Car Subscriptions

Posted On February 23, 2018 By Scott Stratton, CFP(R), CFA In Financial Planning /

The question used to be “Should I buy or lease a car?”, but there’s a new alternative, a Car Subscription. It’s intriguing and I am curious to see where this goes five years from now. Maybe you are hearing about it here for the first time.

A car subscription is all-inclusive: for one monthly price, you get the vehicle, maintenance, registration, roadside assistance, AND insurance. You should have no other cost than gasoline. These car subscriptions are brand new and being tested by major manufacturers including Ford, Volvo, Cadillac, and Porsche. Right now, subscriptions seem to be targeted at opposite ends of the market: luxury vehicles for the very wealthy and more entry level vehicles for younger adults.

At the high end, Cadillac offers Book, which will deliver a new Cadillac of your choice to your door. Get bored with an Escalade? Log in to the Book app and swap it for a CTS-V or one of five Cadillac vehicles. You can change vehicles 18 times a year. The program’s monthly cost is $1,800 and it includes 2,000 miles a month. Presently, Book available only in NYC, Los Angeles, and right here in Dallas.

Porsche’s subscription service, Passport, offers your choice of different vehicles for $2,000/month or $3,000/month, currently limited to the Atlanta area. Porsche’s service has unlimited miles and unlimited switches between models. Weather’s going to be nice, order a convertible. Taking a road trip? Swap for an SUV.

The Porsche and Cadillac deals might appeal to people who are very wealthy and aren’t price conscious. I’m sure some companies will offer this as an executive bonus. Other subscribers may have a temporary need for a few months and may find a subscription appealing for its flexibility with being able to switch from a sports car to a sedan or SUV. But for most drivers, it isn’t a very economical alternative to owning a vehicle.

There are two other programs which might be more suited to the average driver, especially if you are paying a lot for car insurance. Here in Dallas, it seems like everyone pays several hundred dollars a month in car insurance, and possibly more, if you have a younger driver in your household, or have some tickets or claims in your recent driving history. In a subscription, the insurance is already included and doesn’t change based on your individual background.

Care by Volvo is the first nationwide subscription program, and will be available for their new XC40 crossover this spring. Both the car and the subscription are targeted at Millennials, but I think will have appeal to many others. The subscription is $600 a month, but if that saves you $200 a month in insurance, that would be similar to a $400 lease, except there’s no down payment. Is the insurance any good? Yes. It’s Liberty Mutual, with $500,000 in liability coverage, and a $500 deductible for collision and comprehensive.

Volvo’s subscription is a 24 month commitment, with 15,000 miles a year included. You can get a new car after 12 months, by restarting the 24 month clock. This program is more like a traditional lease, with the inclusion of insurance and all maintenance and repairs.

Ford subsidiary Canvas offers used vehicles in their subscription program, presently available only in Los Angeles and San Francisco. These are 2-3 year old lease returns, and are offered for $375-$575 a month for a Fiesta, Fusion, Escape, Explorer, Mustang, or F-150. The monthly base price includes 500 miles, or you can upgrade to 850 miles for $30, 1250 miles for $60, or unlimited monthly miles for $90. This is a month to month subscription, with no long-term commitment. You can change cars every month if you want, but if you keep one vehicle, they lower your base price each month.

A subscription might be an opportunity for someone who has very high insurance costs to lower their total costs. The unlimited miles subscriptions, could be an alternative to leasing or buying for the road warriors out there who rack up a lot of miles. For a family that needs a second or third car for just a month or two, a short term subscription might be an alternative to keeping an extra car all year around. While some car subscriptions are targeted towards the very wealthy, other plans will appeal to people with a low credit score who might otherwise have difficulty getting credit to buy a car.

Would I recommend this? The reality is that all vehicles depreciate very quickly when new, so your most cost-effective choice will always be to keep your existing car and drive it for 200,000 miles. But many of us don’t want to keep one car for 10+ years and carry the risk of having to pay for unexpected and expensive repairs, even though these costs are likely to be low when considered over the life of the vehicle. Some drivers will prefer to have a fixed monthly cost for their transportation, rather than tying up $40,000 or more in one car. And that’s why I think Subscriptions are going to be popular, they’re a good match for our innate preferences for flexibility and predictable costs.

