Archives for September 3, 2019

Nobody likes a job that’s only halfway done, but partial progress often is better than none at all.

When it comes to managing money, many Americans still aren’t meeting their savings objectives, or they’re mismanaging their investments or skipping opportunities involving Social Security.

People sometimes fail to get going or complete the task, because they view the full goal as unachievable. In these cases, going halfway might be more realistic. These are some situations where getting 50% of the way there could be better than doing nothing.

Build half your cash reserves

Financial planners routinely recommend compiling a cash reserve equal to three to six months of living expenses to meet unexpected costs like a car-repair or air-conditioning bill. But that’s clearly way too much for many people to achieve.

With average U.S. household expenses of around $60,000 a year, according to the Bureau of Labor Statistics, a cash balance of three to six months would imply saving $15,000 to $30,000. If that’s too daunting, try cutting it in half to 1.5 to three months, or $7,500 to $15,000.

Savings can include various accounts — cash on deposit at the bank, in money-market brokerage accounts and elsewhere. So, too, for money that you accumulate in health savings accounts or HSAs, said John Campbell, senior wealth strategist for U.S. Bank Private Wealth Management in Chicago.

HSAs, which are available to employees utilizing high-deductible health insurance plans through work, are a flexible, tax-efficient way to save for a range of medical expenses.

Contributions go in on a pre-tax basis, and earnings build up tax-sheltered for later use, much like a Roth Individual Retirement Account. Given that medical expenses often are what push people over the edge, it can be smart to utilize HSAs as a savings solution.

Wait until 66 to collect Social Security

When it comes to claiming Social Security retirement benefits, recipients can start as early as age 62, wait until 70 or start within that range, meaning they have an eight-year window to act. Each year you wait, your benefits increase. The flip side is that you’ll be giving up payments in the meantime.

At any rate, most people start taking Social Security within the first few years of reaching 62. Hardly anyone waits until age 70, when benefits are maximized.

There can be sound reasons to claim Social Security sooner — if you can’t find a good job in the meantime and need the income, for example, or if you don’t expect to live into your 80s, 90s or beyond.

But even if you can’t wait until 70, how about splitting those eight years in half? Claiming around age 66 is a compromise strategy that would put you near “full retirement age,” the time when you receive “unreduced” benefits, as the Social Security Administration  puts it.

For most people now in the workforce, full retirement age is around 66 or 67. If you can delay further beyond that, your benefits will rise by 8% each year you hold off.

Go halfway in the stock market

Over time, the stock market not only appreciates handily but drastically outperforms bonds, cash and other conservative investments. That’s why, logically, it’s often smart to invest as much as you can, right away.

The problem is that it’s emotionally difficult to do that. Stock prices occasionally drop sharply, and these downdrafts can be enough to prod some investors to pull out all their money, usually near a cyclical low, which often is the worst move.PAID STORY FROM DISCOVERWhy it’s important to have a sense of community in the LGBTQ space

That’s why many advisers suggest taking a balanced investment approach, putting roughly half your investment dollars in stocks/stock funds and the rest in bonds/bond funds and cash instruments.

Even with a 50-50 split between stocks and bonds, which is fairly conservative, you could fare well over time. This portfolio allocation would have generated an average annual return of 9% including reinvested dividends, over the long haul, according to Morningstar/Ibbotson, which examined a nearly nine-decade stretch ending in 2014.

A full-stock portfolio would have fared better, rising 12% yearly on average, but it also would have lost money more often and would have subjected investors to sharper declines. One investing key is staying put for the long haul, and a 50-50 mix might make it easier to achieve that

Put half your retirement funds into Roth accounts

If you have a lot of money in Roth IRAs or Roth 401(k) options, give yourself a pat on the back.

Money withdrawn from these accounts generally comes out tax free in retirement (after age 59 1/2). It’s also not subject to required minimum distributions later in retirement (after 70 1/2), as is the case with regular IRA and 401(k) money. That means you have greater flexibility in timing withdrawals.

But it’s not always easy to contribute to Roth accounts because you won’t get a front-end tax deduction, as are typically available on traditional IRA and regular 401(k) accounts. As a compromise, consider splitting your retirement contributions between regular (taxable) and Roth (untaxed) accounts.

In fact, when ordinary income-tax rates are fairly low, like now, Roth contributions can make more sense, Campbell said. That’s because the size of the tax deduction you’d give up, by not going the traditional-IRA route, is smaller.

“You definitely want some flexibility” in using both types of accounts, he said.

