Stock Can Be a Good Option in Retirement

 

 

 

 

 

 

Jane M. Young

As we approach retirement, there is a common misconception that we need to abruptly transition our portfolios completely out of the stock market to be fully invested in fixed income investments.   One reason to avoid a sudden shift to fixed income is that retirement is fluid; it is not a permanent decision. Most people will and should gradually transition into retirement.  Traditional retirement is becoming less common because life expectancies are increasing and fewer people are receiving pensions. Most people will go in and out of retirement several times.  After many years we may leave a traditional career field for some well-deserved rest and relaxation.  However, after a few years of leisure we may miss the sense of purpose, accomplishment, and identity gained from working.  As a result, we may return to work in a new career field, do some consulting in an area where we had past experience or work part-time in a coffee shop.

Another problem with a drastic shift to fixed income is that we don’t need our entire retirement nest egg on the day we reach retirement.   The typical retirement age is around 65, based on current Social Security data, the average retiree will live for another twenty years. A small portion of our portfolio may be needed upon reaching retirement but a large percentage won’t be needed for many years.   It is important to keep long term money in a diversified portfolio, including stock mutual funds, to provide growth and inflation protection.   A reasonable rate of growth in our portfolio is usually needed to meet our goals. Inflation can take a huge bite out of the purchasing power of our portfolios over twenty years or more.   Historically, fixed income investments have just barely kept up with inflation while stock market investments have provided a nice hedge against inflation.

We need to think in terms of segregating our portfolios into imaginary buckets based on the timeframes in which money will be needed.  Money that is needed in the next few years should be safe and readily available.  Money that isn’t needed for many years can stay in a diversified portfolio based on personal risk tolerance.  Portfolios should be rebalanced on an annual basis to be sure there is easy access to money needed in the short term.

A final myth with regard to investing in retirement is that money needed to cover your retirement expenses must come from interest earning investments.  Sure, money needed in the short term needs to be kept in safe, fixed income investments to avoid selling stock when the market is down.  However, this doesn’t mean that we have to cover all of our retirement income needs with interest earning investments.  There may be several good reasons to cover retirement expenses by selling stock.   When the stock market is up it may be wise to harvest some gains or do some rebalancing.  At other times there may be tax benefits to selling stock.

 

Pitfalls in Taking Early Social Security

Jane M. Young CFP, EA

 

You can begin taking Social Security at age 62 but there are some disadvantages to starting before your normal retirement age.   The decision on when to start taking Social Security is dependent on your unique set of circumstances.  Generally, if you plan to keep working, if you can cover your current expenses and if you are reasonably healthy you will be better off taking Social Security on or after your normal retirement age.  Your normal retirement age can be found on your annual statement or by going to www.socialsecurity.gov and searching for normal retirement age.

Taking Social Security early will result in a reduced benefit.  Your benefits will be reduced based on the number of months you receive Social Security before your normal retirement age.    For example if your normal retirement age is 66, the approximate reduction in benefits at age 62 is 25%, at 63 is 20%, at 64 is 13.3% and at 65 is 6.7%.  If you were born after 1960 and you start taking benefits at age 62 your maximum reduction in benefits will be around 30%.

On the other hand, if you decide to take Social Security after your normal retirement age, you may receive a larger benefit.  Do not wait to take your Social Security beyond age 70 because there is no additional increase in the benefit after 70.  Taking Social Security after your normal retirement age is generally most beneficial for those who expect to live beyond their average life expectancy.  If you plan to keep working, taking Social Security early may be especially tricky.  If you take benefits before your normal retirement age and earn over a certain level, the Social Security Administration withholds part of your benefit.   In 2012 Social Security will withhold $1 in benefits for every $2 of earnings above $14,640 and $1 in benefits for every $3 of earnings above $38,880.  However, all is not lost, after you reach full retirement age your benefit is recalculated to give you credit for the benefits that were withheld as a result of earning above the exempt amount. 

Another potential downfall to taking Social Security early, especially if you are working or have other forms of income, is paying federal income tax on your benefit.  If you wait to take Social Security at your normal retirement age, your income may be lower and a smaller portion of your benefit may be taxable.  If you file a joint return and you have combined income (adjusted gross income, plus ½ of Social Security and tax exempt interest) of between $32,000 and $44,000 you may have to pay income tax on up to 50% of your benefit.  If your combined income is over $44,000 you may have to pay taxes on up to 85% of your benefit. 

The decision on when to take Social Security can be very complicated and these are just a few of the many factors that should be taken into consideration.

 

 

 

Learn More About Long Term Care Insurance at Our Next Fireside Chat on July 11th

Please join us for lunch, at Pinnacle, for our next Fireside Chat on July 11th at 11:30.  We will discuss Long Term Care Insurance.  As always this is purely educational and free of charge.  Please call Judy at 719-260-9800 to RSVP.  Please let us know if there are any topics that you would like us to discuss at future Fireside Chats.

