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 | Nov 9, 2012 | Happiness, Pursuits, Risk
I recently had a friend who quit his job after working there for almost 20 years. When I asked him why he said, “I had just gotten too comfortable.”
Too comfortable?! Is there such a thing? After all, isn’t that what we’re all striving for? What’s wrong with being too comfortable?
As I thought about it, I think I caught his meaning. For him, comfort had become risky because:
- It was sapping his drive and motivation
- It was keeping him from taking risks
- It was making him lazy and fearful of change
- It was causing him to give up on certain dreams
He had a stable income and a warm bed, but he was starting to feel stuck and stagnate. He was comfortable, but he wasn’t feeling particularly fulfilled. Not only that, but he was afraid to do anything about it for fear that things would get uncomfortable.
Have you ever felt that way? I have. Comfort is nice, but it can be dangerous if it leaves you feeling overly content. That’s because contentment demands little. It steers you into a rut that can be hard to get out of.
This comfort paradox can be especially worrisome as we get close to retirement. Why? Comfort is often a by-product of successful retirement planning (e.g. no job, financial independence, etc.). In some ways that can be good. After all, who wants to be worried about where your next meal is going to come from or how you’re going to pay the electric bill.
Unfortunately, it can be bad too. First of all, retirement is a major transition and transitions can be uncomfortable. You’re leaving a job and a routine you’ve know for decades. You’re dealing with unfamiliar things like Medicare and Social Security. You may be moving to a new house or a new city. Being too focused on comfort can cause you to make decisions during that transition that favor short-term comfort over long-term good.
Second, retirement is the time to make your plans and dreams a reality. That means you’ll be doing new things, visiting unfamiliar places and meeting new people. To make that happen, you can’t be content to sit back and play defense.
In other words, both the transition into retirement and your lifestyle in retirement require you to get out of your comfort zone. There needs to be a tension between your desire for comfort and your desire to strive for more. If your primary goal is comfort, don’t expect great things. If, however, your primary goals are growth, fulfillment and personal satisfaction, then you can expect a remarkable retirement, but you can also expect to be a bit uncomfortable in the process.
~ Joe
Photo by Becky McCray. Used under Creative Commons License.
by Joe Hearn | Oct 17, 2012 | Social Security
Imagine for a moment that you are one of the few lucky people in America still covered by a defined benefit pension plan. Now imagine that you’ve reached the ripe old age of 62 and you’re considering hanging up your work boots (or Wingtips) and heading off into retirement. Your employer would like to see you stick around for a few more years, so he presents you with three options:
1) Retire now and you can start collecting your $1,500 per month pension.
2) Retire four years from now and he will bump your pension up by more than a third to just under $2,000 per month.
3) Stick around for eight more years and he will increase your pension by more than 75 percent to around $2,625 per month.
If only you were so lucky, right? Actually this is more than just a hypothetical. You will likely face a very similar decision as you plan for your retirement, except the “pension” is called Social Security and the “employer” is Uncle Sam.
You will have four basic choices when it comes to claiming Social Security. Three of those were mentioned above: Retire early, retire on time (age 66 or 67 for most baby-boomers) or retire late. The fourth option is called file and suspend (more on that later). If married, your spouse will have the same options.
According to the Social Security Administration more than 73 percent of people start taking benefits early. Should you go with the majority or heed Oscar Wilde’s warning that “Everything popular is wrong.”? It depends.
Your goal should be to choose the option or combination of options that will result in the greatest cash flow for you and your family. Generally speaking, the longer you wait, the higher your benefits will be, but waiting isn’t a given. Below are several questions to consider that will help you evaluate when to file.
Are you still working?
If you are still working and you decide to begin receiving Social Security benefits early, chances are good that your benefits will be reduced. If you earn more than the earnings limit ($14,640 for 2012), your benefits will be reduced by $1 for $2 you make above the limit. That penalty shrinks in the year that you reach full retirement age. This is more of a delay than a permanent reduction. Once you reach full retirement age, the earnings penalty goes away and Social Security will recalculate your benefit amount to credit you for the months you were penalized. Still, if your plan is to file early in order to supplement your income, you may have less coming than you thought.
Do you have a long life expectancy?
Some people spend only a few years in retirement, while others spend decades. Consider the life expectancy of both you and your spouse. If you are healthy and expect to be collecting benefits for a long time, it might benefit you to delay filing for Social Security until you have accrued the maximum benefit. Alternatively, if your health is poor, you might consider collecting benefits as soon as possible, unless your spouse is healthy and is relying on your earnings history (spousal benefits allow your spouse to either claim their benefit or half of yours, whichever is greater). In that case, if you file early and receive reduced benefits, your spouse will be stuck with those reduced benefits for the remainder of his or her life. Be sure to consider how your actions affect your spouse’s benefits and vice-versa.
Will you have health insurance?
You can begin collecting Social Security benefits as early as age 62, but you won’t be eligible for Medicare until 65. It’s not a good idea to be without coverage, so make sure you have a plan to replace your employer provided health coverage if you decide to retire early.
Do others qualify for benefits based on your earnings record?
If someone is filing based on your benefits, when you choose to file will affect the benefit that they receive. If you choose to file early and take a reduced benefit, any person filing based on your record will take a reduced benefit as well. The decision that maximizes your lifetime benefits might drastically reduce those of your spouse. Keep that in mind.
Do you qualify for benefits on someone else’s record?
If your spouse or former spouse has died and you qualify for survivor benefits based on his or her earnings history, it could make sense to apply for those benefits now and wait to claim your own retirement benefits until later, when they are higher.
If your spouse is still living and has reached full retirement age, it might make sense for him or her to employ a file and suspend strategy. Here your spouse would file for benefits, but ask the Social Security Administration to suspend the payment of those benefits. Because you can’t file for benefits on their record until they do, this would allow them to continue earning delayed retirement credits, but would also allow you to file for spousal benefits.
Where will you get more growth?
Your Social Security benefits will be about 75 percent higher if you wait until 70 to collect as opposed to 62. That’s a compound rate of growth of more than 7 percent per year to your benefits. Can you get a better rate of return with your personal investments? Certainly not with a money market or certificates of deposit whose rates are at multi-decade lows. You might be able to get that kind of growth in stocks, but not without added risk. My point? If your benefits are growing faster than your personal investments, it might be better to tap your nest egg first and wait to take Social Security until later.
Thankfully, there are many tools available to help you evaluate your options. To analyze your personal situation and get ideas for how best to maximize your benefits, use the Social Security timing calculator at www.intentionalretirement.com/social-security. No matter what you ultimately decide, be sure to consider your options carefully. Your choice will likely be one of the most important decisions you will make when it comes to your retirement.
~ Joe
I originally published this article at www.fpanet.org.
by Joe Hearn | Oct 9, 2012
Social Security A majority of people approaching retirement expect Social Security to be a significant portion of their retirement income. The information on this page will help you understand the program and make election decisions that result in the maximum... Page 7 of 11
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