SECURE Act Abolishes Stretch IRA

The SECURE Act passed in December and will take effect for 2020. I’m glad the government is helping Americans better face the challenge of retirement readiness. Although I work with clients who are often fairly well prepared, the reality is that a majority of Americans are falling behind and need to do more to plan for their retirement income. 

It’s highly likely that the SECURE Act will directly impact you and your family. Six of the changes are positive, but there’s one big problem for families with larger retirement accounts: the elimination of the Stretch IRA. We’re going to briefly share the six beneficial new rules, and then take a deeper dive into the impact of eliminating the Stretch IRA.

1. RMDs pushed to age 72. Currently, you have to begin Required Minimum Distributions from your IRA or 401(k) in the year in which you turn 70 1/2. For 2020 and going forward, the age for RMDs is pushed to 72. This is going to be very helpful for people who are working longer or who have other sources of income and who don’t need to take money from their retirement accounts. People are living longer and working for longer, so this is a welcome change.

2. You can contribute to a Traditional IRA after age 70 1/2. Previously, you could no longer make a Traditional IRA contribution once you turned 70 1/2, but this restriction has been eliminated. Good news for people who continue to work into their seventies!

3. The definition of eligible income for an IRA has been broadened to include stipends or fellowships (for students) and home healthcare payments. This will allow more people to fund their retirement accounts, even if they don’t have a traditional job.

4. For 529 College Savings Plans, you can now take $10,000 in qualified distributions to pay student loans or for registered apprenticeship programs.

5. The SECURE Act will help more Americans be covered by 401(k) plans by allowing small companies to join together to form multi-employer plans and by expanding eligible workers to include part-time employees.

6. 401(k) plans will be allowed to offer income annuities and enable retiring participants to create a guaranteed monthly payout from their 401(k). 

7. The elimination of the Stretch IRA. This is a problem for a lot of families who have done a good job building their retirement accounts. A spousal beneficiary will still be allowed to roll over an inherited IRA into their own account, however a non-spousal beneficiary (such as a daughter, son, or other person) will be required to withdraw the entire IRA and pay taxes within 10 years.

Existing Beneficiary IRAs (also known as Inherited IRAs or Stretch IRAs) will be grandfathered under the old rules. However, for anyone who passes away in 2020 going forward, their IRA beneficiaries will not be eligible for a Stretch.

If you have a $1 million IRA, your beneficiaries will have to withdraw the full amount within 10 years and count that distribution as ordinary income. If you do inherit a large IRA, try to spread out the distributions over many years, if it will enable you to stay in a lower income tax bracket. 

For current IRA owners, there are a number of strategies to consider to plan ahead to reduce this enormous tax liability for your heirs.
Read more: 7 Strategies If The Stretch IRA Is Eliminated

Additionally, if you created a trust to serve as the beneficiary of your IRA, this provision of the SECURE Act might negate the value and efficacy of your trust. See your attorney and financial planner immediately.

The elimination of the Stretch IRA is how Congress is going to pay for the other benefits of the SECURE Act. While I understand there is not a lot of sympathy for people who have to pay taxes on inheriting a $1 million IRA, this is a big tax increase for upper-middle class families. It won’t impact Billionaires at all, but for the average millionaire next door, their retirement account is often their largest asset, and it’s a huge change. 

If you want to start to reduce this future tax liability on your beneficiaries, it will require a gradual, multi-year strategy. It may be possible that I could save your family hundreds of thousands of dollars in income taxes by creating an efficient pre and post-inheritance distribution plan. They key will be to start early, though, and not wait. 

Otherwise, Uncle Sam will be happy to take 37% of your IRA (plus possible state income taxes, too!). And don’t forget, the top tax rate is set to go back to 39.6% after 2025. That’s why the elimination of the Stretch IRA is so significant – many middle class beneficiaries will suddenly be taxed at the top rate. 

From a behavioral perspective, most Stretch IRA beneficiaries limit their withdrawals to just their RMD, and the continually invested inheritance lasts them for decades. I’m afraid that by forcing beneficiaries to withdraw the funds, many will squander the money rather than investing prudently and taking measured distributions. There will be a lot of consequences from the SECURE Act, but we are here to help you unpack these changes and move forward with an informed plan.

Your Home Is Like A Bond

You’re doing well: you’ve got your emergency fund, you’re maxing out your 401(k), and you don’t have any credit card debt. At this point, a common question is: Should I send extra payments to my mortgage? And with markets near their highs, maybe you’re even wondering, Should I pay off my mortgage?

There are a lot of emotional reasons to do this: to own your house free and clear, to never have to worry about a mortgage again, or to reduce your bills in retirement. Investments carry uncertainty, whereas paying down a debt is a sure thing. Those are typical thoughts, but that’s not necessarily a rational answer.

In financial planning, our goal is to determine the solution which maximizes utility. Will I have a higher net worth if I pay off my mortgage or invest the money?

