Please join us for lunch and an interactive discussion on annuities vs. mutual funds at Pinnacle Financial Concepts, Inc. on May 16th. Our Fireside Chat will run from 11:30 to 1:00. Please call 260-9800 to RSVP. There is no charge and our Fireside chats are always purely educational!!!
Jane Young, CFP, EA
Below are some general guidelines and rules of thumb for retirement planning. While general guidelines can be useful, I recommend that you do the work to run retirement calculations with well thought out figures that represent your unique situation. These should be revisited on an annual basis to be sure you are on track. Guidelines and rules of thumb can be misleading and may not fit every situation.
- Always save between 10% and 15% of your annual income. If you are starting late this needs to be much higher.
- A rule of thumb is that you will spend 60-80% of your pre-retirement expenses in retirement. However, I recommend doing the detailed work to determine what your unique situation may look like.
- Over a long period of time inflation has averaged about 3%. In retirement some of your expenses may not be subject to inflation such as your house payment. Other expenses, such as healthcare, will be higher. Health care is projected to increase at a rate of 7% annually.
- You will probably spend more during your first few years of retirement and much less during your last years in retirement. Due to compounding, money spent early in retirement has a more dramatic impact on reducing your nest egg than money spent later in life. You may want to consider working a part time or seasonal job to help cover large travel expenses during the first few years of retirement.
- One guideline to determine the size of retirement nest egg required is to assume you will need $15 – $20 in savings for every dollar of shortfall between your projected income from pensions and social security and your expenses.
- A guideline on how much you can pull from your retirement savings without running out is 3-4% if you have a conservative portfolio and 4-5% if you have a moderate or more aggressive portfolio. Most retirement guidelines assume 30 years in retirement. I recommend running numbers that represent your specific situation to get a better understanding of what you can spend.
- Avoid taking Social Security before your normal retirement age if you plan to work between 62 and your normal retirement age. In 2011, Social Security will withhold $1 for every $2 earned above $14,160 between the time you are 62 and your normal retirement age. Additionally, working while taking Social Security may result in more income tax on your benefit.
- If you are planning to retire before 65, be ready to pay a hefty bill for health insurance until Medicare kicks in at 65.
- Avoid pulling money from your retirement funds to meet short term, pre-retirement living expenses.
- Don’t sacrifice your retirement to put your children through college.
- Don’t automatically transfer your entire portfolio into CD’s or other extremely conservative investments upon retirement. You may spend more than 30 years in retirement. Some of your money should be invested in the stock market to stay ahead of inflation.
- You don’t need an “income” producing investment to cover your retirement distribution needs. You can make systematic withdrawals from your portfolio to meet your living expenses. However, you should maintain at least 5-10 years of expenses in fixed income investments. This will prevent the need to sell equities when the stock market is down. A significant portion of your annual return will come from capital appreciation on the stock portion of your portfolio.
- Maintain a diversified portfolio and don’t keep too much in your company’s stock or in the stock of any one company.
- Monitor your situation on an annual basis to stay on track.
Jane M. Young, CFP, EA
Below are some questions you may want to consider when you start planning for retirement.
What does retirement look like?
When do you want to start cutting back on your work hours? Do you want to stop working altogether or try something new?
Do you want to take a break for a few years and return to work part time? What are the opportunities for someone of retirement age in your chosen field?
How will you feel in retirement? How much of your personal identity and self esteem is associated with what you do? How will you feed your need for a sense of accomplishment, friendships, social interaction and status? Are you ready for retirement? Maybe a gradual transition will be more comfortable.
Where and how will you live? Do you plan to move to a less expensive city or country? Are you going to stay in your home or downsize to something with less maintenance?
How will you spend your time and money? Do you plan to travel, write a book or play tennis?
How will your expenses change in retirement? (Downsize or pay-off house, travel, no kids and no 401k contribution)
Where are you today?
What are your current expenses and what are you earning? How will this change in the coming years? Do you need to make some improvements in your career/earning situation?
How much are you saving for retirement? Could you squeeze out just a little more? Most people need to be saving between 10 – 15%. If you are getting started late you should be saving more.
What can you expect from a pension or social security?
