by Joe Hearn | Nov 20, 2012 | Retirement, Taxes
Do you keep hearing the phrase “Fiscal Cliff,” but don’t know exactly what it means? Well, get ready to impress your friends at the next cocktail party, because here’s a short cheat sheet on what it is as well as a few thoughts on how it might affect retirees.
The Fiscal Cliff is a combination of tax increases and spending cuts that will automatically occur on December 31 unless Congress and the White House come to some sort of compromise.
The tax increases include:
- An increase in Federal income taxes. We will go from six brackets to five, and the rates will go from 10%, 15%, 25%, 28%, 33% and 35% to 15%, 28%, 31%, 36% and 39.6%.
- The maximum long-term capital gains tax rate will go from 15% to 20%.
- Dividends will go from being the same as long-term gains (usually 15%) to being taxed as ordinary income (up to 39.6%)
- The temporary 2% reduction in the FICA payroll tax will go away.
- Itemized deductions and dependency deductions will be phased out for high wage earners.
- The earned income tax credit, child tax credit and Hope tax credit will revert to their old (and less generous) limits.
- People with student loans will no longer be able to deduct loan interest beyond the first 60 months of repayment.
- Estate and gift tax provisions will change drastically. The amount that can be excluded from an estate will drop from $5.12 million to $1 million and the top tax rate will increase from 35% to 55%.
- The alternative minimum tax (AMT) exemption amounts will fall significantly, subjecting many more people to this tax.
- In addition to the above, high wage earners will see a 0.9% increase in the Medicare portion of their payroll tax as well as a new 3.8% tax on some or all of their net investment income.
The spending cuts include:
- The failure of the “Super Committee” to reach a deal to cut spending in 2011 means across the board cuts will happen automatically in 2013. The cuts will total about $1.2 trillion ($109 billion of that in 2013) and will be spread evenly between defense and non-defense spending.
What this means for you:
There’s good news and bad news if all of these things are allowed to happen. The good news is that, according to the Congressional Budget Office, the deficit will be significantly reduced (i.e. We will go into debt more slowly). The bad news is that the country will likely go back into recession.
I’m assuming that Congress and the White House will come to some sort of agreement to avoid at least some of the things outlined above. That will grab the headlines and cause the markets to rally, but don’t let that obscure the larger point.
Our country has promised and spent far beyond its means for many decades. That cannot go on forever. If you filter out the “noise,” the major themes of the next decade or two will likely be higher taxes, more reserved spending and less generous benefits (think Medicare, Social Security, etc.). That’s not doom and gloom, it’s just reality. Keep that in mind as you plan for retirement and do your best to build a margin of safety into your planning.
~ Joe
Photo by Victoria. Used under Creative Commons License.
by Joe Hearn | Nov 15, 2012 | Asset Allocation, Distribution Planning, Estate Planning, Retirement
If you spend a good portion of your day in a building like an office or a school, chances are good that you’ve participated in a fire drill. Those faux escapes give everyone a chance to practice evacuating the building and give those in charge an opportunity to identify and fix any potential problems.
If retirement is on your horizon, it would probably make sense to do something similar. Call it your “Retirement Fire Drill.” After all, sometimes you get to choose when you retire, sometimes (through illness or layoffs) you don’t. It’s good to be prepared.
So let’s sound the alarm and pretend that today is the day that you’re transitioning into the next phase of life. How will the planning you’ve done so far hold up in the real world? Below are 5 areas to test.
Is your budget going to work?
You have made a retirement budget haven’t you? If not, download our free retirement budget worksheet. What will your sources of income be once your paycheck stops? Do you have a realistic estimate of how much that income will be? How about expenses? Some people say you can live on about 70 percent of your preretirement income, but is that realistic for you? There’s only one way to find out. Practice living for a few months on the income and expenses that you’ve projected. Then reexamine your budget and see if anything needs to change. If it didn’t work for a 2 month trial, it probably won’t work for a 20 year retirement. Take what you learned and make adjustments as necessary.
Is your asset allocation going to work?
