Goldstone Financial Group's Blog
Financial decisions in our youth can be simple. How much can I afford to pay in rent? Should I budget for two meals out a week or four? What amount of car payment can I afford?
As we get older, however, our finances—and our financial decisions—can become more complex. As we accumulate wealth and begin thinking about the financial side of issues such as retirement, second homes, and leaving an inheritance, most of us could use some guidance. That’s where wealth management comes in.
What is wealth management?
Wealth management is an individualized financial planning service for highly affluent clients. These individuals work with either a single wealth manager or a financial advising team that provides comprehensive services and has expertise in a wide range of financial services and products.
What is a wealth manager?
Serving as personal consultants, wealth managers focus on issues that affect extremely wealthy clients, such as managing estate tax rules. They spend time getting to know their clients, including their financial and life priorities.
Along with answering questions and meeting with their clients, wealth managers often coordinate legal and accounting services for them as well. Wealth managers help clients with all financial planning needs, whether it’s setting up a trust for your grandchildren or working through how tax rules impact your business’s income.
Wealth managers provide across-the-board financial services, working with clients on all aspects of their financial holdings and decisions. Clients looking for a single service, such as help with retirement planning, may find it is more efficient to work with a financial planner who offers a la carte services. Similarly, individuals who are interested in guidance creating an investment strategy may want to consider a portfolio manager, who will offer advice on maximizing returns and minimizing risk but won’t provide additional financial services.
Wealth managers provide many services. These include estate and tax planning; accounting; retirement planning; providing legal guidance on finance-related matters; offering investment management and advice; setting up trusts and foundations; creating a plan for charitable giving; engaging in risk management; and planning for Social Security benefits.
Your initial meetings with a wealth manager may be more conversational as you talk through your personal and financial goals. A wealth manager will need to be familiar with the entirety of your finances as well as your financial history, hopes and plans for your future, and the legacy you want to leave. Using all this information, a wealth manager will craft a financial strategy that will meet all of your goals.
How do I find a wealth manager?
Generally, there are two types of wealth managers. Large firms such as Merrill and Morgan Stanley offer wealth management experts along with banking and other types of financial services. Smaller independent firms, on the other hand, may provide a more personalized experience.
Either way, you’ll want to make sure that the wealth manager you choose is certified. Only one certification specific to wealth management, the certified private wealth advisor (CPWA) is available.
Financial advisors with this certificate are qualified to work with clients whose net worth is at least $5 million. The certified financial planner (CFP) and chartered financial analyst (CFP) certify a professional in general financial planning practices and are valuable certifications for wealth managers.
You can start looking for a local wealth manager through online search. This should provide information about large financial institutions and small private firms in your area. You also could ask around. Word of mouth can be a valuable tool in finding a qualified professional that others— especially peers who have similar levels of wealth and financial situations—recommend.
The cost of wealth management services typically is based on a percentage of the client’s assets that are being managed. That means the more financial assets you have, the higher your fees will be. Firms may also add other charges—Morgan Stanley, for example, charges fixed fees for specific accounts and services. It’s important to talk to your wealth management advisor about their rates and fees before agreeing to work together.
What if I prefer online services?
If you’re more comfortable behind a computer screen, many financial institutions offer wealth management service online—although you’ll lose the personal touch of face-to-face meetings. Meetings can be moved to the phone or a video conference while much of the financial information is provided online.
Some online services offer unlimited access to a human financial provider or team of providers for a flat annual fee that’s determined by the services you need and how complicated your financial needs are. Other services calculate fees based on a percentage of your assets. The downsides for some of these services, especially when they offer a team approach, is that you may not consistently work with the same financial adviser.
Regardless of the criteria you use to select a wealth management service, it’s vital to think through your needs and research your options thoroughly. You have spent a lifetime building up your wealth. Your financial decisions often will impact your family for decades or more to come. This means it is important to work with a qualified wealth manager who takes the time to understand your financial situation and long-term goals.
The two basic types of retirement accounts are the 401(k) and the individual retirement account (IRA). While it is easy to confuse the two, they are actually quite different. While a 401(k) is an employee-sponsored account, anyone can open an IRA. This makes it an important product for people who do not have access to a 401(k) or who have already maxed out contributions to that account.
Unfortunately, the contribution limits for an IRA are significantly less than for a 401(k). However, they remain extremely important vehicles for retirement savings because of their tax advantages. An IRA is a way for the government to incentivize retirement savings outside of the employee-sponsored account.
The Various IRA Options Available Today
To open an IRA, individuals only need income from a job that is claimed for tax purposes, which rules out income from Social Security or an investment. When opening an IRA, individuals need to choose between a traditional and a Roth account. Like a 401(k), an IRA comes with certain tax benefits.
With a traditional account, individuals can contribute to the IRA and avoid paying any taxes on those contributions. However, when money is withdrawn from the account, it is taxed at that time. A Roth account involves investment of taxed income. Later, withdrawals can be made without paying any taxes, provided that individuals do not touch the account until they are at least 59.5 years old.
Some forms of specialty IRAs exist. For example, a simplified employee pension (SEP) IRA is geared for small-business owners and self-employed individuals. These accounts operate much like other IRAs except that they have much higher contribution limits.
Small-business owners are required to contribute the same rate to eligible employee accounts and their own. In other words, if the owner saves 10 percent of compensation, 10 percent of an employee’s compensation must also be saved. Employees cannot contribute directly to their own SEP IRA.
Another product is the Savings Incentive Match Plan for Employees (SIMPLE) IRA. This product is designed for companies with 100 or fewer employees. A SIMPLE IRA is easy to set up and allows employees to contribute to their own accounts.
Questions to Think about When Opening an IRA
Individuals can open IRAs through most financial service providers, from banks and credit unions to brokerage firms. Different service providers offer various advantages and disadvantages, so it is important to do some homework before opening an account.
Ideally, the financial institution provides individuals with a wide range of resources, from online education materials to in-person meetings, to help guide choices. These resources can help individuals plan for the future. Also, different providers will charge different types of fees. While some companies charge monthly fees, others have customers pay per trade.
Sometimes, companies will charge both monthly and trading fees, so it is important to understand the full payment scheme. Otherwise, individuals may end up paying a lot more for the service than they originally intend. It is also important to figure out what types of investments can be held in the account.
The point of opening an IRA is to invest money for retirement and have it grow over time. As a result, the exact investment options tend to matter quite a bit—especially for people who like to play an active role in investing decisions. People who prefer a more passive approach to investing should consider the possibility that they may want to get more actively involved in the future.
The Basics of Investing in an IRA
When it comes to investing money through an IRA, people need to consider the tradeoff between risk and return. An IRA should be viewed as a long-term investment. Generally, individuals will use an IRA to invest in stocks, especially if they are more than a decade away from retirement.
The stock market involves more risk, but it also usually yields higher returns than products like a certificate of deposit or a Treasury bond. While it is highly unlikely to lose money with these safe investments, individuals will also not earn much money. Different service providers may have some guidance to offer about how to navigate the creation of an effective portfolio. However, it is important that customers not feel pressured.
Alternately, individuals may want to take a fairly hands-off approach to investing in an IRA. In these cases, they may choose something like a total market index fund, which provides access to the kind of diversity needed to mitigate much of the risk involved in the stock market. These funds choose investments from a range of different geographic locations and across a number of different industries.
Individuals would struggle to obtain such diversification alone, even if investing very large sums of money. This option is for people who are willing to leave their money in accounts for long-term gains without the need to micromanage it. Another option for people who prefer a hands-off approach is a robo-advisor. This service will select investments based on the investor’s preferred cost and risk profile.
For many people, the prospect of saving for the future and planning for retirement is daunting. You may feel like you have no options to increase your savings, or worry that you’ll have to make major sacrifices in retirement. You’re not alone—millions of Americans over the age of 40 lack substantial nest eggs for retirement.
However, don’t despair. There are many strategies to substantially boost your savings, even if you feel behind. People under the age of 40 have even more options to get a jumpstart on retirement savings, considering the power of compounded interest.
Some of the strategies you can use to quickly increase your retirement savings include:
Invest in permanent life insurance.
Most people have heard that they should buy term life insurance and invest the rest of their money, rather than going for the more expensive option of permanent life insurance. This option can work for some people, but many others end up spending the money they would otherwise invest, despite their best intentions. For many retirees, permanent life insurance is a better option.