Are you considering a car subscription? I’d love to hear about your experience if you proceed or decide against it. For many people, their cars are their second largest expense after housing (or third largest, if we consider taxes). Cars depreciate quickly, so saving money on transportation can leave more of our cash available for investments which do appreciate. Here’s how I hope people will evaluate subscriptions: is the cost of the subscription less than if you pay for the vehicle, insurance, and other costs separately?

FAQs: New 20% Pass Through Tax Deduction

Posted On February 17, 2018 By Scott Stratton, CFP(R), CFA In Financial Planning, Tax Strategies / 1 Comment

You’ve probably heard about the new 20% tax deduction for “Pass Through” entities under the Tax Cuts and Jobs Act (TCJA), and have wondered if you qualify. For those who are self-employed, here are the five FAQs:

1. Do I have to form a corporation in order to qualify for this benefit?
No. The good news is that you simply need to have Schedule C income, whether you are a sole proprietor (including 1099 independent contractor for someone else), or an LLC, Partnership, or S-Corporation.

2. How does it work?
If you report on Schedule C, your Qualified Business Income (QBI) may be eligible for this deduction of 20%, meaning that only 80% of your net income will be taxable. Only business income – and not investment income – will qualify for the deduction. Although we call this a deduction, please note that you do not have to “itemize”, the QBI deduction is a new type of below the line deduction to your taxable income. The deduction starts in the 2018 tax year; 2017 is under the old rules.

There are some restrictions on the deduction. For example, your deduction is limited to 20% of QBI or 20% of your household’s taxable ordinary income (i.e. after standard/itemized deductions and excluding capital gains), whichever is less. If 100% of your taxable income was considered QBI, your deduction might be for less than 20% of QBI. If you are owner of a S-corp, you will be expected to pay yourself an appropriate salary, and that income will not be eligible for the QBI. If you have guaranteed draws as an LLC, that income would also be excluded from the QBI deduction.

3. What is the Service business restriction?
In order to prevent a lot of doctors, lawyers, and other high earners from quitting as employees and coming back as contractors to claim the deduction, Congress excluded from this deduction “specified service businesses”, including those in health, law, accounting, performing arts, financial services, athletics, consulting, or any business which relies primarily on the “reputation or skill of 1 or more employees”. Vague enough for you? High earning self-employed people in one of these “specified service businesses” are not eligible for the 20% deduction.

4. Who is considered a high earner under the Specified Service restrictions?
If you are in a Specified Service business and your taxable income is below $157,500 single or $315,000 married, you are eligible for the full 20% deduction. The QBI deduction will then phaseout for income above this level over the next $50,000 single or $100,000 married. Professionals in a Specified Service making above $207,500 single or $415,000 married are excluded completely from the 20% QBI deduction.

5. Should I try to change my W-2 job into a 1099 job?
First of all, that may be impossible. Each employer is charged with correctly determining your status as an employee or independent contractor. These are not simply interchangeable categories. The IRS has a list of characteristics for being an employee versus an independent contractor. Primarily, if a company is able to dictate how you do your work, then you are an employee. It would not be appropriate for an employer to list one person as a W-2 and someone else doing the same work as a 1099.

Additionally, as a W-2 employee, you have many benefits. Your employer pays half of your Social Security and Medicare payroll tax (half is 7.65%). As an employee you may be eligible for benefits including health insurance, vacation, unemployment benefits, workers comp for injuries, and the right to unionize. You would have a lot to lose by not being an employee.

Even still, I expect we are going to see a lot of creative accounting in the years ahead for people trying to reclassify their employment from W-2 to pass-through status. Additionally, businesses which are going to be under the dreaded “specified services” list will be looking for ways to change their industry classification. We will continue to study this area looking for ways for our clients to take advantage of every benefit you can legally obtain.

This information is for educational purposes only and is not to be construed as individual financial advice. Contact your CPA or tax consultant for details on how the new law will impact your specific situation.