Both types of accounts have eligibility restrictions centered largely around income, and you would need to have work-related earnings to contribute.

Cut your debt payments in half

This goal might be more feasible than trying to pay off all your debts at once or within a few years. Refinancing mortgages and other loans at lower interest rates could be one option, especially now that rates are dropping again. And if you must borrow further, take out smaller loans if possible.

Auto loans are a case in point. Yes, interest rates are low, but vehicles are depreciating assets, and you probably don’t want to lock in terms of 72 or even 84 months. 

“If you’re looking at 72 months or longer, you’re probably buying more car than you can afford,” said Mike Sullivan, a consultant with Take Charge America, a Phoenix credit-counseling firm. With loans that long or longer, you risk having to continue making payments well after the vehicle has lost most of its value.

New vehicles on average sell for about $33,000, according to researcher J.D. Power. Labor Day weekend is one of the peak shopping periods.

Sullivan also cautions that dealer financing often is more costly than shopping around for a vehicle loan. But if you feel you must take the dealer-loan option, consider refinancing it later through a bank or credit union, he suggests.

With credit cards, Sullivan suggests paying off your most costly cards first, then moving to those with the next highest interest rates. Another option is to pay off the lowest-balance loans first, so that you feel like you’re making progress psychologically.

Debt, rather than a lack of income, is one reason a lot of middle-class people complain of feeling cash-strapped.

One in six households earning $100,000 or more said they would have trouble meeting even an unexpected $400 expense, according to a 2017 Federal Reserve study. These households typically do have more than $400 in assets. But because of debt burdens, they often don’t feel they can afford new expenses.

Saving for retirement is a lifelong process. One-third of Americans think they’ll need between $1 million and $3 million saved to retire comfortably, according to a report from Charles Schwab, and saving that much cash takes decades of hard work.

But when you’re young and just starting your career, retirement is likely the last thing on your mind. It’s easy to put off saving for another day, especially when you may have a mortgage, children’s expenses, student loans, and a laundry list of other financial responsibilities to think about. Put it off too long, though, and before you know it you’ll be just a few short years away from retirement with little to nothing saved for your golden years.

Although it’s never too late to save at least something for retirement, it’s also never too early. The earlier you begin, the easier it is to build a strong and sturdy nest egg for the future.

The most common age to begin saving

Nearly 4 in 10 workers started saving for retirement in their 20s, a recent survey from Morning Consult found. Roughly one-quarter began in their 30s, and another quarter waited until their 40s or beyond to start saving. Also, 8% of workers stared very young, before age 20.

A separate survey from Nationwide found that among all American workers, the average age to start saving was 31 years old. That’s promising news, because if you start saving in your early 30s, you’ll still have several decades to build your retirement fund. Wait much longer than that, however, and you’ll need to save a lot more each month to reach your retirement goals.

For example, say you want to retire at age 65 with $700,000 in your retirement fund. If you started saving at age 31, you’d need to save around $450 per month, assuming you’re earning a 7% annual rate of return on your investments. But if you waited until age 40 to begin saving, you’d need to save roughly $925 per month to reach your goal. Delay until age 50, and you’d have to save approximately $2,300 per month.

Even if retirement seems far away, it will be here before you know it. And saving for retirement isn’t something you can do overnight — or even with 10 to 15 years of preparation. It takes several decades of saving consistently to create a nest egg worth hundreds of thousands of dollars, and the longer you put off saving, the harder it will be to catch up.

How to catch up if you’re off to a late start

If you’re behind on your savings, all hope is not lost. There are a few things you can do to make sure you can afford to live a comfortable, enjoyable retirement.

First, create a budget to map out all your expenses and see if there are areas where you can make cuts. Depending on how far behind you are on your retirement planning, you may need to make minor cuts or significant sacrifices to save as much as you should.

Sometimes, all it takes is multiple small adjustments to save a lot more each month. Divide your costs into different categories based on how necessary they are, and try to trim your expenses by at least a few dollars in each category. If you’re seriously behind on your saving, you might need to take more drastic measures — like selling your car or downsizing your home. If you’re unable to save anything more now, just remember that you’ll likely need to make major sacrifices in retirement. With little to nothing saved, you may end up depending on Social Security benefits to get by. And when the average check amounts to just $1,471 per month, you could find yourself struggling to make ends meet.

That said, Social Security can help make retirement a little more comfortable financially. Though you won’t be able to depend on it for all your expenses (your benefits are designed to replace only around 40% of your preretirement income), it can help bridge the gap between what you have and what you need. And if you don’t have much in terms of personal savings, you may be able to boost your Social Security benefits to make up for it.

