Rethink Your Car Expenses

Posted On April 13, 2015 By Admin In Financial Planning / 1 Comment

“Don’t be penny wise and pound foolish.”

This old nugget of wisdom remains relevant today with many people feeling frustrated that even with a decent income, it seems so difficult to save as much as we’d like for retirement and our other financial goals. Rather than worrying about the pennies, I think investors who want to increase their saving are best served by focusing on their two biggest expenses: their home and cars.

Although not a great investment, a home is generally an appreciating asset and offers some valuable tax deductions. It is possible to have too much home and be house rich and cash poor, but our focus is better first directed on car expenses. I love cars, as do most Americans. A car represents freedom, and as a kid, I couldn’t wait to learn to drive. I took my drivers permit test right on the day of my 16th birthday. We view our cars as a representation of our self, our status, and our importance. Yes, even Financial Advisors are guilty of this irrational vanity! (Or is it insecurity?)

Unfortunately, a car is a depreciating asset and often our biggest expense outside of our home. New car prices seem to have outpaced wage growth, and everyone always wants the latest and greatest. We have to set priorities for how we use our income, and any money we spend on a car is gone. You won’t get it back, it’s just flushed away. That’s money we can’t invest and can’t use to create our future independence and income. If you want to have more of your money working for you, it pays to be smart about your cars. Here are five ways to keep your automotive expenses down.

1) Keep what you have. Cars greatest depreciation is in their first 3-5 years, so if you can keep your car longer, your annual costs will be lower. The more frequently you replace your cars, the more expensive it will be. That’s the number one thing you can do: keep your vehicles 7-12 years. The more often you sell one car and buy another, the higher your costs over time.

2) Don’t fear the occasional repair. Today’s cars are more dependable and long-lasting than ever. Psychologically, people hate repairs, since they seem to always occur at the most inopportune moments. Many people would rather spend $500 a month on a new car payment rather than risk having $1,000 to $2,000 a year in maintenance and unplanned repairs. Does it make sense to spend $6,000 a year to avoid spending $2,000? Probably not, but this is what you are doing if you think that you must sell a car as soon as it is past its warranty.

It’s true, it feels much worse to spend $2,000 on an unplanned repair than to spend the same amount in scheduled car payments. In behavioral finance, this is called “prospect theory”, where people feel the impact of a loss much more severely than the benefit of an equivalent gain. Unfortunately, this can lead to less than ideal decisions, such as buying a $40,000 car because we’re upset over a $400 repair.

If a car is in relatively good shape, it will most likely be cheaper to keep a car with 100,000 miles on the road, rather than replacing it with a new car.

3) Pay cash for your cars. Most people don’t want to spend $60,000 on a new car, even though we all want that $60,000 car. I’d like to first point out the opportunity cost here. At a hypothetical 8% rate of return, spending $60,000 today on a car means not having $120,000 in 9 years, $240,00 in 18 years, or $480,000 in 27 years. That’s a steep price for a car. Which would you rather have, a new car today or potentially an additional $480,000 at retirement?

The strategy of paying cash for cars isn’t just about saving on interest payments; it’s about changing your behavior. Paying cash will force you to spend less, to look at used cars, and to keep your current car longer. Too often, I hear people brag that they got a new car and kept their payment the same. So what! Your current payment was going to end – all you’ve done is keep yourself in debt for another 5 or more years.

If you currently have a car payment, once your payments end, set aside that monthly amount in a savings account for your next car. Paying cash forces you to delay buying a new car. Otherwise, it’s very easy to take a loan for a new vehicle and then rationalize why you “needed” a new car.

4) Save money on maintenance. If you’re handy with tools, you can save a lot of money by doing some routine maintenance yourself. My dealership wanted $499 for a 30,000 mile service consisting of an oil change, tire rotation, brake fluid change, and replacement of two air filters. I did the work myself and spent less than $70 on materials. Oil changes are cheap, so you can’t save much there, but you can save a lot if you learn to replace your brakes.

Don’t try to save money by skipping preventative maintenance. Make sure you change all fluids on the factory recommended schedule. Even if you do some work yourself, I’d also suggest developing a good relationship with an independent mechanic who you trust to give you honest advice.

5) Know when to buy new, buy used, or lease. The price of used cars has skyrocketed in recent years. It used to be that a 1-year old car had lost 20% or more of its value. Today, that can be under 10% for some popular makes and models. This increased residual value has changed some of the old rules about car buying. A gently used 2-3 year old car is, in many cases, not the bargain that it was 10 years ago. In those situations where resale value is very high, you might actually consider buying new. This will improve your future resale value, keep you under warranty longer, and possibly offer better terms on any financing. If you’re planning to keep the car for a long time (7-12 years), starting with a new car can be a good decision.

Buying used cars used to be an easy way to save 30% or more. There are still some good deals on used cars, but consider dependability, any remaining factory warranty, and the cost of maintenance on used vehicles. If you get bored with vehicles after a couple of years, used cars will have less depreciation than buying new.

Leasing is more expensive than keeping your cars for as long as I’d suggest. However, it is still a good alternative to buying a new car every three years, provided you drive fewer miles than stipulated in your lease agreement (often 10,000 or 12,000 miles per year). For models with high residual values, lease rates have stayed low.

Manage your car depreciation like you would any other liability. At the end of the day, a car is just a way to get from point A to point B. It doesn’t define us, who we are, or what our value is to our family or society. If you have other priorities like retiring early, buying a vacation home, or making your first million (or your second or third million), recognize when your car buying is not helping you get closer to achieving your more important goals.