The answer, then, is it depends. It depends on the rate of return on your investments compared to the rate you are paying on your mortgage. If your mortgage is 3% but your cash is earning 0.5%, you would be better off paying down the mortgage (assuming you still kept sufficient liquidity for emergencies). On the other hand, if your mortgage is 3% and you could be making 7%, you would maximize your net worth by staying invested and just paying your mortgage at the expected rate.

While most people would prefer to be debt free, the fact is that if you can borrow at a low cost and invest at a higher return, you will grow your net worth faster. I don’t think of a home as being a great investment. Houses generally keep up with inflation, but have returns similar or less than bonds.

Looking at the Case-Shiller 20 City Home Price Index (which includes Dallas), the overall rate of return since 2000 was 4.02%. Looking at actual bond funds, not just hypothetical indexes, I see that an investor could have earned 5.15% a year in the Vanguard Intermediate Term Bond Index fund, since the fund inception in 2001. 

The money you put into your house, will likely behave like a bond, although possibly with more volatility. Over a long period, it should keep up with inflation, or if you are lucky, do a little better than inflation. (See below for my concerns about home prices, or thinking of a home as an investment.)
I do believe it is realistic, based both on historical returns and projected returns, to anticipate a return of 5-8% from a diversified portfolio containing 60% or more in stocks. That’s not guaranteed, but if your time horizon is twenty or thirty years for a mortgage, it’s a reasonable assumption. And the longer the time period we consider, the greater likelihood of a positive outcome from stocks.

While I think it is important to consider your portfolio as a whole entity, with total levels of risk and return, a portfolio is made up of specific segments. Today, the yields on high quality bonds are very low. With the 10-year treasury yielding only 1.7%, there’s not much return to be had in bonds.

Let’s consider an example, using round numbers for simplicity. Let’s say you have a $1 million portfolio in a 60/40 portfolio: $600,000 in stocks and $400,000 in bonds. You also have a $200,000 mortgage at 3.5%. The expected returns (hypothetical) for stocks is 7% and for bonds 2.5% today. That would give the overall portfolio an expected return of 5.2%, which is higher than your mortgage rate.

On the bonds, though, the expected return of 2.5% is less than your mortgage cost of 3.5%. If you believe that today’s low yield environment is likely to persist for a long time, it might make sense to take $200,000 from your bonds to pay off the mortgage. That would leave you with a portfolio containing $600,000 of equities and $200,000 in bonds, a 75/25 portfolio. 

The new portfolio would be more volatile than the original 60/40 portfolio, but the dollar value of your stock holdings will remain the same. And your net worth will grow faster, since we paid off debt at 3.5% with bonds that would have yielded only 2.5%.

Provided you are comfortable with having a more volatile portfolio, you might maximize your net worth by withdrawing from bonds but not from your equities, and therefore increasing your equity percentage allocation. However, if you are considering selling stocks to pay down a long dated mortgage, I think we should go through the math on that decision more carefully.

There’s a lot to consider here, so it is important we discuss your individual situation and not try to simplify this to some type of universal advice or rule of thumb.

Here are some additional considerations:

  1. If your choices are to send in extra mortgage payments or do nothing (spend that money), then yes, send in extra payments.
  2. If you are choosing between extra payments versus another investment, consider the long-term expected rate of return of the investment versus the cost of the mortgage.
  3. While bond yields are low today, it is possible they could rise in the future. If you have short-term bonds you might gradually reset your yields to higher levels. If you have a fixed mortgage, however, it’s guaranteed to stay at the same rate for the full term of 15 to 30 years. Now is a great time to borrow very cheaply. If we have higher inflation in the future, it will benefit borrowers and penalize savers.
  4. You can invest outside of a retirement account. In fact, if your goal is to retire early, become a millionaire, or create a family trust, you need to do a lot more than just a 401(k). Some people stop after funding a 401(k) and think they don’t need to make any additional investments. Paying down a mortgage is not your only option; consider a taxable account.
  5. A mortgage is a form of forced savings. If you have a monthly mortgage of $1,500, maybe $500 of that is interest and the remaining $1,000 is building equity in your home. If you pay off your mortgage from investments, you will save $1,500 a month, and you will feel wealthier because you improved your cash flow. But if you don’t create an automatic savings plan to invest that $1,500 a month, you will likely just increase your discretionary spending. Be careful to not miss that opportunity to increase your saving.

On house values:

  • Your home price will increase the same whether you have a mortgage or own it free and clear.
  • There are significant expenses in being a home owner which make it a poor investment, including property taxes, insurance, utilities, and repairs or improvements. These costs are not included in a home price index. Read more: Tracking Your Home Improvements.
  • Selling costs can also be significant, such as a 6% realtor commission. I bought a house for $375,000 in 2006 and sold it in 2017. After paying closing expenses, I received $376,000. That’s not a good return, and those amounts do not even include any of the improvements I made to the house. 
  • If your primary goal is to grow your net worth, consider your home an expense and not an investment. If you aren’t going to stay for at least five years, rent.
  • After the Tax Cuts and Jobs Act, you are less likely to be able to deduct your property taxes and mortgage interest, especially for married couples. So, forget about having a home as a great tax deduction; most people will take the standard deduction.