How Much Income Do You Need In Retirement?

Posted On January 13, 2018 By Scott Stratton, CFP(R), CFA In Financial Planning /

Many people significantly underestimate how much income they will need to maintain their lifestyle in retirement. We’re going to point out how people underestimate their needs, explain why a common “rule of thumb” is a poor substitute, and then share our preferred process.

If we begin with the wrong budget, then our withdrawal rates, target nest egg, and portfolio sustainability are all going to be inaccurate, which is very difficult to correct after you’ve retired.

In general, when I ask someone to estimate their monthly financial needs, they use a process of addition. They think of their housing expenses, utilities, taxes, food costs, etc., and try to add those up. Unfortunately, the number many arrive at can be significantly too low, and here’s how I know.

They tell me that they spent $5,000 a month, or $60,000 last year. But I ask how much they made and they tell me $150,000. How much did they save last year? $30,000. To me, that suggests they spent $120,000, not $60,000. If they only spent $60,000, they would have saved more than $30,000. You either spend or save money; if it wasn’t saved it was spent, even if that spending wasn’t discretionary.

Here’s why most people fail with the “addition method” of trying to create a retirement income budget:

They don’t include taxes. Taxes don’t go away in retirement; pensions, Social Security (up to 85%), and IRA withdrawals are all taxable as ordinary income.
Unplanned expenses such as home repairs, emergencies, or car maintenance can be substantial and fairly regular, if not consistent or predictable.
Your health care costs may be much higher in retirement than you anticipate, especially in the later years of retirement.
You may finally have time to pursue activities which you did not have time for while working, such as travel, golf, or spoiling your grandchildren. With an additional 40 hours a week available, you will likely be spending money in new ways.

Some financial calculators use a rule of thumb that most retirees will need 75% (or 70-80 percent) of their pre-retirement income. This is called the “replacement rate”. And while there have been a number studies that confirm this 75% estimate as an average, its applicability on an individual basis is poor.

We know for example, that lower income people will need a higher replacement rate than higher income people. That’s because the lower income levels may have had a lower savings rate, a smaller proportion of discretionary spending, and little tax savings in retirement. Higher income workers may have been saving more and find significant tax savings in retirement, and therefore have a lower replacement rate.

Instead of trying to use an addition method or a one-size-fits-all rule of thumb, I’d suggest using subtraction:

Begin with your current income.
Subtract any immediate savings you will experience in retirement, including: the amount you were actually saving and investing each year, payroll taxes (7.65% if a W-2 employee), and work expenses, if significant.
Examine your sources of retirement income and if you calculate any income tax reduction, subtract those savings.
Consider any increases in retirement spending, starting with health care costs and discretionary spending (travel, hobbies, etc.). Add these back to your spending needs.

Unless you are planning to have paid off your mortgage, substantially downsize your house, get rid of a car, or stop eating out, I think most people will initially continue their spending habits in retirement very much the same as they did while they were working. Like everyone else, retirees spend a significant portion of their income on things which they did not want (property tax, income tax, insurance) and on things which were not planned (replacing a roof, medical expenses, etc.).

Underestimating your retirement income needs could lead to some very painful outcomes, such as depleting your nest egg, being forced to downsize, or impoverishing your spouse after you pass away. You have to still plan for occasional expenses, such as replacing a car, home repairs, and emergencies, in a retirement budget.

If you’ve calculated your retirement income needs and your planned budget is significantly less than your pre-retirement income, please be careful. When the number you reached through addition isn’t the same number I reach through subtraction, it’s possible you are not budgeting for some costs which you currently have and are likely to still have in retirement.

I Had $562 in Unclaimed Property

Posted On December 10, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

Several years ago, I changed firms, and in the process of moving, apparently my old firm did not forward a check for an insurance commission they had received. With the $562 check going unprocessed for more than one year, the insurance company filed an “Unclaimed Property Report” and turned the funds over to the State Comptroller of Texas.

To my surprise, I found my name on a list of unclaimed property and was able to receive this $562 from the state last year. Here in Texas, the Comptroller has returned more than $2 Billion in unclaimed property. Maybe you moved and missed a check? Maybe you had an old bank account that you forgot about? Maybe a company owed you a credit and was unable to reach you?

