by Joe Hearn | Mar 13, 2012 | Investing, Retirement
Update: Before jumping into today’s article I wanted to give you an update on the learning post from last week. It must have struck a chord with the IR community (who, like those from Lake Wobegon are good looking and above average), because it was the most read and forwarded article on the site to date. If you enjoy learning new things, follow along with the challenges as we go and you’ll have plenty of things to talk about at the next cocktail party.
With the current challenge I’ve memorized the Americas, Europe and Africa. A good start, but there are a lot of countries in Asia and Oceania that will be challenging. With that update, let’s move on to today’s post, which is an article that I wrote for the Financial Planning Association. With tax time upon us, I thought many of you would find it helpful.
As April 17 (you have two extra days this year) rapidly approaches, people all across the fruited plain are sharpening their pencils, firing up their calculators, and figuring out what, if anything, they owe Uncle Sam. For all the ink spilled lamenting the complexity of the tax code, doing your taxes during your working years is a pretty straightforward task for most people. Just add up what you made, subtract any allowable credits or deductions, and then grab your checkbook.
The process is similar during retirement, with the exception that you have greater control over your income, which means greater control over your tax bill. That control means you can stretch your nest egg further by making good distribution decisions. With that in mind, here are five ways to minimize your tax bite during retirement.
Know which accounts to access first
The money you’ve saved for retirement is likely held in different types of accounts that are taxed differently. Some accounts are fully taxable, while others, like traditional IRAs, defer taxes until you withdraw the money. Still other accounts, like Roth IRAs, may be free from federal taxes altogether.
Which accounts should you tap first? A good rule of thumb is to take money from your taxable accounts first. This will allow the money in your tax deferred accounts to continue compounding. Access tax-free accounts last.
One exception to the rule of thumb might be if you are in a lower tax bracket now and anticipate that you will be in a much higher tax bracket in the future. In that case, you may want to begin taking distributions from your tax-deferred accounts earlier. In any event, work closely with your tax and financial advisers each year to make distributions decisions that make the most sense for your specific situation.
Minimize taxes on Social Security
If Social Security is your only source of income, chances are that you will not need to pay taxes on those benefits. If you have other income sources, however, you may need to pay taxes on a portion of your benefits if your modified adjusted gross income (MAGI) plus one-half of your Social Security benefits exceeds what the IRS calls the base amount for your filing status.
For example, if your MAGI plus one half of your Social Security benefits is between $32,000 and $44,000 (for those married filing jointly) in 2012, you may need to pay taxes on 50 percent of your Social Security benefits. If your income exceeds $44,000, you will likely need to pay taxes on 85 percent of your Social Security benefits. Armed with this knowledge, it’s easy to see how a poorly timed IRA distribution or acceptance of some part-time work during retirement can impact your tax bill in a given year.
Relocate to a tax-friendly state
Different states tax things differently. Consequently, where you decide to live during retirement is no small decision when you think about the various types of taxes that you pay (e.g. income taxes, Social Security and Medicare taxes, capital gains taxes, dividend taxes, property taxes, sales taxes, estate taxes and inheritance taxes). If a particular state is willing to cut you a break in one or more of these areas, it is worth factoring that into your decision making.
For example, do you plan on working at least part time during retirement? There are seven states that do not impose personal income taxes. Will most of your income be from Social Security? Thirty-six states don’t tax Social Security benefits. Do you anticipate a free-spending retirement? There are five states with no sales taxes. Do you have a pension? Ten states don’t tax federal, state and local pension income. Before deciding where to live, inventory your income streams and decide which state will allow you to keep more of what you make.
Consider tax-free bonds
Municipal bonds are issued by states or municipalities and are usually exempt from federal taxes. They may also be exempt from state and local taxes if you live in the state that is issuing the bond. This preferred tax treatment along with their historically low default rate make municipal bonds a staple in many peoples’ retirement accounts.
Take advantage of Net Unrealized Appreciation (NUA)
If you own highly appreciated company stock in your 401(k) or other employer sponsored plan, you should review your options carefully before rolling that money into an IRA when you retire. That’s because tax law permits you to distribute those shares from your 401(k) and pay income tax on the basis (your original purchase price) of the shares while continuing to defer the taxes on the unrealized gains. Once the stock is eventually sold, you will only pay capital gains taxes on the difference between your basis and the sale price. If, however, you roll all of those shares into your IRA at retirement, you will pay ordinary income taxes on the entire amount when you eventually distribute it from your IRA.
This strategy might be particularly appealing to someone in a high marginal tax bracket who currently pays income taxes at a much higher rate (35 percent) than capital gains taxes (15 percent).
