What Should You Expect from Social Security?

piggy bank

The big surprise this week was that the new budget approved by Congress and signed by President Obama on Monday abolishes two popular Social Security strategies for married couples. The two strategies that are going away are:

1) File and Suspend. A spouse could file his or her application but immediately suspend receiving any benefits. This would enable the other spouse to be eligible for a spousal benefit, while the first spouse could continue to delay benefits to receive deferred retirement credits until age 70.

2) Restricted Application. Also called the “claim now, claim more later” strategy, this would allow a spouse to restrict their application to just their spousal benefit at age 66, while continuing to defer and grow their own benefit until age 70.

Both of these strategies were ways for married couples to access a smaller spousal benefit, while still deferring their primary benefits until age 70 for maximum growth. And now, these strategies will be gone in 6 months from today. It was estimated that these strategies could provide as much as $50,000 in additional benefits for married couples. Needless to say, people close to retirement who were planning on implementing these strategies feel disappointed and upset.

Some Baby Boomers have done a lousy job of saving for retirement and are going to be heavily reliant on Social Security. According to Fidelity Investments, the average 401(k) balance as of June 30 was $91,100 and their average IRA balance is $96,300. If an investor had both an average IRA and 401(k), they’d still have only $187,400. But those figures don’t tell the true depth of the problem facing our nation, because those “average balances” don’t count the 34% of all employees who have zero saved for retirement. For many retirees, savings or investments are not going to be a significant source of retirement income.

Looking at current beneficiaries, the Social Security Administration notes that 53% of married couples and 74% of single individuals receive at least 50% of their income from Social Security. For 47% of single beneficiaries, Social Security is at least 90% of their retirement income! As of June 2015, the average monthly benefit is only $1,335, so that should give you some idea of how little income many retirees have today.

Our country simply cannot afford to let Social Security fail, and yet the current approach is unsustainable. People think that Social Security is a pension or savings program, but it is not. It is an entitlement program where current taxes go to current beneficiaries. Back in the years when the ratio of contributors to retirees was 5 to 1, there was a surplus of taxes which was saved in the Social Security Trust Fund. Currently, there are only 2.8 workers per beneficiary and since 2010 Social Security benefits paid out have exceeded annual revenue into the program. By 2035, there will be only 2.1 workers per beneficiary, and this demographic change is the primary reason the system cannot work in its current form.

Today’s estimate is that the Trust Fund will be depleted by 2034. The Disability Trust Fund will be depleted next year, in 2016, at which time funds will have to shifted within Social Security to pay for Disability benefits not covered by payroll taxes.

The 2015 Trustees Report calculates that to fix Social Security for the next 75 years, the actuarial deficit is 2.68% of taxable payroll. This represents an unfunded obligation with a present value of $10.7 Trillion. Every year, the Trustee’s Report tells Congress the size of the shortfall, so Congress can take steps to either reduce benefits or raise taxes to correct the problem.

Unfortunately, changing Social Security has become a “hot potato” which no politician wants to touch. For those who have been brave enough to propose a solution, they are attacked with one-liner sound bites, accusing them of “trying to take away your Social Security benefits.” It is so disappointing that our elected officials cannot come together on a solution to ensure the solvency of our primary source of national retirement income.

It was surprising that the two Social Security claiming strategies were abolished so quickly and with such little opposition or discussion. This will save Social Security a small amount, but it’s doubtful this will make any material improvement in the program’s long-term viability.

For workers close to retirement, it seems unlikely that there will be any significant changes to the Social Security system as we know it today. The best thing you can do is to delay benefits from age 62 to age 70, which will result in a 76% increase in benefits. If you live a long time (to your late 80’s or longer), you will end up receiving greater lifetime benefits for having waited, and the guaranteed income from Social Security will decrease the “longevity risk” that you will deplete your portfolio over time.