With permanent life insurance, you’ll pay ongoing premiums, which is a sort of automated savings. Each premium increases the cash value of the policy tax-free, and you can borrow funds against the policy or sometimes withdraw cash from it. In addition, the policy will pay out death benefits, which aren’t subject to income taxes. In other words, permanent life insurance can serve as a way of supplementing your retirement income with non-taxable money. Think of permanent life insurance as a sort of bond or certificate of deposit (CD) that increases in value steadily over time.
Save the raise.
As you advance in you career, you’ll likely receive raises that provide a little extra room in your budget. While a raise can sometimes relieve the pressure on a tight budget, many people can make ends meet without the extra income. Frequently, a raise just leads to a corresponding increase in spending. But what would happen if you saved your raise instead? If you put that extra income into a retirement account rather than buying a nicer car or new home, for example, you’ll set yourself up for a more comfortable retirement where you won’t have to sacrifice much to maintain your standard of living. The best part about this strategy is that you won’t have to make cuts to your budget or feel pinched by the extra savings, since you’ll still enjoy the same monthly income.
Take advantage of Roth savings.
Research has shown that Roth accounts are one of the most underutilized retirement preparation strategies. Many people understand the importance of maxing out a 401(k) and taking advantage of employer matching, but aren’t aware that they can do even more. Roth accounts are funded with after-tax income, but withdrawals during retirement are not subject to taxes. This option is especially good for people who may be in a higher tax bracket in retirement than they currently are. The other value of a Roth account is its potential to diversify your retirement savings. With both tax-deferred and Roth accounts, you can minimize the potential impact of future tax changes.
Purchase a home.
There’s still debate about whether buying or renting makes better financial sense. In some areas, renting a home is certainly cheaper in the short term than a down payment, mortgage, and property taxes. At the same time, research by the Harvard University Joint Center for Housing Studies shows that people who own homes tend to increase their wealth significantly more than renters, even after controlling for socio-economic differences and other factors. This may be because home ownership is a type of forced savings. Every mortgage payment builds equity in your home. You pay down your debt on the home while its value likely increases. Of course, it’s important to think strategically about home ownership and realize it is a long-term investment. If you buy and sell homes frequently, you’ll squander any gains on closing fees and other one-time expenses.
Fund a Health Savings Account.
Not everyone is eligible for a Health Savings Account (HSA), but those who are often fail to use them strategically as they prepare for retirement. Contributions to an HSA are tax-deductible and can be invested to fund qualified healthcare expenses you’ll encounter later in life, including during retirement. Very few people use an HSA for long-term savings, even though the accounts can be rolled over annually. With healthcare costs typically increasing during retirement, it’s important to have money set aside to deal with these expenses. An HSA can help you offset the costs of healthcare without needing to rely on your primary sources of income. Ideally, you would start investing in an HSA early and invest the money so that it grows over time and serves as a sort of insurance.
Ideally, retirement is a time when people relax and enjoy their lives, but following bad financial advice or not planning enough can keep you from fulfilling your retirement dreams. While it is imperative to understand the key financial steps to take in preparation for retirement, it is equally as important to know the errors that many people make. Knowing these common pitfalls can help you to ensure that you stay on the right track as you plan for retirement.
Read on for some of the most common financial mistakes that people make in relation to retirement:
Paying off a mortgage.
People often want to enter retirement with as little debt as possible. Many think that paying off their biggest monthly expenses, such as their mortgage, early is the quickest way to free up more money. However, home loans tend to have very low interest rates—paying off a mortgage now will not save you much in the long run. In fact, it may be best to refinance your home at a low rate and invest the money that you would have otherwise used to pay off the home loan early.
You should always think about interest rates in relation to debt and strive to get rid of high-interest debt, such as credit cards, first. When it comes to low-interest debt, paying it off is not always the best decision since your money can be invested with a return higher that the interest on the loan.
Investing in variable annuities.
An annuity is a great investment tool for retirees since it provides monthly payouts, sort of like a pension. The most common type of annuity is deferred, which means there is a set payout upon maturity.
However, many people select variable annuities, which invest in the market. While the return can prove higher with variable annuities, they are also vulnerable to market fluctuations and can fees as high as 3 percent. These fees quickly eat into retirement savings, especially when that loss is compounded over the years. For these reasons, variable annuities can actually detract from retirement savings.
Neglecting emergency funds.
Everyone needs an emergency fund, even retirees. In fact, emergency funds become even more important during retirement, a time when many people live on a fixed income.
Emergency funds also prevent you from dipping into retirement accounts, such as a 401(k), during a financial emergency. Borrowing from retirement comes with massive penalties and fees, and doing it even once can significantly lower your overall savings (as the money that would otherwise compound over the years has been taken out). The makeup of an emergency fund will vary according to household, but a good general rule of thumb is to have enough saved to cover living expenses for at least a few months.
Taking Social Security benefits too early.
Too many retirees fail to understand how the value of Social Security benefits changes depending on when they are taken. Though you can get 100 percent of your Social Security benefit at age 66 or 67 (depending on birth year), it pays to wait even longer if you do not have a great financial need. Benefits continue to increase beyond 100 percent after full retirement age until you turn 70 (at that point, it will not grow anymore). Waiting means a significantly higher monthly benefit, and that amount will remain the same for as long as you remain living. The increase in payout starts to outweigh the cost of delaying for anyone who lives past age 82.
Purchasing a timeshare.
Many retirees imagine themselves using a timeshare frequently enough to make the purchase worth it. Unfortunately, this is rarely the case. In addition to the upfront cost of the timeshare, you will also need to pay annual fees to maintain the property. Even if you do use your timeshare frequently, the fees may not be any cheaper than simply renting a vacation home, an option that provides much more flexibility. Also, timeshares are not very liquid, so getting rid of them can be quite difficult.
In general, retirees should avoid timeshares altogether unless they get them at a significant discount from a third party and are sure they will use them regularly.
Retiring too early.
Too often, people retire before they are ready because they feel some sort of pressure to do so. Taking the time to work a few more years can keep you from getting bored, and it can also help you save more money for retirement. Then, when you do retire, you will have more spending money to engage in fun activities, like traveling. While you may have expectations about when you should retire, it’s important to be realistic about savings and work for a few more years, if you can.
The decision to retire can cause a great deal of anxiety, especially if you aren’t sure if you’re ready. Some people use milestones like career achievement, age, or even savings to assess their readiness for retirement, but there are other factors you should consider as well.
Ideally, you should create a comprehensive plan for your financial well-being in retirement. Such a plan makes it easier to deal with financial setbacks and other bumps along the road. Furthermore, the plan should help protect against as many contingencies as possible, to minimize the odds of being caught off guard. To ensure you’re prepared for retirement, it can be helpful to create a readiness checklist. While this list will look different for everyone, some of the key items to include are:
It’s probably not possible to say exactly how much you’ll spend in retirement, but estimates can help you get a general sense. A detailed budget will give you a better idea of how much you’ll need, both monthly and annually. This estimate should include all expenses: basic costs such as housing, utilities, food, transportation, and healthcare, as well as irregular expenses like travel and vacation. Your expenses may change in retirement, but it’s still a good idea to figure out how much you’re spending now, to create a baseline estimate. Remember that the more detailed your budget is, the better—don’t leave any expenses out.
During retirement, you may receive income from a wide number of sources, including investments, Social Security payments, and more. You may also have an annuity or pension income. Adding up your expected monthly income from these different sources can give you a better sense of what you’ll need to save to close the gap and ensure you can cover your bills. In addition, this tally will help you determine if you’ll need to reduce your spending or increase your income through options like downsizing to a smaller home or getting a part-time job.
The question of how much you need to save for retirement is a complicated one. Ultimately, you should base this number on the retirement budget you created for yourself, and then add plenty of room for cushion. To get a very broad estimate, multiply your estimated annual spending by 25. If you expect to have other sources of income in your retirement besides savings, subtract them from your annual spending, then multiply that number by 25. If your actual savings are less than the calculated estimate, it is time to revisit your budget and see what adjustments you can make.
Prior to retiring, you’ll need to plan how you will draw from your retirement accounts. It’s important to be strategic about how you draw down, especially if you have a variety of different accounts. Typically, tax-advantaged accounts should go untouched for as long as possible. Of course, traditional 401(k) and IRA plans have minimum required distributions once you reach 70.5 years of age, but Roth accounts do not have the same requirements. Roth accounts can continue to grow well into retirement, so try to keep as much money as possible in these accounts, for as long as you can.