Which IRA is Right For You?

Posted On April 6, 2015 By Admin In Retirement Planning / 3 Comments

We talk about Individual Retirement Accounts (IRAs) regularly, yet even for long-time investors, there are often some gaps in understanding all your options. This means that many investors are missing chances to save money on taxes, which is the primary advantage of IRAs versus regular “taxable” accounts.

Here’s a primer on the six types of IRAs you might encounter. For each type of IRA, I’m including an interesting fact on each, which you may be something you haven’t heard before! All numbers are for 2015; call me if you have questions on 2014 eligibility.

1) Traditional IRA. This is the original IRA, yet has the most complicated rules. Anyone can contribute to a Traditional IRA. Contributions grow tax-deferred and then you are taxed on any gains when the money is withdrawn.

The confusing part of the Traditional IRA is whether or not you can deduct the contribution from your income taxes. If you are in the 25% tax bracket, a $5,500 contribution will reduce your taxes by $1,375. Anyone can contribute, but not everyone can deduct their contribution. Here are the rules for three scenarios:

a) If you are not eligible for an employer sponsored retirement plan (and your spouse is also not eligible for one), then you (and your spouse) can deduct your IRA contributions.

b) If you are covered by an employer sponsored retirement plan, you can deduct your contribution if your Modified Adjusted Gross Income (MAGI) is below $61,000 (single), or below $98,000 (married, filing jointly).

c) If your spouse is covered by an employer sponsored plan, but you are not, you can deduct your contribution if your joint MAGI is below $183,000.

I suggest avoiding non-deductible contributions to a Traditional IRA as the deduction is the main benefit. If you’re eligible for a Roth IRA, never make a non-deductible contribution to a Traditional IRA. Non-deductible contributions create a cost basis for your IRAs, which you will have to track for the rest of your life. It’s a headache you don’t need.

Spouses can contribute to an IRA based on joint income, even if they do not have an income of their own. You cannot contribute to a Traditional IRA in the year you reach age 70 1/2. At that point, you must start Required Minimum Distributions. A premature withdrawal, before age 59 1/2, is subject to a 10% penalty, in addition to any income taxes due.

Interesting Fact: A Rollover IRA is a Traditional IRA. You can roll a 401(k) or other employer sponsored plan to a Traditional IRA or a Rollover IRA; they receive the same treatment. 401(k) plans are governed by Federal ERISA rules, whereas IRAs are protected under state creditor laws. If you want to remain under the Federal Regulations, you should designate the account as a “Rollover IRA” and not commingle with a Traditional IRA. I consider this step unnecessary. In Texas, we have robust protection for IRAs, so you are not at risk by consolidating accounts into one Traditional IRA.

2) Roth IRA. In a Roth IRA, you contribute after-tax dollars, so there is no upfront tax deduction. Your account grows tax-free, and there is no tax due on withdrawals in retirement. The Five Year Rule” requires you to have had a Roth open for at least 5 years before you can take tax-free withdrawals in retirement. So, if you open a Roth at age 58, you would not be able to access tax-free withdrawals until age 63.

Not everyone is eligible to contribute to a Roth IRA. To be eligible for a full contribution, your MAGI must be below $116,000 (single), or $183,000 (married).

Interesting Fact: There are no RMDs on Roth IRAs and no age limits. Even after age 70 1/2, you can contribute to a Roth IRA (provided you have earned income) or convert a Traditional IRA to a Roth.

3) “Back Door” Roth IRA. This is not a separate type of account, but rather a funding strategy. If you make too much to contribute to a Roth IRA, you can fund a Non-Deductible Traditional IRA, then immediately convert the account to a Roth. You pay taxes on any gains, but since there were no gains, your tax due is zero. Very important: the conversion is only tax-free if you do not have any existing Traditional IRAs.

Both Traditional and Roth IRAs are subject to a combined contribution limit of $5,500, or $6,500 if age 50 or older.

Interesting Fact: Thinking of rolling your old 401(k) to an IRA? Don’t do it if you might want to do a Back Door Roth in the future. Rolling to an IRA will eliminate your ability to do a tax-free Roth conversion. Instead, leave your old 401(k) where it is, or roll it into your new 401(k).

4) Stretch IRA, also called an Inherited IRA or a Beneficiary IRA. If you are named as the beneficiary of an IRA, the inherited account is taxable to you. If you take the money out in the first year, it will all be taxable income. With a Stretch IRA, you can keep the inherited IRA tax-deferred, and only take Required Minimum Distributions each year. Note that Stretch IRA RMDs are based on the original owner’s age, so you cannot use a regular RMD calculator to determine the amount you must withdraw.

Interesting Fact: a spouse who inherits an IRA from their deceased spouse does not have to do a Stretch IRA. Instead, he or she can roll the IRA into their own account and treat it as their own. This is especially beneficial if the surviving spouse is younger than the decedent.

5) SEP-IRA. SEP stands for Simplified Employee Pension. A SEP is an employer sponsored plan where the employer makes a contribution of up to 25% of the employee’s compensation, with a contribution cap of $53,000. Since it is an employer plan, you cannot discriminate and must make the same contribution percentage for all employees. As a result, pretty much the only people who use a SEP are those with no employees. The SEP is most popular with people who are self-employed, sole proprietors, or who are paid as an Independent Contractor via 1099 rather than as an Employee via W-2.