If you retired today, how would your investments fare if we had another downturn like 2008? Are you invested too aggressively? Or how about if we got into a period like the late 1970s and early 1980s when inflation increased by double digits each year. Are you invested too conservatively for your retirement income to keep pace? Shocks to your portfolio early in retirement greatly increase your chances of running out of money. You can minimize that risk by having your asset allocation correct and by setting aside a year or so of retirement income in cash so you can draw from that, rather than your investments, in the event of a downturn.
Is your health care going to work?
You won’t be eligible for Medicare until 65. Are you planning on retiring before that? If so, how are you planning to bridge the gap? Even if you wait until 65, do you have enough set aside to pay for the premiums and co-pays required under Medicare? Have you budgeted in the cost of a Medicare supplement policy? Are there any health care issues (e.g. dental work, operations) that you should take care of now, before transitioning into retirement? And what about long term care? What if you or your spouse became disabled or needed ongoing professional care? Do you have a plan to pay for that care that doesn’t include spending down all of your assets and leaving the healthy person in a financial bind?
Is your income strategy going to work?
If you and your spouse are 65, there’s a 72 percent chance that one of you will live to age 85. There’s a 45 percent chance that one of you will live to age 90. Will your income last that long? Are you taking a sustainable amount from your investments each year or are you in danger of running out of money because you’re taking too much? Will part or your income (such as a pension or Social Security) disappear when you or your spouse dies? Can the surviving spouse live on the remainder? Rework your budget to factor in one or more of those income shocks and then think about how you would respond.
Is your estate plan going to work?
If you plan on moving to a different state, have you checked with your attorney to see if your will and estate plan documents will be valid in the new state? What if you became disabled or incapacitated? Do you have powers of attorney that specify who takes charge? If that person is your spouse, what happens if he or she dies before you? Does your will reflect your current wishes? Do you have the correct beneficiaries listed on accounts and insurance policies? Are your documents organized and easily accessible? Do everything you can to have your affairs in order.
How did you do? If you encountered a few problems, don’t worry. One of the great things about a drill is that it’s just practice. Take the information you learned from the fire drill and tweak your plans to give yourself a better outcome. That way you’ll be ready when the real alarm bell sounds.
~ Joe
I originally published this article at www.fpanet.org.
by Joe Hearn | Oct 23, 2012 | Estate Planning, Investing, Retirement
As we age, our brains don’t work as well as they used to. This is particularly true when it comes to making financial decisions.
A recent study by the Texas Tech Financial Literacy Assessment project showed that our ability to understand financial concepts and make good decisions based on that information peaks in our 50s. After age 60, our abilities decline by about 2 percent per year. By age 90, the typical person has about half the cognitive financial abilities that they had at 65.
Ironically, the study also showed that our confidence in our financial decision making ability rises as we age. In other words, we get more and more confident even as we become less and less able. How does the old saying go? Often wrong, but never in doubt?
Since aging is a reality for all of us, what can we do to protect our finances from self-inflicted wounds? Here are a few suggestions:
- Hire a financial adviser that is trustworthy and younger than you.
- Have a trusted family member that you can take to meetings with you.
- As much as possible, have your finances on autopilot after 60.
- Have a financial power of attorney in place so that someone can step in to help you if needed.
In short, surround yourself with people you trust and don’t be afraid to use them as a sounding board as you make decisions with your money. Come to think of it, that’s good advice for any age.
~ Joe
by Joe Hearn | Oct 5, 2012 | Pursuits, Retirement
We spend a lot of time thinking about how we’re going to retire. “How” is an important question to ask, but don’t forget about “Why.”
If you don’t have a good answer for “Why,” you won’t have much success with “How.” That’s because we’re much more effective at doing things when we have a motivation for doing them. If you asked me to lift up a car to simply test my strength, I wouldn’t even try. If you asked me to lift a car that had rolled onto my daughter, I promise you I’d find a way to get it off the ground.
So as you make those 401(k) contributions, review your quarterly statements and meet with your adviser, don’t forget to ask “Why?” Why are you saving and sacrificing? Is it so you can have more money? Money is the means, not the end. It will enable you to retire, but then what? Why do you want to retire? The stronger your “Why” the more successful your “How.”
How strong is your “Why?”
~ Joe
by Joe Hearn | Oct 3, 2012 | Health, Lifestyle Design, Retirement
For the past year or so, I’ve noticed a disconcerting trend. Each time I step on the scale, the number gets larger. Has there been some sort of change in the gravitational pull of the earth or am I putting on weight?