Should I Invest in Variable Annuities?

Jane M. Young CFP, EA

Due to the high costs, lack of flexibility, complexity and unfavorable tax treatment variable annuities are not beneficial for most investors.  Traditional retirement accounts and Roth IRAs meet the tax deferral needs for most investors.  In some instances a variable annuity may be attractive to a high income investor who has maximized all of his traditional retirement options and needs additional opportunities for tax deferral of investment gains.  This is especially true for an investor who is currently in a very high tax bracket and expects to be in a lower tax bracket in retirement.

Generally, money in retirement accounts should not be invested in variable annuities.  The investor is already receiving the benefits of tax deferral.

A variable annuity may also be an option for someone who is willing to buy an insurance policy to buffer the risk of losing money in the stock market.  For most investors, due to the long term growth in the stock market, this guarantee comes at too high a price.  However, some investors are willing to pay additional fees in exchange for the peace of mind that a guaranteed withdrawal benefit can provide.  A word of warning, guaranteed minimum withdrawal benefits (GMWB) can be very complex and have some significant restrictions.  Do your homework, make sure you understand the product you are buying and read the contract carefully.

According to a study conducted by David M. Blanchett – the probability of a retiree actually needing income from a GMWB annuity vs. the income that could be generated from a taxable portfolio with the same value is about 3.4% for males, 5.4% for females and 7.1% for couples. The net cost is about 6.5% for males, 6.1% for females and 7.4% for couples.

Advantages and Disadvantages of Variable Annuities

 

Jane M. Young, CFP, EA

 

What is a Variable Annuity?


A variable annuity is a contract with an insurance company where you invest money into your choice of a variety of sub-accounts, similar to mutual funds. Non-qualified, variable annuities provide tax deferral on gains until the funds are withdrawn. Upon distribution your gains are taxed at regular income tax rates as opposed to capital gains rates. Variable annuities generally charge fees twice those charged by mutual funds. Additionally, you will be to subject to substantial early withdrawal charges if you purchase an annuity from an advisor who is compensated through commissions. Most variable annuities provide the option to buy a guaranteed death benefit option and/or a Guaranteed Minimum Withdrawal Benefit. These do not come without a cost and can be very complex.  Below are some advantages and disadvantages of Variable Annuities.
Advantages and Disadvantages of Variable Annuities:

Advantages:

  • Tax Deferral of gains, beneficial if you have maximized limits on other retirement vehicles such as 401ks and IRAs.
  • No Required Minimum Distribution at 70 and ½ as with traditional retirement accounts. There is no Required Minimum Distribution on Roth IRAs.
  • Death benefit and Guaranteed Lifetime Withdrawal Benefits (GLWB) riders can be purchased for additional fees. However, the death benefit is rarely instituted due to long term growth in the stock market. GLWBs can be very complex and not without risk.
  • Trades can be made within annuity without tax consequences – this is also true within all retirement accounts.
  • Non-taxable transfers can be made between companies using a 1035 exchange.
  • No annual contribution limit. Traditional retirement plans have annual contribution limits.

Disadvantages:

  • Gains taxed at regular income tax rates as opposed to capital gains rates on taxable mutual funds.
  • Higher expense structure –Mortality and Expense fees substantially higher than mutual funds.
  • Substantial surrender charges for up to 10 years on commission products
  • 10% penalty on withdrawals prior to 59 ½, this is also true with most traditional retirement accounts.
  • Complex insurance product
  • Lack of liquidity due to surrender charges and tax on gains
  • No step-up in basis, taxable mutual funds and stocks have a step-up in basis upon death
  • Loss of tax harvesting opportunities

Join us for a Fireside Chat on Annuities vs. Mutual Funds on May 16th

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!!!

Retirement Guidelines, Pointers and Pitfalls

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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.

 

Planning for Retirement is More Than Picking a Date

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.

Watch Out for These Pitfalls with Social Security and IRA Rollovers

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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!

Your Money Bus is Coming to Colorado Springs

Your Money Bus is coming to Colorado Springs.

                               Get free professional advice, no strings attached

It’s never too late to secure your financial future.

Re: Free Non-profit Financial Education Event – Please share with friends, family and business associates.

All of us have family; friends and colleagues who are struggling to save money, eliminate debt and find jobs. Please share with them the opportunity to meet for a free one-on-one with local independent financial advisors when the national Your Money Bus Tour rolls into Colorado Springs on July 8th and 9th. Pinnacle Financial Concepts, Inc. is coordinating the Colorado Springs stop of this non-profit tour, visiting more that 25 cities. We will be volunteering at this event along with several other fee-only financial planning firms in town. The Your Money Bus Tour is sponsored by The National Association of Personal Financial Advisors (NAPFA) Consumer Education Foundation, TD AMERITRADE, Kiplinger’s Personal Finance magazine and FiLife.com.