Carefully consider your anticipated healthcare costs in retirement and figure out what insurance you’ll need. For most people, healthcare is the most significant cost in retirement. Medicare is a given, but many people find that they need supplemental insurance. You should also have an emergency fund for expenses not covered by insurance plans. Keep in mind that the cost of long-term care can quickly lead to bankruptcy, because traditional insurance does not cover it. If you know you won’t be able to shoulder the cost of long-term care, it’s vital to research insurance for this level of care. Long-term care policies become more expensive as you age and your health declines, so you may want to purchase a policy sooner rather than later.
While you might wait until you’ve actually retired to begin legacy planning, start thinking about what you want to leave behind before leaving the workforce. Your legacy could influence your retirement savings target, the timing of your retirement, and your estimated retirement budget. You should also draw up an estate plan. Be sure to revisit it regularly (at least every five years) to ensure everything remains up to date. During retirement, it’s important to have regular conversations with your spouse and heirs, so that everyone knows what to expect and any transition of assets proceeds smoothly.
No one wants to think about the possibility of losing their spouse. However, if you are married, it’s important to consider how your death or the death of your spouse will affect the survivor’s finances. Failing to plan for this could put one of you in a terrible financial situation during one of the most emotional times in life. Talk to your partner about what the surviving person should do; consider things like whether you should stay in the same home or whether you’d need additional sources of income. Some sources of retirement income are tied to one partner, so their death could mean the loss of a specific income stream. Identifying these potential gaps early will help you and your spouse protect each other and your family.
One of the biggest risks that people face in retirement is the cost of healthcare. People frequently underestimate the cost of healthcare and often do not get adequate insurance to protect themselves.
That said, sometimes it’s impossible to correctly anticipate the coverage you’ll need in retirement. While some people know the health issues they will face in the future, most people must guess. Either way, underestimating healthcare needs can put a significant strain on your finances and make it difficult to make ends meet. Many people believe that Medicare will cover them completely. While Medicare Part A covers some levels of hospitalization, you’ll have to pay premiums for Medicare Part B, and you may need supplemental insurance. Even with this, you’ll still have out-of-pocket expenses.
Some of the Issues with Health Insurance Coverage in Retirement
During your working years, your employer will often pick up the majority of healthcare insurance premiums, so it’s understandable that many retirees are caught off guard with the amount they suddenly have to pay. At the very least, you will need to pay Medicare Part B premiums. These premiums depend on income; costs are higher for people who make more money. While the premiums are low, starting around $140 per month, Medicare Part B does not cover all health expenses, which leaves many people needing a Medicare Advantage Plan or a Medigap policy to fill in the cracks. Even still, Medigap policies may not provide dental or vision coverage, both of which could also leave you with costly bills. Medicare Advantage covers dental and vision needs, but it offers fewer hospitalization benefits, so a serious illness could come at a very high expense.
The other issue you’ll need to consider as you approach retirement is long-term care coverage. Long-term care is one of the most expensive healthcare needs for older adults, and Medicare does not cover the majority of the cost. Luckily, long-term care insurance is available, but it’s not always cheap, especially if you wait until retirement to purchase it.
As a general rule, purchasing insurance earlier in life makes the premiums much more affordable. The downside is that you’ll be making monthly payments during a time when you’re less likely to actually need long-term care. At the same time, long-term care can quickly bankrupt you in retirement, so this type of insurance shouldn’t be dismissed lightly. This is especially true if you have a family history of a serious geriatric disease, or if you have a serious chronic health condition.
The Average Healthcare Costs Faced by Today’s Retirees
As you approach retirement, it can be helpful to use an online calculator to help estimate the costs of care you’ll face in the years to come. For the average, 65-year-old male, the typical cost for premiums and out-of-pocket healthcare expenses is about $4,500 per year, which translates to $375 per month. You should try to factor at least this amount into your monthly expenses.
Keep in mind that the cost of healthcare is rising at a rate double that of inflation. In other words, your out-of-pocket healthcare expenses could easily be closer to $675 in another decade. If you have a chronic condition, you may have to pay even more, and couples will need to double that figure. In addition, this amount does not account for long-term care. In other words, the cost of healthcare in retirement can be extraordinarily high.
The Key Strategies for Reducing Healthcare Costs in Retirement
Luckily, retirees aren’t completely helpless when it comes to the extremely high costs of healthcare. One of the most important things that you can do to control your costs is to stay healthy by receiving proper preventative care. Healthcare plans prior to and during retirement will cover preventative visits and services. While routine check-ups and such may seem unnecessary and come across as a hassle, they are all aimed at keeping you healthy and helping you avoid costly treatments and procedures. Skipping out on these visits can cause a small health problem to become more serious and therefore more difficult and expensive to treat. In addition, some cancers are curable only when detected and treated early.
The other side of the strategy for keeping your healthcare costs low involves managing distributions in a strategic way. As mentioned above, the cost for Medicare increases as your income rises, but you can manage your distributions in such a way that your premiums are kept in check.
For example, income from HSA accounts, Roth IRA accounts, and cash value life insurance policies do not factor into the formula that determines monthly Medicare Part B premiums. Income from a reverse mortgage is also not included in this calculation. If you have significant amounts of money in a traditional IRA, you may want to consider transferring some to a Roth account before turning 65 to avoid being forced to take large minimum withdrawals down the line. These minimum withdrawals do not apply to Roth accounts. You can also use deductible healthcare expenses to offset the money withdrawn from a traditional retirement account.
Figuring out the best way to save for retirement can be tricky—everyone’s financial situation is different, which can make it hard to find the right balance between saving for retirement, putting money aside for other goals, and maintaining a comfortable lifestyle.
There is a lot of retirement advice out there, but not all advice is created equal. In fact, most of the advice commonly shared about retirement savings should be altogether ignored. To help you determine which savings plan is right for you, first you have to learn what not to do. Here are five of the most frequently shared—but ultimately ill-advised—retirement advice tips.
Monthly expenses go down in retirement.
If you assume your monthly expenses will go down once you retire, you may end up not saving enough. Many people think that they will save on commuting expenses or they will no longer have a mortgage, but the reality is that the majority of retirees replace their old expanses with new ones. While you may no longer drive to work every day, you will likely still drive to volunteer or recreational activities, not to mention incur the increased costs of travel that often occur during retirement.
Also, when homeowners pay off their mortgage, they may funnel that money into new hobbies or making lifelong dreams come true. Though research has shown that about 20 percent of retirees have lower monthly expenses, another 20 percent spend more. The remaining 60 percent tend to have about equivalent monthly expenses.
People need X amount of money to retire.
Many people will offer an exact figure for how much money you need to save to be able to retire. Unfortunately, these numbers rarely reflect the truth for everyone—though you will need a significant chunk of money to retire, choosing an arbitrary number is not helpful. If you choose an amount that’s too high, you may become discouraged because you feel like you will never hit that amount. Or you may become so focused on saving enough that you forego important opportunities in the present.
In reality, future retirees need to think about how much they will likely spend each month in retirement and use that number to come up with a figure that more accurately reflects their personal goals and lifestyle preferences. Financial advisors and other professionals can help you set more realistic goals.
Social Security will run out in the next few years.
Over the years, many people have talked about how Social Security is going broke. While Social Security has been more robust in the past, it is not in imminent danger of going bankrupt. Most often, retirement professionals hear people bring this fact up when they want to draw on Social Security early (even though this involves a penalty). These people tend to want to get in on the money while they can. However, Social Security is funded through a payroll tax, so as long as people are paying their taxes, there will be benefits for retirees. Taking a permanent reduction in monthly income can cause a lot of issues down the line. While you may be tempted to hedge your bets and plan for retirement without factoring in Social Security, the truth is that this money is not running out anytime soon.
There is always time to catch up with savings.
If you have not been able to save for some reason, do not despair—there are things you can do over time to help you boost savings. However, thinking that there is always time to catch up and using that as an excuse to delay savings is unwise. When you start saving early, you maximize the benefit of compounding returns and also give yourself some leeway when it comes to investing decisions.
Individuals who start down the road put themselves at a serious disadvantage since their money will never grow at the same rate it could have if they had started earlier. Sometimes, extenuating circumstances get in the way, but you should be diligent about saving as much as possible—now.
Only one savings tool is necessary.
