’t have any gains to offset, up to $3,000/year can be used to offset ordinary income which can yield even higher tax savings.

Example: You buy XYZ stock for $10,000 and it declines to $6,000.  You sell it for a $4,000 loss.  You have $2,000 of capital gains from other stock transactions and you are in the 25% Federal tax bracket.

$4,000 loss offsets the $2,000 gain.  The remaining $2,000 of losses offset your ordinary income.  Tax savings:

$2,000 of offset capital gains x .15 (long-term capital gains tax rate) = $300  

$2,000 of offset ordinary income x .25 (Federal tax rate) = $500  

$800 in taxes saved/avoided.

If you still think the stock is worth owning you can simply buy it back as long as you wait 30 days to avoid the wash sale rules.  Here is a nice recap of the wash sale rules*:

http://www.investopedia.com/terms/w/washsalerule.asp

*Source: Investopedia

Best of all, if you have substantial capital losses over and above offsetting $3,000 of ordinary income, the losses carry forward to future tax years so they aren’t wasted.

4.  Make a contribution to a 529 plan for your child.  Many states offer a tax break for contributions to a college savings 529 plan.  A 529 plan allows contributions to grow tax-deferred and if the money is used towards qualified college expenses there are no taxes owed on the earnings.  In New York a married couple can deduct up to $10,000/year of 529 contributions which may save them approximately $650 in state taxes.  This type of account is a great way to save for your child’s college costs. 

This website provides a great recap of which states allow tax breaks for contributions*:

http://www.savingforcollege.com/529_plan_details/ 

*Source: Savingforcollege.com 

3 Ways You Are Taxed In Retirement

Ever since you got your first job you’ve probably hated paying taxes.  They are a staple of life while you work and for most people that doesn’t stop in retirement.  While it’s true that your overall taxes usually go down in retirement that doesn’t mean they go away.  Let’s discuss some different types of income you can receive in retirement and how they will be taxed.

1.  Social Security – If you have worked for at least 10 years you should qualify for Social Security benefits.  In retirement, depending on your income, your benefits may or may not be taxed.  At worst, only 85% of your Social Security benefits will be taxable.  Here is how it breaks down:

• file a federal tax return as an "individual" and your combined income* is
• between $25,000 and $34,000, you may have to pay income tax on up to 50 percent of your benefits.

o    more than $34,000, up to 85 percent of your benefits may be taxable.

• file a joint return, and you and your spouse have a combined income* that is
• between $32,000 and $44,000, you may have to pay income tax on up to 50 percent of your benefits

o    more than $44,000, up to 85 percent of your benefits may be taxable.

* Source: http://www.ssa.gov/planners/taxes.htm 

Follow the link above to see an example of how to calculate your “combined income.”

2.  Pensions/401k/IRA Distributions – Distributions from your retirement accounts or monthly payments from a pension will be taxed like ordinary income.  You will owe taxes at your marginal tax rate on each additional dollar you take out of your IRA/401k.  Any withdrawals from a Roth IRA will not be taxed federally or by the state as long as it is a qualified withdrawal.  Many states allow exemptions on some or all retirement account distributions. New York, for example, doesn’t tax the first $20,000 withdrawn from each individual’s retirement account each year.  Also, many states don’t tax your pension if you worked for the state.

Fortunately, we get to choose how much we withdraw from our retirement accounts each year, or at least until you turn 70 ½.  Once you turn 70 ½ you are required to take a certain amount out of your IRA/401k each year.  The amount you are required to take is based on the value of your account at the end of the previous year divided by a factor.  You can find the factor by referring to the IRS uniform life expectancy tables listed here:

http://www.irs.gov/pub/irs-tege/uniform_rmd_wksht.pdf

Source: IRS

3.  Capital Gains & Qualified Dividends – If you have a taxable brokerage account with investments you will owe taxes on the dividends, interest and capital gains realized each year.  Depending on your tax bracket you may owe taxes at your marginal tax rate on the interest, non-qualified dividends and short-term capital gains.  Your qualified dividends and long-term capital gains will be taxed at 0%, 15% or 20% depending on how high your income is.  If your income is high enough you may also face an additional 3.8% tax.  Here is a nice recap of the various tax brackets and rates depending on the source and amount of income:

http://www.schwab.com/public/schwab/nn/articles/Taxes-Whats-New

Source: Charles Schwab & Co.

Conclusion: Retirement is one of the biggest tax planning opportunities you will get and it’s worthwhile to spend time thinking about your cash flow.   Many retirees can manipulate which accounts they take money from to minimize their taxes.  The difference can add up to thousands of dollars of tax savings each year.

The Most Important Number You Need To Know When Thinking About Retirement

When meeting with clients who are about to retire I inevitably come to the question of how much money do you need each year to live on? Very few people have an answer to that question. If you don’t know how much you need how can you ever expect to know if you are ready to retire?

Let me give you an example: if someone asked you to help budget how much gas they might need for an upcoming road trip what would you ask them? Obviously you’d ask where they are going.  Now imagine they said they didn’t know.  There would be no way for you to help them because you don’t know if they are driving across the country or across town.

Knowing how much you need to live on is vital to preparing for retirement.  Unfortunately this means you need to budget, which is one of those things we all know we need to do but rarely gets done.  Once you have a handle on your budget you can adjust for anticipated changes in retirement and move on to reviewing how adequate your savings/income will be to meet your expenses.