At best, you might consider home equity to be a substitute for a bond investment. Given today’s very low yields, if you want to reduce bond holdings to pay off a mortgage, that may be something to consider. Certainly, your home is significant part of your net worth statement, and it is often one of your biggest assets, liabilities, and expenses. It’s worth thinking carefully about how you manage those costs, looking to genuinely analyze how different decisions could impact your net worth over ten or more years. 

Giving Strategies, Now and Later

If you have a significant estate and are thinking about how to give money to charity or individual beneficiaries, you might want to consider if it would be possible to make some of those gifts during your lifetime. Today, we are going to look at the tax benefits or implications of different large gift strategies.

A gift to charity from your estate will reduce your your taxable estate. However, with the estate tax threshold presently at $11.4 million per person, most people will never pay any estate taxes. This was not the case 15 years ago when the estate tax threshold was just $1.5 million. For married couples, the threshold is doubled to $22.8 million. So if your past estate plan was based on estate tax avoidance, it may be time to update your plans and revisit your charitable strategies.

Charitable donations remain eligible as an itemized deduction, although many tax payers will not have enough deductions to exceed the 2019 $12,200 standard deduction ($24,400 married). However, if you are contemplating a large charitable donation, you can deduct up to 60% of your Adjusted Gross Income (AGI) when making a cash donation to a public charity. (This was increased from 50% under the 2017 Tax Cuts and Jobs Act.) If making a donation of non-cash property, such as appreciated shares of stock, the limit is 30% of AGI. In both cases, you can carry forward any excess donation for five years.

Here are seven principles for giving to charities and to individuals, such as your children or grandchildren:

1. If you have stocks or funds with a large gain, you can give those shares to charity, get the full tax deduction and avoid capital gains tax. The charity will not pay any taxes on the shares they receive and sell.

2. If you leave an IRA to a charity, that is name a charity as a beneficiary of your IRA rather than a person, they will pay no tax on receiving your IRA.

3. For individual beneficiaries of your estate, they will have to pay income tax on inheriting your IRA. Presently, there is a Bill which has passed the House which will eliminate the Stretch IRA. However, beneficiaries will receive a step-up in cost basis on inherited taxable accounts. The most tax efficient split is to leave your Traditional IRA to charity and your taxable assets and Roth IRAs, to your heirs. Then neither will pay income taxes on the assets they receive.

Read More: 7 Strategies If the Stretch IRA is Eliminated

4. If you are over age 70 1/2, you can make up to $100,000 a year in gifts from your IRA as Qualified Charitable Distributions, which count towards your RMD. You do not have to itemize to use the QCD.

 Read More: Qualified Charitable Distributions From Your IRA

5. You can give $15,000 a year to any individual; this is called the annual gift tax exclusion. A couple could give $30,000 to an individual. This includes your adult children. Additionally, you can directly pay medical or educational expenses for any individual without this limit. 

Where many people are confused: exceeding the gift tax exclusion does not automatically require you to pay a gift tax. It simply requires filing a gift tax return, which will reduce your lifetime Gift/Estate tax limit, which again is $11.4 million per person (2019). For example, if you give someone $17,000 this year, the $2,000 over the $15,000 limit will be subtracted from your $11.4 million estate tax exemption when you die.

6. If you want to create college funds for your grandchildren or other relatives, you can fund up to five years upfront into a 529 Plan without exceeding the gift tax exemption. That is $75,000 per beneficiary, or up to $150,000 if coming from both Grandma and Grandpa. You can retain control of the funds, even change the beneficiary if desired, and the money grows tax-free for qualified higher education expenses. 

Read More: 8 Questions Grandparents Ask About 529 Plans

7. You can make a large donation to a Donor Advised Fund to receive an upfront tax deduction and then make small donations in the years ahead. For example, it would be more tax efficient to make a $100,000 donation into a DAF and make $10,000 a year in charitable distributions for 10 years from the DAF, than to make regular $10,000 donations each year for 10 years. 

Read More: Charitable Giving Under The New Tax Law

Even if you know all of this information, I think many potential donors are still looking for more flexibility in their giving plans. What if you need money later? How much should you keep for your own expenses and needs? Creating a comprehensive retirement analysis is an essential first step, and then we can help you consider other more advanced giving strategies.

There are many ways of structuring charitable trusts which can split assets and income between the creator of the trust, a charity, and/or beneficiaries. Generally, the donor is able to receive an upfront tax deduction for the present value of a gift, based on their expected lifetime or duration of the trust. The present value is calculated using your age and a specific discount rate, known as the Section 7520 rate, which is published monthly by the IRS. It is based on intermediate treasury bonds and is currently 2.2% for trusts created in September 2019. This rate is down from 3.4% from last August. 

With a very low interest rate being used for the discount rate today, it is quite unappealing to establish a Charitable Remainder Trust (CRT). The low rate means that the tax deduction is very small compared to trusts that were established when the rate was higher. That’s unfortunate, because a CRT is an ideal structure: the creator receives income from the trust for life (or a set period of years) and then the remainder is donated to the charity when you pass away (or at the end of the term). 