Let’s say you have a regular job and also do some freelancing as an Independent Contractor. You can contribute to the 401(k) through your employer AND contribute to the SEP for your 1099 work. You can also do a SEP in addition to a Traditional or Roth IRA.

Interesting Fact: The SEP is the only IRA which you can fund after April 15. If you file a tax extension, you have until you file your taxes to fund your SEP. We can accept 2014 SEP contributions all the way up to October 15, 2015.

6) SIMPLE IRA is the Savings Incentive Match Plan for Employees. It’s like a 401(k), but just for small businesses with fewer than 100 employees. Employees who choose to participate will have money withheld from their paycheck and invested in their own account. The employer matches the contribution, up to 3% of the employee’s salary. This is a great option for small businesses because the costs are low and the administration and reporting requirements are easy. The 2015 contribution limit is $12,500, or $15,500 if over age 50.

Interesting Fact: Traditional and SEP IRAs have a 10% penalty for premature distributions prior age 59 1/2. For a SIMPLE IRA, if you withdraw funds within two years of opening the account, the penalty is 25%. Contributions made by both the employee and employer are immediately vested, so the high penalty is to discourage employees from raiding their SIMPLE accounts to spend the employer match.

IRAs are a very important tool for wealth accumulation, yet a lot of investors miss chances to participate and maximize their benefits. Since the contribution limits are low, it can be tough to make up for lost years. Your best bet: meet with me, bring your tax return and your investment statements and we can discuss your options.

Our Investment Process

Posted On April 1, 2015 By Scott Stratton, CFP(R), CFA In Portfolio Management / 1 Comment

An investment approach designed to support retirement income planning, tax considerations, and long-term decision-making.

Request an Introductory Conversation 👉 /appointment/
A brief introductory call to see if working together may be appropriate.

How We Think About Investing in Retirement

For retirees and pre-retirees, investing often serves a different purpose than it did during the accumulation years. Rather than focusing solely on growth, investment decisions are typically made in the context of income needs, taxes, time horizons, and long-term flexibility.

Our investment process is designed to support broader financial planning conversations — particularly retirement income planning and tax planning — rather than operate as a standalone strategy.

Our Investment Process in Practice

Step 1: Understand the Planning Context

Investment decisions begin with an understanding of your broader financial situation, including retirement timing, income needs, tax considerations, and existing accounts.

Step 2: Establish an Appropriate Investment Strategy

Based on the planning context, we develop an investment strategy aligned with time horizons, cash flow needs, and long-term objectives — rather than short-term market movements.

Step 3: Portfolio Construction

Portfolios are constructed using diversified investments intended to reflect the agreed-upon strategy, account types, and planning considerations.

Step 4: Ongoing Monitoring and Adjustment

As circumstances, markets, and planning needs evolve, portfolios are monitored and adjusted as part of an ongoing planning relationship.

How Investment Decisions Are Coordinated With Planning

Investment management does not exist in isolation. Portfolio structure influences how retirement income is generated and how taxes are experienced over time. For this reason, investment decisions are coordinated with retirement income planning and tax planning considerations whenever appropriate.

This integrated approach helps ensure that investment decisions are informed by the broader financial picture rather than disconnected objectives.

Retirement Income Planning → /retirement-income-planning/

Tax Planning → /tax-planning/

Who This Investment Approach May Be a Good Fit For

Our investment process is typically appropriate for individuals who:

Are approaching retirement or already retired
Want investment decisions informed by income and tax planning
Prefer an ongoing advisory relationship
Value a fiduciary, planning-centered approach

We work with retirees and pre-retirees nationwide through a virtual advisory relationship.

Next Step

If you are considering how investment management fits into your broader retirement and tax planning, an introductory conversation can help determine whether working together makes sense.

Request an Introductory Conversation 👉 /appointment/
No obligation. Designed for retirees and pre-retirees.

Growth Versus Value: An Inflection Point?

Posted On March 30, 2015 By Admin In Portfolio Management /

Over time, Value stocks outperform Growth stocks. There are a number of reasons why this has held true over the history of the market. Value stocks may include sectors which are currently out of favor and inexpensive. Investors, on the other hand, are sometimes willing to pay too much for a sensational growth story rather than a boring, blue chip company. Often, those great sounding stocks flame out rather than shooting higher as hoped. The result is that the long-term benefit of value strategies has persisted.

Although the “Value Anomaly” is a historical fact, it hasn’t worked in all periods, and we’re at such a point in time now. Growth has actually outperformed value over the past decade. Even though growth beat value in only 5 of the past 10 calendar years, the cumulative difference is notable. Over the past 10 years, the Russell 1000 Growth fund (IWF) has returned an annualized 9.18% versus 7.10% for the Russell 1000 Value (IWD). And so far this year, Growth (IWF) is up 5%, whereas Value (IWD) has gained only 0.63%.

The last time growth showed a marked divergence from value was the 90’s. And at that time, we saw the valuations of growth companies rise to unsustainable levels. This largely occurred in the tech sector, where for example, we saw Cicso trade for more than 200 times earnings, and become the most valuable company in the world in 2000. Eventually, growth corrected with the bursting of the tech bubble, and we saw value stocks return to favor. These are the cycles of the market, as inevitable as the seasons, although not as consistent, predictable, or rational!

