Archives for October 7, 2019

Chocolate or vanilla? Coke or Pepsi? Cheeseburger happy meal or chicken nuggets, and so on. We Americans love choices.

Retirement is no different. As we head into unchartered waters, as a tax attorney, it’s clear that our tax choices in building our retirement are the most important.

With designated retirement accounts, we really have two tracks – the employer-platform track and the individual track. Most typically, these break down into the 401(k) and the IRA (Individual Retirement Account).

The two tracks: 401(k) and the IRA (Individual Retirement Account)

IRAs were created in 1974, the 401(k) in 1978, but we didn’t get options within them until the late Senator Roth spurred the creation of the Roth IRA, some 20+ years later in 1997. And the Roth 401(k) is the newest kid on the block, just available in 2006.

Traditional IRAs and 401(k)s are pre-tax – meaning that your contribution is made with current earnings that escape present income taxation, deferring those taxes until you withdraw the funds in retirement.

(If you withdraw funds before 59½ years old, you pay the tax plus a 10 percent tax penalty, unless you have separated from your employer at age 55 or older and withdraw the funds directly from a 401(k) – not an IRA.)

With the Roth versions, your contributions are made with after tax funds, where you pay the income taxes first and the net amount is invested. Although less goes in upfront, your original investment plus all of its earnings come out tax free.

Americans have gotten addicted to kicking the can down the road by paying taxes later – now is the BEST time since the Reagan years to pay taxes, because President Trump’s tax reform lowered rates and widened brackets.  – Rebecca Walser, tax attorney and CFP

Best time to pay taxes in decades

THAT IS HUGE – as the CBO reported in 2008 that tax rates will need to rise enormously as the Baby Boomers retire en masse, which really starts in 2022. And while Americans have gotten addicted to kicking the can down the road by paying taxes later – now is the BEST time since the Reagan years to pay taxes, because President Trump’s tax reform lowered rates and widened brackets.

The Roth has some special rules – like you cannot access growth tax free until you have had a Roth for at least five years and your 401(k) employer match, if you get one, will still go into the traditional 401(k).

There are also income limits on utilizing an IRA, although increased in 2019, but there are no income limits on a Roth 401(k) – so you cannot be income phased-out like you can with a Roth IRA.

And the Roth, because the tax has already been paid, eliminates the requirement of RMDs (required minimum distributions) at age 70½ – providing much more flexibility.  And if you have already built your dollars in the traditional accounts, then a Roth conversion could be an excellent option – if it fits your circumstances.

And Roth IRAs eliminate the requirement of RMDs at 70½ – providing much more flexibility.

The bottom line is retirement strategy now goes well beyond just making contributions.

We must especially prepare for the tax consequences we’ll face once we are living off those funds in retirement and that means we should consider whether to leverage the beneficial Trump tax table now, or take our chances on where taxes are headed in the future, knowing the government has already told us that they must go up.

Struggling to save enough for retirement seems to be just part of the human experience for the majority of Americans. Six in 10 say they’re behind on savings and need to catch up, according to a recent TD Ameritrade survey. Most of them understand the importance of saving for their future and are willing to do what is necessary to ensure they have enough. But some are not.

One of the most troubling statistics to come out of the survey was that 13% of Americans are unwilling to make any concessions to store up their retirement savings. Many of these individuals said they’re more interested in cutting their expenses in retirement than before they retire. This is a dangerous attitude that could cost them a lot more than they realize.

Why you need to be willing to make sacrifices for your retirement savings

Your retirement savings are going to keep a roof over your head and food on your table. They’re also going to pay for your medical bills, clothing, and other essentials. You don’t want to gamble that you won’t have enough. 

It might sound more appealing to put off cutting costs until retirement or to work longer so you don’t have to save more now. But chances are, when you reach the age where you have to start making sacrifices, you’ll wish you’d planned better when you were younger. A part-time job or slashing expenses might not be enough if you’re way behind on retirement savings. 