One of the biggest traps that people fall into is putting all of their savings into a single type of account. There are many different types of savings accounts, and they all have their unique benefits and drawbacks. You can look into other options, like an IRA, to supplement the money you put into your work-related savings accounts, such as a 401(k).
The problem with having one savings tool is that you may start to feel like you have maxed out your savings. For example, when you have gotten as much matched from your employer as possible, you may stop saving. At this point, you need to look at other options and figure out what will benefit you the most once you have achieved the maximum for an employee-sponsored account. Often, it makes sense to have at least one traditional and one Roth account, giving you options for lowering your taxes in retirement.
Nowadays, the majority of workers do not have a traditional pension that they can depend on for income once they retire. As a result, saving through a 401(k) has become more important than ever. However, maximizing your savings through this vehicle is not always as simple as it seems. You will need to pay close attention to the rules governing deposits into your account, as well as current tax policy. Otherwise, you may end up costing yourself money down the line.
Importantly, rules and policies change every year, so it is imperative that you pay close attention as you continue to save for retirement. However, there are some general tips that you should follow to maximize your savings:
1. Avoid fees
When choosing your 401(k) provider through your work, you should opt for one with the lowest or fewest amount of fees. While fees may not sound like much, they can add up quickly and significantly cut into the account value down the line, especially when accounting for compounding over time. Of course, the plan should also have the right risk tolerance. You should never feel like you have been cornered into a particular plan because of fees. If that happens, it is time to talk to human resources and consider an alternate savings plan, such as an IRA. Taking advantage of employee matches may still make sense, but once that is maxed out, another product may prove to be the best choice.
2. Diversify savings
When it comes to investing for the future, diversification is important—but many people do not understand how to do so. Diversification reduces your portfolio’s risk by making it more stable during market volatility or downturns. Financial planners recommend choosing both stocks and bonds to provide some degree of balance, as well as periodically rebalancing the portfolio to target allocations.
For example, individuals may rebalance their portfolio to reduce their investment risk as they get closer to retirement to protect the stability of their overall investment. One piece of advice that all financial planners agree with is that investors should never make impulsive changes to their risk profiles without consultation and great need.
Diversification may also mean investing in more than one 401(k) product. A Roth account can offer several benefits to people who max out their contributions to a traditional account.
3. Get matched
Perhaps the most important aspect of maximizing 401(k) savings is taking advantage of employer matching programs. Most often, employers offer 50 cents on every dollar from the employee, up to 6 percent of total pay (although the policies differ between companies). You should know exactly what your company will match and plan to take full advantage of the program. After all, matching is basically free money in your account. This matching program is an easy way to significantly boost your account and provide a larger base for further compounding in the future.
4. Get vested
Importantly, companies also have different policies on getting vested, which means that employees who leave the company too early may not get their 401(k) contributions matched. At some companies, getting vested takes as long as five or six years of service. While some will not pay out at all until an employee becomes vested, other companies will allow employees to keep a portion of their matched contributions when they leave early.
Often, becoming vested means thousands of dollars directly to the retirement fund, so it makes sense to stay as long as possible. However, you should never let the promise of getting vested drive you to stay in a bad job.
5. Rollover balances
When people do switch jobs, they have the opportunity to cash out their 401(k) plan—this is rarely a good idea. Before the age of 59 1/2, you will face a 10 percent early withdrawal penalty and you will be required to pay income tax on the balance. This can be problematic even if you want to reinvest your money in a different account rather than spend it.
Luckily, there are other options. You can choose to keep the money in the 401(k) and let it grow over the years, but it can be difficult to keep track of your different accounts from each company you have worked at. Another option is asking your former employer to transfer the balance to a new account, which helps to avoid any fees or penalties and keeps all of your retirement money in a more centralized location.
6. Take distributions
Just because you’ve finished adding to the principal of your 401(k) account does not mean that you’re finished managing your account. These accounts have required minimum distributions starting at the age of 70 1/2. At this point, you must make minimum withdrawals on an annual basis or face a hefty penalty: 50 percent of the amount that should have been withdrawn. Since you may draw on multiple accounts during retirement or you may not be retired come this age milestone, making the withdrawal can sometimes fall through the cracks and result in a significant loss. Notably, this rule only applies to a traditional 401(k) account. With a Roth 401(k), there are no mandatory annual distributions.
When people feel like they may not have enough money saved for retirement, they may think about selling their homes to reduce their monthly costs. Even those who have saved may consider downsizing their homes as a way of making the most out of the money they have in retirement. After all, retired couples often do not need the same amount of space that they once did after their children moved out and started their own families. Certainly, downsizing your home or moving to a less expensive area can save you money, but it does not always make sense to take this step during retirement. Ultimately, individuals need to think about the total costs involved with this decision and whether or not they will actually save money as a result.
The Numerous and Sometimes Intangible Costs of Selling a Home
Selling a home is a considerable investment. Often, individuals need to pay for some updates or a facelift to maximize the price that they get. In addition, sellers frequently need to pay Realtors a commission, which can total 6 percent or even more of the total sale price. Another consideration is capital gains taxes, which can take a large chunk out of earnings if individuals make a lot of money during the sale. Beyond these costs, retirees could also potentially face expenses involved in moving to a new space, which could range from purchasing or renting a new home to paying for the cost of movers. Closing costs can consume even more money. Furthermore, people often find themselves needing new, smaller furniture for a smaller living space. Other incidental costs may also arise. Another issue is the fact that people often think that their homes are worth more than they actually are.
Selling a home may also involve some intangible costs. These costs also deserve some consideration before a decision is made. Particularly when people move to a new area, they will have to say good-bye to friends, family members, doctors, community members, and others. These relationships are not easy to rebuild in a new place, which can make individuals feel somewhat lonely once they move and result in some regrets about their decision. Plus, our homes have a lot of sentimental value. People should avoid treating this decision too lightly and find themselves wishing that they had followed a different path. For many people, staying put is worth the extra expense in retirement.
When Moving to a New Home in Retirement Can Make Sense
Some people may put themselves in a better position by moving. Perhaps moving will bring them closer to family members or make it easier for them to run their weekly errands. Another important consideration relates to health. As people grow older, they may begin to experience mobility problems, which could make it appealing to move into a home with greater accessibility, such as one without stairs. Of course, individuals can often make their current homes more accessible, but the costs involved can be high, making it more appealing to find a new one. As health concerns become more serious, individuals may end up needing some assistance, which could also influence their decision to move.
Another point to keep in mind is that many retirees successfully boost their monthly retirement income by opting to downsize. According to a study published by the Boston College Center for Retirement Research, individuals who move from a $250,000 home to one that costs $150,000 can net $6,250 annually from the decision. This gain translates to an additional $520 per month, which is a lot of money for the average retiree. Of course, this number is only theoretical. Before making the decision, retirees should create a budget that takes into account utility costs, commuting expenses, insurance needs, and other monthly expenses related to both homes to figure out how much they could potentially save with the move. This figure will often make it much more clear whether or not the decision is the right one.
Choosing a Middle Path When It Comes to Relocating in Retirement
Retirees may want to consider a third option other than relocating to a new home or keeping their current one. This third option involves renting out their current home and then moving to a smaller one. The rental proceeds can help to put a lot of money in the bank without involving many of the expenses mentioned above. Of course, renting a home can also involve a number of costs, such as hiring a management company to dealing with losses if your home goes unrented for a month. However, these costs are generally much less than those involved with an outright sale, especially if the value of your home is expected to increase in the years to come.
People may choose this third option for a number of different reasons. Some may simply want to test out a smaller place while having the option to move back to their home in case they decide that they made a bad decision. Others may want to keep the home in the family so that they can will it to their heirs. Retirees may also simply not want to go through the hassle of a sale, or they may want to have the freedom to relocate easily with the security of knowing that they already own their home should something happen. As with the decision to sell, it is important to think about the expenses involved and the rent that you can potentially secure to ensure that the deal is worth the hassle.
Many people struggle when it comes to choosing the best retirement account because, in part, choosing the right account involves making predictions about the future. But how can you tell if a traditional or Roth IRA is best for you?
Roth accounts are relatively new, as they were only introduced in 1998. In the most basic sense, Roth IRAs can help you to avoid tax ramifications down the road since any contributions are made after taxes, meaning that withdrawals are not taxed. They also have a number of benefits; for instance, you are able to withdraw prior to retirement without penalty and continue making contributions after turning 70 ½ (traditional IRAs require you to take required minimum distributions starting at this age).