I don’t think we’re in bubble territory for the market today, but some popular growth names have certainly started to become expensive and value is looking like a relative bargain. Looking at the top 10 stocks in the both indices, the growth stocks have an average PE of 27, versus 17 for the 10 largest value companies. Some of that difference is Facebook, #4 on the Growth list, with a PE of 75. However, the difference in valuation is across the board. Two of the largest value companies, Exxon Mobil and JPMorgan Chase have a PE of only 11.

So, what are the take-aways from the Growth/Value divergence?

Growth has outperformed value in recent years. This will not continue forever.
Our portfolios are diversified, owning both growth and value segments. We have a slight tilt towards value, which we will continue. When value returns to favor, this will benefit not only pure value funds, but will also likely help dividend strategies, low volatility ETFs, and fundamentally-weighted funds.
As the overall market becomes more expensive, I would expect to see that we will move from a unified market, where all stocks move up or down together, to a more segmented market, where stocks move more based on their valuation and fundamentals. Global macro-economics have been the primary driver of stock prices in recent years, but this should abate somewhat as the recovery continues.

We won’t know if we’ve reached an inflection point, where value will overtake growth, until well after the fact. Growth can’t outperform indefinitely, and as investors become more cautious, value stocks will start to look more and more attractive. That’s what we’re seeing in the market today and why we started to increase our value holdings in 2015.

Source of fund data: Morningstar, through 3/27/2015

How Much Can You Withdraw in Retirement?

Posted On March 24, 2015 By Scott Stratton, CFP(R), CFA In Retirement Planning /

With corporate pensions declining in use, retirees are increasingly dependent on withdrawals from their 401(k)s, IRAs, and investment accounts. The challenge facing investors is how to plan these withdrawals and not run out of money even though we don’t know how long we will live or what returns we will receive in the market on our portfolio.

Pensions and Social Security provide a consistent source of income that you cannot outlive. When I run Monte Carlo simulations – computer generated outcomes testing thousands of possible scenarios – we find that the larger the percentage of monthly needs that are met from guaranteed sources, the lower chance the investor will run out of money due to poor market performance from their portfolio.

If you do have a pension, it is very important to consider all angles when deciding between a lump sum payout and participating in the pension for the rest of your life. It is not a given that you will be able to outperform the pension payments, especially if you are healthy and have a long life expectancy.

The most obvious way to avoid running out of money (called longevity risk by financial planners) would be to annuitize some portion of your portfolio through the purchase of an immediate annuity from an insurance company. While that would work, and is essentially the same as having a pension, very few people do this. You’d be giving up all control of your assets and reducing any inheritance for your beneficiaries. With today’s low interest rates, you’d probably be less than thrilled with the return. For example, a 65-year old male who places $100,000 in a single life immediate annuity today would receive $542 a month.

The problem with annuitization, besides giving up your principal and not leaving anything for your heirs, is that it doesn’t allow for any increase in expenditures to account for inflation. There are three approaches we might use to structure a withdrawal program for a retiree.

1) Assume a fixed inflation rate. In most retirement planning calculators, projected withdrawals are increased by inflation to maintain the same standard of living. After all, who doesn’t want to keep their standard of living? The result of this approach is that the initial withdrawal rate then must be pretty low. 20 years ago, the work of William Bengen established the “4% rule” which found that a withdrawal rate of 4% would fund a 30-year retirement under most market conditions.

On a $1 million portfolio, 4% is $40,000 a year. But that is just the first year. With 3% inflation, we’d plan on $41,200 in year two, and $42,436 in year three. After 24 years, withdrawals would double to $80,000. The 4% rule is not the same as putting your money in a 4% bond; it’s the inflation which requires starting with a low initial rate.

While we should plan for inflation in retirement, this method is perhaps too rigid in its assumptions. If a portfolio is struggling, we’re not going to continue to increase withdrawals by 3% and spend the portfolio to zero. We have the ability to respond and make adjustments as needed.

2) Take a flexible withdrawal strategy. We may be able to start with a slightly higher initial withdrawal rate if we have some flexibility under what circumstances we could increase future withdrawals. In my book, Your Last 5 Years: Making the Transition From Work to Retirement, I suggest using a 4% withdrawal rate if you retire in your 50’s, a 5% rate if you start in your 60’s, and 6% if retiring in your 70’s. I would not increase annual withdrawals for inflation unless your remaining principal has grown and your withdrawal rate does not exceed the original 4, 5, or 6%.

This doesn’t guarantee lifetime income under all circumstances, but it does give a higher starting rate, since we eliminate increases for inflation if the portfolio is shrinking. Under some circumstances, it may even be prudent to reduce withdrawals to below the initial withdrawal amount temporarily. That’s where having other sources of guaranteed income can help provide additional flexibility with your planning.

3) Use an actuarial method. This means basing your withdrawals on life expectancy. Required Minimum Distributions (RMDs) are a classic example of an actuarial strategy: you take your account value and divide by the number of years of life expectancy remaining. If your life expectancy is 25 years, we take 1/25, or 4%. The next year, the percentage will increase. By the time someone is in their 90’s, their life expectancy will be say three years, suggesting a 33% withdrawal rate, which may work, but obviously will not be sustainable. However, the more practical problem with using the RMD approach is that many people aren’t able to cut their spending by 20% if their portfolio is down by 20% that year. So even though it has a sound principle for increasing withdrawals, the withdrawal amounts still require flexibility based on market results.

But there are other ways to use the actuarial concept, and even my approach of different rates at different retirement ages is based on life expectancy. There’s no single method that will work in all circumstances, but my preference is to take a flexible strategy. But this does mean being willing to reduce spending, and forgo or even cut back inflation increases, if market conditions are weak.

