When It Comes to Saving For Retirement – How Does One Start?

The longest journey begins with a single step. That adage is particularly applicable to the retirement planning process. Unless we inherit a nest egg, most of us begin the retirement savings journey with a very modest sum.  

Although the terms “saving” and “investing” are often used interchangeably, these words have different meanings.  “Saving” refers to setting aside money, which may or may not earn interest. “Investing” refers to exchanging dollars for ownership shares in companies (stocks or equities) that an investor expects to increase in value.  Thus, the stockholder is vested in the company.  Stocks may also yield shareholder dividends along the way.

Beyond stocks, individuals can invest in bonds issued by an entity. Bonds function as loans for investors or loans to companies or municipalities. Assuming everything goes as planned (bonds occasionally fail to pay off), bondholders receive their principle back when the bond matures.

In addition to stocks and bonds, individuals can deposit funds into an interest-earning bank account. We recommend that our clients include stocks, bonds and cash in their journey toward retirement.  How much money should be allocated to each asset class? Although performance the past few years has deviated from historical trends, stocks tend to be more volatile than bonds on an annual basis. Over the years, stocks have also delivered a higher return on investment compared to other asset classes.

Bonds tend to be less volatile than stocks on an annual basis. However, bonds have historically yielded lower returns than stocks. Again, recent history has fluctuated from the “norm”.

Cash or money market accounts are not subject to volatility, but deliver almost zero return on investment. The asset classes described above reflect generalized trends and do not guarantee future performance.

Individuals new to the stock market commonly select mutual funds, exchange traded funds (ETFs) or individual positions. Based on minimum deposit requirements, most new investors start with mutual funds. As ETFs have lower fees, investors should consider these types of investments when their savings reach the threshold eligible for ETF products.

Unfortunately, individuals often fail to consider tax diversification. After-tax accounts mean that taxes have already been paid taxes on invested funds. Employees eligible for 401k or 403b plans can choose to have their employer withhold money from their paycheck. Most of the time these accounts are tax-deferred and individuals pay taxes on the initial principle and earnings growth at the time of withdrawal. Individuals who qualify for a Roth IRA pay taxes on the funds deposited in the account, but earnings grow tax-free.

Congratulations on choosing to begin the journey of funding your retirement. Start by determining the percentage of income you will set aside to fund your retirement. Next, determine how to allocate your contributions based on asset classes and volatility. Finally, determine the most advantageous tax treatment.

Tax advice provided by CPA’s affiliated with Financial Enhancement Group, LLC.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

Consider This… Radio Show 9/16/2017

Here is this week’s radio show, hosted by Joe Clark, CFP with Sherri Contos.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

Before You Buy – Questions Homebuyers Should Consider

National Home Ownership Month may have been in June, but housing is a perennial topic of interest. For most of us, our home is the largest investment we’ll ever make and housing is one of the biggest sectors influencing our national economy.

Home ownership has been called the American Dream, but what’s the right time to invest in that “dream”?  Conventional wisdom has long suggested that buyers purchase a home as soon as they can meet the financial obligations of a down payment, monthly mortgage payment and of course, settle on a location. But these aren’t the only issues to consider.   

We advise prospective buyers to be reasonably certain they will live in the home for at least seven years. On top of the recurring mortgage payments, insurance and taxes that come with home ownership, there are “carrying costs” such as yardwork, replacing water heaters or roofs and general upkeep. And of course there are transactional costs involved in the buying and selling process.  

If a prospective buyer intends to reside in an area for some time, is comfortable with the costs and has the desire and means to buy, the next question often becomes, “How much house can I afford?”

Qualifying for the monthly payment is usually the starting point in the buying process. Mortgage companies use a formula called debt-to-income ratio to calculate a monthly payment. The bankers add up all of an individual’s existing monthly obligations (car payments, minimum monthly payments due on credit cards, monthly student debt obligations, etc.) and divide the debt by the borrower’s monthly income. Including the new potential mortgage payment, the debt-to-income ratio should be lower than 40% and ideally less than 27-36%.