While these benefits may make Roth accounts sound attractive, they do not always make sense for everyone. Generally, the decision between Roth or traditional IRAs comes down to how much a person is currently making and how much that person plans to make in the future. Roth accounts make the most sense when people think that they will have a higher income in retirement than they do now, meaning that they would be taxed at a higher rate later than they are now. Individuals who expect to earn less during retirement than now typically should opt for a traditional account since it will allow them to enjoy a lower tax rate in retirement.
The Benefits of Roth Accounts for Young Earners
Typically, a Roth account makes the most sense for young workers who have not yet fully realized their earning potential. Young workers often have an effective tax rate in the low single digits, and it is highly likely that they will be in a higher tax bracket once they retire. Front-loading the tax burden makes sense for them since it will save money down the road. In addition, investments grow tax-free in Roth accounts, an important consideration for young workers as the money will likely accrue compounded interest over the course of decades. When these individuals reach retirement, they will be able to spend all the money they have accrued without worrying about paying any taxes.
However, young workers should also consider that, since their contributions are taxed, they will need to divert more of their monthly income to retirement to make the same impact as non-taxed accounts. In a sense, Roth accounts require that individuals pay both the contribution and the taxes to a retirement fund.
At the same time, if a young worker made maximum contributions to a traditional retirement fund and then invested the tax they saved into a Roth, they would likely end up paying more in taxes than if they used a Roth to begin with, due to the required tax on the investment growth.
The Primary Strategy for Older and Higher Earners
Once individuals start to approach the peak of their careers, a Roth account stops making a lot of sense. Individuals who have high salaries, and who are thus in higher tax brackets, will likely experience a lower tax rate during their retirement years. As such, they may do best to choose a traditional account, which will defer taxes for the future.
For the highest earners, this may actually prove a moot point since there are income restrictions for opening Roth accounts. In 2019, the IRS is prohibiting people from contributing to a Roth account if they earn more than $137,000 annually as a single person or more than $203,000 as a married couple. There are some strategies for getting around this rule, but people generally do not have a compelling reason to do so, especially considering that traditional IRAs do not have income caps for contributions.
Higher earners with traditional accounts can also enjoy a lower adjusted gross income (AGI). Pre-tax contributions are deducted from the AGI, whereas post-tax deposits into a Roth IRA are not. A lower AGI can help maximize the Saver’s Tax Credit for people who make contributions to traditional plans, although this credit mostly applies to individuals with modest incomes or AGIs below $64,000 for joint filers.
The Benefits of Having Both Traditional and Roth Accounts
The people who may have the most difficulty deciding between a Roth or traditional account are those in the middle of their careers. These individuals probably do not have a clear idea about their future tax status. In this case, it can make sense to contribute to both a Roth and a traditional account at the same time. This strategy is akin to hedging their bets, although individuals should note that combined contributions cannot exceed $6,000 annually or $7,000 for people over the age of 50, according to current tax law.
However, there are some other advantages to investing in both. During retirement, people may have low tax years, such as when they have significant long-term care expenses. During these years, it makes sense to take from traditional accounts. These same individuals can also have high tax years, especially with large capital gains. In these years, distributions can come primarily from Roth accounts.
When thinking about retirement, the most important thing is to start saving early. However, it’s also important to realize that saving is not enough on its own. You need to plan strategically for how you will fund your retirement years, which means considering all forms of income and how to maximize them.
When you pay into Social Security, you’ll receive a retirement benefit in an amount that depends on several factors. When you know about these factors early in your working life, you can plan around them and maximize your retirement income. And of course, even if you’re near retirement, it’s also important to understand how Social Security works, so you can pick the right time to start drawing your benefit.
What to Know about Social Security Benefits When You’re Starting Your Career
Your Social Security benefit is primarily determined by your earned income during your working years. In general, the more you earn, the higher your benefit will be. However, there is a maximum Social Security benefit. In 2019, this maximum is $2,861 per month. No one can receive more than that, but many people will end up receiving much less, mainly due to a couple of key factors. One of these key factors is their work history.
The federal government calculates the final benefit you receive based on your lifetime earnings, averaging your salary over the 35 years during which you earned the highest amount. The Average Wage Indexing Series is used to account for inflation in this calculation. However, it is critical to know that if you work fewer than 35 years, your salary is essentially considered “$0” each year that you’re short of 35. This will reduce your average salary calculation and therefore your benefit. It’s true that you only need to work for one decade to qualify for Social Security, but you’ll need to put in at least 35 years to reap the maximum benefit.
The second factor that can bring down your Social Security benefit is when you claim it. You’ll need to work until your full retirement age to get the maximum benefit. The full retirement age depends on when you were born. The government has increased the full retirement age from 65 to 67, although the increase is happening incrementally over a 22-year period that began in 2000. For people born in 1960 and later, the full retirement age is 67. Check the Social Security Administration’s chart to view your full retirement age.
That being said, you can claim your Social Security benefit at 62. However, that benefit will be lower than it would be if you waited until full retirement age. Basically, your benefit will be reduced a certain percentage for each month before your retirement age. If you were born in 1960 or later and your full retirement age is therefore 67, you can claim your benefit at age 62, but that benefit would be reduced by about 30%.
After your full retirement age, the Social Security benefit actually increases incrementally up to 70 years of age. Thus, if you want to maximize your Social Security benefits, don’t claim any until you are 70. Past 70, no further increases occur, so it’s time to cash out.
Understanding these rules early in your career can help you plan for the future effectively. However, it is important to understand that people often need to claim the benefit before reaching age 70—and that’s okay. In an ideal world, you would be able to hold off until 70, but life has a habit of getting in the way.
Similarly, it is important to maximize your earnings for 35 years, but within reason. If you take a year or two off, you may want to plan to work another year or two, so that you don’t have those zero-salary years included in your benefit calculation. The 35-year average also makes it possible to eliminate some low-earning years, such as those right after high school or college.
Your Income and Earnings in the Years Before and After Retirement
Two other important considerations have to do with the years leading up to and following retirement. One concerns penalties: people in early and full retirement have earning limits beyond which their benefit is affected. Currently, early retirees can earn $17,640 in gross wages or net earnings without penalty, but every $2 earned above this amount will result in a $1 reduction from your benefit. In the year leading up to your full retirement age, you can bring in $46,920 before you’re penalized. For every $3 earned above this amount, $1 will be subtracted from your benefit. Once you reach your full retirement age, your earnings will not affect your benefits.
The other important consideration is taxes. Up to 85 percent of your payout can be subject to federal taxes, depending on your filing status and overall income. If your combined income falls between $25,000 and $34,000 for single filers or $32,000 and $44,000 for joint filers, you’ll have to pay taxes on up to 50% of your Social Security income. Above these ranges, you’ll be taxed on 85 percent of your benefit.
Given all this, you may want to think about reducing your overall taxable income in retirement. By distributing funds evenly over the span of a few years without sudden increases, you can decrease your adjusted gross income, but this will require some planning.
How Married Couples Should Strategize for Social Security
Another important consideration is the strategies married couples should use when it comes to claiming Social Security benefits. In general, there are two primary strategies. You can claim your own benefit, or delay this claim and receive half of your spouse’s payout. Your marriage needs to be at least 10 years old to qualify for this strategy. This approach can be especially helpful if one spouse was a particularly high earner.
Generally, one spouse will begin receiving payout earlier, whether at 62 or full retirement age, while the other waits until age 70 to maximize their benefit. Typically, the spouse who earned more delays their claim.
One of the most difficult questions to answer in relation to retirement savings is how much money is enough, especially when one considers the risks involved in investing. Realistically, individuals need to think more about how much they can invest than how much they should invest. The two numbers may be radically different depending on personal situations.
People who consider saving for retirement important should make it a priority and enshrine it within their budgets. The first step is to get a sense of how much people will need in retirement and what that would look like in terms of monthly savings now, even if that number is not immediately feasible. Another approach is to ask how much the amount currently being saved will amount to in the future.
Some individuals figure out how much they must contribute now in order to live as they would like during retirement and translate that into their current investments. Whatever is left after making that deposit is how much individuals have to live on here and now. Of course, this strategy can leave individuals struggling to make ends meet.
Investors still face the question of how to determine the amount they will need in retirement. This is not an easy question to answer, but it is an important one. People who arbitrarily choose to save a certain amount for retirement each month may be in for a surprise when they get close to 65 and realize how little they actually have to live on after retiring.