Here’s how you can find if there is any unclaimed property under your name. You will need to check for each state where you have lived. You can start by going to the website of the National Association of Unclaimed Property Administrators and clicking on your state. Search for your name and city.

For Texas residents, you can go directly to the Texas Site here.

It’s worth spending two minutes doing this, even if you believe as I did, that no one owes you any money. Let me know if you have any success. I hope you do!

Investment Themes for 2018

Posted On November 26, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

Each year, we look closely at trends and valuations to create themes which will be incorporated into our Investment Porfolios. In addition to the Defensive Managers Select portfolio which we highlighted last week, our Premiere Wealth Portfolios are tactical asset allocation models with 10-15 funds or ETFs, at five risk levels: Conservative, with a benchmark of 35% Stocks/65% Bonds, Balanced (50/50), Moderate (60/40), Growth (70/30), and Aggressive (85/15). We are also rolling out a new allocation, Ultra Equity, which will be 100/0.

We will always remain broadly diversified, invested both in Core Assets, which we believe should always be in a portfolio, and in Satellite Assets, which are typically in a more narrow category which we feel offers a benefit to the portfolio at the present time. The Satellite holdings may be changed from year to year, and while the Core funds are “permanent”, their size and weighting in the portfolio will change each year based on their relative valuations and attractiveness of other categories.

We always start with the overall asset allocation in our process, and then choose funds which we think will accurately represent each category. With our themes each year, I think you will see that we are far from being entirely passive. Here are our big picture thoughts for 2018.

1) Foreign over Domestic Stocks. US Equities are quite expensive relative to the rest of the world. The strong performance in 2017 has stretched those valuations even further. We are presently overweight US stocks relative to our benchmark (the MSCI All-Country World Index), but will reduce our weighting to US stocks to an underweight.

2) Overweight Emerging Markets. For 2017, we increased our allocation to Emerging Markets Equities to two-times the level of the index, approximately 17% compared to 8.5%. EM had a phenomenal year in 2017, currently up nearly 30%. When we rebalance, these positions may be trimmed, but please note that we are not reducing our target allocation!

3) Reduce Risk in Fixed Income. While short-term rates rose nicely in 2017, long-term interest rates did not. This was our “low for longer” theme from last year. We sold our high-yield bond ETF over the summer, but will continue to look to reduce the duration of our bond holdings and increase the credit quality. When we do eventually get a correction in the stock portfolio, we want to have high quality bonds to provide support to the portfolio.

4) Increased Volatility. We don’t have a crystal ball and believe that trying to make predictions is not only futile but damaging to your returns. However, we have gone an exceptionally long time without any sort of correction. I don’t know when it will occur, but just as autumn turns to winter, I think investors must not forget that there will be down periods, and be prepared to weather potential storms in 2018 and beyond.

We published Four Investment Themes for 2017 in November of 2016. Click the link if you’d like to see how we did. I think we were generally successful in identifying themes for this year, except that I was expecting Value stocks to take the lead from Growth stocks, which did not occur. However, we saw the gap in valuation between Value and Growth widen in 2017, so I believe that Value offers less risk and potentially a higher long-term return than Growth.

2017 was the first full year to include a 10% allocation to Alternatives within each portfolio. With the stock market producing double digit returns in many categories, our investment in Alternatives was a drag on performance. Still, I think many investors will appreciate that we are looking for more stable sources of returns than just being in stocks and bonds. With high valuations in domestic stocks, and low bonds yields globally, risks remain elevated.

Overall, we will be making only small adjustments to our portfolios for 2018. But compared to two or three years ago, we have already made significant changes to reduce risk and further diversify our portfolios. As always, I am happy to discuss our investing approach in greater detail with anyone who is interested.

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

Posted On October 1, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning, Retirement Planning /

Answer: $18,000. If you are over age 50, $24,000.

Those are the maximum allowable contributions and it should be everyone’s goal to contribute the maximum, whenever possible. The more you save, the sooner you will reach your goals. The earlier you do this saving, the more likely you will reach or exceed your goals.