A more effective structure for a low interest rate environment is a Charitable Lead Trust (CLT). In this type of trust, a charity receives income for a period of years (say 10 years) and then any remaining principal is distributed to your beneficiaries, free from gift or estate taxes. This might hold some appeal for tax payers who would be subject to the estate tax and who do not need or want income from some portion of their assets. But it doesn’t offer much appeal to donors who want income or flexibility from their trusts. 

If you are thinking about charitable giving or where your money might eventually go, let’s talk about which strategies might make the most sense for you. 

Your Goals for 2019

Welcome to 2019! A new year brings a fresh chance to accomplish your goals. Maybe you’re dreaming that this will be the year you buy your first home. Maybe you’ve realized that your kids are one year closer to college and it’s time you start preparing. Maybe this is the year you want to exit from your current job so you can spend more time doing the things you love.

Even if your goals are further out than 2019, by December 31 of this year, you can either be several steps closer to achieving those goals, or you can sit right where you are today and risk that they will remain forever out of reach. Time stands still for no one. This is the only chance to do 2019 before it is gone forever.

Many of your goals have a financial component. Whether it is becoming a home owner, paying off your student loans, getting married, saving for a college education, planning for your retirement, or supporting your favorite charity, we can help you achieve your goals. The objective of our financial planning is not to own a bunch of stocks and bonds or get a nice tax break, it is about finding an effective, efficient, and logical way to help you accomplish your life’s goals.

We love when someone has a concrete, specific objective. When you truly embrace an important goal, there is ample reason to find the discipline for whatever steps are needed to achieve your objectives. I can tell you all about the benefits of a Roth IRA or a 529 College Savings Plan, but if that doesn’t fit into your needs, all my words are worthless. The “why” has to be there first, before we can get excited about “how” we are going to do it.

If you have goals that you want to accomplish in 2019 – or 2020 or 2029 – I’d like to invite you to join us and become a client of Good Life Wealth Management today. We serve smart investors who value personalized advice centered on their goals.

I’d welcome the opportunity to share our approach and allow you to consider whether it would be a good fit for you and your family. 

  • Our process focuses on planning first – we want to fully understand your goals and needs before we make any kind of recommendation. You would think this would be universal, but believe me, most of the financial industry has a product that they want to sell you before they have even met you. (Read our 13 Guiding Beliefs.)
  • We have no investment minimums. Younger professionals have financial goals and complex, competing objectives (hello, student loans!) even if they haven’t started investing or only have a small balance in a 401(k). We think helping young professionals build a strong financial foundation is important work. This is our Wealth Builder Program.
  • I’ve been a financial planner for 15 years and hold the Certified Financial Planner and Chartered Financial Analyst designations. Professional expertise and deep investment experience should be a given if you’re seeking financial advice. (More about Scott.)
  • Having your own plan means that you have taken an objective measure of where you are today, that we have created specific goals and objectives, and that we identify and implement steps to achieve those goals. While this is often savings and investment based, we’re going to evaluate your whole financial picture, from taxes and employee benefits to estate planning and life insurance. Bringing in a professional delivers accountability to a plan and protects you from what you don’t know you don’t know. (Financial Planning Services)
  • We are a Fiduciary, legally required to place client interests ahead of our own. Our fees are easy to understand and transparent. We aim to eliminate conflicts of interest wherever possible and if not possible, reduce and disclose. I invest in our Growth 70/30 model right along with our clients; if I thought there was a better way to invest, we would do that instead. (Skin in the Game)

Successful people – in any field – seek out the help and expertise of others. They surround themselves with knowledgeable professionals, not to abdicate responsibility, but to improve their understanding through asking the right questions. I became a financial planner to help others achieve their goals, and I love my job. For me, it is endlessly interesting and personally rewarding.

You could make a New Year’s resolution about your finances, but I genuinely believe you are more like to have a good outcome if you hire the right advisor who can help guide your journey. If you want 2019 to be the year when you turned your dreams into goals and a plan, then let’s talk about how we can work together.

Extend Your Car Warranty for Free

When it comes to saving money, there are two expenses which will make or break your budget: your home and your cars. If you keep those expenses below your means, you will have a surplus to save and invest. That’s how you generate wealth. 

Unexpected car repairs are the worst. You can spend thousands and it feels like you are just flushing your money away. That’s why we love car warranties: they help extinguish our fear of repair bills. For a lot of people, when their car warranty runs out, they want to get a new car because they can’t stand the thought of a catastrophic repair bill. 

But buying a new car every three or four years exposes you to the steepest part of the depreciation curve. Most cars will lose 50 to 60 percent of their value within five years. Owning new cars is trading the mere possibility of car repair bills, which might not happen, for the certainty of significant depreciation, which is inevitable.

Of course, car dealers would love to sell you an extended warranty. It’s one of their most profitable areas. That alone makes me think they are not worth it. You are spending $2,000 to buy a $1,000 warranty. And the insurer probably only pays out 50 to 80 cents in claims for every dollar in premiums it receives. It seems like you would be betting against yourself. 