Here are a few ways to quickly determine your annual living expenses:

·        Consider using an automated system like Mint.com or Quicken

·        If you aren’t accumulating any debt consider using your net pay for the year

·        Try one of the many online budget calculators (SBV budget calculator)

·        Set up an Excel spreadsheet and track all purchases

Lastly, make sure to factor in any changes to your budget in retirement such as higher health insurance premiums, additional travel expenses, or higher entertainment expenses.  The more accurate your estimate of annual expenses the better prepared you will be to transition into retirement.

3 Reasons Retirees Should Stay Invested In This Market  

The S&P 500 has dropped over 4% from its September high as of this writing.  Foreign markets, commodities, and commercial real estate (REITs) have dropped more with some even negative for the year.  All of this has made many investors very nervous that the decline may get worse.  Recent retirees may be even more nervous since they are just starting to live off their savings.

Many recent retirees are wondering; should I sell my stocks to prevent further declines that would jeopardize my retirement?  I believe that’s a bad idea and have compiled several reasons why. 

1.  Timing the market is incredibly difficult if not impossible.  Selling your stocks now is making a bet that the recent decline will continue.  Research by Vanguard has shown that moving in and out of the markets with the hope to avoid declines is a waste of time. You are more likely to hurt your portfolio returns than improve them. Remember, you have to be right twice to time the market successfully – both selling at the correct time and then buying back in at the right time.  Many people may have sold before the worst of the 2008 decline but missed all of the eventual recovery and the new highs that came after.

2.  The recovery tends to come quickly and last longer than the declines. The stock market can turn on a dime and with no warning.  Usually the upswing happens when all the experts agree the market will continue to decline. Missing those critical upswing periods can cost you significantly.  On top of that, bull markets are three times longer on average than bear markets.  Even if you are 65 and just retired, you still have significant time on your side to wait for a recovery.

3.  You need stocks as a portion of your portfolio to keep up with inflation and make sure you don’t run out of money in old age.  Few of us have enough saved to live off our principal alone throughout retirement.  Most will need growth to keep up with rising costs and to ensure we don’t run out of money if we live to 100.  While bonds can be an important diversifier and stabilizer in a portfolio, rates are very low today and may not provide the protection retirees need.  Having a portion of your money in the stock market is an excellent way to protect yourself from inflation and to help ensure your money lasts as long as you do.

It may be difficult to watch as the market fluctuates but temporary declines are a normal part of investing.  The stock market pays us a risk premium to deal with these declines and staying invested is the best way to make sure you earn the return you deserve for bearing the risk.

4 Ways Changing Your Brakes and Managing Your Portfolio are Similar

1.  It takes time.  Changing your brakes might take you a couple hours or all weekend depending on whether or not you know what you’re doing.  Managing your investments takes time too.  You should review your investments once a quarter to make sure your portfolio is still in balance, to check for tax loss opportunities, and to ensure your funds are performing as expected.

2.  It takes expertise.  The majority of people who own cars wouldn’t dare change their own brakes.  They don’t know how to and they don’t care to learn.  The same can be said for your portfolio.  Are you willing to spend the time to educate yourself about the nuances of proper asset allocation? Or learn the intricacies of tax location optimization? What about researching the most cost-effective mutual funds?  It isn’t impossible to learn but it does take knowledge to effectively manage a portfolio.

3.  It takes willingness.  Many people have both the time and the expertise to change their own brakes, they simply don’t want to.  On a less technical scale, I am guilty of this.  I used to change my oil in college.  Once I graduated I stopped changing my own oil and started paying someone else to do it.  I could do it but I don’t want to.  For some, investing is exciting but for most it’s easier for someone else to handle it so they don’t have to.

4.  You risk getting it wrong.  The major reason I don’t change my own brakes, aside from the first three reasons listed, is the fear of doing it wrong.  If I mess up and my brakes fail then I have a serious problem, potentially fatal.  If, when managing your own portfolio you make a mistake, you may not even know it.  A great example would be selling stocks in a panic when the market is down.  Those that sold out at the bottom of the 2008 crash missed out on an enormous 5 year stock market rally.  This could potentially ruin the financial plan for someone close to retirement.

There are some people who have the time, expertise, and willingness to manage their own portfolios.  For others, one or more of the previously mentioned reasons is enough to consider hiring a fee-only, objective financial advisor to help manage their money.

Build Your Portfolio Like You Build Your Fantasy Football Team

This time of year everyone who plays fantasy football is in the midst of
drafting their team. An enormous amount of time and energy will be spent
researching this year’s potential sleepers and busts. If only we spent that
much time building our portfolios.

A basic fantasy football team is made up of a quarterback, two running
backs, two wide receivers, one tight end, one flex player, one defense and
one kicker. Everybody ends up drafting at least the appropriate number of
players to fill each of those slots.

But when the average person invests they end up owning many funds that do
the same thing. I see it all the time; someone will have six US large cap
stock funds and claim they are diversified. This is the fantasy football
equivalent of drafting six quarterbacks when you can only play one.

A properly diversified portfolio will include US large and small cap stocks,
international large and small cap stocks, emerging markets stocks,
commercial real estate (REITs), commodities and various types of fixed
income. These are the building blocks of a solid portfolio.

After you finish this year’s draft consider checking your investments to
make sure your portfolio is as well diversified as your team.