Several free online calculators exist that can make the math much simpler. Individuals choose an investment strategy (from conservative to aggressive) and indicate how much they are currently saving to see what the monthly retirement income will be.
Thinking about How Much Money Is Really Needed during Retirement
Still, there is the question of how much monthly income is enough during retirement. Certainly, it is quite difficult for individuals to imagine how much they will need to achieve their goals. A good strategy when it comes to this question is to start broad and then get more specific over time. As individuals get closer to retirement, they will have a better sense of what they will need. When just starting to save, people can generalize much more.
Some financial professionals recommend that individuals set a goal of getting their take-home, after-taxes pay today. However, it is also important to adjust for inflation, which can be up to three percent per year, so it is best to round up rather than down. Once retirement is within 10 years, then it is time to get more specific with the numbers.
Budgets often change radically once individuals retire. Some expenses, such as transportation to work, will fall away, while new ones will arise. For example, individuals may need a travel budget for visiting grandchildren.
Individuals also need to think about longevity. In other words, it is not enough to ask how much they need each month. People also need to think about how long they will need the income. Average life expectancy now is about 90 years for men and 92 years for women.
However, current health concerns and familial patterns also need to be factored in. Some people will live significantly longer than that. Getting caught off guard can have undesirable consequences.
The Process of Finding the Right Balance in Retirement Savings
Once individuals have a rough idea of how much they need to save today using the strategies mentioned above and online calculators, then it is time to start thinking about how much can realistically get stashed away. While it can prove painful to increase savings and thus decrease spending money, individuals should also think about the benefits of saving.
The government, as well as many employers, incentivize saving for retirement. Employer retirement plan contributions are made before taxes. Depending on your tax bracket, putting $6,000 away for retirement in a year may only shrink your take-home income by about $4,500. When employers match contributions, that is basically an increase to salary, albeit a benefit that will not be seen until years down the road. Typically, individuals should save at least up to the employer match.
Most people worry that they are not saving enough for retirement, but there is also the risk of saving too much. Giving up today’s financial goals for the future is not always a wise decision. For example, prioritizing retirement savings over a down payment for a home does not always make sense. Individuals need to take stock of their goals and think about what they want for themselves both now and in the future.
Finding the right balance takes time and requires periodic reevaluation, so individuals should look at it as an ongoing process rather than a one-time assessment. Ultimately, saving for retirement is not all-or-nothing. Individuals can put away money for the future while also saving for a mortgage down payment, but they may not achieve the numbers they were hoping for as quickly as they would like. Sometimes, this is okay. Other times, individuals need to think about what is more important to them.
People have a wide range of different vehicles available to them when it comes to saving and investing for retirement. One of the more complex options that individuals tend to overlook is annuities. An annuity is an insurance product that can be used for steady, predictable income during retirement. Individuals invest in an annuity with an agreement about when payments for it will be received in the future. The income from an annuity may come monthly, quarterly, annually, and even in one lump sum depending on the agreement that is made. The size of each payment depends on several different factors, including the desired repayment period.
Through an annuity, investors can choose to receive payments for the remainder of their lives or only for a set period. The decision affects payout totals, as does the type of annuity. A fixed annuity provides guaranteed payments, while a variable annuity pays an amount that is dependent on the performance of underlying investments. The downside of annuities is the high expense, which is one reason why many people steer away from them. Ultimately, however, they can prove to be a great choice for many people provided that they do their research and ensure that the investment will work well with their individual situation.
How Exactly Does An Annuity Work?
While the idea behind annuities is simple, these contracts tend to be highly complex. In the most basic sense, an annuity is a contract with an insurance company to bear the risk of investment. You can pay for annuities in a lump sum or through a series of payments during what is called the accumulation phase. When the annuity begins to pay you back, this is called the payout phase. Payout can start immediately, or it can be delayed for years or decades. One example of an annuity that virtually every American depends on is Social Security. You transfer risk to the Social Security Administration, and in return you receive payments based on how much you paid into the system.
While the federal government guarantees Social Security, insurance companies back traditional annuities. A guaranteed payment is only as secure as the insurance company taking the payment. This fact also means that there is some risk involved in annuities. While the risk in variable annuities is inherent, even fixed annuities can prove problematic if an insurance company grows unstable. Individuals should make certain that they invest with respectable and dependable organizations in order to reduce this risk, especially since most individuals use annuities to provide guaranteed income in retirement.
What Are the Benefits of Annuities for Retirees?
Perhaps the greatest benefit of making annuities part of a retirement portfolio stems from research undertaken by Mark Warshawksy, Robert Veres, and John Ameriks. They found that annuities reduced portfolio failure rates across the board. In other words, annuities help to protect you against running out of money in retirement. While this means the most when viewed through the framework of longevity, it is worth pointing out that this vehicle had benefits across the spectrum. At the same time, this benefit is a double-edged sword, because the same researchers found that annuities can also limit the potential upside of investment by decreasing overall gains. Thus, while annuities provide some stability, they do so at a price, as the money could be invested in riskier vehicles with higher potential returns.
Another benefit of annuities has to do with legacy. Most people assume that annuities decrease legacy since payments are limited, but this is not the case. A study found that annuities actually help people to spend less of the asset during retirement, particularly if they live a long life. This fact translates to a greater legacy for the heirs. Part of the reason behind this is the liquidity of an annuity, which is not the same for other types of retirement investments. While no investment portfolio should have only annuities, knowing that a deposit of cash is coming on a specific date makes it less necessary to dip into other vehicles that take a long time to turn into cash.
Who Would Not Benefit from An Annuity?
Not everyone needs an annuity in their retirement portfolio. Most notably, people who are not concerned about running out of money during retirement would not benefit greatly from an annuity since the money could be used for an investment with a bigger payoff. Also, people who feel like they receive a sufficient fixed income from Social Security may not need to necessarily focus on adding to that fixed income. The other consideration is life expectancy. Individuals with serious health conditions will not get the most from an annuity, of which much of the value derives from longevity. However, people with these conditions who want to make sure a spouse is provided for may benefit immensely from annuities. At the end of the day, individuals also need to think about diversification. Without a lot of money to invest, annuities should not be high on the priority list. Even with a decent nest egg, no more than 25 percent of total savings should be placed in annuities, according to most financial professionals.
Going through a separation or divorce is hard enough on its own, but the situation grows even more complicated when it comes to money. One of the more confusing aspects of the financial ramifications of divorce pertains to retirement savings. Generally, spouses will need to split retirement assets, but the process behind this is not always clear. In some cases, one spouse will maintain an asset entirely. Understanding this process is key to handling the tax implications, as well as reformulating a strategic plan to get individuals where they want to be when it comes time to retire. The key determinant in how an asset is divided has to do with the type of account it is.
IRAs are handled differently than qualified plans, even when two former spouses agree to split both types of assets in the same way. Individuals divide an IRA using a “transfer incident to divorce” claim, while qualified plans, including a 401(k), require a QDRO, or Qualified Domestic Relations Order. Sometimes, courts will use one of these terms to cover both types of assets, but the paperwork must be in the proper order with the right designations to avoid additional headaches and hurdles down the road. With either assets, individuals need to remember to update their beneficiaries, although some divorce decrees require keeping a former spouse on the paperwork.
Key Points for IRA Asset Division
When dividing an IRA, it is important to treat the transaction as a transfer incident to divorce in order to avoid taxes. Without this declaration, both parties may end up losing money unnecessarily. The IRA custodian will classify the transaction as either a transfer or a rollover depending on the ultimate decision on the division of assets, as well as the wording of the official decree. After the transaction is completed, the recipient becomes the legal owner and that person will need to deal with any tax consequences arising from future distributions or the movement of funds. In other words, the former owner of the account does not face ramifications for how the new owner manages the funds, so long as the label “transfer incident to divorce” is used.
However, if the division is not properly labeled, the current owner will end up paying taxes and early withdrawal penalties on the entire amount received by the new owner. In order to avoid mislabeling, it is important to include both the division percentage breakdown and the dollar amount of assets being transferred. Furthermore, all sending and receiving IRA account numbers should be listed to avoid any confusion. Both sending and receiving IRA custodians need to agree with what the language indicates, in addition to the judge handling the case.