I don’t usually endorse products or services here in my newsletter, but I came across a benefit which I think many of my readers might enjoy. It’s a way to provide protection against unexpected car repairs. This might allow you to keep your vehicles for longer and then direct more savings into your investment portfolios. (Selfishly, I will make more if my clients have larger investment portfolios, but hopefully that’s a goal we can both agree on!)

There is a company called BG Products which makes fluids for cars and trucks. They make motor oil (including synthetic), transmission fluid, brake fluid, anti-freeze/coolant, steering fluid, etc. BG offers a Lifetime Protection Plan that when you use their product regularly, if that component breaks down, they will reimburse you for the cost of the repair, up to a specific limit.

Best of all, they will cover your car, even if you don’t start using their fluids until 50,000 or 100,000 miles. That means that if you have a car with 80,000 miles, past the manufacturer’s warranty, you can actually add protection to your vehicle today. They offer double the protection if you start before 50,000 miles, so you might want to start sooner if you can. 

There is no limit on miles. As long as you continue to change the fluids within the specified number of miles, your car will be covered. You could keep your car for 300,000 miles and it would still be protected.

Here are the service intervals required for the Lifetime Protection Plan. If your manufacturer suggests more frequent changes, I would follow those instructions. To stay under this protection plan, you need to replace fluids before reaching these limits.

Engine Oil: 10,000 miles

Coolant: 30,000 miles

Transmission Fluid: 30,000 miles

Power Steering: 30,000 miles

Brake Fluid: 30,000 miles

The BG plan will reimburse repairs if these components break, but not for normal wear and tear. You would have to get the repairs done and then submit your receipts for reimbursement, which are subject to the following limits:

Plan 1, started before 50,000 miles: $4,000 coverage

Plan 2: started between 50,001 and 100,000 miles: $2,000 coverage

Full details of covered components HERE.

BG Products are not available in stores, you have to find a shop which uses them. Here in Dallas, I have used M2 Auto Repair, near Love Field. I’ve had a great experience there and can recommend them. If you talk to Eddie, the owner, please tell him I sent you.

If you’re not in the Dallas area, you can find a BG Dealer here. I have not filed a claim with BG, so I cannot vouch for that process, but obviously it is going to be very important to be able to document that you did have the services performed within the mileage limits and that the repairs required were on the specific parts covered by the protection plan. 

It doesn’t cover electronics, which is an increasingly large component in modern cars, but can give you some peace of mind over mechanical failures. If you’ve used BG and had a claim, please send me an email and tell me about your experience. 

I am aware that other fluid makers offer warranties, including Mobil 1Castrol, and Valvoline. In reviewing their warranty pages, they may offer similar benefits, but I think it may be more difficult to document proof of eligibility, and they don’t cover all of the systems that BG Products covers.

I’d also love to hear from you if you have ever filed a claim with another oil company and what result you received.  Regular maintenance is an important part of keeping your car healthy, and it’s great to see a company stand behind its products. I’m no expert on cars, but I have spent a lot of time looking at spending behavior. Any techniques which can help us spend less over the life of our vehicles will help you achieve your other financial goals. So, even if you don’t end up using the Lifetime Protection Plan, just knowing you were covered may provide you with the extra confidence to keep you car for 150,000 or 200,000 miles.

You CAN Invest in a Taxable Account

I spend a lot of time talking about retirement accounts, and for many Americans, the only stocks they will ever own are in their 401(k) and IRAs. I don’t know why, but many have never even considered investing outside of a retirement account, and a few have even thought it was not possible.

It is a GREAT idea to invest outside of your retirement accounts. Why? Because the contribution limits are so low for IRAs ($5,500) and 401(k) accounts ($18,500). There are a lot of people who put in that amount and then think they can’t do any more investing or that they don’t need to. There’s nothing magical about these amounts. No one is promised that if you save $5,500 a year into an IRA that you will have enough to retire (especially if you are getting a late start). And if you have ambitions to be wealthy, it may take you 30 or 40 years of 401(k) contributions to break the $1 million mark.

While we often talk about the tax benefits of retirement contributions, let’s actually run through the math of an IRA investment and making the same investment in a taxable account. The results may surprise you.

Let’s say you put in $5,000 to a Traditional IRA this year and also deposit $5,000 into a taxable account. In each account, you buy the same investment, such as a S&P 500 ETF, and hold it for 20 years until retirement. Assuming you get an 8% annualized return for those 20 years, in both accounts, your position would have grown to $23,304.79.

At the 20 year mark you withdraw both accounts. What taxes are due?

From the Traditional IRA, the entire withdrawal is treated as ordinary income. You may be in the 24% tax bracket, in which case you would owe $5,593.15 in taxes. That’s pretty painful and the reason why so many retirees hate taking money out of their IRAs and limit their withdrawals to their Required Minimum Distributions.

What about for the taxable account? You started with a $5,000 cost basis, so your taxable gain is $18,304.79. It is a long-term capital gain (more than one year), and will be taxed at the capital gains rate of 15%. Your tax due is $2,745.72. That’s less than half of the tax you’d pay on the withdrawal from the retirement account that you did for the “tax benefit”. Is that IRA a scam?

