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Archive for the ‘Retire in A Day Series’ Category

As noted in previous articles and posts, whether or not your student qualifies for federal financial aid for college will depend on the Expected Family Contribution (EFC) calculation.

Typically, almost all assets and income are included in this calculation by financial aid officers.  There are exceptions to all rules and in this case, federal aid formulas (under the “Federal Methodology”) exclude home or family farm equity, money accumulated in tax-deferred retirement accounts and cash value built up in a life insurance policy.  The cash values of fixed and variable annuities are also excluded.

Since these assets are not counted in determining aid, some families may be tempted to consider “asset shifting” strategies.  With such techniques, a countable asset like savings or investments through a brokerage account are used to acquire one or more of these other non-countable asset types.

Friends and clients have attended financial aid workshops sponsored by college aid planners or insurance agents who recommend purchasing annuities or life insurance.  Sometimes these strategies involve doing a “cash out” refinance or drawing on a home equity line of credit. Tapping home equity to fund a deposit into an insurance or annuity vehicle may benefit a mortgage banker and insurance agent but is it in your best interests?

Asset Shifting to Qualify for More Financial Aid: Is it worth it?

Well, that depends on what side of the table you’re sitting on.

Yes, it’s true that anything you can do to reduce your expected family contribution may help boost the amount and type of aid your student may receive.

On the other hand, remember these points:

  • Family assets are counted at a low contribution rate of 5.6% above the asset-protection allowance calculated for your family circumstances.
  • If you put money into a tax-deferred account, it’s locked up.  Access to the funds before age 59 1/2 results in early withdrawal penalties in most cases.
  • You may have to pay to borrow your own money.

Granted, socking away money into tax-deferred vehicles may make sense for you.  And as I’ve noted before, paying for college is as much a retirement problem as anything else so anything you can do to provide for your Golden Years can be a good thing.

But don’t get tempted into long-term commitments to cover short-term financing issues.

By shifting assets you lose access and flexibility for the cash.  If employing such a strategy reduces your emergency cash reserve, then you’ve increased your risk to handle unexpected cash needs.

Cash Value Life Insurance and the Bank of You

Cash value life insurance accumulates its value over time.  Starting a policy within a couple of years of your student’s college enrollment is not going to help you.  During the initial years of such a policy very little cash is built up as insurance expenses and first-year commissions paid out by the insurer to the agent are very high which limit the amount of paid premiums that are actually invested for growth.

But consider this:  For some who have existing policies or are looking for a way to build cash over time that offers guarantees and is potentially tax-free, then by all means use life insurance.  There are strategies commonly referred to as the Infinite Banking Concept or the Bank of You which champion life insurance as a way to build and access your own pot of money available to you to borrow for almost any purpose.

There are many attributes to life insurance that make these concepts useful

  • Tax-free dividends,
  • Access to money without credit or income qualifications or delays from a traditional bank,
  • Guarantees on the cash value from the insurer.

But one downside is the cash flow needed to actually build up a pot big enough to tap into for buying a car much less paying school tuition.  You would in all likelihood need to divert all other available cash and stop funding any other tax-deferred plans to build up the cash.  And then there is the time line needed.  To effectively build up the cash, you really need to bank on at least 5 years before you have a Bank of You to tap. This is why such a solution is not recommended for those with students about to enter college.

Bottom Line:

Don’t let the financial aid tail wag the retirement planning dog here.  Only use these tactics after consultation with a qualified financial professional, preferably one who has no vested interest in whether or not you purchase a particular product.

 

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Lots of ink has been spilled discussing one of the most hyped retirement and tax strategies: Roth IRA conversions.  The prospect of future tax-free withdrawals is enticing.  But there are lots of issues that need to be considered whether it is right for you.

According to Google, there has been a surge in interest about Roth IRA conversions as it has become one of the top search terms this fall. (1)

This is hardly surprising considering that starting in 2010, all taxpayers, regardless of income, are eligible to convert tax-deferred retirement assets to a Roth IRA.

Prior to the change, the law prevented taxpayers with household incomes above $100,000 from converting assets to a Roth IRA.

Starting this year, tax code changes allow conversions of other tax-deferred retirement accounts regardless of income. This broadens the opportunity for those who did not have these choice before. It should be noted that there are still annual income limits in place for determining eligibility to contribute to a Roth IRA. (There are no limits to use a Roth 401k provision in your employer’s plan).

The majority of Americans believe their own taxes are going to increase.  Given government deficits and entitlements for an aging workforce, taxes may certainly be needed to cover these commitments.