In 2003 I ran the Marine Corps Marathon in Washington D.C. I weighed about 185 pounds and could run 10 miles without breaking a sweat. Now I weigh 215 pounds and get winded chasing my daughter around the park. If that trend continues, in 10 years I’ll weigh 245 pounds and will be pricing mobility scooters.
In life, there are certain problems that are easier to solve sooner rather than later (more on that below). I turn 40 in December and getting into shape is not getting any easier. Not only is my body clinging to calories like a tiger clings to its kill, but finding the motivation is getting harder as I get busier and take on more responsibilities. If I want to be around for another 40 years, however, I need to put the excuses aside and reacquaint myself with physical activity.
Fit by 40
And so, about a month and a half ago I started going to a personal trainer. I had been lamenting to my boss that I wanted to get in shape, but 1) I needed some accountability and 2) I needed to workout during the day because mornings and evenings were too busy with work and family.
As luck would have it, his son (who plays college football) had gone to a trainer for years. My boss had recently started going as well and he invited me to come along. Not only that, but he told me to take off work early three days a week and he would pay for it. Hard to argue with that.
My first day at the “gym” was pretty humbling. First off, it was not a gym, but a converted warehouse. Imagine that barn in the middle of Russia where Rocky trained in Rocky IV and you’ll have a pretty good idea of what I’m talking about. Lifting rocks—check. Chopping wood—check. Pulling Paulie on a sled through a snowstorm—well, you get the idea.
The people training there were serious: Elite high school, college and professional athletes; ultimate fighters (all wearing oxygen depravation masks to simulate altitude); and…me.
So far my time there has been great. My mantra is “Fit by 40.” The pounds have started to come off. I have more energy. Most of all, I feel good that I’m actually being proactive about a problem that I (and millions of other Americans) struggle with.
Why am I mentioning this? Two reasons:
First, I don’t want to publicly fail in front of hundreds of readers who I respect and admire. Thanks for the motivation! 🙂
Second, and more importantly, I wanted to get you thinking about issues or problems in your own life that need some sort of solution. Too often we sweep our problems under the rug because we’re too busy or scared to deal with them. Then someday, when we shed the competing tasks and responsibilities that used to drown out our problems (a.k.a. retirement) those problems come bubbling to the surface.
Rather than enjoying a meaningful, rewarding retirement we spend our time trying to salvage our marriage, get in shape, recover from a preventable illness, mend neglected relationships or figure out what we really want out of life. Don’t ignore your problems. They’re only going to get worse.
Is there something you need to fix? Start down that path today. If I can help, just let me know how.
~Joe
Photo by Laura Gilmore. Used under Creative Commons License.
by Joe Hearn | Sep 28, 2012 | Lifestyle Design, Retirement
When the Pope asked Michelangelo how he knew what to cut away when he was sculpting the statue of David, Michelangelo reportedly answered “Simple. I just chipped away everything that didn’t look like David.”
There are two kinds of processes that artists use when making their art. The first, used by Michelangelo when sculpting David, was a Subtractive Process. You start with something—a block of marble or a hunk of wood—and you slowly chisel, carve and otherwise remove bits of that something until what you’re left with is the finished product.
The other process is an Additive Process. There you start with nothing—a blank canvas, a hunk of clay, an empty lot—and then you paint, shape, mold or build until you have the finished product. Think Van Gogh, Alberto Giacometti or Frank Lloyd Wright.
To create the life you want in retirement you need to use both the Additive and Subtractive Processes.
You need to channel your inner Michelangelo and remove everything that doesn’t look like the life you want. You need to make the “Stop Doing” list that I’ve talked about here many times before and then begin to chip away, purge, streamline and simplify.
At the same time, you need to figure out what you really want out of this life and start adding, shaping and building. What will you do? How will you pay for it? Who needs to be there? What skills do you need? You have a blank canvas. Paint a Rembrandt. You have an empty lot. Build Fallingwater.
“Every block of stone has a statue inside it and it is the task of the sculptor to discover it.” ~Michelangelo
Photo by Scott Ableman. Used under Creative Commons License.
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