For younger workers, I think it is highly probable that we will see the Full Retirement Age increase or a change in how the Cost of Living Adjustments are calculated. For high earners, I believe that you will see the current income cap of $118,500 increase significantly or be removed altogether. Another proposal is to apply a Social Security tax to unearned income, such as dividends and capital gains, to prevent business owners from shifting income away from wages in order to avoid taxes.

I think the strongest approach for investors will be to save aggressively so that your nest egg can be the primary source of your retirement income. Then you can consider any Social Security benefits as a bonus.

Financial Planning for the Sandwich Generation


Nearly every day, I talk with someone who is a member of the “sandwich” generation. No, this isn’t a group of people who like peanut butter and jelly. The sandwich generation refers to people, primarily Baby Boomers, who are caring and providing for both their own children and older family members, most often their aging parents.

This can create quite a strain, emotionally and financially, as adults have to prioritize their time and money to care for their own children as well as their aging relatives who may be dealing with health issues, financial problems, and sometimes declining mental faculties and decision making abilities. Needless to say, given these competing demands, their own retirement planning is often the casualty. Some become full-time caregivers and may be out of the workforce for years while they care for an ailing family member.

In recent months, I’ve heard many sad and difficult situations, including:

  • An 89-year old Grandmother who decided to have cataract surgery only when they said if she did not have surgery, they would take away her driver’s license. No one wants to lose their independence, but maybe her driving isn’t such a great idea, both for her own safety and for others on the road.
  • A relative’s 90-year old mother fell and could not get up. She was unable to reach a phone and spent more than four hours on the floor before someone found her. This was not her first fall incident, and still the children had to go to great lengths to convince their parents that they needed to move to a retirement home. The parents are nearly broke, so the bills will be paid by the son, who is also providing for two college-aged children.
  • A friend’s mother went into hospice and passed away shortly thereafter. He spent the whole summer sorting through her belongings and trying to ready her home for sale. Given her vast collection of items, there are still many months of work ahead.
  • A friend’s older sister was diagnosed with ALS this week. She lives alone, but recently suffered a nasty fall which resulted in a large gash to her head.
  • A statistic from the MIT AgeLab: for people over the age of 70, a broken hip has a 50% mortality rate within 18 months. This is not usually a direct result of the injury, but from a rapidly declining health situation if they become wheelchair-bound. It’s use it or lose it, when it comes to our mobility and health.

We are living longer today, which is a great blessing. However, it also means that many of us will live to an age where we may eventually need some assistance. This is a good problem to have. If everyone only lived into their 50’s, like we did in the 1800’s, we wouldn’t need to address these issues! We should be thankful that medical advances have so greatly extended our longevity over the past century.

While there are many difficult emotional aspects to these conversations, there are many financial considerations as well. If you are part of the sandwich generation, we can help you navigate the difficult decisions you face with your aging parents while making sure that you are also managing your own financial goals.

People who have these conversations with their financial planner in their 60’s may save a great deal of stress and burden on their children in 15 or 20 years. We can help you plan better to make sure that your future doesn’t depend on your children’s finances and generosity. Here are some thoughts about how you can remain healthy and happy as you age:

  1. Create an income plan that budgets for rising health care costs. You do not want to run out of money in your 80’s and have to spend down your assets to qualify for Medicaid. That may be a safety net, but it is a lousy plan.
  2. Work on your home to create a physical space which will allow you to “age in place”. A safe home can not only help prevent injury, but can allow you stay independent for longer.
  3. While no one wants to be in a nursing home, if you live long enough, it is almost inevitable that you will eventually require some help with the Activities of Daily Living. Some are in denial about their abilities in this regard, and it is only a major event, like a broken hip, which eventually prompts a move.
  4. A Long-Term Care insurance policy can pay for home health care. Rather than thinking of an LTC policy as a “nursing home” policy, think of it as the policy which can keep you out of a nursing home.
  5. Today’s retirement communities offer a wide range of services, from truly independent living to round-the-clock skilled nursing. There are many benefits to being part of a community and spending time with friends who have similar interests and backgrounds. Health care professionals are beginning to recognize the significant impact that a social network has on healthy aging.
  6. Create an estate plan which will not create an unnecessary burden on your heirs. Don’t leave a mess for your children to have to clean up.
  7. Reduce taxes on your estate and your heirs. I saw two unfortunate tax situations this year which could have been avoided with better planning. In one situation, an elderly aunt made her nephew the joint owner of her home. The result: no step-up in cost basis on this out-of-state property! In another situation, a father made the beneficiary of his IRA a trust. The IRA was distributed to the trust and was not correctly established as a stretch IRA. As a result, the entire distribution is taxable in 2015. And since the beneficiary was a trust, the applicable tax rate will be 39.6%!