We have a number of different tools available to evaluate these choices throughout retirement, but the other key factor in the equation is asset allocation. Bengen found that his 4% rule worked with equity allocations between 50% and 75%. Below 50% equities, the portfolio struggles to keep up with inflation and withdrawals become more likely to deplete the assets in the 30-year period. Above 75% equities, the portfolio volatility increases and rebalancing benefits decrease, increasing the number of periods when the 4% strategy would have failed.

When sorting through your options, you need candid and informed advice about what will work and under what circumstances it would not work. We hope for the best, but still have a plan for contingencies if the market doesn’t cooperate as we’d like. We will be able to consider all our options as the years go by and be proactive about making adjustments and corrections to stay on course. For any investor planning for a 30-year retirement, it’s not a matter of if the market will have a correction, but when. It’s better to have discussed how we will handle that situation in advance, rather than waiting until the heat of the moment.

Deferral Rates Trump Fund Performance, Rebalancing as Key to Retirement Plan Success

Posted On March 16, 2015 By Admin In Retirement Planning /

A study by the Putnam Institute, “Defined Contribution Plans: Missing the forest for the trees?” contends that while a number of variables, such as fund selection, asset allocation, portfolio rebalancing, and deferral rates all contribute to a defined contribution plan’s effectiveness — or lack thereof — it is deferral rates that should be placed near the top of the hierarchy when considering ways to boost retirement saving success.¹

As part of its analysis, the research team created a hypothetical scenario in which an individual’s contribution rate increased from 3% of income to 4%, 6%, and 8%. After 29 years, the final balance jumped from $138,000, to $181,000, $272,000, and $334,000, respectively.

Even with a just a 1% increase — to a 4% deferral rate — the participant’s final accumulation would have been 30% greater than it would have been using a fund selection strategy defined as the “Crystal Ball” strategy, in which the plan sponsor uses a predefined formula to predict which funds may potentially perform well for the next three-year period. Further, the 1% boost in income deferral would have had a wealth accumulation effect nearly 100% larger than a growth asset allocation strategy, and 2,000% greater than rebalancing. Of course these results are hypothetical and past performance does not guarantee future results.

One key takeaway of the study was for plan sponsors to find ways to communicate the benefits of higher deferral rates to employees, and to help them find ways to do so.

Retirement Savings Tips

The Employee Benefit Research Institute reported in 2014 that 44% of American workers have tried to figure out how much money they will need to accumulate for retirement, and one-third admit they are not doing a good job in their financial planning for retirement.² Are you? If so, these strategies may help you to better identify and pursue your retirement savings goals:

Double-check your assumptions. When do you plan to retire? How much money will you need each year? Where and when do you plan to get your retirement income? Are your investment expectations in line with the performance potential of the investments you own?

Use a proper “calculator.” The best way to calculate your goal is by using one of the many interactive worksheets now available free of charge online and in print. Each type features questions about your financial situation as well as blank spaces for you to provide answers. But remember, your ultimate goal is to save as much money as possible for retirement regardless of what any calculator might suggest.

Contribute more. At the very least, try to contribute enough to receive the full amount of any employer’s matching contribution. It’s also a good idea to increase contributions annually, such as after a pay raise.

Retirement will likely be one of the biggest expenses in your life, so it’s important to maintain an accurate cost estimate and financial plan. Make it a priority to calculate your savings goal at least once a year.

Today’s blog content is provided courtesy of the Financial Planning Association.

Source/Disclaimer:

¹Putnam Institute, Defined Contribution Plans: Missing the forest for the trees?, May 2014.

²Ruth Helman, Nevin Adams, Craig Copeland, and Jack VanDerhei. “The 2014 Retirement Confidence Survey: Confidence Rebounds–for Those With Retirement Plans,” EBRI Issue Brief, no. 397, March 2014.

Because of the possibility of human or mechanical error by Wealth Management Systems Inc. or its sources, neither Wealth Management Systems Inc. nor its sources guarantees the accuracy, adequacy, completeness or availability of any information and is not responsible for any errors or omissions or for the results obtained from the use of such information. In no event shall Wealth Management Systems Inc. be liable for any indirect, special or consequential damages in connection with subscriber’s or others’ use of the content.

Three Things Millennials Can Teach Us About Money

Posted On March 9, 2015 By Admin In Financial Planning /

As a financial planner, I spend a lot of time thinking about how to approach the different goals of my clients. While each client has a unique set of needs and circumstances, I’ve been studying and observing generational trends with a keen interest. Baby Boomers are approaching retirement, or newly retired, and are redefining what retirement means compared to their parents. Gen Xer’s (born 1965-1979), like myself, are mid-career and working towards myriad goals with cautious self-reliance. And then there are Millennials (born 1980-2000), who are now starting their careers and families and making their own stamp on financial planning.

Each generation has unique ways of doing things, and it’s not simply that today’s 30 year old has the same issues as a 65 year old had 35 years ago. We often hear about the financial challenges facing Millennials: student debt, living at home longer, less decisive about careers, delaying starting a family. There’s no doubt Millennials have been shaped by two recessions, a war, a housing bubble and collapse, and a difficult job market for entry level employees. But, there’s more than enough articles detailing those concerns. I want acknowledge three of the things they are doing right, because there are plenty of Millennials who have high expectations and are well on their way to becoming wealthy.

