Interesting article in today’s WSJ on delaying Social Security and simultaneously withdrawing from both Traditional IRAs and regular taxable accounts simultaneously to fund retirement.
Archive for the ‘Retirement Plans’ Category
What Should You Do When the Market Gets Crazy?
Wednesday, August 17th, 2011This is a letter I sent to my clients on the recent market votility. I thought I would share it with everyone.
“Dear Clients,
With the recent quick decline in the stock market and talk of a double dip recession and rising interest rates, I wanted to take a moment and share with you my perspective on the recent stock market declines.
- This too shall pass. The stock market goes up and it goes down. In times of uncertainty like now it does it more frequently. This is why each of you have an asset allocation strategy where you understand the downside risk in your portfolio.
- Historical perspective is important. Is anyone talking about the crash of 1987 when the market dropped over 22% in a single day? The Wall Street Journal ran a series of articles comparing 1987 to 1929, hinting that another Great Depression was on the way.
- Interest rates on US Debt dropped yesterday even though it was downgraded. When money was pulled from stocks there was really no other place to put it which drove bond prices up and interest rates down. Even if interest rates rise in the future they would still be very low from a historical perspective. Did you know that in 1965 mortgage rates were 6% and did not drop below that level again until 2003? The interest rates we see today are lower than they have been in a very long time.
- Sometimes press coverage does not reflect an accurate picture of what is really happening.
a. On a given day only a very small percentage of outstanding shares are traded – most people are not selling and for every seller there is a buyer.
b. The press is often interested in covering the unusual because that is what sells. I received several press requests over the past few days asking me if I had any “panicked clients” who were calling me about the market. They did not wish to speak to clients who were not panicked for their stories. So they only report one side of the story, which is not at all representative of reality. - Emotional investing decisions often lead to poor outcomes. The typical investor who tries to time the market usually underperforms significantly. This is because they tend to sell after a big market sell off and wait until the market recovers to get back in. This is the “Sell Low, Buy High” theory of investing. Not too many market timers were jumping into the market in March, 2009. Even the pros (mutual fund managers) who practice this type of strategy, underperform the market by about 2% per year .”
Unmarried Partners and Planning Software: Often a Bad Fit
Thursday, July 14th, 2011If you are in a domestic partnership, civil union, or marriage that is not recognized at the Federal Level most of the software that financial planners use won’t work for you.
Here’s why:
Most software is keyed off the IRS tax filing status. This filing status is used to generate future tax projections. Let’s say you are in a newly minted Civil Union here in Illinois which is not recognized by the Federal Government. The planner has two options.
Option 1: Plan jointly but get the taxes wrong
In this scenario the planner enters in the information for both partners together. This allows for sharing of household expenses, and joint purchases, or liabilities. That’s great but in order to do that the software only allows the planner to check the “married” box, which means that all of the federal tax calculations will be incorrect leading to possible misleading projections.
Option 2: Get the taxes right but no joint planning
In this scenario the planner enters information for each partner separately. This means that the Federal tax calculations will be correct, but the couple will have two separate plans, vs. a joint plan.
Luckily a few software programs, including the one I use, do allow for joint planning with a “single” federal tax status. If you are part of a couple that is not considered married under Federal law make sure to ask your planner if their software can handle that. You may be surprised by the answer.
Are you on track for retirement?
Thursday, March 3rd, 2011Here is a ‘quick and dirty’ tool that I found in Money Magazine (Feb 2011), that gives you a quick assessment to see if your retirement savings are on track.
For each age there is a savings factor (e.g. at age 30 the savings factor is 0.3). This means that if you want to retire at age 65 you need to have 30% of your salary saved by age 30. If you earn $100,000 this means that you would need to have $30,000 saved for retirement. At age 50 the factor is 4.5 which means that if you earn $100,000 you would need to have $450,000 in retirement savings.
Age Savings Factor
30 0.3
35 1.1
40 2.0
45 3.2
50 4.5
55 6.2
60 8.2
65 10.6
This table is a better estimate for younger ages when retirement is far off and you want a quick reality check. As you get closer to retirement so many other specific factors could affect your number (e.g. will you have a mortgage, will you move, will your lifestyle change, etc.) that it may be worth doing a more specific sophisticated analysis, or even seeing a Fee-Only(tm) Financial Planner.
Index Funds are Hard to Beat
Tuesday, November 30th, 2010According to the Wall Street Journal index funds are likely to become even better in the future. The new twist: indices that phase out and phase in new stocks vs. adding and dropping them abruptly. This eliminates that tactic of active managers taking advantage of the time before the index changes and the index fund buys or sells the stock.
There are also some other great reasons to own index funds:
According to the Wall Street Journal index funds are likely to become even better in the future. The new twist: indices that phase out and phase in new stocks vs. adding and dropping them abruptly. This eliminates that tactic of active managers taking advantage of the time before the index changes and the index fund buys or sells the stock.There are also some other great reasons to own index funds:
- Lower fees. The typical actively managed stock fund has total annual expenses of 1.35% or $1.35 per $100 invested. Index fund fees tend to me much lower. For example, the Vanguard Total Stock Market Index charges 0.07% or $0.07 per $100 invested.
- Tax efficiency. An actively manage fund turns over its portfolio about three times per year. This means that it generates capital gains on any profits from those sales and all of those gains are taxable, whether or not you sell you shares. An index fund buys and sells shares much less frequently generating much lower annual capital gains. Meaning that most of the tax is owned when you sell your shares, and those gains are taxed at lower capital gains tax rates.