No, because you also got an upfront tax deduction for the IRA contribution. If you were in the 24% bracket, you would have saved $1,200 in taxes for making that $5,000 contribution. If you subtract the $1,200 in tax savings from $5,593, you still see that your net taxes paid was quite high: $4,393.

However, that is ignoring the time value of money and getting to save that $1,200 now. If you actually invest the $1,200 you saved that year, and have it grow at 8% for 20 years, guess what it grows to? $5593.15. (If you invested this in a retirement account, you will owe 24% in taxes on this gain, or another $1342.)

The key to coming out ahead with doing an IRA versus a taxable account is that you need to actually invest the tax savings you receive in year one. If you just consume that tax savings, instead of saving it, you actually might have been better off instead doing the taxable account where you could receive the lower capital gains rate.

The best solution is to maximize your retirement accounts AND save in a taxable account. If you want to become a millionaire in 10 years, save $5,466 a month. People have ambitious finish lines, but don’t set savings goals that are in line and realistic with their goals. The short-term activity has to match the long-term objectives. Once you are in retirement, it is a great benefit to have different types of accounts – IRAs, Roth, and taxable – to manage your tax liability.

My point is: Don’t be afraid of a taxable account. Retirement accounts are good, but mainly if you are going to save the upfront tax benefit you receive! Today’s ETFs are very tax efficient. While you will likely have dividend distributions of about two percent a year in a US equity ETF, when you reinvest those dividends, you are also increasing your cost basis. If you’re looking to invest in both a retirement and taxable account, let’s talk about how you can do this in the most effective way possible.

Financial Planning In Your Sixties

Investors in their sixties are in a decade of decisions. Up to this decade, you could do very well by putting your saving on autopilot, and doing little more for your portfolio than occasionally rebalancing it. Now, you’re faced with some important decisions, whether you are planning to retire soon or to wait many years down the road.

See: Six Steps at Age 60

1. Social Security. The decision of when to start receiving your Social Security benefits is independent from when you retire from your job. The Full Retirement Age (FRA) today is 66, but you can start early benefits from age 62 on. Or you can delay past FRA, all the way to age 70, and receive an 8% annual increase in benefits for waiting.

Where else can you get a guaranteed 8% increase in benefits? It’s a great deal to wait, even if it requires that you spend down some of your cash. Guaranteed benefits are the best way to offset longevity risk, so maximizing your Social Security can be a great idea if you are healthy and have a family history of long lives. For married couples, there is a survivor’s benefit, which means that the spouse with the higher benefit has essentially a joint benefit. There are a lot of things which people don’t consider about Social Security, and that’s why it’s best to talk to me first.

See: Social Security, It Pays to Wait
See: Guaranteed Income Increases Retirement Satisfaction
See: Social Security Planning: Marriage, Divorce, and Survivors

2. Health Care. Medicare starts at age 6r5. If you retire before 65, you will have to figure out how you will be covered until age 65. And when you do reach age 65, you will sign up for part A, and probably Part B (unless you have proof of employer coverage), and will then need to consider whether a Medicare Supplement or Advantage plan makes sense for you. Again, lots of decisions here, and if you don’t sign up at your “window” at age 65, you may have to pay permanent penalties on Part B when you do enroll.

See: Types of Medicare Health Plans

3. Retirement Age. The most dangerous thing I can hear is “It’s okay, I don’t plan to retire.” There are so many people in their sixties who planned to work for another decade or more and things didn’t work out as planned. Maybe they were laid off, or had a health situation, or their spouse had a health issue, or their employer asked them to relocate. Things change. We can’t assume that we have the ability to maintain the status quo indefinitely by choice. My goal for every sixty-something client is that you work because you want to and not because you have to. So even if your planned retirement age isn’t until sometime after 75, make sure you and your family will be all set financially if you decide to retire earlier.

See: How Much Income Do You Need In Retirement?

4. Withdrawal Strategies. If you are retiring and starting withdrawals from your accounts, you will need to make decisions about how much to withdraw and from which account or assets. If the market goes down, can you withdraw the same amount? What is the most tax efficient way to withdraw from your accounts?

See: Taxes and Retirement

5. Asset Allocation. We typically plan for a 20-30 year retirement period, so even if retirement is close, we are still investing for the long-term. Even so, we want to reduce market risk in the five years before retirement to mitigate the potential impact of a bear market right before you plan to begin withdrawals. After retirement has begun, there is evidence that it may be beneficial to sell your bonds first and not rebalance your portfolio. This would mean that your equity holdings would become a larger weighting in your allocation over time.

See: What Is The Best Way To Take Retirement Withdrawals?

Of course, there are many other decisions which we evaluate in a financial plan, such as whether to take a pension or a lump sum upon retirement. When you are facing these decisions, what you don’t know can hurt you. That’s where I can help you navigate these decisions whether you have already retired, are retiring soon, or have many years before you plan to retire.