1) Millennials participate in their investing. Growing up with Google, cell phones, and the Internet, Millennials are going to gather information, confirm details, and find out what their friends and colleagues are doing. Comfortable with technology, they favor paperless banking and are more organized than previous generations, keeping track of their finances using online tools, mobile apps, and programs like Mint or Quicken. We can have meetings by video conference or webinar, and there will be no difference between having an advisor who is one mile away or a thousand miles away. Technology is here to stay, and is really only getting started as far as its impact on the planning process.

Millennials are more personally involved in their finances, seeking to be partners with advisors, rather than delegators. The more Millennials read about the rationale behind using index funds, the more indexing makes sense. They want to find an investment solution that works and are not as competitive about wanting to “beat the market”. Even when they use index funds, they want a plan which is customized just for them and their goals, and not a cookie-cutter plan. In that regards, they are actually more likely to value financial planning than Gen X.

2) Millennials are more frugal and less materialistic. They recognize that buying things you can’t afford with a credit card is a mistake. And while they want the financial freedom to express themselves as a unique individual, they are less interested in trying to impress others with a display of wealth. They understand that having more “things” doesn’t make you happier. Overall, Millennials are making good decisions as consumers and would likely have less debt than previous generations, if it weren’t for the dramatic rise in student loan debt in recent years.

3) Millennials recognize when renting is a better fit for their lifestyle than owning a home. They saw the effects of the housing crisis and likely know people who went through foreclosure and lost their homes. Unlike previous generations, they no longer consider home ownership as the definition of adulthood or as a sure-fire investment. Baby Boomers typically bought a house as soon as they could, upsized when possible, and used their home equity to fund their lifestyles. Millennials want community and convenience and are less willing to tolerate a long commute to the suburbs to afford the largest home possible.

For Millennials who are career driven, renting offers the flexibility to move anywhere in the country as their career dictates. This change reflects the new reality of today’s job market: employees aren’t going to have a career with just one or two companies. They need to move to where the jobs are located.

Millennials outnumber Gen X nearly 2 to 1, so they will have a significant impact on the development of our economy, business, and even the future delivery of financial planning. I don’t view the generational differences as right or wrong, or better or worse. Each is a product of their environment. What I am interested in is understanding each investor fully so that our plan can be as thorough and complete as possible in helping each achieve their goals. That’s my commitment to you and why I built Good Life Wealth Management: to provide the flexibility and resources to enable investors of any age to create and execute a plan that works.

And for those of use who are a little more experienced, keep an open mind – it’s never too late to learn a few new tricks from the younger generation!

Retiring Soon? How to Handle Market Corrections.

Posted On March 2, 2015 By Admin In Retirement Planning /

I was recently asked “How would you protect a soon to be retired investor against the inevitable market correction that will occur in the next couple of years?” It’s a great question and I think it’s very important that investors understand the risks they take when investing. Having not had a significant correction in six years, we may be well overdue. Of course, some forecasters have been calling for a correction for a couple of years, and yet the S&P 500 was up 13% last year and 32% the year before. That’s the problem with trying to time the market – it’s not possible to predict the future and it’s too easy to miss good returns by sitting on the sidelines. So, how should investors position their money if they’re a couple years from retirement?

The first thing is to frame the investment portfolio in a broader context. Someone who is four years from retirement does not have a four-year time horizon, but more likely, a 30-year time horizon, so we want to focus on finding the best solution for the whole 30-year period. That means we have to balance the desire for short-term safety with the long-term need to keep up with inflation and not run out of money. While retirement may be a one-time event, retirement planning is an on-going process.

In addition to withdrawals from accounts, retirees will have other, guaranteed, sources of income, such as Social Security, Pensions, or Annuity payments. These may cover a significant amount of fixed expenses, which allows the investment portfolio to be used in a somewhat discretionary manner during retirement. With corrections occurring every 5 to 6 years on average, a retiree could experience five or more corrections over the course of a 30-year retirement.

The reality is that we have to be willing to accept some level of volatility in a portfolio in exchange for the potential for a higher long-term rate of return. We start with a risk tolerance questionnaire to get to know each client and help select a target asset allocation that will be the most likely to accomplish their financial objectives with the least amount of risk. There’s no magic bullet to give investors a great return and no risk, so it truly is a decision of selecting an acceptable level of risk that will fulfill their planning needs. Almost everyone needs to have a mix of safer assets and assets which offer an opportunity for higher long-term growth. Some of my clients have 50 percent or more in bonds, and that may work for their situation.

With the portfolio construction, I am very focused on creating a strong risk/return profile for each of my models. We diversify broadly to reduce correlation of assets and systematically rebalance each portfolio on an annual basis. Rebalancing provides a discipline of selling assets which have run up and buying assets which are cheaper. We can eliminate some types of risk altogether, including company-specific risks (by owning the whole market rather than a handful of individual stocks), and manager risks. We know that typically 65-80% of equity managers under perform their benchmark over five years, but since we don’t know which managers outperform in advance, choosing managers is simply not a good bet to be making. That’s why we use index funds rather than selecting “five star” fund managers for our core holdings – it puts the odds in your favor.