If you are already retired, we can make sure you have a retirement income plan, health care funding, and an estate plan to carry out your wishes. Don’t wait. Our cognitive abilities decline slightly each year, so it’s best to make these decisions in your 60’s or early 70’s and not wait until your 80’s or 90’s.

Men, especially, seem to be in denial about the importance of this planning. Typically, the husband does die first and most retirement homes I have visited are 60% to 90% women. So gentlemen, if you don’t want to plan for yourself, plan for your wife. If you fail to plan for her, sorry, that’s just plain irresponsible. And hopefully you agree she deserves better.

Whether you are in the sandwich generation or just want to make sure you aren’t going to make your children part of the sandwich generation in the future, financial planning can help.

How to Make the 4% Rule Work for You

happily retired

Retirement planning today has largely shifted from guaranteed income from pensions to withdrawal strategies from 401(k) accounts and IRAs. Most financial planners recommend retirees start with an initial withdrawal rate of 4%. This approach was developed because historically, a 4% withdrawal rate, adjusted for inflation each year, would allow a retirement portfolio to last for 30 years under almost all circumstances.

The market was up in each of the past six years, which can give retirees a false sense of security about increasing their spending. In recent years, investors could take out 5%, 6%, or more from their portfolio and still end the year with more money than they started with. Markets go up and down, and if you withdraw all of your gains when the market is up, you can run into trouble when the market drops by 20 or 30 percent.

I find the challenge many retirees face with the 4% rule is forgetting to budget for unexpected expenses. If they have $1,000,000, a 4% withdrawal would be only $40,000 a year (before taxes). They can get by on this amount, but when their car needs replacing, they want us to send another $25,000. Suddenly, their annual withdrawal is up to $65,000. The next year, they need $10,000 for a new roof, and the next year, it’s something else. The issue is rarely reckless spending, but failing to set aside money for these unanticipated expenses.

The danger is that if a retiree takes too much, too soon, there won’t be enough remaining principal in their account to last for 30 years. Diminishing your account early in retirement means that future dividends and capital gains will be smaller in dollar terms, and cannot adequately replenish the annual withdrawals. Then the retiree may have to make drastic changes in their spending and lifestyle to avoid depleting their account. If there is a multi-year correction (like 2000-2002), combined with several years of large withdrawals, it is possible a retiree could see their portfolio drop to one-half their starting value in just five years.

I write this because the first challenge with the 4% rule is that many retirees don’t follow it and take out much more when the market is up. The good news, however, is that for the great majority of history, a 4% withdrawal rate was actually extremely conservative.

In a recent article by Michael Kitces, he examined the 4% rule, looking at 115 rolling 30-year periods, invested in a 60/40 portfolio. He found that in more than 90% of the periods, after 30 years of inflation-adjusted 4% withdrawals, a retiree would have finished with more money than they had at the beginning of retirement. In fact, the median wealth after 30 years, was 2.8 times the initial principal. The 4% rule was not an average withdrawal rate, but based on surviving a steep and prolonged downturn like The Great Depression.