If you can’t care for yourself, you’ll have to fall back on government assistance or your children. Supporting you could prevent your children from providing for their own kids or saving for their retirement, so you’ll pass your own misfortune on to future generations. But that doesn’t have to happen if you’re willing to make small changes today.

Easy ways to save more for retirement

Small lifestyle changes can make a big difference to your retirement savings if you’re serious about sticking with them and putting the money into a retirement account. The TD Ameritrade survey suggests several concessions that people could make to free up more cash for retirement, including packing lunch, brewing coffee at home, cutting back on vacations, and using public transit whenever possible instead of driving your own vehicle.

More-drastic measures include limiting discretionary purchases and downsizing your home. It’s worth considering if you’re far behind on retirement savings.

An alternative to slashing your expenses is to look for ways to increase your income and then put those additional earnings toward your future. Extra jobs are becoming increasingly popular, and they don’t always require a lot of work. If you own an extra property or have a spare room, you could rent it out for some easy cash. Just make sure to save a portion of your earnings for taxes. If you’ve had a side business in the past, your prior-year tax return should tell you how much you must pay quarterly this year to avoid penalties. Otherwise, you can fill out Form 1040-ES to estimate what you’ll owe.

You could also work overtime at your regular job, pursue promotions, or switch employers or careers to increase your income. Always prioritize your retirement savings before increasing spending on other things.

Making sacrifices today for a benefit you won’t even realize for years, possibly for decades, is tough for many. But those sacrifices don’t always have to be large to make a difference. Try some of the above tips, and if you can’t stay motivated to save, remember the bigger picture — you’ll be glad you did when you’re finally ready to leave the workforce.

Millennials — the selfie obsessed, avocado toast-loving generation — might be behind slower economic growth, according to a research note last week from Raymond James. This new generation, scarred by the financial crisis, is saving more than the free-spending boomers did before them, and it’s causing an economic imbalance.

According to data from the St. Louis Federal Reserve, the current U.S. personal savings rate, defined as income minus spending, is 8.1% as of August. By comparison, in 1996 the rate was 5.7%.

“The higher savings rate, we believe, has had disinflationary impact, driving the relatively slow growth and low inflation in this recovery … causing the incentives for excess supply, and disinflation/deflation biases in the global economy,” Raymond James analyst Tavis McCourt wrote in a note to clients Thursday.

One of the earliest financial lessons people learn is that saving early and often is key.

However, while saving is beneficial for individuals, a slowdown in spending hurts businesses and therefore the economy. Since the recession “supply increases have continued,” which coupled with a higher savings rate has led to “excess supply seemingly everywhere in the economy,” McCourt notes.

“This leads to frustratingly low growth, deflationary biases in prices, excess supply, and increasing debt from the supply side attempts to improve the situation because the savings rate is going higher,” he said.

McCourt chalks up the increase in savings to a “generational change.” Following the financial crisis, millennials began to save more, and this habit is becoming increasingly important as they replace “baby boomers as the primary income and spending generators.”

“The U.S. consumer has had enough, so they are saving instead of purchasing like last generation, limiting demand growth,” he said.

And it’s not only a problem in the United States. China also has a relatively high personal savings rate which hurts the global outlook given the size of the country’s economy and its rapid rate of growth.

“So, what we have is a global increase in personal savings rate, which has caused excessive supply increases globally [disproportionally in China], and U.S. consumers wanting to save more [to be less insane than the last decade], which makes trade deficits less severe than they would be otherwise, growth to be slower than expected for both economies, and inflation to be lower than what it would be otherwise,” McCourt explained.

While the U.S. personal savings rate might be rising, the national savings rate as a percentage of Gross Domestic Product was around 18% as of 2016, according to data compiled by the IMF. By comparison, Great Britain’s rate was around 13%, while Japan and China’s were 27%, and 46%, respectively.