One way to do that is to delay claiming benefits. The only way to receive the full benefit amount you’re entitled to is to claim at your full retirement age (FRA). Claim before that (as early as age 62), and you’ll receive a reduction in benefits of up to 30%. But delay past your FRA (up to age 70), and you’ll receive extra money each month in addition to your full benefit amount. If you’re struggling to save, that boost in benefits can go a long way.

There’s never a perfect time to save for retirement. When you’re young, you may think you have plenty of time. But it takes longer than you may think to prepare for the future, especially as retirement becomes more expensive. No matter your age, the key is to simply get started now.

The calculations used to craft a traditional retirement plan assume that you’ll work well into your 60s and draw income from your savings to fund your remaining two to three decades.

But what if you’re not planning a conventional retirement? What if you’re interested in financial independence at a much earlier age? That is the goal of those in the increasingly popular FIRE movement, an acronym for “financial independence, retire early.”

Financial planning for early retirement

Planning for early retirement isn’t simply about setting super-aggressive savings targets (as in half or more of your household income, compared with the standard recommendation of 10% to 15%), although that’s a big part of it.

It’s also about building a portfolio that can accommodate an extended period of withdrawals, thinking differently about retirement income streams and navigating tax laws that expect you to wait until your late 50s to take retirement account distributions.

In other words, it requires a different approach to traditional financial-planning rules.

Here are five tips to help you turn a traditional retirement plan into an early-retirement plan:

1. Plan on earning extra income

Work after leaving the workforce? That may sound contradictory to the early-retirement dream, but it’s more common in the FIRE community than you might think.

Financial planners say clients who are driven enough to achieve financial independence by 35 or 40 almost always are doing something that brings in money.

“You can only golf and sail so much before you get bored,” says Mike Rauth, founder of North Haven Financial in Scarborough, Maine.

Part of Rauth’s planning process is helping clients identify meaningful work to avoid retirement boredom. When you’re financially independent, working differs from pre-retirement employment: With less pressure to earn an income right away, you’re free to pursue work that you love, even if it’s not lucrative.

2. Focus on the right financial independence number

A popular concept in the FIRE community is reaching your financial independence number — an audacious savings goal based on the “rule of 25,” which says you’re financially self-sustainable when you’ve saved 25 times your planned annual spending going forward.

In practice, that means if you need $40,000 a year to cover your expenses, your financial independence number is $1 million.

Daniel Kenny, founder of FI-nancial Planner in Sterling, Va., a firm with a focus on FIRE-oriented planning, reframes the equation for his early-retirement clients. He has them focus on their income number.

If you earn $10,000 a year in retirement and subtract that from a $40,000 annual spending need, you only need to draw $30,000 from savings. Based on the rule of 25, that reduces your savings goal from $1 million to $750,000. (A good retirement calculator can help calculate your savings needs.)

3. Lower your withdrawal rate

Another traditional retirement rule of thumb is the 4% withdrawal rule — the amount a retiree can safely withdraw from their nest egg during the first year of retirement. Each following year, that amount is adjusted for inflation.

Based on historical data, your savings should last as long as you do if you follow the 4% guideline. But that rule assumes you’re going to be retired for 30 years, not five decades.

Lowering your withdrawal rate can set off a positive chain reaction: The less money you withdraw, the longer your savings remains invested, giving your balance a chance to continue to grow.

Using the $40,000 scenario above, reducing your spending by, say, $500 a month ($6,000 a year) means you only need to pull $34,000 a year from your investments. That lowers your portfolio withdrawal rate to 3.4%, which, according to Kenny, is more in line with a 50-year retirement time horizon.

4. Diversify your investments to ride out market downturns

A poorly timed stock market downturn can put your main income source in retirement — your portfolio — at risk no matter what age you are when you quit the traditional 9-to-5 grind. But it can be particularly disastrous if that downturn happens early in your retirement, Rauth says.

Diversifying your investment portfolio among stocks, bonds and cash will lessen the long-term damage of a downturn. But even better is letting your investments ride it out while that downturn is happening.

Setting up income sources that aren’t as exposed to market risk — like a bond ladder, or buying bonds that have staggered maturity dates — can help you avoid having to sell investments at a loss. So can having a ready stash of cash in a high-yield savings account to cover expenses.