Looking at all 115 30-year periods, Kitces found that retirees could have withdrawn a range of 4-10% of their initial principal, with a median of 6.5%. The 4% rule is the lowest withdrawal rate that worked, and since we don’t know future returns, the safest assumption. While that’s no guarantee that the 4% rule will work in the future, investors should feel very confident with this approach.

Now for some even better news: looking at all 115 periods, Kitces found that whenever the portfolio had grown to 50% above the starting value, withdrawals could be increased by 10%. This “ratchet” approach could be done every three years, and is on top of annual increases for inflation.

For example, let’s consider a retiree who started with a $1 million portfolio and experienced 3% inflation for 5 years. The annual withdrawal amount would have started at $40,000 (4%) and grown to $46,371 with inflation. If the portfolio were now to exceed $1.5 million, we could ratchet up their spending by an additional 10%, to $51,008 and that would become the new annual withdrawal amount.

Here’s a summary of how to make the 4% rule work for you:

1) Make sure you stick to a 4% withdrawal and don’t forget to set money aside for unexpected expenses.
2) Remember that the 4% rule is based on the worst case scenario of terrible market performance.
3) You can plan to increase your withdrawals each year for inflation.
4) If your portfolio grows to 50% above your initial starting value, you can ratchet up your annual withdrawal by an additional 10%.
5) Finally, recall that the 4% rule worked for a portfolio comprised of 60% stocks, 40% bonds. Don’t think that you can apply the 4% rule to a portfolio that is 80% invested in cash or CDs. It’s stocks that fuel the growth which enables the withdrawals to be increased.

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

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Roth IRAs are incredibly popular and for good reason: the ability to invest into an account for tax-free growth is a remarkable benefit. Unlike a Traditional IRA or Rollover IRA, there are no Required Minimum Distributions, and you can even leave a Roth IRA to your heirs without their owing any income tax. For retirement income planning, $100,000 in a Roth IRA is worth $100,000, whereas $100,000 in a Traditional IRA may only net $60,000 to $75,000 after you pay federal and state income taxes.

The only problem with the Roth IRA is that many investors make too much to be able to contribute and even those who can contribute are limited to only $5,500 this year. If you’re a regular reader of my blog, you may recall a number of posts about the “Back-Door Roth IRA”, which is funded by making a non-deductible Traditional IRA contribution and immediately making a Roth Conversion.

But there is another way to make much bigger Roth contributions that is brand new for 2015. Here it is: many 401(k) plans offer participants the ability to make after-tax contributions. Typically, you wouldn’t want to do this. You’d be better off making a tax-deductible contribution.

When you separate from service (retire, quit, or leave) and request a rollover, many 401(k) plans have the ability to send you two checks. One check will consist of your pre-tax contributions and all earnings, and the second check will consist of your after-tax contributions.

What can you do with these two checks? This was a gray area following a 2009 IRS rule. If the distributions were from an IRA, you would have to treat all distributions as pro-rata from all sources; i.e. each check would have the same percentage of pre-tax and after-tax money in it.

Remarkably, the IRS ruled in 2014 that when a 401(k) plan makes a full distribution, it can send two checks and each check will retain its unique character as a pre-tax or after-tax contribution. No pro-rata treatment is required. This will allow you to rollover the pre-tax money into a Traditional IRA and the after-tax money into a Roth IRA. This rule applies only when you make a full distribution with a trustee to trustee transfer.

Since this is a new rule for 2015, it is likely that your HR department, 401(k) provider, and CPA will have no idea what you are talking about, if you ask. Refer them to IRS Notice 2014-54. Or better yet, refer them to me and I can explain it in plain English!

Even though the salary deferral limit on a 401(k) is only $18,000, the total limit for 2015 is actually $53,000 or 100% of income. So you should first contribute $18,000 to your regular, pre-tax 401(k). Assuming there is no company match or catch-up, you could then contribute another $35,000 to the after-tax 401(k) to reach the $53,000 limit.

