As 2011 draws to a close, there are several financial moves that you should consider. Below are 10 steps that could help reduce your tax bill, solidify your investment strategy and ensure that your retirement planning is on track.
Review beneficiary designations
Many accounts, such as Individual Retirement Accounts (IRAs), 401(k)s, annuities, and insurance policies allow you to name a beneficiary who will receive those assets when you die. Many people don’t realize that those designations take precedence over their will, even if the will is more accurate and up to date. Because of this, it is important to review the beneficiary designations on all your accounts annually to make sure that they accurately reflect your wishes. Meet with your financial adviser and estate planning attorney to ensure that your designations not only pass property to the correct people, but also minimize expense and taxes.
Take required minimum distributions
If you turned (or will turn) 70 ½ during 2011 then it’s time to start taking required minimum distributions (RMDs) from IRAs and other tax deferred accounts like your 401(k). RMDs don’t apply to Roth IRAs. Your financial adviser can help you calculate your RMD based on IRS guidelines. You are required to take the distribution by December 31st of each year with one exception. If you turned 70 ½ during 2011 you can delay your distribution until April 1, 2012. If you do that, remember you will need to take two distributions next year—one for 2011 and one for 2012.
IRA charitable exclusion
The government extended the IRA charitable exclusion for 2011. Basically this exclusion allows you to distribute (tax-free) up to $100,000 from your IRA and direct it to a charitable organization. If you are charitably minded and don’t need the income from your distribution, then this could be a good way to avoid the tax bite on your RMD.
Medicare open enrollment
The Medicare open enrollment period is the time each year when those on Medicare can make changes to their existing plans to better suit their needs. If you are on Medicare, then you should review your health and prescription drug plans and decide if you want to stick with them or if you would be better served by switching to another plan. The open enrollment period typically runs from November 15 to December 31, but it has been moved up this year to October 15 through December 7. Visit www.medicare.gov for more information.
Year-end charitable contributions
One way to reduce your tax liability in a given year is to make charitable contributions. If you are considering making charitable contributions prior to year-end, consider using appreciated stock rather than cash. Not only will you benefit from the charitable deduction, but you could also avoid paying the built in capital gains tax on the stock.
Year-end gains and losses
Capital gains and losses can be used to offset each other. If you took profits in some of your investment positions this year, look to see if you have any positions that could be sold for a loss to offset the gain and minimize your taxes. Excess losses can be used to offset up to $3,000 in ordinary income taxes. Losses beyond that can be carried forward indefinitely to offset future gains.
Maximize retirement contributions
For 2011, you can contribute a maximum of $5,000 to your IRA and $16,500 to your 401(k). If you are over 50, you can contribute an additional $1,000 to your IRA and $5,500 to your 401(k) per year. By maximizing your contributions each year, you greatly increase your chances of being able to adequately fund your retirement.
Review your asset allocation
The market upheaval of the last several years and investors’ response to that upheaval has wreaked havoc on many people’s asset allocations. Rather than having a balanced, diversified portfolio, many have sought safety by moving everything to cash or bonds. That could cause serious problems in the future if inflation picks up or the bond market stumbles. To protect your assets and maximize your returns, you should meet with a trusted adviser and make sure the investments you hold are appropriate based on your risk tolerance, goals and time frame.
Review your estate plan
Your estate plan should not be a static document. As your life changes, your planning must change with it. Getting married or divorced would likely change how you want to distribute your property; likewise if there is a death in the family. Each year you should review your documents, including your will, trust, and powers of attorney to make sure that they still reflect your wishes and have the correct people taking charge if you were to die or become incapacitated. Also, if you move to another state when you retire, meet with your attorney to make sure that your documents will be valid in your new state of residence. Make revisions as necessary.
Shred unnecessary paperwork
Much of the paperwork you have can be purged once a year. For example, if your December investment statements summarize the year’s activity, you can shred the statements for the previous 11 months. Likewise, any bills, credit card statements, and receipts that you are not using as supporting documentation for your taxes can go.
According to the IRS, you should keep your tax records for “the period of time during which you can amend your tax return to claim a credit or refund, or that the IRS can assess more tax.” Seven years should do the trick for most tax documents, such as returns and any supporting documentation like cancelled checks, receipts, or credit card statements. Identity theft is on the rise, so always remember to shred documents before discarding them.
As you can see, by taking a few simple steps before year-end you can enter 2012 organized and on a firm financial footing.
Note: I first published this article at www.fpanet.org and the Omaha World Herald.
If your kids are grown and moving on to the next stage of their lives, it’s time for you to begin thinking about the next stage of yours. For many, the empty nest years fall in that decade or so just before retirement. Because of that, it’s an ideal time to make adjustments to your finances and make sure you’re on track to meet your retirement goals. Here are 7 financial tips for empty nesters.
