Archives for April 13, 2019

Most of us probably know that we ought to be on top of our finances. In an ideal world, we’d all have a clear understanding of our expenses, how close we are to meeting our goals, and how we’re doing savings-wise. But in the actual world, a large chunk of younger adults are somewhat clueless on the money-management front: 36% of millennials are “winging it” when it comes to matters of personal finance, according to a survey conducted by U.S. Bank.

If you, too, have been taking an overly casual approach to your finances, you may be doing yourself a major disservice. But it doesn’t have to be that way: Here’s a simple, three-step plan that you can use to painlessly get your finances in order.

1. Create a budget

Following a budget is one of the most effective means of managing your money. And the best part? Setting one up is really easy. All you need to do is list your recurring monthly expenses, factor in once-a-year expenses (like annual membership renewals), and compare your total average spending to your total earnings. If the numbers don’t align — meaning, you’re maxing out each paycheck without leaving room for savings, or, worse yet, spending more than you take home — then you’ll need to go through your various expenses and identify areas you can cut back on.

Now, if you’re trying to get out of the habit of being too vague about your money, this is where the rubber meets the road: When creating your budget, it’s vital to use the most accurate data you can to figure out how much you spend. Don’t guess at those figures. Instead, comb through your bank and credit card statements to get a solid handle on what you’re spending, and take some time to track your “incidental” cash spending over the course of a month, too. That will give you a starting point from which you can make changes as needed.

2. Automate your savings

Saving for the future often doesn’t fall high on our lists of priorities. Even if we know we should do it, more immediate needs — and, let’s be honest, wants — can be more compelling, which makes it difficult to consistently set money from our paychecks aside. To bypass the risks of temptation, automate your savings. Doing that will effectively force you to pay yourself first.

If you don’t have a solid emergency fund that can cover three to six months’ worth of your expenses, building one should be your first priority. Arrange for a portion of each paycheck you receive to land automatically in a savings account until you hit your target. Next, start to automate your retirement savings. If your employer offers a  401(k) plan, sign up, and have your contributions deducted from your pretax earnings. If a 401(k) isn’t offered, you can set up your own, or find an IRA that offers an automatic savings option.

In all of the above situations, the mental trick is simply to route the cash toward those future needs seamlessly and invisibly. Money you don’t ever see in your paycheck or checking account is money you’ll be less likely to spend.

3. Map out your financial goals

If you haven’t done so already, set down a list of your financial goals for both the short term and the long term, and figure out what actions it will take on your part to achieve them. For example, you might want to buy a house and pay off your student debt within the next five years — but doing both may require a serious frugality push on your part. Down the line, you might have the goal of retiring early, or saving enough to put your kids through college without them taking on heavy student loan debt. Either one will will demand consistent savings.

Once you’re clear on which financial objectives are most important to you, don’t just cross your fingers and hope you magically manage to achieve them. Do the math, develop a plan, and take an active approach to hitting those goals.

There are plenty of parts of life where a “let’s just wing it” strategy often works out beautifully. Personal finance is not one of them.

The country is facing a retirement crisis, but some Americans are worse off than others.

Workers in the top 20% of earnings distributions have half of all retirement wealth in both 1992 and 2010, compared with the bottom group, which saw its share fall from 3% to 1% between those years, a recent analysis at The New School’s Schwartz Center for Economic Policy Analysis (SCEPA) found. The share of workers in the bottom fifth of the earnings distribution with no retirement savings jumped from 45% to 51% in those 18 years.

The study looked at employees between 51 and 61 years old in 1992 and 51 to 56 years old in 2010 and divided their earnings based on lifetime labor market earnings, taking into consideration individual retirement accounts and employer-sponsored plans (like 401(k) plans). Survey findings were also matched with tax records and plan summary descriptions.

The findings reveal Americans, especially lower-income workers, nearing retirement are in dangerous territory. But some individuals within all types of lifetime earnings rates — high and low — are in trouble. In both 1992 and 2010, the top 10% of savers in each earnings distribution quintile had between 10 and 20 times as much in retirement assets as those in the bottom 10% of their groups. In the lower three quintiles of workers, the bottom 10% of each had nothing at all saved.

“Unlike income inequality which is distorted by skyrocketing incomes for the 1%, inequality in retirement wealth reflects the bottom falling out for low and moderate earners,” said Teresa Ghilarducci, director of SCEPA’s Retirement Equity Lab, and a co-author of the study.