Unfortunately, your tax bill doesn’t retire when you do, but there are actions you can take to minimize what you owe. By working closely with your advisers, you can maximize your income and increase retirement security.
by Joe Hearn | Mar 8, 2012 | Hobbies, Learning Challenge, Pursuits, Retirement
Show me someone who loves to learn new things and I’ll show you someone who will most likely have an interesting, rewarding retirement. Why is that? Learning comes with a host of benefits like:
- It keeps your mind sharp
- It keeps you engaged with advances in society (Congrats to my mom on buying her first iPad!)
- It helps you figure out what you like
- It helps you discover new things
- It gives you new people to interact with
- It gives you something fun to do with your spouse or significant other
- It provides personal satisfaction and a sense of accomplishment
And when I talk about learning, I’m not talking about learning in the traditional, sometimes boring sense of the word (e.g. What year did the Spanish-American War start?), but in the fun, practical, interesting sense of the word (e.g. How do you scuba dive?). In other words, pursuing knowledge and experiences that enrich your life.
How about you? Do you like to learn new things? I love to learn. In fact, every year I pick one or two things that I’d like to know more about and spend time learning all I can about them. In years past this has included things like:
- Learning to play chess (to play me search for joe hearn on Chess With Friends)
- Learning to play the guitar
- Learning how to run a marathon (and then running one)
- Learning how to make a great omelet (hint: get the right pan)
- Joining a Master’s (a.k.a.: Old Man’s) swim club
- Taking cooking classes with my wife
- Get my motorcycle license
- Taking a travel photo workshop
One of the great things about our world today (besides the Snuggie) is that self learning (also known as Autodidactism) is easier than ever. Gone are the days when you need an expensive education or lengthy apprenticeship just to learn more about something that you find interesting. Now you can just sit down on your own time and access a plethora of resources, tools, apps, books, and videos on just about any topic that interests you.
Take photography for example. For less than $1,000 you can have a camera that is head and shoulders above anything that Ansel Adams ever had. The store you buy it from will likely offer free “Get to know your new camera” classes so you can learn how to use it. To learn how to take better pictures you can download (for free) The Art of Photography podcast on iTunes. Then you can edit and improve all those great new vacation photos you take using something like iPhoto or Snapseed (available in software and app form).
30 Day Learning Challenges
As you can tell by the name of my blog, I think being intentional is one of the most important things in life. Everyone has ideas, plans and dreams, but those never really become reality unless you intentionally make them happen.
With that in mind, I thought it would be fun to do periodic “challenges” where I intentionally learn about something that interests me and then write about it here at the blog. And of course, if the topic interests you, you are more than welcome to follow along at home and pick up a new skill as well.
Some of those things I can probably learn to do in 30 days (like how to make a good omelet). In those cases, I’ll write about the topic, why I want to know more about it, the tools I used to learn about it, what I was able to learn after the 30 days and a plan you can follow to do the same thing.
In other cases, it will take much longer than 30 days to learn something (learning to speak a second language, for example). In those cases, I will spend the 30 days learning everything I can about how best to teach yourself that skill. Then I’ll write about what I learned and try to give you a road map to follow if you’re interested.
In either case, the idea is to become intentional learners through a combination of reading, researching, asking experts, experimenting, practicing and improving. Sound fun?
The first challenge
The first thing I’ll be doing is a smaller challenge, but something I’ve always wanted to know. I would like to be able to locate every country in the world on a map. You may remember the painful video a few years ago of the Miss Teen USA contestant explaining why most “U.S. Americans” can’t find the United States on the map (If not, you can watch it here).
I chuckled at that video, but in reality, my knowledge of world geography is nothing to write home about. If you asked me to find places like Suriname or Macedonia, I’m not even sure I could get you on the right continent. For someone who loves to travel and eventually wants to visit most of the countries in the world, that geographical ignorance will not abide.
So in the next 30 days, I will learn how to locate every country in the world (about 195 depending on how you count) on a map. To do this, I will be using an app from Brainscape called Learn Geography. The app uses a scientifically optimized algorithm to repeat flashcards in just the right pattern so that your brain will absorb the information. I’ll be learning the countries one continent at a time and in 30 days I’ll report back to you on how I did. If that sounds like something that interests you, I’d love to have some of you follow along as well. Just download the app from the App Store and get started.
Don’t worry if this challenge doesn’t interest you. I’ll make a list of some of the other ones I’m considering below and I’ll be adding new ones all the time. Hopefully, something on the list will pique your interest (or absolutely feel free to suggest something to me) and we can channel our inner Polymath and learn something fun together.