Are you maximizing your ability to contribute to retirement plans such as 401ks, 403bs and Roth IRAs? Are you taking advantage of opportunities for matching contributions from your employer?
How much do you have put away for retirement?
Is your portfolio well diversified to meet your retirement needs? Avoid being too conservation or too aggressive.
Jane M. Young, CFP, EA
Here are a couple issues on Social Security and IRA Rollovers that frequently catch people by surprise.
Think twice about taking your Social Security at 62 or before your regular retirement age, if you plan to work during this timeframe. In 2011, if you earn more than $14,160, Social Security will withhold $1 for every $2 earned above this amount. However, all is not lost, when you reach full retirement age Social Security will increase your benefits to make up for the benefits withheld. Once you reach your full retirement age there is no reduction in benefits for earning more than $14,160. However, the amount of tax you pay on your Social Security benefits will increase as your taxable income increases. This may be a good reason to wait until your full retirement age or until you stop working to begin taking Social Security.
If you are thinking about moving your IRA from one custodian to another I strongly encourage you to do this as a direct transfer and not as a rollover. We frequently use these terms synonymously but I assure you the IRS does not! A transfer is when you move your IRA directly from one IRA trustee/custodian to another – nothing is paid to you. A rollover is when a check is issued to you and you write a second check to the new IRA Trustee/Custodian. This must be done within 60 days or the transaction is treated as a taxable distribution. You can do as many transfers as you desire in a given year. However, you can only do one rollover per year, on a given IRA. This is a very stringent rule and there are very few exceptions even when the error is out of your control. Whenever possible be sure to use a direct transfer not a rollover to move your IRA Account.
“What is Modern Retirement and Will You be Ready?” Join us on September 7th for our next Pinnacle Fireside Chat.
Please mark your calendars for our next Pinnacle Financial “Fireside Chat”, to be held on Wednesday, September 7th from 7:30am – 9:00am.
Jane will discuss the characteristics of modern retirement and how to plan for it. She will explore different approaches to retirement and some of the factors to be considered. She will also explain the various plans available to help you save for retirement.
The Fireside Chat sessions are informational only (no sales!) and interactive — a great opportunity to learn new things and ask questions in a relaxed environment. These sessions are open to your family and friends, so please feel free to pass this email along to anyone that you think might be interested in attending.
Please call Judy (719-260-9800) if you would like to attend this session on September 7th, as space is limited.
We hope to see you on September 7th! Coffee and donuts will be served!
Jane M. Young CFP, EA
1. Set Goals –
Review your personal values, develop a personal strategic plan, establish specific goals for the next three years and identify action steps for the coming year.
2. Understand Your Current Situation –
Review your actual expenses over the last year and develop a budget or a cash flow plan for the next 12 months. Compare your expenses and your income to better understand your cash flow situation. Are you’re spending habits aligned with your goals? Can or should you be saving more?
3. Have sufficient Liquidity –
Maintain an emergency fund equal to at least four months of expenses in a fully liquid account. Additionally, I recommend having a secondary emergency fund equal to another three months of expenses in semi-liquid investments. Increase your liquidity if you have above average volatility in your life due to job instability, rental properties or other risk factors.
4. Always save at least 10% of your income –
Regardless of whether you are saving to fund your emergency fund or retirement you should always pay yourself first by saving at least 10% of your income. Most of us need to be saving closer to 15% to meet our retirement needs.
5. Pay-off Credit Cards and Consumer Debt –
Learn the difference between bad debt (credit cards) and good debt (fixed-rate home mortgage). Avoid the bad debt and take advantage of the leveraging power of good debt.
6. Take Advantage of the Leveraging Power of Owning Your Home –
Once you have established an emergency fund and have paid off your bad debt start saving for a down payment to purchase your own home.
7. Fully Fund Your Retirement Accounts be a tax smart investor –
Participate in tax advantaged retirement programs for which you qualify. Maximize your Roth IRA and 401k contribution take full advantage of any company match on your 401k. If you are self-employed consider a SEP or Simple plan. Always select investment vehicles that provide the most beneficial tax solution while meeting your investment objectives.