Social Security is so vital to so many people’s retirement plans, and yet is so shrouded in uncertainty. Some of this is beyond our control, but you have more power than you think when it comes to determining the size of your checks. Understanding how your decisions affect your Social Security benefits can help you avoid devastating mistakes that could cost you tens of thousands of dollars over your retirement.

Here are three of the most common — and costly — Social Security mistakes you can make.

1. Retiring without considering the consequences to your benefits

Your Social Security benefits are based on your average monthly income during your 35 highest-earning years with adjustments for inflation. This is called your average indexed monthly earnings (AIME). If you haven’t worked for at least 35 years, the Social Security Administration adds a zero to your calculation for every year you didn’t work, which can bring down your AIME considerably. This, in turn, reduces your Social Security benefit checks, possibly by tens or even hundreds of thousands of dollars over your lifetime, depending on how many years you actually worked.

If you work less than 10 years, you could disqualify yourself from Social Security altogether, although you still might be eligible for spousal benefits if your spouse has worked enough years to qualify for Social Security. For most people, a spousal benefit — which is half of your spouse’s Social Security benefit — is less than what they’d be entitled to based on their own work records if they worked for at least 10 years, so it’s best to pursue your own benefit whenever possible.

Try to work for at least 35 years, and longer if you can. If you work more than 35 years, your lowest-earning years will drop off of your record to be replaced by higher-earning years. This will give your benefits a boost that will continue to pay dividends for years to come.

2. Not coordinating your Social Security plan with your spouse

The age at which you begin taking Social Security also affects your benefits. In order to get your full benefit, you must wait until your full retirement age (FRA), which is 66 or 67 for today’s workers. You can start as early as 62, but you’ll only get 70% or 75% of your scheduled benefit per check depending on whether your FRA is 67 or 66, respectively. Delaying benefits past your FRA increases the number on your checks until you reach the maximum benefit of 124% of your scheduled benefit for a FRA of 67, or 132% for a FRA of 66 at age 70.

Single individuals only have to decide when they want to start benefits, but married couples have to consider how their decision will affect their spouse, especially if their spouse is planning to claim benefits on their work record. It’s best to coordinate with your spouse in advance so you can better estimate how much each of you will get from Social Security. Otherwise, you could accidentally cost one or both of you a lot of money.

A common strategy among couples looking to maximize their benefits is for the lower-earning spouse to begin claiming benefits as soon as they’re eligible, at 62. This enables the higher-earning spouse to delay benefits until 70, when they’re entitled to the largest checks. If the higher earner’s spousal benefit would give the lower-earning spouse more money than they’re entitled to based on their own work record, the SSA will automatically switch them over when the higher-earning spouse applies for benefits. 

If both people earn about the same amount, you can still use this strategy, though it may not make as much of a difference in your lifetime benefits. You might be better off both delaying your Social Security benefits as long as you are able to.

3. Failing to verify the accuracy of your earnings record

The SSA keeps track of how much you’ve paid into the program using your earnings record, which you can view, along with estimates of your Social Security benefits at different ages, by creating a my Social Security account. As part of the government, its information is usually pretty accurate, but mistakes do happen.

If your employer made an error reporting your income, or you’ve changed your name but failed to notify the SSA, your income might not be reported correctly, and your earnings record will indicate that you earned far less than you actually did. This could bring down your AIME and consequently reduce your Social Security benefits. It’s especially problematic if the error indicates that you didn’t earn any money at all for a year that you know you worked.

Check your Social Security earnings record at least once per year, and compare the information listed there against your own records. If you notice a mistake, contact the SSA and gather paperwork, like your W-2, a tax return, or wage records, to indicate how much you earned throughout the year in question. You typically have three years, three months, and 15 days from the end of the year to correct the error.

Most people think the size of their Social Security checks is largely up to the government, but this attitude could lead you to overlook the power you do have and, consequently, make mistakes that prove costly later. If you haven’t yet made a plan for taking Social Security or checked your Social Security earnings record, do so now.