We buy Low Volatility ETFs for some client portfolios, and I think many investors would be interested in learning about ways to reduce market fluctuations. Low Volatility funds select a basket of the least risky stocks from a larger index. They’re designed to offer a return similar to traditional indexes over time, but with a noticeably lower standard deviation of returns. They’re fairly new strategy (available the last three years or so), but I think are one of the more compelling ideas in portfolio management today. Read more here: http://www.ishares.com/us/strategies/manage-volatility

Lastly, when working with a new client, we can dollar cost average over six months, so if we do have a pullback in the fall (as we did last October), we would have cash to put to work. The key is that even someone who is planning on retiring in the next couple of years needs to have a clear plan that addresses both their accumulation needs and a retirement income strategy. That’s our focus at Good Life Wealth Management and we’d be happy to meet with you and discuss how to accomplish your retirement goals.

4 Strategies to Reduce the Medicare Surtax — Updated for 2026 (NIIT + Income Planning)

Posted On February 23, 2015 By Scott Stratton, CFP(R), CFA In Tax Strategies /

Many retirees and pre-retirees are surprised to learn that additional surtaxes related to Medicare can apply to their income, even after age 65. One of these is the Net Investment Income Tax (NIIT) — a 3.8% surtax often referred to as the Medicare surtax on unearned income. Unlike earned-income Medicare taxes, NIIT applies to investment-type income once your modified adjusted gross income (MAGI) exceeds certain thresholds that are not indexed for inflation. As a result, more retirees are subject to NIIT over time even without large wage increases.

Important distinction:

The NIIT (Net Investment Income Tax) is a 3.8% surtax on investment income (interest, dividends, capital gains, rents, royalties, etc.) for taxpayers whose MAGI exceeds the statutory thresholds;
The additional 0.9% Medicare tax on wages applies to high-income earners in employment/self-employment, not investment income;
IRA distributions and Roth conversions are not net investment income (so they are not directly subject to NIIT), but they can raise MAGI above the thresholds that trigger NIIT.

2026 NIIT Income Thresholds (unchanged for inflation):

Single/Head of Household: $200,000
Married Filing Jointly: $250,000
Married Filing Separately: $125,000

If your MAGI exceeds these thresholds and you have net investment income, the NIIT can add 3.8% to your tax bill on the lesser of (a) your net investment income or (b) the amount your MAGI exceeds the threshold.

Strategy 1 — Plan Retirement Income to Manage MAGI

Careful sequencing of income can keep your MAGI below thresholds that trigger NIIT in specific years:

Balance taxable, tax-deferred, and tax-free income so you smooth out spikes that could push MAGI above NIIT levels.
Consider spreading taxable events (such as capital gains or IRA distributions used for living expenses) across multiple years rather than realizing them all in one year.
Use qualified charitable distributions (QCDs) — up to the annual limit — to satisfy IRA withdrawal requirements without increasing MAGI. See our article on QCDs From Your IRA for more context.

Note: IRA distributions themselves are not NIIT net investment income, but they count toward MAGI, which can trigger NIIT on your investment income if you exceed the thresholds.

Strategy 2 — Tax-Loss Harvesting and Gain Timing

Reducing net investment income directly is one of the most straightforward ways to reduce NIIT:

Tax-loss harvesting: Sell losing assets to realize capital losses that offset gains, which lowers net investment income.
Stagger sales of appreciated assets: If you must sell appreciated investments (e.g., for a home purchase or other needs), consider spreading the sales over several years to avoid large investment income in one year.
Hold tax-efficient investments in taxable accounts (e.g., municipal bonds, tax-efficient ETFs) to reduce taxable investment income.

All of these can help keep net investment income — and therefore NIIT — lower.

Strategy 3 — Use Tax-Advantaged Accounts

Putting income inside vehicles that don’t generate taxable investment income can reduce your exposure to NIIT later:

Roth accounts (IRA, 401(k), Roth conversions): Qualified Roth withdrawals are excluded from taxable income (and thus not subject to NIIT).
Fixed Annuities: Rather than holding taxable bonds, we use MYGA Fixed Annuities. The Annuity is tax deferred until you withdraw your funds. And unlike an IRA or 401(k), there are no Required Minimum Distributions (RMDs).
Pre-tax retirement accounts: Contributing to 401(k)s, traditional IRAs, or HSAs reduces your MAGI in the year of contribution, potentially keeping you under NIIT thresholds.
Tax-exempt municipal bonds: Interest income from municipal bonds generally isn’t included in net investment income for NIIT purposes.

For example, strategic Roth conversions in years with lower taxable income can help lower future MAGI and reduce both NIIT and potential Medicare premium surcharges.

Strategy 4 — Charitable and Gifting Techniques

Charitable giving and gifting can reduce the taxable base for NIIT by lowering MAGI or net investment income directly:

Qualified Charitable Distributions (QCDs): Distributions from a traditional IRA to charity (for age 70½+ retirees) reduce MAGI and remove RMD impacts on income calculations.
Donating appreciated securities to charity: This avoids the realization of capital gains that would otherwise increase net investment income.
Charitable remainder trusts (CRTs) and charitable lead trusts (CLTs): In certain contexts, these tools can spread income over time and reduce taxable investment income.

Additional Planning Ideas

Use Installment Sales for Large Gains

If you have assets with significant unrealized gains and you plan to sell, structuring the sale via installment method can spread income over multiple years, helping keep MAGI under NIIT triggers.

Consider Business Structure (if applicable)

If you receive passive income through a business, reviewing whether it’s truly passive vs. active (e.g., real estate professional status) may affect how much income is considered investment income.

Review Asset Location

Holding income-producing assets inside tax-deferred accounts and keeping less efficient income in Roth or tax-exempt accounts may reduce net investment income.