As it stands, tax rates are scheduled to increase in 2011. Unless Congress acts to delay reversion to the prior tax rates, taxes on Roth IRA conversions will be higher after 2010.

A Roth IRA conversion offers an opportunity for future tax-free income.2

But does it make sense?

Does Roth Conversion Make Sense

Whether or not a Roth conversion makes sense really depends on an individual’s circumstances.

Money in all types of tax-deferred accounts like IRAs, 401ks and such are all jointly owned by the participant and Uncle Sam as silent partner.

Although the tax tail shouldn’t wag the dog, you should cut the best deal with the least impact on your personal tax situation.

It makes the most sense for those who expect to have more than enough assets and income for retirement and don’t want to be forced to take Required Minimum Distributions (RMDs) on IRA accounts.  It also makes sense for estate planning purposes as a way to build a multi-generational legacy of tax-deferred wealth accumulation.

And for most who believe that their marginal income tax rates in retirement will be higher whether because of tax policy or because of their own success with work and investments, then it may make sense to lock in the tax liability now.

It also makes sense for those who expect a low income year in 2010 because of retirement or unemployment for example.  Being in a lower tax bracket may reduce the tax bite on the converted funds.

While income and earnings may be withdrawn in retirement tax-free, an investor will still need to pay Uncle Sam now for that future privilege.

And all of this analysis assumes that Congress doesn’t change the rules down the road and even tax Roth accounts.  Consider the fact that during the 1980s, Congress changed the rules about taxing Social Security benefits.

Keeping that in mind, it still may make sense as a way to hedge against future tax policy to do a partial conversion of some of your tax-deferred retirement accounts especially if you have money from non-IRA accounts to tap.

If you use the funds from the tax-deferred account and you’re younger than 59 ½, you’ll be hit with an early withdrawal penalty and your investment will be starting from a lower base making the payback of the strategy more complicated.

Because the tax is assessed on the gains in the account, an ideal time to do this and minimize the tax impact is when account values are off their highs.  With the gains over the past year, this may make a conversion less attractive.

Another thing to consider is that by doing a conversion, your adjusted gross income will increase and potentially result in loss of COBRA subsidy or education credits which are subject to income phase outs.

You Can Change Your Mind Later

Unlike most things in life, you can get a “do over” called a recharacterization that converts everything back to the way it was. The assets would be converted back to tax-deferred status and you can file an amended tax return seeking a refund of the income taxes you paid on the conversion.

Roth IRA conversions offer the potential for tax-free income in retirement for taxpayers at all income levels. If you want more information about converting to a Roth IRA, call 617-398-7494 or email today.

It’s critical to review your individual situation before making a decision about moving important assets.
1) InvestmentNews, November 16, 2009
2) Rasmussen Reports, September 3, 2009

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“The safest way to double your money is to fold it over once and put it in your pocket.” Kin Hubbard

Investing takes time.  As humans our brains are more wired toward the flight-or-flight survival responses that got us to the top of the food chain.  So we are more prone to panic moves in one direction or another and this is not always in our best long-term interests.

So to retire richer requires a little work on understanding who we are and what we can do to improve our sustainable retirement odds.

There are lots of things in life that we cannot control.  And humans in general are easily driven to distraction. We are busy texting, emailing, surfing the web, and all other manner of techno-gadget interruptions from phone, computer and office equipment around us.

It’s no wonder that folks find it difficult to focus on long-term planning.  We hear a snippet of news on the radio or watch a talking head wildly flailing his arms about one stock or another and think that this is the ticket to investing success.

For those who remember physics class and one of Newton’s great discoveries, you can just as easily apply the rules of the physical world to human financial behavior:  A body at rest will tend to stay at rest; a body in motion will tend to stay in motion.

For most investors, inertia is the dominant theme that controls financial action or inaction.  Confronted with conflicting or incomplete information, most people will tend to procrastinate about making a commitment to one plan or another, one action or another.  Even once a course of action is adopted, we’re more likely than not to leave things on auto-pilot because of a lack of time or fear of making a wrong move.

To get us to move on anything, there has to be a lot of effort.  But once a tipping point is reached, people move but not always in the direction that may be in their best interests. Is it any wonder that most people end up being tossed between the two greatest motivators of action – and investing:  Greed and Fear.

So while someone cannot control the weather (unless you remember the old story line from the daytime soap General Hospital in the 1980s), the direction of a stock index or the value of a specific stock, we can all control our emotions.

Easier said than done?  You bet.  That’s why you need to approach investing for retirement or any financial goal with a process that helps take the emotional element out of it.  And you need to develop good habits about saving, debt and investment decisions.