Adjust your insurance coverage
With your kids out on their own, it’s time to review your insurance coverage. If they’re no longer driving your cars, ask your insurance agent about removing them from your policy or getting a distant-student credit. Similarly, if they have health coverage provided by their school or a new employer, removing them from your policy will likely reduce your premiums. And don’t forget about life insurance. If your kids are through school and the house is paid for, you probably don’t need as much life insurance, but you may want to consider adding long-term care insurance. Meet with a trusted adviser to evaluate your circumstances and craft a plan that is appropriate for your current stage in life.
Re-focus your finances
Several studies have shown that the cost of raising a child from birth to age eighteen can run anywhere from $250,000 to $500,000. That’s a big chunk of change and causes many people to neglect their planning for things like retirement. With fewer mouths to feed and big expenses like college and braces out of the way, it’s time to re-focus your finances on you.
The good news is that you’re likely in your peak earnings years and retirement plan contribution limits are higher for people over age fifty. Take advantage of those higher limits by putting away as much as possible. The maximum 401(k) contribution for 2019 is $19,000 plus an additional $6,000 if you’re over 50. IRA contribution limits are $6,000 plus an additional $1,000 if you’re over 50. That means that a working, married couple could sock away an additional $320,000 in just five years simply by maximizing their 401(k) and IRA contributions.
Re-do your budget
A budget for a family of five looks drastically different than a budget for two. Take a hard look at your expenses and re-design your budget with your new circumstances in mind. I’ve already talked about insurance and savings, but don’t forget to consider things like cell phone plans, cable tv channels that only junior watched, the grocery bill, and memberships or subscriptions that you were covering for the kids. Once you’ve freed up some extra money each month, see point two.
Go back to work
If you stayed home to raise your kids, consider going back to work at something you really enjoy. Not only can a job replace some of the purpose you derived from raising the kids, but it can also increase the Social Security benefits you’ll be eligible for and provide extra money for savings or meaningful pursuits.
Selling the home you raised your family in can be difficult, but it might make sense if you don’t need the space or if you plan on moving when you retire. Even if you don’t initially downsize your house, work at downsizing your stuff, especially those things that you no longer need now that the kids are gone. Paring down your stuff will make the transition easier if you eventually decide to move to a smaller place or retire in a different state.
Downsizing can also help you unlock the value in your home. For many, their home is their biggest asset. If your house made sense for a growing family, but is overkill now that the kids are gone, moving to a smaller place could free up tens or hundreds of thousands of dollars for retirement.
Get out of debt
The typical empty-nester has about ten or fifteen years to go until retirement. That’s plenty of time to make sure your debt retires when you do. Retiring debt free can slash 20-40 percent off the amount you need to save for retirement. For more information, read my earlier post on how (and why) to retire debt free.
Review your asset allocation and retirement plans
As you get closer to retirement, you will likely want to adjust your investments to make your portfolio more conservative. Meet with a trusted financial adviser to make sure your asset allocation is appropriate and to track your progress towards retirement goals. If married, it’s also a good idea to talk with your spouse about your retirement plans and dreams to make sure you’re both on the same page.
As you can see, sending the kids out on their own can be a major transition, both emotionally and financially. By taking a few simple steps and being intentional with your planning, you can enter the next stage of life with confidence and purpose.
Retirement has a lot of moving parts and when you consider that it could last for thirty years or more, it should come as no surprise that it will have several distinct phases. Sixty-five will look different from seventy-five, which will look different than eighty-five. The world, your health, your finances, your responsibilities, and your priorities, will be dynamic and ever changing. Because of that, it’s important to review your planning and circumstances each year and make whatever course corrections are necessary to keep you on track. Below is a list of questions to ask yourself each year to help determine if any changes or adjustments are in order.
1) Is my withdrawal rate sustainable? The answer to that question depends on many things, including investment performance, inflation, how long you live, and, not surprisingly, luck. Running out of money is not a pleasant option, so you should periodically evaluate your distribution strategy to see if it is sustainable. A good rule of thumb is to keep withdrawals at 4 percent or less of your overall portfolio. Everyone’s circumstances are different, however, so meet with your adviser to make sure your income lasts.
2) Is my income still sufficient and keeping pace with inflation? Inflation is constantly eroding the purchasing power of your money. That means you will likely need to pay yourself more and more with each passing year simply to buy the very same goods and services. Consider a day in the hospital. In 1980 it cost $340. That same day in 2010 cost $5,310. To offset the impacts of inflation, most people need to continue to grow their portfolio, even after retiring. That means you can’t shun risk altogether. You’ll likely need a well-diversified portfolio of stocks and bonds in order to keep pace. That leads us to number three.
3) Is my asset allocation appropriate? Simply put, asset allocation is the process of spreading your investments among stocks, bonds, cash, real estate, commodities, and foreign securities. Research shows that asset allocation is extremely important. Not only does it help to minimize risk, but studies show that it is responsible for nearly 90 percent of your overall return. As markets fluctuate you will likely need to rebalance your portfolio to get your allocation back to your intended target. In the same way, if your goals and objectives change, you should adjust your allocation to match.