At a 4% withdrawal rate in retirement, a $1 million 401(k) account would provide only $40,000 a year or $3,333 a month in income. And since that income is taxable, you will probably need to withhold 10%, 15%, or maybe even 25% of that amount for income taxes. At 15% taxes, you’d be left with $2,833 a month in net income. That amount doesn’t strike me as especially extravagant, and that’s why we should all be trying to figure out how to get $1 million or more into our 401(k) before we do retire.

I’ve found that most people fall into four camps:
1) They don’t participate in the 401(k) at all.
2) They put in just enough to get the company match, maybe 4% or 5% of their income.
3) They contribute 10% because they heard it was a good rule of thumb to save 10%.
4) They put in the maximum every year.

How does that work over the duration of a career? If you could invest $18,000 a year for 30 years, and earn 8%, you’d end with $2,039,000 in your account. Drop that to $8,000 a year, and you’d only have $906,000 after 30 years. That seems pretty good, but what if you are getting a late start – or end up retiring early – and only put in 20 years of contributions to the 401(k)? At $8,000 a year in contributions, you’d only accumulate $366,000 after 20 years. Contribute the maximum of $18,000 and you’d finish with $823,000 at an 8% return.

I have yet to meet anyone who felt that they had accumulated too much money in their 401(k), but I certainly know many who wish they had more, had started earlier, or had made bigger contributions. Some people will ignore their 401(k) or just do the bare minimum. If their employer doesn’t match, many won’t participate at all.

Accumulators recognize the benefits of maximizing their contributions and find a way to make it happen.

Become financially independent sooner.
Bigger tax deduction today, pay less tax.
Have their investments growing tax deferred.
Enjoy a better lifestyle when they do retire. Or retire early!
Live within their means today.
401(k)’s have higher contribution limits than IRAs and no income limits or restrictions.

Saving is the road to wealth. The investing part ends up being pretty straightforward once you have made the commitment to saving enough money. Make your goal to contribute as much as you can to your 401(k). Your future self will thank you for it!

Equifax and Your Cyber-Security

Posted On September 24, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

You work hard to protect your personal data only to learn that one of the top three credit reporting agencies was hacked and jeopardized private financial information of 143 million Americans. What can you do to safeguard your money, time, and credit score from theft and fraud?

1. Everyone should check to see if they have been impacted by the Equifax breach. Unless you are four years old, you probably have a file at each agency: Equifax, Experian, and TransUnion. To find out if your information was stolen from Equifax, go to this website:
https://www.equifaxsecurity2017.com/am-i-impacted/

2. If you have been impacted, Equifax will allow you to register for free for their protection service, TrustedID Premier. You should do this. Please note that when you request this the first time, it will give you a date to come back and register your membership. After you register, you will later be sent an email with instructions to activate your membership. If you skip these steps, you are not enrolled or protected. It took them two weeks from the time I first applied until my account was activated.

3. Consider putting a credit freeze on your account. This means that if anyone tries to open a credit card or take out a new loan using your identity, that the process will be stopped. That includes yourself – if you go out car shopping and decide to get a new Subaru, your loan will be rejected. You would want to unfreeze your credit a day or two before you do any of these things.

4. Please note that even if you go through this freeze process with Equifax and TrustedID, you may not be 100% safe unless you go through the same steps with Experian and TransUnion.

If you think there may have been unauthorized activity on your accounts, you can also place an Initial Fraud Alert on your account, which is free and lasts for 90 days. By placing an Alert with one agency, they notify the other two.
http://www.experian.com/blogs/ask-experian/what-is-the-difference-between-a-credit-freeze-and-fraud-alert/

5. You should check your credit report at least annually for errors or possible fraud. A free report is required by Federal Law and is available online from each agency at: https://www.annualcreditreport.com/index.action

6. Wallet security: Consider keeping one credit card at home so if your wallet is stolen, you still have one to use. Never keep your Social Security Card in your wallet. If a thief has your credit cards, drivers license, AND social security number, they can do a lot of damage. Keep a photocopy of your credit cards (front and back), drivers license, and passport at home in a safe. If those are lost, you at least know who to call.