Let’s say you do this for five years and then retire or change jobs. At that point, you would have made $175,000 in after-tax contributions which could be converted into a Roth IRA, and since your cost basis was $175,000, there would be no tax due.

The earnings on the after-tax 401(k) contributions would be included with your other taxable sources of funds and rolled into a Traditional IRA. Only your original after-tax contributions will be rolled into the Roth account. Please note that this two-part rollover only works when you separate from service and request a FULL rollover. You may not elect this special treatment under a partial withdrawal or an in-service distribution.

Lastly, before attempting this strategy, make sure your 401(k) plan allows for after-tax contributions and will send separate checks for pre-tax and after-tax money. While this strategy is perfectly legal and now explicitly authorized by the IRS Notice, 401(k) plans are not required to allow after-tax contributions or to split distribution checks by sources. It’s up to each company and its plan administrator to determine what is allowed. The IRS Notice stipulates that this process is also acceptable for 403(b) and 457 plans, in addition to 401(k) plans.

Not sure if this works with your 401(k)? Call me and I will review your plan documents, enrollment and distribution forms, and call your plan administrators to verify. I think this would be a great approach for someone who is a handful of years away from retirement who wanted to stuff as much as possible into retirement accounts. Additionally, anyone who has the means to contribute more than $18,000 to their 401(k) each year might also want to consider if making these after-tax contributions would be a smart way to fund a significant Roth IRA.

Choosing a Small Business Retirement Plan


If you own your own business, or are self-employed, there are a myriad of options for establishing a retirement plan for yourself and your employees. If you want to attract and retain high quality employees, you need to be able to offer wages and benefits that are competitive within your industry. There are many employees who will prefer a job that includes the stability of a robust benefits program over a job that just offers a higher salary.

I am surprised how often owners of small businesses balk at establishing a retirement plan. Yes, it may entail some additional costs and extra administrative work. Some business owners aren’t planning to retire, so they aren’t focused on creating a retirement nest egg. Of course, if you think your employees feel the same way – that they want to work for you until they die, you may be overestimating the attractiveness of your workplace!

Establishing a company retirement plan doesn’t need to be complicated or have unknown, limitless expenses. There are quite a few benefits to starting a plan, including:

  • Being able to move company profits into a creditor-protected account for the owner and his or her family as a tax deductible business expense.
  • Creating assets that are separate from your company. Diversifying your net worth so your wealth is not 100% linked to the value of your company. What would your spouse be able to do with your company, if you were hit by a bus tomorrow?
  • Providing valuable benefits so you can hire and keep top quality employees. Offering your employees a program to encourage their own retirement saving.

Luckily, there are a number of retirement plan options for employers, each with its own unique benefits. Here is a quick overview of six retirement plans to consider and a profile of the ideal candidate for each.

1) 401(k). The 401(k) is the gold standard of retirement plans, and while it would seem to be the obvious choice, 401(k) plans can be expensive, complicated, and often a poor fit for a smaller company. Many 401(k) providers are happy to work with your company if you have $500,000 or $1 million in plan assets, but fewer are willing to work with start-up plans or companies with fewer than 50 full-time employees.

Sometimes employers decide to offer a 401(k) but are not willing to provide a matching contribution. You may think you’re adding a benefit, but this often backfires. You will have very low participation without a match, so the administrative cost per employee and the fixed costs for the amount of assets in the plan ends up being higher. And since 401(k)’s have “top heavy” testing, the higher paid employees who do want to participate are often told that they have contributed too much to the plan and that they have to remove some or all of their contributions. No one wins in this situation.

The solution to avoiding the top heavy testing is to establish a “safe harbor” plan, but this will require that the company provides a matching contribution.

Best candidate for a 401(k): a company who is willing to provide a matching contribution for employees and will have at least 10 or 20 participants in the plan (actual participants, not just eligible employees). Without the company willingness to offer a match, I’m not sure the plan will satisfy the needs of the owner or the employees. 401(k)’s tend to have a better participation rate in companies with higher paid, white collar employees.