Financial Planning In Your Fifties

My hope for every fifty-something investor is that you have by now attained financial independence, where you have enough assets to stop working if you wanted and live off your investments. Most aren’t quite there yet, but if you’re working with me, we have a good idea of your finish line, a quantifiable goal, and the steps needed to get there.

What does scare me is when someone says that they plan to never retire, so this doesn’t matter or apply to them. While it’s natural to wish that time would stand still or that things won’t change, it’s a poor plan to assume that change isn’t going to happen to your life.

I think of a relative who worked for one company for 30 years, until age 59, when they went out of business. He was used to making a certain level of income, which just wasn’t available in his small town, for someone with skills that didn’t easily carryover to other types of business. He was planning to work forever, but it turns out, he wasn’t interested in jobs that paid 50% of his previous salary. He was unemployed for three years, before starting Social Security at age 62.

See: The Boomer’s Guide to Surviving A Lay-Off

For many employees in their fifties and sixties, they want to keep working, but if they lose their job, they discover how tough it is to get another high-paying job in today’s economy. Others leave work due to health issues, or to care for an ailing spouse. The point is that things change. It’s great to work if you want to, but not because you have to. The single-minded goal of every fifty-something investor should be to build their nest egg to where they would be fine if they didn’t work.

1) Prepare your retirement finish line. What size nest egg should you have? At a 4% withdrawal rate, you need 25-times your annual needs. Need $50,000 in withdrawals? Your goal is $1.25 million. Are you there now? How much do you need to save to get there? And while you are at it, download your Social Security statement.

Why 3% withdrawals might be better for retiring early: Can You Retire In Your Fifties?

2) Increase your contributions to catch-up levels. In the calendar year that you turn fifty, you can now contribute an extra $1,000 to an IRA ($6,500 total), and an additional $6,000 to your 401(k) or 403(b) ($24,500 total for 2018). There’s also a $1,000 catch-up for Health Savings Accounts (HSA), but you have to be 55 for the HSA catch-up.

Learn about The Secret Way to Contribute $35,000 to a Roth IRA. 

3) While it’s possible to manage debt into retirement, most people are more confident about their finances when they are debt-free before they retire. I’d suggest you avoid creating new debt in your fifties and consider paying your mortgage off entirely.

4) Many of us are going to need some type of long-term care in the future, especially as life expectancy rises with medical advances. Increasingly, in-home care can allow people in their eighties to remain in their home. Why are we talking about this now? The most cost effective time to buy long-term care insurance is in your fifties to early sixties. You can’t wait until you have a need for care, and then apply for insurance. Instead, we ought to look at creating a pool of funds that could provide this care should you or your spouse need it, decades in the future.

5) Rethink Retirement. Some of you will have a traditional retirement, where one day you stop working and never work another day. However, many of you will have a very different “retirement” than your parents. Maybe you change careers, go to part-time, start a business, or find new sources of income. It’s all possible! Let’s figure out how to make it happen.

See: Replacing Retirement With Work-Life Balance.

Financial Planning In Your Forties

In your forties, it’s time to get serious about your money. Let’s take care of business and establish your financial plan. You can create your future. When I meet with people in their sixties, their net worth and retirement preparedness has little to do with their income, but has a lot to do with how consistent they were with their planning and saving in their thirties and forties. So, be the 40 year old that will make your 65 year old self proud.

1. You are behind. Chances are that you have neglected some aspects of your financial planning at this point and many people in their forties are not on a trajectory that will lead to a comfortable future. Some people are only a little behind and just need to add a few things, but others are severely in danger. You still have the potential for significant compounding of your investments so take advantage of the fact that time is on your side.

Here’s a checklist of what you should have:

  • savings plan of how much to save and where;
  • a retirement plan that calculates a finish line when you can retire;
  • an estate plan;
  • a college funding plan for your kids;
  • comprehensive insurance for your assets, life, and for unexpected liabilities;
    tax strategies to minimize your tax bills;
  • a disciplined, investment program and target asset allocation.

Catch up: Financial Planning In Your Twenties
Financial Planning In Your Thirties

2. Get Rid of Debt. At this point, you should have a mortgage as your only debt. You should have paid off your student loans, and should be paying your credit cards in full every month. “Living within your means” means you don’t borrow money for furnishings, vacations, or toys.

If you are serious about your financial future, you will recognize that cars are a terrible waste of money. All cars lose about 50% of their value within five years. I see a lot of people who are leasing a Mercedes or driving a new $65,000 truck who tell me they cannot afford to put $400 a month into an IRA. My advice: keep your current car for as long as possible, 100,000 miles or more, then buy used and pay cash.

See: Rethink Your Car Expenses
Should You Get A New Car to Save Gas?

3. Save Based on Goals. In your twenties and thirties, you probably saved based on ability: I can afford to save $300 a month, or, I’ll save 10% to my 401(k). That’s okay to start, but it’s not looking at what is actually needed to accomplish your goals. Maybe you didn’t even have a goal! When your goal is specific, a course of action becomes obvious. If your goal is to pay for four years of tuition at a certain university, we can project how much that will cost and how much we need to save to achieve that goal.