4) Is the amount of risk I’m taking still appropriate? Too often people discover their tolerance for risk only after they have exceeded it. This can be a painful lesson any time, but it is devastating to someone in retirement. This is easy to see when you consider the arithmetic of loss. Any investment loss you experience requires a considerably larger gain just to get back to even. For example, if your portfolio loses 50 percent, you would need a 100 percent return just to get back to where you started. Most people in retirement don’t have the luxury of waiting around for 100 percent returns. Better to avoid the loss in the first place.
5) Has the value of my assets changed significantly? Once you retire, you need to turn your assets into an income stream. The bigger the asset, the bigger the potential income stream. Big swings in net worth, like a large inheritance or a significant market loss, affect the amount of income your portfolio can generate. You don’t want to run out of money by taking too much or live miserly by taking too little. Any time the value of your assets changes significantly, reevaluate your withdrawal rate and your asset allocation to make sure they are still appropriate.
6) Are my beneficiary designations up to date? You might not realize that your beneficiary designations (like those on your IRA, 401(k), and life insurance policies) override your will. If your will leaves your life insurance to your kids, but you never updated the beneficiary designation on the insurance policy after your divorce, your ex is getting the money. As you can see, it’s important to periodically check your beneficiary designations to make sure that they reflect your current intentions.
7) Have any of my sources of income been impacted? Personal savings is only one source of income during retirement. You will likely also receive Social Security and possibly a pension. If your spouse dies, that might cause the pension to go away or be reduced. Worse, if the company you worked for goes bankrupt, your pension might get taken over by the Pension Benefit Guarantee Corporation and be significantly reduced. Social Security is on an unsustainable path and your benefits there might be altered as well. Any changes to these other sources of income will put more of the burden on your personal savings, so monitor them closely.
8) Has mine or my spouse’s health changed significantly? At some point, the desire to live close to the beach might give way to the desire to live close to a good medical facility. As you age, investigate assisted living areas and medical facilities in your area. You might eventually need to sell your home to move into a facility or even move to another state if you want to be closer to friends or family that will be involved in your care. Do as much of this planning as possible while you are still healthy so you can easily transition into the next phase.
9) Is my estate plan up to date? Your estate plan should not be a static document. As your life changes, your planning must change with it. Getting married or divorced would likely significantly change how you want to distribute your property. Likewise if there is a death in the family. Each year you should review your documents, including your will, trust, and powers of attorney to make sure that they still reflect your wishes and still have the correct people taking charge if you were to die or become incapacitated. Also, if you move to another state when you retire, meet with your attorney to make sure that your documents will be valid in your new state of residence. Make revisions as necessary.
10) Have my insurance needs changed? Not surprisingly, your insurance needs will change over time. It’s a good idea to periodically review your policies and make changes as necessary. Is Medicare adequate or do you need additional coverage to fill certain health care gaps? Do you anticipate that you or your spouse will need assistance with basic daily activities? If so, you might want to consider a long-term care policy. Does your pension go away when you die? Will your death burden your heirs with a large estate tax bill? If so, changes to your life insurance may be in order.
For a handy PDF of this document, visit the Resources page.
“Good judgment comes from experience and experience comes from bad judgment.” I’m not sure who said that, but it sure is true. When considering investment lessons learned from the financial train wreck of last few years, many people at or near retirement are likely to put the arithmetic of loss at the top of their list. Unfortunately, this knowledge (like that gained from touching a hot stove) usually comes at a painful cost.
To see what I mean, imagine you had a $1 million portfolio that lost 20 percent, or $200,000, in a given year. Gaining 20 percent the following year would not get you back to even. A 20 percent gain on $800,000 would only get you to $960,000. You would need a 25 percent gain to fully recover from a 20 percent loss. The greater the loss, the more difficult it becomes to get back to even. If you lose a third of your portfolio, you need a 50 percent gain to recover. Losing half of your portfolio means that you would need to double your assets just to get back to where you started. Those types of gains take time, which is fine if you have thirty years to go until retirement, but not if you have three.
When you understand the math, it is easy to see that one of your primary concerns as you approach and enter retirement should be avoiding large losses. Large losses are extinction level events. They are like meteors to dinosaurs. They can wipe you out. All else being equal, the closer you get to retirement, the more conservative your asset allocation should be. Take a minute to review your allocation. Is it appropriate for your circumstances or is it the financial equivalent of “Put it all on red”?
Chances are you’ve been asked that question before. Maybe by your spouse or a co-worker. Maybe by your kids. When someone asks you that question, is the answer you give a date or a dollar amount? For most people it’s a date. Something like “March of next year.” or “When I’m sixty-five. Two years to go!”
When you think about it, though, your age has very little to do with it. Sure, you can start taking Social Security at 62, but the average Social Security payment couldn’t lift you above the poverty line. If you’re like most, your nest egg will be doing the really heavy lifting during retirement. It will take over the job that the payroll department handled while you were working. So instead of basing retirement on your birthday, consider basing it on your bank account instead. Figure out the amount of money you need in order to generate the annaul income you require to fund the retirement you want. Get that amount saved and you’re retired, regardless of how old you are or whether or not you are still working.