Meeting a specific down payment amount can help buyers avoid paying for Private Mortgage Insurance (PMI) that provides the lender default protection. Generally, lenders will require buyers to put down between 10% and 20% to avoid mandatory PMI. When considering how much to spend on the down payment, it’s important to take PMI into account.

A buyer’s credit score helps to determine the loan terms available. Lenders typically offer homebuyers fixed loans with the option to repay over 15 or 30 years.  The 30-year option usually requires a little higher interest rate but less of a monthly payment. Lenders may also offer homebuyers an adjustable rate mortgage (ARM). An ARM specifies a fixed rate for a certain number of years, but then the rate adjusts up or down based on future economic conditions.

Becoming a homeowner and embarking on the American Dream is an exciting time, but there are many serious decisions to ponder.  In addition to the items noted above, don’t forget about the cost to move in, the furniture and hooking up the utilities. 

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

Consider This… Radio Show 9/9/2017

Here is this week’s radio show, hosted by Joe Clark, CFP with Sherri Contos.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

The Tax You May Be Overlooking When it Comes to Your IRA

Introduced in 1975, Individual Retirement Accounts (IRAs) initially allowed individuals to contribute up to $1,500 to a tax-deferred account. Three years later, 401k plans were adopted, then overhauled in 1986 to allow maximum employee contributions of $7,000. Back then, it was hard to imagine an IRA or 401k account reaching $1,000,000, yet today many families’ accounts exceed that figure.

When a tax-deferred account owner dies, the value is transferred to a new owner via a beneficiary document. Tax-deferred accounts are not included in the decedent’s last will and testament unless the beneficiary is unnamed, has already passed, or the deceased specifically directed such accounts to the estate.

There are three types of IRA beneficiaries: spouses, non-spouses and charities. The spouse is the only beneficiary who can roll the asset into their name thus using their age for withdrawal rules and Required Minimum Distribution (RMD) calculations. Non-spouse beneficiaries (typically a child) must begin taking RMD’s regardless of their age, even if they are a minor. Charitable beneficiaries pay no income tax and may use the funds as they choose.

When individuals planning to leave tax-deferred accounts to their children or grandchildren do not consider tax rules applying to RMD’s, excess taxation can result. The idea that a grandparent or great grandparent could pass assets on via the “stretch” – a term describing a beneficiary who holds assets in an IRA or even a Roth IRA with withdrawals coming out over the beneficiary’s life expectancy – may sound very tempting. But it is important to understand the entire tax code and not just the parts you like!

Recently, a widowed great grandfather planned to leave his IRA exceeding $1,000,000 to his both of his four year-old great-grandsons. Under current tax code rules, the boys would be able to withdraw the money out of the account over their life expectancy. If the great-grandfather passed away today, each four year-old grandson would have to withdraw approximately $6,350, with annual withdrawals increasing incrementally. This sounds like a small taxable amount, except that the Kiddie Tax applies, taxing a child’s interest, dividends and capital gains at the same marginal tax rate as the child’s parents.

The great-grandfather recognized his son and grandson didn’t need the money and there were other assets involved. The elders assumed the boys would be in the lowest tax bracket as non-income earners and they were correct – for the first $2,100. The problem is that inherited IRA RMD’s are subject to Kiddie Tax rates. Any funds above $2,100 of non-earned income is taxed at the parents’ (both surgeons at the 39.6% marginal tax rate) marginal tax rate. The great-grandfather was actually in a lower tax bracket than his great grandsons.

Planning can go afoul when people understand only part of the tax code. The attorney wasn’t wrong in designating the kids as beneficiaries. However, viewed through the lens of tax code rules, other options such as a Roth conversion or other assets could potentially provide the kids with tax-free income.

Tax advice provided by CPA’s affiliated with Financial Enhancement Group, LLC.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.