For financial independence, start with your living expenses and apply a 4% withdrawal rate. If you need $60,000 a year to spend, that would require a portfolio of $1,500,000 (4% = $60,000). Now you have a specific goal. How much do you need to save to get to $1.5 million at age 65? Can you do it by 62? Are your investments likely to achieve the return necessary to reach your finish line? Your actions – spending, saving, and investing – should be based on a plan for your goals.

See: Setting Your Financial Goals

4. Family Needs. Increasingly, we are seeing adults who besides having to plan for their own future and their children’s needs are having to help their retired parents with care or financial support. Have a conversation with your parents and understand how they have planned for their retirement. Do they have a retirement income plan and an estate plan? Are you seeing any signs of memory loss or a decline in cognitive skills? These are signs of potential difficulty managing money in the future. If your parents are in their seventies or older, it might be a good idea to have conversations about money and their wishes. And of course, they might need a financial planner to help them as well.

See: Financial Planning for the Sandwich Generation

5. Umbrella Policy. When it comes to insurance, don’t just get “a” policy. Take the time to understand what your policies cover and exclude and make sure your coverage is more than adequate. People who look only at getting the lowest rate on their home and auto insurance are likely to be disappointed by their coverage, exclusions, and deductibles if, or should I say when, they have a claim. It’s important to make sure you have enough insurance, especially as your net worth grows.

That’s why I recommend clients consider an Umbrella Policy, which will supplement the liability coverage on your home and auto policies. If you have a car accident, your umbrella policy can provide another $1 million or more in coverage above the $250,000 limit on your auto policy. For a few hundred dollars a year, it’s worth owning an umbrella. If you don’t have a policy, or want to shop rates, I can refer you to an independent agent who can help you consider your options.

See: Don’t Forget Your Umbrella

Financial Planning In Your Thirties

In your thirties, you are establishing the financial habits which will last for the rest of your life. Choose carefully! You might think that it was tough to save and invest in your twenties. Well, I wish I could say things get easier in your thirties, but there are going to be new demands and expenses. You might still have student loans, but will be adding in a mortgage and car payments. Besides your own expenses, you may have a young family and all the joys and bills of day care, pre-school, and then clubs, sports, and music lessons. Your time and your money can disappear very quickly!

It’s important that you don’t delay your financial planning for another year. One year can turn into five or ten before you know it. I know it is easy to feel overwhelmed with all the financial pressures you face. Although there is a lot to do, we can help you get through the process and take the steps to create financial security and eventually, financial independence.

1. Catch Up. Most people in their thirties still need to do some of the key steps we discussed for your twenties: establishing an emergency fund, managing debt, tracking net worth, starting investing, and getting term life insurance.

See: Financial Planning in Your Twenties

2. Increase Savings. As your career progresses, you may find you are being promoted from entry-level to higher paid positions. You might change employers, relocate, or even pursue a new, more lucrative career. From 30 to 39, you might see a significant increase in your income. The question is: When you get a raise, will you spend it or save it? If you can get in the habit of increasing your saving and investing, you can generate a significant amount of investment capital in your thirties.

The challenge is that you will see so many friends who are buying a bigger house, leasing two luxury cars, taking lavish vacations, or buying a boat or a lake house. You have to resist the temptation to “Keep up with the Joneses”. They may be taking on a vast amount of debt to fund their lifestyle and are not being responsible with their money. Just because a bank will give you a credit card or loan, doesn’t mean it’s a good idea to spend the money.

3. Put Your Investing on Auto-Pilot. What works is squirreling away money consistently. Set up the accounts you need: 401(k), Roth IRA, 529 Plan, Health Savings Account (HSA), etc. Pay yourself first and set up monthly automatic contributions to each account. Don’t worry if you have to start small, you can always increase your amounts later. If you don’t make contributions automatic, you probably aren’t going to have an extra $5,500 lying around at the end of the year to fund your IRA.

See: How Much Should You Contribute to Your 401(k)?

4. 15-Year Mortgage. If you begin your house search process with the pre-approval for a 15-year mortgage, you can save a fortune in interest over the life of the loan. Of course, you also have the opportunity to own your house free and clear in just 15 years. Even if you move after 10 years, you will have significantly more equity if you started with a 15 year rather than a 30 year loan.

See: The 15-Year Mortgage: Myth and Reality

5. Start a 529 College Savings Plan. The sooner you can starting saving for your kids’ college, the more time you can enjoy the benefits of compounding. And since a chief benefit of 529 Plans is tax-free growth, you get more benefit by starting at age 6 than at age 16. An early start is helpful.

See: How Much Will It Cost to Send Your Kids to College?

6.  Establish an Estate Plan. No one wants to think about their own mortality, but this is an important step that you need to take. If you have minor children, you really do not want to leave decisions about what happens to your children (and the money to support them) in the hands of a Judge who doesn’t know you. Courts are bound by rules that may lead to outcomes that you would not have wanted. I can refer you to an attorney who can complete this process with you. The cost for most plans will be only $750.

See: What Happens If You Die Without a Will.