Americans have a conundrum: they face inadequate savings in the future, according to this research, but in some cases, they can’t do anything about it. Many workers do not have access to an employer-sponsored plan, but even if they do, they may not be able to save the recommended 20% each year to fund their retirement. Those without 401(k) plans or similar accounts at work can open individual retirement accounts, but contribution limits are less than half of what a 401(k) allows ($6,000 in an IRA for someone under 50 years old versus $19,000 in a 401(k) plan). Americans of all ages find it challenging to balance saving for the future and paying for current expenses or shorter-term goals, like buying a home or helping their children with college tuition.

Still, future retirees would be better off if they could allocate even a small percentage of their salaries to a retirement account. Median retirement wealth falls 84% short of what it would be if people were to save 6% of every paycheck and receive a 50% employer match, according to the SCEPA study.

With the growing number of proposals to increase taxes, its time to rethink how we save for retirement. Proposals to increase the top income tax rate, impose a new annual estate/wealth tax, and to tax unrealized capital gains, are not likely to pass this year. However, the odds are rising that by the time you retire, taxes will be higher making a Roth IRA, where withdrawals are usually tax-free, significantly better for most people than a Traditional IRA. Here’s what you need to know.

The main differences

With a Traditional IRA, you don’t pay tax on the money you deposit, but the money you take out is taxed as ordinary income.

With a Roth, you deposit money on which you’ve already paid taxes, but the money you take out is not taxable.

Which one is better for you?

Let’s suppose that you are in the 30% tax bracket for 2018 and this weekend you have to decide whether to put $5,500 into a Roth or a Traditional IRA.

If you put the $5,500 in a Traditional IRA, you will get an immediate benefit of $1,650 because you won’t have to pay taxes of 30% on the $5,500. Sounds good, but fast forward 20 years to when you start taking money out of the IRA. Your account will have grown tax-free for 20 years. At 10% a year, your account would be worth $33,637.

The catch is that the money you withdraw from a traditional IRA is taxed as ordinary income. If your income tax rate at that time is higher than it is now, you will pay that higher rate not just on the original $5,500 but also on all of the growth, even the portion due to capital gains which are usually taxed at a lower rate than ordinary income. If your tax rate at withdrawal time is 40%, you’ll pay $13,455 in taxes as you withdraw the money so you’ll have $20,182 to spend.

If you put the $5,500 in a Roth IRA, your tax bill will be $1,650 higher this year. But 20 years from now, you’ll be able to start withdrawing $33,637 without any additional taxes. Think of the $1,650 of extra taxes you pay this year as prepaying the taxes on a $5,500 investment.

Normally it’s not a good idea to pre-pay taxes. But in this case, the numbers argue otherwise. Instead of paying taxes of $13,455 as you withdraw the money from a traditional IRA, with a Roth you pay $1,650 now and then get 20 years of growth on $5,500 tax-free.

In other words, your $1,650 payment reduces your future taxes by $13,455. That in itself is a tax-free return of a little more than 11% a year on your $1,650 — a sweet deal!

If your taxes are lower in the future, or you have less than 20 years until retirement, the numbers will still favor the Roth, though by a smaller margin.

The return on your $5,500 investment over the 20 years is probably the biggest factor on the decision to fund a Roth or Traditional IRA. I assumed a 10% annual return in my example which approximates the long-run return of the S&P 500. If you invest 40% in bonds, your long-run return will likely be lower, but the Roth will still come out better.

Although there is a whiff of socialism in the air these days, the proposals to raise taxes are not likely to pass this year or next. But in the next 20 years, there will be 10 more elections.

In most scenarios, the Roth will work out to be better for your retirement even if tax rates don’t change. However, the more tax rates rise, the better the Roth looks.

Retirement may mean different things to different people, but most agree on one thing.

It should be stress-free.

However, lack of stress usually comes from years of planning and decades of saving — which not everyone can do.

The average savings balance in the U.S. is less than $60,000. Few people can depend on pensions. Baby boomers heading into retirement may find themselves struggling because of inadequate savings and high health costs.

Even with the best of plans, despite saving and investing diligently, economic forces can derail everything.When plans go belly up

Moving is never fun. Moving to a foreign country comes with even more logistical pain. “It creates anxiety plus the thought of leaving behind life as we’ve known it, including family and friends,” said Cynthia Staton, an expat retiree in Ecuador.

In 2008, Staton and her husband, Edd, now both over 65, found their retirement savings had been crushed.

The financial meltdown created an economic tsunami that swept away not just their jobs but even the fields they worked in. Edd was a marketing rep at a bank that specializes in auto loans. Cynthia worked in high-end new construction.