2) SIMPLE IRA. The Savings Incentive Match PLan for Employees (SIMPLE) was created to enable employers with fewer than 100 employees to be able to offer a “401(k)-like” plan, without complicated rules or high administrative costs. Employees choose to participate and have money withheld from their paycheck. They may contribute up to $12,500 for 2015; if over age 50, they may contribute an additional $3,000. The company will match employee contributions up to 3% of their salary.

If you have payroll of $200,000 a year, and ALL employees participate, you’d match $6,000 of their contributions. The company match is a tax deductible business expense. Both employee and employer contributions vest immediately and are held in each employee’s name where the employee chooses how to invest their account. If a participant makes a withdrawal in the first two years, the penalty is 25%. If the withdrawal is after two years, but before age 59 1/2, the penalty is 10%. For the business owner, there is no top heavy testing, so you may contribute the maximum (plus the match) to your own account, regardless of whether your employees choose to participate or not.

Best candidate for a SIMPLE IRA: any company with 2-100 employees that is willing to match 3% of employee contributions and wants a plan that is easy to administer and low cost. More owners should be looking at the SIMPLE rather than trying to make a 401(k) fit. It’s a great option. There are two reasons why you might choose a 401(k) instead. The first would be if you plan to have more than 100 employees. Second, if you think many of your employees will want to contribute more than $12,500 in a SIMPLE, they could contribute $18,000 to a 401(k). If neither of those reasons apply, a SIMPLE is a great alternative to a 401(k).

3) SEP-IRA. The Simplified Employee Pension (SEP) is an employer-funded plan. The employee does not contribute any money to a SEP; employer contributions are elective and can vary from year to year. However, the company must provide the same percent contribution to all eligible employees, from zero to 25% of salary. The maximum contribution for 2015 is $53,000 (at $265,000 of net income). Contributions are a tax deductible business expense.

If you are looking for a profit-sharing type of plan that allows the employer flexibility of how much to contribute each year, the SEP may be a good fit. In practice, the vast majority of SEP plans are established by sole proprietors or other self-employed individuals who do not have any employees, other than possibly a spouse. Since your contribution amount to a SEP depends on your profits, it is impossible to know the exact amount you can contribute until you do your taxes. Most SEP contributions occur in April, but the unique thing about a SEP is that it is the only IRA which you can fund after the April 15 deadline. If you file an extension, you can contribute to a SEP all the way up to October 15 on your individual return, or September 15 on a corporate return.

Best candidate for a SEP: a business owner with no additional employees. Note that any 1099 independent contractors you hire are not eligible for your company SEP, only W-2 employees.

4) Individual 401(k). Also called a “Solo 401(k)” or “Self-Employed 401(k)” sometimes, this is just a regular 401(k)/Profit Sharing plan where a custodian has created a set of boilerplate plan documents to facilitate easy administration. Even though the Individual 401(k) is for a single individual (and spouse) who is self-employed, there are technically two contributions being made: as the employee, you can make a salary deferral contribution (up to $18,000), and then as the employer, you can make a profit sharing contribution, up to 25% of net income. The plan has the same total contribution limit as a SEP, but because of the 2-part structure of the contributions, people with under $265,000 in net income can often contribute more the the Individual 401(k) than they can to a SEP.

The Individual 401(k) is what I have used for myself for my work as a financial advisor. I am also then able to make a SEP contribution based on my (small) earnings as a free-lance musician. Note that once your Individual 401(k) assets exceed $250,000, you will be required to submit a form 5500 to the IRS each year. If you are interested in an Individual 401(k), we can establish one for you with our custodian, TD Ameritrade.

Best candidate for an Individual 401(k): Self-employed person, with no employees (and no plans for employees), who wants their own 401(k) and plans to contribute more than they can to an IRA.