Why Thresholds Matter for Retirees

Because the NIIT thresholds are fixed and not indexed for inflation, more retirees are becoming subject to the surtax over time even if their spending needs haven’t changed. A combination of required minimum distributions (RMDs), Social Security, capital gains, and dividends can push MAGI above these thresholds — triggering NIIT on net investment income.

This makes retirement income planning an essential part of managing tax liability overall. Thoughtful sequencing of withdrawals, Roth conversion timing, and income smoothing — all aligned with your long-term goals — can reduce the amount of NIIT and link back to broader tax planning such as our Retirement Tax Planning hub.

Frequently Asked Questions (Retiree-Focused)

Q: Are IRA distributions subject to the NIIT?
No — distributions from traditional IRAs aren’t counted as net investment income for NIIT purposes. However, they count toward your MAGI, which can trigger NIIT on your investment income if you cross the thresholds.

Q: Is selling a rental property subject to NIIT?
Yes — income from passive activities like rental and royalty income is typically included as part of net investment income that can be subject to the 3.8% NIIT if your MAGI exceeds the thresholds.

Q: Does timing matter for capital gains?
Yes — timing the sale of appreciated investments across multiple years or pairing gains with deductions (like losses or charitable gifts) can reduce your net investment income in any one year.

Q: Will future inflation indexing change NIIT thresholds?
Currently, NIIT thresholds are not indexed for inflation, meaning over time more individuals are likely to be subject to the tax even if real incomes do not rise.

Planning to manage surtaxes like the NIIT and Medicare income-related adjustments is most effective when coordinated with your broader retirement income picture — including Social Security timing, RMD planning, and investment income sequencing. If you’d like a planning-first conversation about how these surtaxes might affect your retirement income strategy, you’re welcome to Request an Introductory Conversation.

Proposed Federal Budget Takes Aim at Investors

Posted On February 17, 2015 By Admin In Retirement Planning /

It was Presidents’ Day yesterday, a day to reflect on the great thinkers and leaders who founded our remarkable nation and have molded its course across the centuries. I try to avoid political commentary here on this blog as my job is to help clients find financial independence so they can be able to retire one day, send their children to college, and not spend the rest of their lives worrying about money.

However, I think my clients and readers should hear about the President’s proposed 2016 budget, which contains a number of never heard before provisions that take aim directly at middle-class investors. The administration says that they are looking to close “loopholes for the rich”, but these proposals aren’t going to increase taxes for Warren Buffet, Bill Gates, or the latest hedge fund billionaire; they’re going to be funded by working professionals who are trying to make a better life for their families.

When I think about closing loopholes to raise taxes, the first thing I think about are eliminating corporate incentives and subsidies, so I was shocked that these proposals are squarely aimed at the wallets of individual investors and primarily their retirement plans. Here are some of the proposals which would impact investors like you.

The first proposal was to eliminate 529 College Savings Plans. I’m sure there are some wealthy elderly grandparents who use 529’s to reduce their estate taxes, but most of the 529 accounts I have seen are barely enough to pay for a year or two of state school, let alone pay for 4 years of SMU, Medical School, or an MBA. But instead of suggesting that we reduce the maximum caps on 529 contributions, the proposal was to eliminate the tax benefits altogether for everyone! Luckily, after widespread outrage, the administration nixed the proposal days later.
Another proposal is to eliminate the “Back Door Roth IRA”. This has been one of my favorite strategies since 2010 and I look for any client who might be eligible. I’ve mentioned the Back Door approach a couple of times in this blog and described it in some detail here. I believe the government should encourage people to save more for retirement, but when you start taking away benefits, it makes it even more of a challenge.
The 2016 budget would also require investors in a Roth IRA to take Required Minimum Distributions after age 70 and 1/2. Currently, you can let a Roth account grow tax free for as long as you’d like, and even leave those assets to your spouse or heirs income tax-free. The only relief the budget provides is that if all of your retirement accounts (all types) are under $100,000, you would not have to take RMDs.
The 2016 budget would eliminate the “Stretch IRA”. Today, if you inherit an IRA from a non-spouse (such as a parent), you can take only RMDs and continue to let the money grow. Under the proposal, the Stretch IRA (also called Beneficiary IRA or Inherited IRA) goes away, and all the money must be withdrawn within 5 years. If it’s a sizable IRA, that could be quite a tax hit, pushing an heir into a high tax bracket. It means that more of your IRA will end up with the IRS and less with your heirs. Instead of encouraging heirs to manage the inheritance as a long-term program, it will force them to take the money out quickly.
The proposed budget would cap the tax benefit of retirement contributions to 28%. So, if your family is in the 39.6% tax bracket (actually 40.5% when you include the 0.9% Medicare surtax), you will only get a partial deduction for the money you contribute to your 401(k) or IRA.

In all, there were a dozen proposals that would impact investors in retirement accounts. And since my business is focused on retirement planning, you bet I’m concerned. You should be too. Luckily the proposed budget is little more than a wish-list or starting point. Hopefully, few of these will make it into law for 2016. If they do, investors in the future are likely to have a different mix of retirement accounts and “taxable” accounts. Luckily, we’re already skilled at creating tax-efficient investment portfolios with low-turnover ETFs and municipal bonds.

In the mean while, you can still fund a Back Door Roth for 2014 (through April 15) and 2015, or take advantage of any of the current programs. I know what I would prefer to happen with these proposals, but no matter what does occur, we will learn, adapt, and still be successful. I still believe that there is no better place on Earth to become wealthy than America.