Special Situations with IRA Division
The courts must approve the division agreement or else the IRS will consider the amount sent to the recipient as ordinary income. Also, the recipient will not be able to place the funds in an IRA since it would not be an eligible transfer, and the tax deferral benefit is lost. Sometimes, recipients will demand compensation for that loss.
Another special situation occurs if the IRA being transferred was funded in part by nondeductible contributions. In this case, both parties will need to calculate the dollar amount of nondeductible contributions and report this on Form 8606 to the IRS. This form is very important, and calculations can prove tricky, so sometimes it makes sense to hire a professional for assistance. Otherwise, both people may pay unnecessary taxes down the line.
Considerations of Qualified Retirement Plans
When it comes to qualified retirement plans, particularly a 401(k), individuals need to understand the specific technicalities. Federal law provides a wide range of protections for these assets, but some notable exceptions involve seizure and attachment by creditors and lawsuits. Both divorce and separation proceedings make it possible for someone to ask for attachment of qualified plan assets through a QDRO. Such an order divides qualified retirement plan assets among formers spouses and/or children and dependents.
Like transfers incident to divorce, QDROs eliminate tax obligations, provided that they get correctly reported to both courts and IRA custodians. Through this order, the recipient has a wider variety of options. The funds can be transferred to a new or existing qualified plan, or they can be deposited into a traditional or Roth IRA. In the latter case, the money is taxed as a conversion but is not penalized. Any sort of transfer that does not fall under the QDRO umbrella will incur both taxes and penalties, so getting the right paperwork in order is extremely important.
The Takeaway Message
In the end, dividing retirement assets in a divorce can seem complicated, but it does not need to be provided that individuals do their homework and accurately report all information. The primary concern needs to be to get a transaction declared as a “transfer incident to divorce” or QDRO in order to avoid tax consequences. All custodians, as well as the courts, need to agree with these declarations. Lacking attention to detail in this matter could mean that the process becomes much more expensive and time-intensive than necessary.
Most people think about putting money away for retirement as “savings.” However, these accounts are really a form of investing today’s income in the hopes that it grows and provides a nice nest egg for the future. As with any investment, retirement accounts come with a certain amount of risk.
The amount of risk with which someone is comfortable depends on the person, as well as the situation. With retirement, individuals often try to reduce risk as they approach their sixties to protect the money that they have saved since there is less time for rebound.
Managing risk when it comes to retirement savings starts with understanding what risks exist. This is particularly true in light of the fact that more investment decisions are falling to the individual than ever before. Some of the key risks involved with retirement savings include:
Perhaps the most obvious (but still frequently overlooked) risk is inflation. Because of high inflation rates, the money that is put aside now will simply not be worth as much in terms of purchasing power in the future.
Since 1981, the inflation rate has been about 2.8 percent annually. That means people need to earn a return on investments of 2.8 percent just to break even when it comes to inflation.
Furthermore, inflation tends to be higher for retirees largely because of healthcare costs, which have actually grown at a rate that outpaces general inflation. Individuals should always think about inflation in terms of their low-risk investments, which may not even break even if they have a very low rate of return.
Sequence of Returns
The phrase “sequence of returns” refers to the state of the market during the time withdrawals are made. When retirees need to withdrawal from an investment account during a bear market, they will deplete their savings far more quickly than in a bull market.
This is exacerbated by the fact that depleting one’s savings limits the amount of money left to generate returns going forward. While most people focus on the average rate of return before retirement, afterward it is quintessential to consider the sequence of returns. Perhaps this consideration becomes most important when thinking about when to retire.
Ideally, individuals retire during positive market performance. This minimizes the need of liquidating investments to generate an income. When the liquidation happens, individuals may find themselves running out of money before predicted.
While the subject of longevity may seem morbid, it is a critically important consideration for people facing retirement. When it comes to retirement risk, longevity refers to how long individuals will actually live. Funding a retirement that lasts 20 years is significantly less challenging than making the same money last for 30 years.
While no one can predict exactly how long they will live, this consideration does have an impact on how fast individuals spend money once they have retired. Even individuals with a very solid foundation will have trouble generating enough income for 30 years. Yet people today are living longer than ever before, with many individuals living until their late nineties.
Current interest rates are considered fairly low. Retirees should recognize this fact because it means that they can generate only limited returns with “safe” investments, such as Treasury notes. While these notes once generated a return of more than 5 percent, or even 7 percent in the early 1990s, they now have a return of about 2 percent, which does not even cover inflation. As a result, individuals may have to save more than they initially thought when they started saving a few decades ago.
Another strategy is to move these investments into more aggressive accounts with the potential for greater yields, but this comes with the risk of losing considerably. While rates could increase, it leaves many people just starting to save relying on riskier options for the time being.
Healthcare costs continue to increase rapidly. People who do not plan for these expenses may find themselves going bankrupt when something happens. Before retirement, individuals need to think critically about their needs and prepare as best as they can. Looking at current health and genetics can say a lot about likely needs in the future. This will help direct people toward the best options for them.
Individuals also need to consider the level of care that they want. Private nursing homes cost much more than other options. To offset health costs, individuals can purchase long-term care insurance or supplemental policies for Medicare. However, it may also be prudent to save more than initially thought necessary for healthcare expenses, just in case.
Laws can change quickly, creating completely new tax situations. These risks are hard to predict, but they could really take a bit out of retirement plans. For example, taxes could skyrocket, which leaves individuals with traditional retirement accounts with much less money than they thought when they start to withdrawal funds.
On the other hand, people who prepare for this issue by investing primarily in Roth accounts may kick themselves if taxes are much lower when they start making withdrawals than they currently are. Many people try to mitigate this risk by investing in both traditional and Roth accounts so that they can be more strategic in how they withdraw down the road.
It is important to begin saving for retirement as early as possible. Fortunately, it is never too late to take control over retirement planning. Even in the decade leading up to retirement, there are important steps that individuals can take to maximize their savings. This is particularly true if they need to catch up in order to meet their goals.
Individuals in this situation should not feel alone. A survey conducted a few years ago found that three out of 10 individuals over 55 have no retirement savings at all. About 25 percent of responders had less than $50,000. These situations are serious, but all hope is not lost. The key last-minute steps to take when it comes to saving for retirement include:
Delay pulling on Social Security.
The age at which someone starts pulling on Social Security has a big impact on the monthly benefit. When individuals claim before their full retirement age, which is either 66 or 67 depending on birth year, the payments are reduced.
On the same token, payments increase by delaying retirement, at least up to the age of 70. Individuals who choose to retire at 70 will maximize their monthly benefit.
To see how much of an impact this will have in each individual’s particular situation, people can visit the Social Security website and track the payments that they would receive retiring between the ages of 62 and 70. People who are already behind on saving definitely need to make the most of this important benefit. The added effect is that this delay gives people even more time to save.
Diversify accounts to minimize taxes.
Once people retire and start to pull on their traditional 401(k)s and individual retirement accounts (IRAs), they will need to pay taxes on withdrawals. Furthermore, withdrawals become mandatory once individuals reach the age of 70 and a half.
These tax payments can significantly cut into the amount of money available for everyday living. People can help offset this issue by diversifying their retirement savings with a Roth 401(k) and/or a Roth IRA. Both of these accounts require that individuals invest after-tax money, but then no taxes are due upon withdrawal.
Diversification of accounts can help provide better planning for the future since individuals know more fully how much they will have to spend. With fluctuating tax rates, planning with traditional accounts becomes more difficult.
Downsize or consider a reverse mortgage.
One of the best strategies that individuals can undertake to increase retirement savings is downsizing their home, which in turn reduces cost of living. People often find this step necessary to survive in retirement anyway. Doing it early can mitigate some of the headaches that would otherwise come down the round.
However, individuals who wish to stay in their home can consider a reverse mortgage to help cover monthly bills. Such a loan is only available to people over the age of 62.
However, it does come with disadvantages that individuals need to consider. People will need to repay the loan to move. Additionally, they will not be able to leave the home to children unless they pay back the money. Also, these loans often involve a number of fees.
Reduce retirement savings fees.
Once people retire, they have the option to roll over the savings in a 401(k) into an IRA. If individuals have great investment options with the IRA and low fees, meaning less than one percent, then it makes sense to transfer money into that account. While this may not seem like a big deal at first, this move can easily translate into thousands of dollars of savings over the course of retirement.
The best part of this savings is that it requires only a one-time action on the part of the retiree and the savings will continue throughout retirement. These savings are quite significant when one considers how percentage fees compound.