- How to plan an around the world trip
- Learn video and photo editing software
- How to tell a great story
- How to play tennis
- Gardening
- How to simplify/declutter my house
- Scuba diving
- Learn about particular foods (coffee, beer, wine, olive oil, etc.)
- How to snowboard
- How to make great croissants
- Photography
- How to pack light for a trip
- How to hike and camp (e.g. navigating with a compass, starting a campfire, backwoods first aid, planning a hike, etc.)
Thanks for reading!
Joe
by Joe Hearn | Mar 2, 2012 | Investing, Retirement
The question I’m asked most frequently by clients about their retirement is this:
“Will I have enough?”
If baby boomers are losing sleep over an issue, that’s it. And I don’t blame them. There’s a lot hanging on the answer to that question. Having enough means freedom, opportunity, peace of mind, and independence.
So how can you improve your chances of success? A few years back the mutual fund company Putnam and the data firm Lipper did a study on that very topic. They measured the impact of changes in several key variables like asset allocation, fund performance, and contribution rates.
Rather than bore you with the details, I’ll just share one conclusion. The variable that had the greatest impact by far was how much a person saved. In fact, increasing savings rates from 2 percent to 4 percent had 90 times (90 TIMES!) the impact of being able to perfectly pick the best performing mutual funds.
So if you want to make a small change today that will have a huge impact on your retirement security, get online or call your HR department and increase the percentage that you’re contributing to your 401(k) each month. The change will take five minutes, but will have more impact than anything this side of winning the lottery.
Thanks for reading. Have a great weekend!
Joe
by Joe Hearn | Feb 28, 2012 | Pursuits
I had the following text message exchange about a month ago with a friend of mine:
Him: Call me when you have a second.
Me: Will do. I’ll call you when I leave my nephew’s birthday party.
Him: I am buying a Volvo SUV and I can save 6% if I go to Sweden and pick it up. They cover the flights for 2 people and some hotel cost. We could stay from 1 night up to a week. Window April 15-May 30th.
How would you respond? We’re all presented with situations like this in life. OK, maybe not this exact one, but we all face situations where opportunity knocks and we need to decide whether or not to answer the door.
When responding, I’ve found that people usually focus on one of two things: either the opportunity or the obstacles. Those who focus on the opportunity say “Sounds great. Let’s make it happen.” Those who focus on the obstacles say “I’d love to, but <insert excuse here>” (e.g. I need to work, I don’t have the money, my spouse won’t let me, I don’t know how, etc.).
So how did I respond? It took me about five seconds (mostly because I type slowly):
Me: I’m in.
Him: Awesome! I need your Social Security number and date of birth to send to the Volvo travel office.
No one wants to get to the end of life and have a long list of things that they wish they’d done. Unfortunately, human nature is such that we tend to reach for excuses when presented with something (even a good something) that might take effort, be a risk, or take us out of our comfort zone. Not surprisingly, everything in life that’s worth doing takes effort, is somewhat risky and takes you out of your comfort zone. If you constantly say no to those things, your “yes” muscles atrophy and you end up living a pretty unsatisfying life.
So how can we do a better job at embracing adventure and living a life that provides meaning and purpose?
Decide what’s important to you. As I have said on this site before, each of us needs to decide what we really want out of life and then take those things very seriously. For my family, travel is a key priority. I didn’t even ask my wife before texting back about the Sweden thing, because I knew the answer would be yes. When you have a clear understanding of what you want out of life, decision making becomes pretty easy.
Be willing to make things happen. Saying no is easy because that’s the end of it. Saying yes means that you will need to put forth effort and overcome obstacles. It means having to plan, practice, take risks and make sacrifices. No is easy, but it has no payoff. Yes takes effort, but it is an investment that produces a return.
Time and money will never be perfect. Time and money are the “go to” excuses for most of us. Looking at it honestly, however, we have more of both than just about any civilization in the history of the world. Time and money are almost always red herrings. You can find a way around both if you really want something. Our true obstacles are things like inertia, fear, laziness, and being unwilling to sacrifice or put forth the effort required.
Get comfortable with risk. One of my all time favorite advertisements is Michael Jordan reciting a huge list of his failures. At the end of the commercial he says “I’ve failed over and over and over again in my life. And that is why I succeed.” (Watch the ad on YouTube here). Be like Mike. Don’t be afraid to take calculated risks in pursuit of meaningful goals.
Thanks for reading! I’ll give you an update on Sweden in a later post. In the meantime, be on the lookout for opportunity.
Joe
by Joe Hearn | Feb 23, 2012 | Distribution Planning
(Note: This is Part 3 in a 3 part series that I did for the Omaha World Herald on retirement planning for different life stages.)