5) Traditional IRA. The Traditional IRA is not an employer-sponsored retirement plan. However, if you are single and do not have an employer-sponsored plan, you can contribute up to $5,500 to a Traditional IRA as a tax-deductible contribution, regardless of how much you make. Or, if you are married and your spouse is also not eligible for an employer-sponsored plan, then you can each contribute $5,500 into a Traditional IRA, with no income restrictions. I point this out, because if you don’t have any employees and only plan to contribute $5,500 (or $11,000 jointly) each year, then you don’t need to start a 401(k) or any of these other plans. Just do the Traditional IRA.

Best candidate for the Traditional IRA: a business owner not looking to offer an employee benefit, who will contribute under $5,500 per year.

6) Defined Benefit Plan (Pension Plan). 401(k) plans are “Defined Contribution” plans, where the employee makes the majority of the contributions and determines how to invest their account. At the other end of the spectrum is the Defined Benefit Plan, or Pension Plan, where the employer makes all the contributions, manages the investment portfolio, and guarantees the participants a retirement pension. Undoubtedly, there are fewer and fewer large employers offering DB plans today because of their cost and complexity. However, for a specific set of situations, a DB Plan can be a brilliant way to make very large contributions on behalf of owners and highly-paid employees of small companies. The Plan will aim to provide a set benefit, for example, 50% of the final salary, with 30 years of service, at age 65. Each year, the plan’s actuary will calculate how much the company needs to contribute to the plan’s account to be on track to offer this benefit for all eligible employees. Obviously, the amount contributed for employees who are older will be higher, as will be the amount contributed for higher income employees.

The plan does not need to pay pension benefits for an indefinite period. Assuming the owner is the oldest employee, he or she can simply shut down the plan when he or she retires and then distribute the plan assets into IRAs for vested participants. In a situation where the owner is much older (say 61, versus employees in their 30’s and 40’s), and the owner makes $300,000 versus employees who make $50,000, the vast majority of the assets will be distributed to the owner upon dissolution of the plan. The DB Plan can be in addition to a DC Plan, like a 401(k), and is a great way to maximize contributions for an owner with very high earnings who is planning to retire in a couple of years.

Best candidate for a DB Plan: high earners who are older, who will retire and shut down their business, and who have a couple of much younger employees. Many small law firms and medical practices fit this profile exactly. If you have been lamenting that the $53,000 limit in a Profit Sharing Plan is too low for you, consider adding a DB Plan.

At Good Life Wealth Management, retirement planning is our forte. We can help you determine the best plan for your needs and make it easy for you and your employees to get started. Drop me a line and let’s schedule a time to talk about how we can work together.

Guaranteed Income Increases Retirement Satisfaction

Coffee Crossword

Several years ago, for a client meeting, I prepared a couple of Monte Carlo simulations to show a soon to be retired executive possible outcomes of taking his pension as a guaranteed monthly payment, versus taking a lump sum, investing the proceeds, and taking withdrawals. When I showed that the taking the pension increased the probability of success by a couple of percent, my boss promptly cut me off, and warned the client that if they didn’t take the lump sum they would have no control of those assets and would not be able to leave any of those funds to their heirs. That’s true, but my responsibility was to present the facts as clearly as possible for the client to make an informed choice, without injecting my own biases.

The fact is that retirees who are able to fund a larger portion of their expenses from guaranteed sources of income are less dependent on portfolio returns for a successful outcome. New research is finding that retirees with higher levels of guaranteed income are also reporting greater retirement satisfaction and less anxiety about their finances. Sources of guaranteed income include employer pensions, Social Security, and annuities. This is contrasted with withdrawals from 401(k) accounts, IRAs, and investment portfolios.

For the last two decades, the financial planning profession has been advocating 4% withdrawals from investment portfolios as the best solution for retirement income. Unfortunately, with lower interest rates on bonds and higher equity valuations, even a conservative 4% withdrawal today, increased annually for inflation, might not last for a 30+ year retirement. (See my white paper, 5 Reasons Why Your Retirement Withdrawals are Too High, for details.)