- Transparency. Actively managed funds only report their holdings a couple of times per year so it’s difficult to know exactly if their actual holdings match your expectations. For example a large cap fund could hold significant small cap stocks, or a large amount of cash without disclosing it. This could make maintaining an asset allocation more difficult. With an index fund you have much greater transparency into their holdings since they are required to track a publicly disclosed index.
When does a Guaranteed Income Annuity Guarantee Nothing but Excessive Fees?
Tuesday, November 23rd, 2010I recently reviewed a “Guaranteed Income” annuity contract that a new client had purchased before starting work with me. Here’s how it works:
Client purchases and annuity and chooses how to invest the funds.
- The annuity has a “Guaranteed Base” on which the “Guaranteed Income” is based on
- The Guaranteed Base will grow either by 6% or the actual contract value whichever is higher.
- After 10 years the client has a choice of receiving a guaranteed income stream based on either the Guaranteed Base value which will never go down, and will go up by at least 6%/year
Sounds great doesn’t it? There are a lot of “gotchas” though.
- Although the Guarantee Base will go up by 6% per year, there actual income received is a function of the Guarantee Base multiplied by an “annuity factor.” The annuity factor is determined by the insurance company at the time the client wishes to receive income and the insurance company can determine choose whatever value they wish, meaning that the client has no idea what her “Guaranteed Income” will be.
- Fees, fees, and more fees. Try 3.45% per year or OVER $9,000/year on a $250,000 annuity. This is about $8,500 more per year than a basket of low cost index funds would cost.
- Surrender charges. They start at 8% in the first year and go down by 1% per year for the next four years.
- All of the guaranteed income will be taxed at ordinary income rates. Had the client invested in low cost index funds most of the income would be taxed at lower capital gains income tax rates.
- No inflation protection. The amount is guaranteed by it doesn’t rise each year (unless you pay even higher fees).
So what do we have:
- A future undermined guaranteed income with no inflation adjustment
- High fees meaning that the real value is significantly eroded over time vs. investing in low-cost index funds.
- Tax inefficiency.
- High surrender charges.
And this is good because . . .??
Why Guaranteed Value Variable Annuities are not what they seem.
Tuesday, June 8th, 2010Many of my clients have been sold a type of variable annuity that has a guaranteed value and a minimum guaranteed annual payout after a holding period. The guaranteed payout is often 5% of the guaranteed value. So if the guaranteed value is $100,000 you would get $5,000/year regardless of what the investment value of the annuity is. If the value of the annuity rises above $100,000 you would get 5% of that higher value.
Sounds like a great deal. Upside potential and downside protection.
Well a fellow NAPFA advisor analyzed one of these annuities on the insurance company’s website. Here is what she found:
- On a $100,000 contract the guaranteed payout was $416/month. This compares to $609/month for an immediate annuity (a different animal)
- In order for the contract value to grow above $100,000 there would have to be a return of at least 9%/year. This is because the internal expenses (fees, premiums, commissions etc. were 8% per year!)
- Assuming 3% inflation the annuity growth would have to be 12% per year. That would be very difficult to achieve over the long-term!
If someone offers this type of product to you. Take the time to analyze it looking at what rate of return you would have to achieve in the long-term in order for your payout to rise.
As an alternative consider a combination of an immediate annuity at retirement for some guaranteed income, along with a combination of stock mutual fund investments for long-term growth.
Money Bus Serves Over 100 People in Chicago
Tuesday, April 27th, 2010Well the numbers are in and the Money Bus (www.yourmoneybus.com) served over 100 people in two days in the Chicago area. The Money Bus was sponsored by the NAPFA Consumer Education Foundation, Kiplingers, TD Ameritrade, and FiLife/WSJ. The bus travels the country and at each stop local NAPFA advisors provide free advice (no product sales!!) to consumers. We answered questions about retirement planning, 401ks, credit card debt, college savings, emergency funds, layoffs, foreclosures, mortgages, etc.
New 401k Fee Disclosure Coming
Monday, April 12th, 2010The Labor department is proposing new 401k fee disclosure rules which will require written agreement in place to provide services to disclose both direct and indirect compensation for plan advisors. This will affect many advisors who do not work with plans as fiduciaries and who’s compensation arrangements are not transparent. For more watch this video.
401k vs. Roth IRA, vs Traditional IRA — what should you do?
Friday, March 26th, 2010Many of us face a dilemma: Should I invest in a Roth IRA, my 401k plan, or a Traditional IRA or some combination? Here are some simple rules of thumb:
If you employer matches your 401k contributions:
- Invest in your 401k up to the amount to get the maximum match
- Then invest in a Roth IRA if you are eligible
- Then invest in your 401k again (no match)
If you employer does not match
- Invest in a Roth IRA if you are eligible
- Invest in your 401k
The situation is more complex if you are not eligible to contribute to a Roth IRA with many contingencies that are best handled on a case by case basis. Also, if your employer has a high cost 401k plan you may actually be better off investing some of your funds outside of your 401k in a regular taxable account once you have invested enough to receive the maximum 401k match.
The reason why Roth IRA contributions are a better bet for most people vs. a regular 401k contribution include:
- Tax rates are likely to be higher than they are today in the future when you withdraw your 401k contributions.
- You will have Required Minimum Distributions from a 401k plan at age 70-1/2.
- Your heirs will required to take distributions from your 401k plan and pay taxes on them. There are no required distributions from a Roth IRA and any distributions are tax free.