In addition to their home, the couple owned investment properties that made up a large portion of their retirement portfolio. All lost substantial value almost immediately.

“We had great careers and a great retirement plan — until we didn’t,” Edd Staton said.Think outside the box

The Statons realized they’d have to think outside the box if they wanted a decent quality of life. It was like facing three doors on a game show: Give up and accept a miserable retirement; keep on working and hope things would work out; or move abroad for a lower cost of living.

“After working so hard our entire adult lives, giving up wasn’t going to happen,” Edd Staton said. And continuing to work was equally unappealing. The Statons say they lost too much, too fast. “Time wasn’t on our side,” he said. They felt ready for a new chapter and did not want to work.

Their original retirement dream involved travel: They were going to chase perfect weather around the globe. Living abroad was more a shift in focus than an unwelcome idea.

Their wish list had three top items: proximity to the U.S., a lower cost of living and a temperate climate. Cuenca, Ecuador, seemed to have all three, so they moved there and haven’t looked back.

Since then, they’ve enjoyed living in a four-bedroom penthouse apartment they rent for $700 a month, paying under $60 a month for utilities. They have a weekly housekeeper and regular massages, facials and mani-pedis.

The Statons, who have written several books on retirement, have a new project — an educational course called Retirement Reimagined! — that they hope will help bring more attention to moving abroad as a retirement option for U.S. citizens.Shifting definitions of retirement

Longer life expectancy means many people will have more years in retirement or in the years we consider retirement age. These days, retirement doesn’t necessarily mean the end of work — and it’s not just the need for income that keeps people working.

We all know people who worked as long as possible because they love what they do. More people are finding out their life’s purpose may change, but they still thrive in the retirement years when they have something to wake up for each day. The last year and a half has seen a big change in how people think about retirement.

“Today’s retirees are much more realistic than even 10 years ago,” said Winnie Sun, founder of Irvine, California-based Sun Group Wealth Partners. “They realize they can’t just simply retire and get on a cruise ship.”

More and more, people are starting to think about retirement earlier. And, according to Sun, those who haven’t planned far enough in advance almost immediately feel the need to find another source of income in retirement.

Sun works with several clients who retired because they felt burnt out after decades in the same industry. “A lot of them are nervous [about money], but they need to come up with income for that mortgage payment,” she said.

Many people are finding they need to pivot, Sun added. “The whole concept of the side hustle was always about Gen X and millennials,” Sun said. “But baby boomers are realizing this is something they have to do, and they are doing it.”

One client plans to retire at 75, an age when people typically want to spend more time with their grandkids. Instead, Sun’s client hopes to create a radio show for seniors.Retirement scramble

Brian Scott Lipton, 58, is an editor in New York. His parents retired somewhere near his age, but he’s unsure about his own future. He’d like to be able to stop working somewhere between ages 60 and 65 but doubts that will happen.

“The difference is, they had pensions,” Lipton said. “They started working young, and they worked steadily.”

Lipton has money in traditional and Roth IRAs, as well as a 401(k) plan. “But most of my life I worked at companies that either didn’t have a 401(k) or those that did, did not have a matching component,” Lipton said. He currently contributes to a 401(k) at a level that gets him the employer match.

Like many people, Lipton is uncertain about how much he can expect in retirement income. After chatting with a friend, Lipton realized he had no idea what his Social Security income would be, so he checked. “It will be helpful,” he said. “But I won’t be able to live off it.”

For now, Lipton’s retirement strategy includes investing at an aggressive risk level in a professionally managed account and considering a relocation.

Lipton and his husband don’t have a destination in mind, but it’s a near constant subject. “We can’t maintain our current life in New York City on a retirement budget,” he said.

“I think I will always want to write, but perhaps not eight to 10 hours [a day],” Lipton said. “Perhaps someday I will switch from journalism to books or essays. But I’d also like time to travel and to play bridge on a regular basis.”

Neither Lipton or his husband drives, so they’d like a city. Retirement, Lipton says, brings mixed feelings. “I’m always looking for the happy medium,” Lipton said. “So it’s probably a little bit of both terror and excitement.”Size matters

Kathy Gottberg, 63, and her husband, Thom, who live in Quinta, California, began reading and learning more about sustainability in their 50s. 

Gottberg had been thinking about what retirement might look like. At the same time, her interest in living in a way that would sustain the environment was sparked because of friends from Colorado. “They were really into sustainability,” Gottberg said. “And it started seeping in.” Gottberg blogs about sustainability and other issues that touch on retirement.