Professor Michael Finke from Texas Tech, writing about a Successful Retirement, found that, “The amount of satisfaction retirees get from each dollar of Social Security and pension income is exactly the same — and is higher than the amount of satisfaction gained from a dollar earned from other sources of income. Retirees who rely solely on a defined contribution plan to fund retirement are significantly less satisfied with retirement.”

Emotionally, there are a couple of reasons why guaranteed income is preferred. It mimics having a paycheck, so retirees are comfortable spending the money knowing that the same amount will be deposited next month. On the other hand, investors who have saved for 30 or 40 years find it very difficult to turn off that saving habit and start taking withdrawals from the accounts they have never touched.  Although taxes on a $40,000 withdrawal from an IRA are the same as from $40,000 income received from a pension, as soon as you give an individual control over making the withdrawals, they want to do everything possible to avoid the tax bill.

The biggest fear that accompanies portfolio withdrawals is that a retiree will outlive their money. No one knows how the market will perform or how long they will live. So it’s not surprising that retirees who depend on withdrawals from investments feel more anxiety than those who have more guaranteed sources of income. The 2014 Towers Watson Retiree Survey looked at retirees’ sources of monthly income and found that 37% of retirees who had no pension or annuity income “often worry” about their finances, compared to only 24% of retirees who received 50% or more of their monthly income from a pension or annuity.

While I’ve pointed out the negative outcomes that can occur with portfolio withdrawals, in fairness, I should point out that in a Monte Carlo analysis, investing a pension lump sum for future withdrawals increases the dispersion of outcomes, both negative and positive. If the market performs poorly, a 4% withdrawal plan might deplete the portfolio, especially when you increase withdrawals for inflation each year. However, if the market performs on average, it will likely work, and if the initial years perform better than average, the portfolio may even grow significantly during retirement. So it’s not that taking the lump sum guarantees failure, only that it makes for a greater range of possible outcomes compared to choosing the pension’s monthly payout.

What do you need to think about before retirement? Here are several steps we take in preparing your retirement income plan:

1) Carefully examine the pension versus lump sum decision, using actual analysis, not your gut feeling, heuristic short-cuts, or back of the envelope calculations. If you aren’t going to invest at least 50% of the proceeds into equities, don’t take the lump sum. Give today’s low interest rates, the possibility of retirement success is very low if you plan to invest 100% in cash, CDs, or other “safe” investments.

2) Consider your own longevity. If you are healthy and have family members who lived for a long time, having guaranteed sources of income can help reduce some of the longevity risk that you face.

3) Social Security increases payments for inflation, whereas most pension and annuities do not, so we want to start with the highest possible amount. We will look at your Social Security options and consider whether delaying benefits may improve retirement outcomes.

4) If your guaranteed income consists only of Social Security, and is less than 25% of your monthly needs, you are highly dependent on portfolio returns. Consider using some portion of your portfolio to purchase an annuity. If you are several years out from retirement, we may consider a deferred annuity to provide a future benefit and remove that income stream from future market risks. If you are in retirement, we can consider an immediate annuity. For example, a 65-year old male could receive $543 a month for life, by purchasing an immediate annuity today with a $100,000 premium.

Annuities have gotten a bad rap in recent years, due in large part to unscrupulous sales agents who have sold unsuitable products to ill-informed consumers. However, like other tools, an annuity can be an appropriate solution in certain circumstances. While many financial planning professionals still refuse to look at annuities, there has been a significant amount of academic research from Wade Pfau, Michael Finke, and Moshe Milevsky finding that having guaranteed income may improve outcomes and satisfaction for retirees. This growing body of work has become too substantial to ignore. I believe my clients will be best served when we consider all their options and solutions with an open mind.

Which IRA is Right For You?


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.

How Much Can You Withdraw in Retirement?


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


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.


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.

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Retiring Soon? How to Handle Market Corrections.

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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.