7. Online security: Please don’t use passwords that are simple or easily guessed. Don’t use the same password for all accounts. Consider using a password storage software that will generate and store complex passwords for each account. Avoid public wifi when accessing financial accounts. Use two-factor authentication if available.

8. Computer security: 75% of computer breaches are due to “known vulnerabilities”. That means it could have been prevented by an available software update. Each Tuesday night, Microsoft releases patches for security issues. If you are on automatic updates, you are covered. By Wednesday, hackers from around the world try to reverse engineer the patches to uncover how they can break into computers which did not update. Keep your computer updated and use a good anti-virus software. Wipe your hard drives and phones before recycling.

9. Email security: Email is not a secure form of sending information. Avoid emailing your Social Security number, credit card information, tax forms, or account numbers. Hackers have found signatures on emailed PDFs and copied them to “sign” wire transfer requests and steal money from bank accounts.

10. Paper security: Avoid putting sensitive documents in the trash. Buy a shredder. Consider installing a mailbox with a lock.

We take cyber security very seriously and know that fraud and identity theft is a major source of stress. If you have a question about how to best protect your identity and safeguard your money, please give me a call.

Floods and Your Insurance

Posted On September 3, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

In the aftermath of Hurricane Harvey, many Texans are discovering that SURPRISE, homeowners insurance doesn’t cover flooding. The damage from Harvey was from torrential rains, not wind, and in most cases will not be covered by insurance. Only those with Federal Flood Insurance will be covered, but most people do not have flood insurance unless you live in a flood zone that requires it.

If you have a mortgage and thought that you’d be covered by your homeowner’s insurance or that the bank would forgive your loan, sorry, but even if your house is a total loss you still owe every penny of your mortgage balance. What can you do? For counties which are declared a disaster area by FEMA, you may be eligible for Federal Assistance.

FEMA’s Individuals and Households Program (IHP) provides grants to those in disaster counties. You can apply online at disasterassistance.gov or by phone at 800-621-FEMA (3362). To apply, you must have already filed a claim with your insurance and been denied. The IHP will not pay for your deductible, if the damage is covered. For those who receive a grant, you must agree to purchase and maintain Federal Flood Insurance on your property going forward.

The IHP offers two types of assistance:

1. Housing Assistance, including lodging expense reimbursement, rental assistance, and repair or replacement of your primary residence. The IHP only covers a primary residence and not a vacation home, rental property, or other type of property.

2. Other Needs Assistance, such as damage to household goods, vehicles, cleanup costs, medical expenses, child care, or funeral expenses.

The IHP is a terrific program to help cover disaster costs which are uninsured, however, the limit is only $33,000 and many homeowners will easily exceed this amount if their home has been sitting in three feet of water. A grant through the IHP is non-taxable and does not have to be repaid.

The Small Business Administration (SBA) offers Home and Property Disaster Loans of up to $200,000 to homeowners – and you do not need to be a small business owner. The loan must be used to repair or rebuild your home after it was damaged.

While homeowner’s insurance does not cover losses from flooding, most auto insurance policies do. Current estimates are that 500,000 cars will be total losses from Hurricane Harvey and most are covered by insurance. Rental companies, insurers, and car makers are already shipping significant numbers of vehicles to Texas to help people get back on the road.

If you’ve been impacted by Hurricane Harvey and have questions, please feel free to call or email me. And if you haven’t been impacted, it might be a good time to actually look at your insurance policies in some detail and figure out what is covered and what is not covered. No one likes surprises when it comes to insurance.

Income Planning by Retirement Age

Posted On August 19, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

What is often missing in most academic articles about retirement is a consideration of age at retirement. Most articles just assume that someone retires at 65 and has a 30 year time horizon. We know that is not always the case! If you retire early or later, how does that impact your retirement income strategy?

Let’s consider three age bands: early retirement, full retirement age, and longevity planning.