The Your Money Bus Tour will stop in Colorado Springs at the Penrose Library (downtown) on July 8th from 12:00 – 7:00 and at UCCS, Lot 1 on July 9th from 12:00 – 5:00. At each stop, consumers can sit down with locally-based volunteer financial advisors to ask pressing financial questions. All Money Bus visitors will receive a free financial education kit, including a Kiplinger magazine and a budgetary workbook.

Forty percent of American families spend more than they earn and the average American with a credit file has more than $16,000 in debt, not including mortgages. We encourage people to stop byYour Money Bus to learn how to better save, eliminate debt and develop personal financial sustainability habits that will get them through and beyond these tough times.

The NAPFA Consumer Education Foundation is a 501c (3) organization committed to educating Americans on personal finance. Consumers need easy to understand information without any bias, sales, or conflicts of interest. All volunteer financial advisors are fee-only fiduciaries; nothing is being sold or promoted. This is strictly educational and free information for the public. The public is welcome to just stop by or make an appointment ahead of time.

For more information, visit www.YourMoneyBus.com and for up-to-date schedule information contact Krist Allnutt,krista.allnutt@perceptiononline.com.

Warmest Regards,

Jane M. Young, CFP, EA

The Possibility of Becoming a Widow Should be Part of Every Married Woman’s Financial Plan

Jane M. Young CFP, EA

I know this is a subject we don’t want to think about but the reality is most wives will out live their husbands. We plot and we plan all kinds of cash flow scenarios for couples to live happily ever after until they fall gently asleep in each others arms at age 100. That would be nice but life isn’t quite so predictable. Therefore as a wife, you should plan to out live your husband. This includes being ready to handle all of the arrangements and paperwork that must be handled upon death as well as long term planning for your financial needs. Below is a list of issues that should be addressed before you become a widow.

 • Select an Estate Planning Attorney who you trust and are comfortable with to draft a will and help you through the process of settling your husband’s estate.
• Draft a will and a Health Power of Attorney.
• Discuss end of life plans with each other.
• Review the beneficiary designations on IRAs, 401ks, and life insurance policies.
• Organize your financial papers so you know what you have, where you have it and who your contact is.
• Take an active role in managing your finances.
• If you are uncomfortable with finances, take some classes and read some books to educate yourself.
• If you choose to work with a Financial Planner take the time to select someone who you trust and feel comfortable with – especially when you are alone. The National Association of Personal Financial Advisors provides some good guidelines on selecting a financial planner at www.Napfa.org.
• Run some retirement planning scenarios as a widow – will you have enough money to cover your expenses if you husband predeceases you? Are you still entitled to his pension or will you receive a decreased payout?
• Does your cash flow fall short of what you need? Consider buying some term life insurance? Consider adjusting your work situation to save more money?
• What happens if one of you needs long term care? Can you cover the expense or should you consider long term care insurance?
• What happens to your health insurance when your husband dies? How much time do you have to secure health insurance in your name?   Are you entitled to Cobra?
• Establish credit in your name, get your own credit card.
• Do you have adequate emergency reserves to cover funeral expenses and several months of expenses?

The loss of a spouse is extremely difficult. Most widows feel like they are in fog for the first year. The last thing on your mind will be money but some issues will need to be addressed. Make it easier on yourself and plan ahead.

Three Significant Changes to Your Retirement Plans in 2009 and 2010

Jane M. Young, CFP, EA

1. No required minimum distribution in 2009 for IRA, 401k, 403b, 457b, 401k and profit sharing plans. This does not apply to annuitized defined benefit plans.

2. If you are older than 70 ½, in 2009 you can make charitable gifts from your IRA without the payment being included in your adjusted gross income. The distribution must be a “qualified charitable distribution”, which means it must be made directly from the IRA owner to the charitable institution. This is especially beneficial if you claim a standard deduction and were unable to deduct charitable contributions by itemizing.

3. Beginning in 2010 individuals earning over $100,000 in modified adjusted gross income will be able to convert traditional IRAs to Roth IRAs. Modified adjusted gross income is the bottom line on the first page of the 1040 tax form. Income from a conversion in 2010 may be reported equally over 2011 and 2012.

While there are many benefits to converting from a traditional IRA to a Roth IRA the conversion will increase your adjusted gross income (AGI) which can have some unintended consequences. An increase in AGI may impact the taxability of your social security, phase-outs on itemized deductions, education and your tax bracket.

I will write more about Roth IRA conversions in a future blog.

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