Down the road, you’ll be eligible to take advantage of other income sources, including Social Security and tapping into the equity in your home via a reverse mortgage. On the latter, Rauth recommends a Home Equity Conversion Mortgage, which is insured by the Federal Housing Administration, because it allows you to draw on the line of credit only when you need it.

5. Pick your investment accounts wisely

Unqualified withdrawals from tax-favored retirement accounts like an IRA or 401(k) before age 59 1/2 will cost you a penalty equal to 10% of the amount you withdraw on top of the income taxes you’ll owe the IRS.

The good news: The higher savings rate among FIRE devotees means many are maxing out those retirement accounts and investing additional savings in taxable accounts. You can take money out of a taxable account at any time, so most early retirees will want to draw from these accounts first.

Another option is a Roth IRA, which has more lenient distribution rules — contributions can be withdrawn at any time. With some fancy footwork, you can also move money from traditional IRAs (and 401(k)s with former employers) into a Roth IRA. This is called a Roth IRA conversion. You’ll pay income taxes when you convert the money, but you’ll be able to pull it out tax- and penalty-free after five years. Kenny recommends a strategy called Roth laddering — converting just a portion of money each year — to spread out the tax burden over a handful of years.

One of you may be living as a survivor for a long time. Are you prepared?

Here’s a question for couples whose retirement is imminent. You think you’ve got it all figured out. Now, what’s your widowhood plan?

There’s a good chance one of you will be alone for a decade. This has an impact on both your budget and the matter of who’s managing the finances.

I thought of this recently on running into a small-business owner I know who’s 66. How is your 401(k) invested? I asked.

I was warming up to deliver a lecture about switching to lower-cost funds. I didn’t get the chance, because this guy didn’t have a clue about his funds. He explained that all of his finances, including billing, taxes and investing, are handled by his wife.

A fine arrangement for now, but if she dies young he will be not just grieving but helpless.

Financial management is one matter, budgeting another. How much will the household’s spending go down when one of you dies? How much will the income go down?

Start by contemplating some actuarial odds. When I look at my own family tree, I see women consistently outliving their husbands, typically by a dozen years or so. One of my great-grandmothers was a widow for 29 years.

Some widowhoods last much longer than that. The last widow to collect a Civil War veteran pension was a woman who outlived her husband by 65 years.

Will your widow(er) be well provided for? That should be at the top of mind in the decision about when to collect Social Security. If you’re turning 62 this year, you can start now. But you’d boost your benefit 76% by waiting until age 70 to collect.

You might think that if your health is poor it makes sense to start early. But if you are married to a healthy, lower-earning spouse, early benefits are probably a mistake. When you depart, your spouse will collect whatever you were collecting. (Survivors get the higher of their own retirement benefit or the decedent’s, not the sum of the two.) She or he may be living with your choice for 29 years.

I’ve gathered the economics of early versus late claiming in a Social Security calculator. Open the file in Google Sheets, make a copy, then enter ages, genders and other data in the copy. You will probably find that early collecting chops $100,000 or more out of your family’s expected payoff.

A similar trade-off comes into play with a corporate pension. Do you take $4,000 a month for your life only or $3,200 with a joint and survivor annuity? The latter might be the better deal. I have a guide for that decision, too: see the pension calculator. Same Google Sheets procedure.

The pension calculator has a feature useful to retirees with or without a corporate pension: On line 24 it provides a number for expected widow(er)hood, in years. The number is based on a couple’s ages, health statuses and genders.

My arithmetic uses a simplifying assumption, that a couple’s death dates are independent. That’s not the case, since there is such a thing as dying of heartbreak (like George H.W. Bush not living long after Barbara passed away). But the shortcut doesn’t do too much damage to reality. You’ll probably see a double-digit number for years lived alone.

I’ll close with two pieces of advice for that small-business owner, or any other couple in which one person makes all the investing decisions.

The first rule is to own only things that have a price you see quoted every day. U.S. Treasury bonds are okay. Stocks, like shares in Apple or AT&T, are okay. Mutual funds and exchange-traded funds are okay.

Not okay: complicated things sold by stockbrokers. Those would include hedge funds and indexed annuities. Something with a 60-page prospectus and a name like Enhanced Yield Protected Insured Portfolio III is almost certainly a bad buy, although you’d need a roomful of mathematicians to find out why.

The second rule, aimed at the survivor who never before had to make financial decisions solo, is to pay for advice by the hour. Most financial planners would prefer to pocket a percentage of your assets. Don’t agree to that. Hourly advisors are scarce but not impossible to find.