Early Retirement (age 50-64)

Fewer and fewer people are retiring early today. In fact, more than 70% of pre-retirees are planning to continue to work in retirement. Kind of makes you wonder what “retirement” even means today? However, I can see a lot of appeal to retiring early and there are plenty of people who could pull this off. Here are four considerations if you are thinking of retiring early:

Healthcare. Most people who want to retire before 65 abandon their plans once they realize how much it will cost to fund health insurance without Medicare. Let’s say you have a monthly premium of $1250 and a $5000 deductible. That means you have $20,000 a year in potential medical expenses, before your insurance even pays a penny! If you want to retire at 55, you might need to set aside an additional $200,000 just to cover your expenses to get you to Medicare at 65. It’s a huge hurdle.
If you have substantial assets, you will need to have both sufficient cash on hand for short-term needs (1-3 years), and equity investments for long-term growth. This is why time-segmentation strategies are popular with early retirees: setting aside buckets for short, medium, and long-term goals. While time segmentation does not actually protect you from market volatility or sequence of returns, there may be some benefit to a rising equity glide path, and it may be more realistic to recognize that spending in future decades will depend on equity performance, rather than assuming at 55 that your spending will be linear and tied to inflation.
For those who do retire early, taking withdrawals often makes them very nervous, especially after you realize that you must invest aggressively (see #2) to meet your needs that are decades away. If you have $1 million and want to take a 4% withdrawal, that works out to $3333 a month. Taking that much out of your account each month is more nerve wracking than having $3333 in guaranteed income, which leads us to…
A Pension. Most people I have met who retired in their fifties have a Pension. They worked for 20 or 30 years for a company, school district, municipality, branch of the military, etc. At 55 or so they realize they could collect 50% of their income for not working, which means that – in opportunity cost – if they continue to work it will only be for half the pay! It’s kind of a convoluted way of thinking, but the fact remains that a pension, combined with Social Security and Investments, is the strongest way to retire early.

Full Retirement Age (65-84)

The primary approach for retirees is to combine Social Security with a systematic withdrawal strategy from their retirement and investments accounts. We choose a target asset allocation and withdraw maybe 4% or so each year. We often set this up as monthly automatic distributions. We increase our cash target to 4% (from 1%) and reduce our investment grade bonds by the same amount. Dividends and Interest are not reinvested, and at the end of the year, we rebalance and replenish cash as needed. That’s the plan.
Depending on when you start retirement, I think you can adjust the withdrawal rate. The 4% rule assumes that you increase your withdrawals every year for inflation. It also assumes that you will never decrease your withdrawals in response to a bear market. What if we get rid of those two assumptions? In that case, I believe a 65 year old could aim for 5% withdrawals and a 75 year old for 6% withdrawals. This can work if you do not increase withdrawals unless the portfolio has increased. Also, a 75 year old will have a shorter withdrawal period, say 20 years versus 30 years for a 65 year old retiree.
Although retirement accounts are available after age 59 1/2, most clients don’t want to touch their IRAs – and create taxable distributions – until age 70 1/2 when they must begin Required Minimum Distributions (RMDs). Investors who are limiting their withdrawals to RMDs are following an “actuarial method”, which ties your income level to a life expectancy. This is a good alternative to a systematic withdrawal plan.

Longevity Planning (85+)

Many retirees today will live to age 90, 95, or longer. It is certainly prudent to start with this assumption, especially for couples.
Social Security is the best friend of longevity planning. It’s a guaranteed source of lifetime income and unlike most Pensions or Annuities, Social Security adjusts for inflation through Cost of Living Adjustments. Without COLAs, what may have seemed like a generous pension at age 60 will lose half of its purchasing power by age 84 with just 3% inflation. If you want to help put yourself in the best possible position for longevity, do not take early Social Security at age 62. Do not take benefits at Full Retirement Age. Wait for as long as possible – to age 70. Delaying from 62 to 70 results in a 76% increase in monthly benefits.
If you are concerned about living past 85 and would also like to reduce your Required Minimum Distributions at age 70 1/2, consider a Qualified Longevity Annuity Contract (QLAC). A QLAC will provide a guaranteed income stream that you cannot outlive. Details on a QLAC here.
While equities are probably the best investment for a 60 year old to get to 85 years old, once you are 85, you may want to make things much more simple. There is, unfortunately, a significant amount of Elder abuse and fraud, and frankly, many people over age 85 will have a cognitive decline to where managing their money, paying bills, or trying to manage an investment portfolio will be overwhelming. Professionals can help.