To state the obvious, farming and cooking are two different things. One is about creating. The other is about consuming. A similar relationship exists between preparing for retirement and being retired. One is about filling the barn—your 401(k), IRA, pension, Social Security credits, etc.—and the other is about emptying it by using what you created to provide for your needs.
That transition—from accumulation to distribution—has a lot of moving parts. Any missteps can impact your retirement for years to come. Taking too much too soon from the wrong accounts or in the wrong markets can be the difference between retirement bliss and retirement blunder. So what can you do to improve your odds of success and get your retirement off on the right foot? Begin by asking yourself the following four questions.
How much do I need?
Before you can begin drawing income, you need to figure out how much you’re going to need. Your costs will largely depend on the lifestyle you choose to live, so start by thinking about what you have planned for retirement. Do you want to travel? Are you planning on moving? Is there a particular hobby you want to focus on? Once those decisions come into focus, it will be easier to craft a detailed retirement budget. To help with this process, you can download a free Retirement Budget Worksheet at www.intentionalretirement.com/resources/.
Where is it going to come from?
Once you have a good handle on your expenses, determine what percentage of them will be your responsibility. Start by making a list of all of your potential income sources. Social Security and Medicare will likely do some of the heavy lifting. If you are lucky enough to have a pension, it will cover another portion of your expenses. If you plan on working part-time or have some other source of income, list that as well. Using this information, fill in the blanks to the equation below. The difference between your total need and the income provided by things like Social Security and your pension is the amount that you will need to draw from your nest egg each year to fund your retirement.
Is my nest egg up to the task?
Now that you know how much you need and where it’s going to come from, you can determine if your nest egg is up to the task. When you retire, your portfolio takes over the job that the payroll department handled during your working years. If you retire at 65 and live until you’re 85, it needs to cut you 240 monthly paychecks. There is no foolproof answer for how much you can safely draw from your portfolio each year, but much of the research points to around 4 percent.
With that in mind, grab a calculator and divide the number you came up with in the previous question by your total retirement assets. If the result is less than or equal to .04 (4 percent), you’re in pretty good shape. If it is greater than .04, it should raise a red flag. All is not lost, but some changes are likely in order. To avoid running out of money, you may need to save more, work longer, work part-time, or cut retirement expenses.
What is my withdrawal strategy?
The last piece of the puzzle is to decide on a withdrawal strategy that is right for you. There are a number of ways to draw from your accounts. You can take dividends only, convert all or a portion of your accounts to guaranteed payments by purchasing an annuity, or structure the accounts to self-liquidate over your lifetime, to name a few.
The strategy that I prefer is often referred to as the bucket strategy. Done correctly, it gives you the most flexibility and greatly increases your chances of outliving your money. It involves structuring your investments into different “buckets” that you can pull from at different times or under different conditions.
For example, you would have one bucket that contained several years of needed distributions in a very safe investment like a money market or certificate of deposit. In another bucket you would have riskier investments like your stocks and bonds. In still another bucket, you would have your tax advantaged investments like your IRA or an annuity.
The idea is to pull your distribution each year from the most appropriate bucket. If you retire just prior to a bull market, you can pull income from your growing investments. If you retire on the cusp of a bear market, you can take withdrawals from your cash. The safe bucket keeps you from being forced to sell your riskier assets in a declining market. The risk bucket increases your odds of outpacing inflation. The tax-advantaged bucket allows you greater control over your tax bill.
The primary advantage of this strategy is that it gives you options. If you, your spouse, and your advisers are able to evaluate those options and make distribution decisions each year that accrue maximum benefit to you, you are likely to see a significant increase in the amount of money you can draw from your portfolio over the years without a commensurate increase in your risk of running out of money.
Monitor and adjust
No matter which distribution strategy you choose, you should never “set it and forget it.” Take time each year to meet with a trusted adviser for a periodic portfolio check-up. This is especially critical during the early years of retirement when your sequence risk (the risk that you will retire and begin withdrawing money during a period of low or negative investment returns) is highest. Some questions you should consider during your annual review:
- Is your withdrawal rate sustainable?
- Is your income still sufficient and keeping pace with inflation?
- Is your asset allocation still appropriate?
- Is the amount of risk you’re taking still suitable?
- Has the value of your assets changed significantly?
- Has your life expectancy changed?
Your answers will help determine if you can keep your withdrawals the same or if a change is in order.
Keep in mind that anyone can retire. Staying retired is the challenge. By crafting a well thought out distribution strategy you can help ensure that your resources will see you through your retirement years.
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