However, individuals should make sure that they perform their due diligence before reinvesting the money. Any IRA should have adequate investment options for meeting realistic goals and charge low fees.
Create a strategic financial plan.
Ideally, individuals create a comprehensive financial plan for retirement savings early in life, but sometimes other factors get in the way. Even people who save diligently face emergency situations that require them to drain accounts.
When approaching retirement with less-than-ideal savings, it is more important than ever before to account accurately for monthly financial needs and figure out how to make the ends meet. Often, this means curbing spending right now to get as much into retirement plans as possible. Sometimes, individuals find that they will need to get a part-time job to cover their monthly expenses once they retire.
However, it is impossible to know these things without mapping out how much people’s financial requirements in retirement and their projected monthly expenses. Of course, much of this practice is prediction, but it also provides some needed guidance for future planning.
While many Americans look forward to their retirement years, saving for this time period can bring a lot of stress. A majority of workers participating in a 2017 AARP survey said they felt that they did not have enough saved for the various expenses, both expected and unexpected, that come with retirement. Part of this problem may relate to the hidden fees associated with retirement accounts, especially 401(k)s.
Often, people do not even know they are paying fees on their 401k, or have little choice in paying them, as their plan is selected by their employer. According to financial expert Robert Hiltonsmith, these fees can cost the average two-earner family more than $150,000 over a lifetime, an amount that accounts for nearly a third of all investment returns.
Understanding the Incredible Impact of Fees on Retirement Savings
Most people saving for retirement do not understand the impact that fees can have on their accounts. In fact, paying a single percent less in fees for an investment over the course of a lifetime can translate to enough money for an additional 10 years of retirement.
Consider three people who all invest $100,000 and achieve a rate of return of 8 percent. One person invests in an account with 1-percent fees and eventually achieves a total of $761,000. Another puts their $100k into an account with 2-percent fees. During the same time interval, this account will only grow to $574,000. The third person invests in an account with 3-percent fees. This account ends with $432,000. These figures demonstrate how seemingly small increases in fees can cut into overall savings.
In 2015 a law professor at Yale published a study concluding that a surprising number of 401(k) plans focus on high-fee funds, and ultimately recommended that employees pay close attention to the fees they pay.
Instead of putting money into plans with high fees, employees may be better off investing in a retirement account outside of their employers’ that will conserve a much higher percentage of their investment for the future. Pew Charitable Trusts has also researched this issue, noting that fees lower the amount of money available for compounding and thus have a reverberating effect on growth through the life of the investment. Unfortunately, many people think that fees are an inevitable part of saving for retirement, but this is not the case.
Pushing through the Confusing Language of Fee Disclosures
Often, 401(k) plans bury the nature and number of fees in pages upon pages of statements and then use undecipherable names to describe them. Since 2012, retirement plan companies have been required to declare the amount and purpose of fees, but that does not mean they do not try to confuse the average investor. Even savvy investors may feel lost in a 30-page disclosure document designed to discourage people from asking questions. Phrases like “asset maintenance fee” and “required revenue fee” seem legitimate, but they actually just refer to revenue sharing and commissions.
To determine if you are paying too much in fees, you will first need to know what an appropriate amount is. In general, fees should be less than 1 percent, but many finance professionals note that they have seen fees as high as 3.25 percent. Some plan managers will try to justify a higher rate by saying that a small company needs to pay higher fees until they grow larger—this is not the case. Ideally, it should be under 1 percent, regardless of the size of the company.
Viewing Employers as a Key Partner in Fee Negotiations
The regulatory changes that took place in 2012 made employers responsible for the plans they select for employees on a fiduciary level. Employers have a duty to select plans solely for the benefit of their employees and are required to review fee disclosure documents within 90 days of receiving them. During this time period, it is possible to make changes to the plan. Company owners and managers can actually face rather significant fines if they do not review the disclosure since it is considered disregard for the welfare of employees both now and in the future. In other words, employees are not alone when it comes to negotiating for better fee structures and should view their employers as partners in this struggle.
Employees should advocate for a joint disclosure assessment with their managers to make sure that the plan is the best for the future. When people take the time to learn what the fees mean and how they may be unnecessary, they can argue for a fairer structure and ultimately put everyone in a better position for retirement.
While historically people could count on Social Security and pension plans to provide a comfortable income during retirement, people today need to save and invest as they prepare for life after work. Luckily, there are wide variety of retirement plans available. However, understanding which vehicle is the best option can be confusing. Learning more about the specific advantages and disadvantages of various plans can help people figure out what they need for their particular retirement needs and goals. One way to categorize retirement plans is to consider those sponsored by employers versus individual retirement accounts.
Retirement Plans Sponsored by Employers
A great way to start saving is through employer-sponsored plans. The most basic employer-sponsored retirement account is the defined-contribution plan, typically a 401(k). A defined-contribution plan involves payroll deductions that go directly to an individual account within the company plan. Ideally, your company will match your contributions, which means that your employer will also put money into the account, up to a certain amount and based on how much you elect to contribute.
Employer-sponsored accounts are generally easy to set up, since the contributions are usually deducted directly from your pay each pay period. They’re also easy to maintain, because the plan administrator handles most of the statements and disclosure. In addition, 401(k) contribution limits are typically higher than those for individual retirement accounts—not to mention the fact that any employer matching is free money. Furthermore, contributions to 401(k) plans reduce your taxable income now. However, you’ll pay taxes on withdrawals from traditional 401(k) accounts during retirement.
In contrast, with a Roth 401(k), your payroll contributions are made after taxes, so your withdrawals during retirement are tax-free. A Roth 401(k) also has no income restrictions, unlike a Roth individual retirement account. Which you choose (traditional vs Roth 401(k)) basically depends on whether you think you’ll be in a higher income tax bracket during your retirement. Roth 401(k)s are often recommended for younger investors, who tend to fall in lower income tax brackets, but there may be good reasons for older investors to consider Roth 401(k)s as well. A financial advisor can help you make the best decision.
There are some drawbacks to defined-contribution plans, the most obvious of which is greater restrictions on investment choices. With an individual plan, you have much more control over where your money is invested. In addition, employer-sponsored plans often come with high management and administrative fees, which can take a significant chunk out of your savings. New employees should also make note of any waiting period before they can make contributions, as this is common. You may also have to wait until you’ve been with your company for a certain period of time (say, a year) before your employer will match your contributions.
Individual Retirement Accounts
The other main option when it comes to saving for retirement is the individual retirement account (IRA), which can be set up through banks, brokerage firms, and other financial institutions. These accounts hold various investments, from stocks and bonds to cash and mutual funds, reserved for retirement. Several different types of IRAs exist, each with its own tax and contribution rules, so it’s important to look through all the options. As with a 401(k) plan, you can select a traditional or Roth IRA, with Roth contributions made with after-tax income, in order to avoid taxation upon withdrawal during retirement. You can contribute to both a Roth and traditional IRA in the same year, provided that you qualify for both.
The main advantage of IRAs is the fact that you’re in the driver’s seat and make all the decisions, whether that means personally or choosing a professional to do so. Furthermore, an IRA comes with a very wide range of investment choices, so it becomes easier to diversify. However, there are some downsides, too. IRAs in general have lower annual contribution limits, although these limits increase once you turn 50. Contribution limits depend on your modified adjusted gross income. Furthermore, even traditional IRA contributions are not always tax-deductible. (Roth IRA contributions are never tax deductible.) The deductibility limits for traditional IRAs depend on your income, as well as your tax filing status and access to workplace retirement plans.
General Guidelines for Deciding on Retirement Contributions
The exact savings strategy you should use will depend on your individual circumstances, but some general guidelines can help you determine your contributions. For the most part, you should first take advantage of any workplace retirement plan that comes with employer matching. Outside of the 401(k), these plans might include 457(b)s, 403(b)s, and defined-benefit plans, which work much like a pension.
Once you’ve maxed out your 401(k) contributions, or at least the matching available from your employer, it might be time to consider an IRA. Additionally, people who do not have a retirement plan through their company should focus on an IRA. Here, the most important decision is whether a traditional or Roth IRA is more appropriate. Determining this will involve making some predictions about your tax status in retirement. People who will fall into a lower tax bracket in retirement will benefit the most from a traditional IRA. Furthermore, people who are self-employed or who own a small business should recognize that specialized accounts exist for them, including the solo 401(k) and specialized IRAs.