There is no one-size-fits-all approach to retirement income. We have spent a lot of time helping people like you evaluate your choices, weigh the pros and cons of each strategy, and implement the best solution for you.

Tracking Home Improvements

Posted On August 6, 2017 By Scott Stratton, CFP(R), CFA In Financial Planning /

When you eventually sell your home, it may be helpful to have a record of your home improvement expenses. Because people often own their homes for decades, this is an area where a lot of records and receipts are lost. Here is what you need to know about tracking home improvements.

Primary Residence Exclusion

At the time of a home sale, the difference between your purchase price and your sale price is a taxable capital gain. Luckily for most people, there is a significant capital gains exclusion from the IRS: $250,000 (single) or $500,000 (married), for your primary residence. If your gain falls below this amount, you will not owe any taxes. In order to qualify, the property must have been your primary residence for at least two of the previous five years, and you must not have taken this exclusion for another property for two years.

If you make a capital improvement (described below), that expense increases your cost basis in the home. But because of the large exclusion ($250,000 or $500,000), many people don’t even bother to keep track of their home improvement expenses. That may be a mistake. Here are a number of scenarios which could be a problem:

If you get divorced or your spouse passes away, your exclusion will decrease from $500,000 to $250,000.
Should you move and make another property your primary residence for four years, you will lose the tax exclusion on the previous property.
If you own your property for the next 30 years, it is possible your capital gain ends up being higher than the $250/$500k limits. These amounts are not indexed for inflation.
Congress could reduce this tax break, although it would be very unpopular to do so. They are not likely to change the definition of cost basis and capital gains.

Capital Improvements

What constitutes a Capital Improvement which would increase your cost basis? In general, the improvement must be permanent (lasting more than one year), attached to the property (not removable or decorative), and add to the value, use, or function of the property. Maintenance and repairs are generally not capital improvements unless they prolong your home’s useful life. The IRS provides the following specific examples of expenses that are Capital Improvements:

Additions, such as a new bathroom, bedroom, deck, garage, porch, or patio.
Permanent outdoor improvements, including paved driveways, fences, retaining walls, landscaping, or a swimming pool.
Exterior features, such as new windows, doors, siding, or a roof.
Insulation for your attic, walls, floors, or plumbing.
Home systems, including heat/central air, wiring, sprinkler, or alarm systems.
Plumbing upgrades such as septic systems, hot water heaters, filtration systems, etc.
Interior improvements, including built-in appliances, flooring, carpet, kitchen remodeling, or a new fireplace.

While there are many expenses which count as improvements, repairs and upkeep do not. Painting, replacing broken fixtures, patching a roof, or fixing plumbing leaks are not improvements. Also, if you install something and later remove it, that expense may not be counted. For example, if you install new carpet and then later replace the carpet with wood floors, you cannot include the carpet expense in your cost basis.

Gain or Loss?

For full information on calculating your gain or loss on a home, see IRS Publication 523. While most homeowners are focused on mitigating taxable gains, I should add that if your capital improvements are significant enough to make your home sale into a loss, that loss would be a valuable tax benefit as it could offset other income. Here’s an example:

Purchase Price: $240,000
Capital Improvements: $37,400
Cost Basis: $277,400

Sale Price: $279,000
Minus 6% Realtor Commission: -$16,740
Closing Costs: -$1,250
Net Proceeds: $261,010

LOSS = $16,390

If you just looked at your purchase price and sales price, you might think that you would have a small gain (under the exclusion amount), and there was no need to keep track of your improvements. However, in this example, you don’t have any gain at all.

Unlike other receipts, which you only need to keep for seven years, you do need to keep records of your capital improvements for as long as you own the home, and then seven years after you file your tax return after the sale. Even if you think you are going to be under the $500,000 tax exclusion, I’d highly recommend you keep track of these capital improvements which increase your cost basis.