8. Be an Investor, Not a Trader. Don’t time the market and don’t let emotions drive your investment decisions –
Investing in the stock market is a long term endeavor, forecasting the short-term movement of the stock market is fruitless. Avoid emotional reactions to headlines and short-term events. Don’t overreact to sensationalistic journalists or chase the latest investment trends. You can establish a defensive position by maintaining a well diversified portfolio custom tailored to your unique situation. Slow and steady wins the race!
“Far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.” -Peter Lynch, author and former mutual fund manager with Fidelity Investments
9. Don’t Invest in anything you don’t understand and be aware of high fees and penalties –
If it sounds too good to be true and you just can’t get your head around it, don’t invest in it! If you want to invest in complicated products, read the fine print. Be aware of commissions, fees and surrender charges. Be especially wary of products with a contingent deferred sales charge. There is no free lunch, if you are being promised above market returns there is probably a catch. Keep in mind that contracts are written to protect the insurance or investment company not the investor.
10. Diversify, Diversify, Diversify – rebalance annually –
It is impossible to predict fluctuations in the market or to select the next great stock. However, you can hedge your bets by maintaining a well diversified portfolio. Establish an asset allocation that is aligned with your goals, investment timeframe and risk tolerance. You should have a good mix of fixed income and equity based investments. Your equity investments should be spread over a wide variety of large, small, domestic and international companies and industries. Re-balance your portfolio on an annual basis to stay diversified and weed out any underperforming investments.
Jane M. Young
I am continually surprised by questions from financial reporters who are still asking how my clients are faring after losing half of their retirement savings or by individual investors who are still fretting over losing half of their nest egg. If you followed our advice, as about 95% of our clients did, to stay the course and avoid selling during the drop in the market you would be close to break even now. If your risk tolerance precluded you from staying in the market, you may have realized a greater loss. This is a good reminder that we need to avoid acting on emotional reactions to the stock market. The stock market is cyclical and you can’t recover from a loss if you aren’t in the market. The stock market is counter intuitive – generally, the best time to buy is when you feel like selling and the best time to sell is when you feel like buying.
Here are some figures that will illustrate the actual change in the market over the last three or four years. The S&P 500 hit an all time high of around 1561 in October of 2007 and dropped about 56% to around 683 by March of 2009. Since March of 2009 the market increased by about 88% to 1286 on January 31, 2011. While it hasn’t reached the peak of 1561 it has returned to the 1200-1300 level where the market hovered throughout the summer of 2008 – before the significant drop in September 2008. The NASDAQ hit an all time high of around 2810 in October of 2007 and dropped about 54% to around 1293 by March of 2009. Since March of 2009 the NASDAQ has increased by about 109% to 2706 on January 31, 2011.
Jane M. Young, CFP, EA
As I mentioned in the previous article on Roth IRAs, with a Roth IRA you pay income tax now and not upon distribution. With a traditional IRA you defer taxes today and pay income taxes upon deferral. When you convert a Traditional IRA to a Roth IRA you must pay regular income taxes on the amount that is converted. The advisability of converting to a Roth depends on the length of time you have until you take distributions, your tax rate today and your anticipated tax rate upon retirement and your projected return on your investments.
When you run your numbers through one of the numerous calculators available on the internet you may or may not see a big savings in doing a Roth Conversion. However, there are several other factors that may tilt the scale toward converting some of your money to a Roth.
• Income tax rates are currently very low and there is a general consensus that they will increase considerably by the time you start taking distributions. With a Roth conversion you pay the tax now at the lower rates and take tax free distributions when the tax rates are higher.
• The stock market is still down about 25% from where it was in August of 2008. There is a lot of cash sitting on the sidelines waiting to be invested once consumer confidence is restored. You can pay taxes on money in your traditional IRA while the share prices are low and take a tax free distribution from your Roth down the road when the market has rebounded.
• You may have a sizable portion of your portfolio in tax deferred retirement accounts on which you will have to take required minimum distributions (RMD). This could put you into a much higher tax bracket. By converting some of your traditional IRA into a Roth you can get some tax diversification on your portfolio. This will lower your RMD– because there is no RMD on a Roth IRA. Diversifying your portfolio between a traditional IRA and a Roth IRA enables you to take your distributions from the most appropriate pot of money in any given year.
For more information on Roth IRAs and the new tax laws for 2010 please review the articles previously posted under Roth IRAs.