What Does Rich Mean To You?

So you say you want to retire rich?  Sure, we all want to.  But what does “rich” look like to you.  There are surveys of folks who have $500,000 or $1million in investable assets describing themselves as middle class.  There are those I know who live quite comfortably on under $30,000 a year and would never describe themselves as poor.

Be Specific

First you should get a good picture of where you expect to be and what kind of life you envision.  Be clear about it.  Visualize it and then go find a picture you can hang up in a prominent place to remind you of your goal every day.  (That’s why I have pictures of my family on this blog reminding me of why I do everything I do).

Appeal to Your Competitive Streak

We are better motivated when we have tangible targets for either goals or competitors.  Ever ride a bike or run on the road and use the guy jogging in front of you as a target?  Same thing here.

So assuming you know what your retirement will look like, you’ll be able to put a number to it.  Now find out how you’re doing with a personal benchmark.  One way is to go to www.INGcompareme.com, a public website run by the financial giant ING which allows you to compare your financial status with others of similar age, income and assets.  Or try the calculators found at the bottom of the home page for www.ClearViewWealthAdvisors.com. This might help give you the motivation you need to save more if needed.

Use Checklists

They can save your life.  And even the lives of your passengers.  Just ask Captain Sully who credits his crew with good training and following a process that minimized the distractions from a highly emotional scene above the Hudson River.

The daily grind can be distracting.  Often we may be unable to see the big forest because of the trees standing in our path to retirement.

So try these tips:

Mid-thirties to early 40s:

  • Target a savings goal of 1.5 times your annual salary
    • Enroll in a company savings plan
    • Take full advantage of any 401k match that’s offered
    • Automatically increase your contributions by 5% to 10% each year (example: You set aside 4% this year; then next year set aside at least 4.5%)
    • If you max out what you can put aside in the company plan, consider adding a Roth IRA
    • Get your emergency reserves in place in readily available, FDIC-insured bank accounts, CDs or money markets
    • Invest for growth: Consider an allocation to equities equal to 128 minus your current age
    • Let your money travel: More growth is occurring in other parts of the world so don’t be stingy with your foreign stock or bond allocations.  Americans are woefully under-represented in overseas investing so try to look at a target of at least 20% up to 40% depending on your risk profile

Mid-Career (mid-forties to mid fifties)

  • Target a savings goal of 3 times your annual salary
    • Rebalance your portfolio periodically (consider at the very least doing so when you change your clocks)
    • Make any “catch-up” contributions by stashing away the maximum allowed for those over age 50
    • Consolidate your accounts from old IRAs, 401ks and savings to cut down on your investment costs and improve the coordination of your plan and allocation target

Nearing and In Retirement (Age 56 and beyond)

  • Target savings of six times your annual salary
    • Prune your stock holdings (about 40% of 401k investors had more than 80% in stocks according to Fidelity Investments)
    • Shift investments for income:  foreign and domestic hi-yield dividend paying stocks, some hi-yield bonds, some convertible bonds
    • Map out your retirement income plan – to sustain retirement cash flow you need to have a retirement income plan in place
    • Regularly review and rework the retirement income plan that incorporates any pensions, Social Security benefits and no more than 4% – 4.5% withdrawals from the investment portfolio stash accumulated
    • Have a Plan B ready:  Know your other options to supplement income from part-time work or consulting or tapping home equity through a reverse mortgage or receiving pensions available to qualifying Veterans.

Don’t be afraid to get a second opinion or help in crafting your plans form a qualified retirement professional.  You can find a CFP(R) professional by checking out the consumer portion of the Financial Planning Association website or by calling 617-398-7494 to arrange for a complimentary review with your personal money coach, Steve Stanganelli, CFP(R).

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Whatever your retirement dreams, they can still be made a reality.  It just depends on how you plan and manage your resources. On any journey it helps to have an idea where you’re going, how you plan to travel and what you want to do when you get there.

If this sounds like a vacation, well, it should. Most people invest more time planning a vacation than something like retirement.  And if you think of retirement as the Next Act in your life and approach it properly, you won’t be so easily bored or run out of money to continue the journey or get lost and make poor money decisions along the way.

It’s How You Manage It That Counts

How much you need really depends on the lifestyle you expect to have.  And it’s not necessarily true that your expenses drop in retirement. Assuming you have an idea of what your annual expenses might be in today’s dollars, you now have a target to shoot for in your planning and investing.

Add up the income from the sources you expect in retirement.  This can include Social Security benefits (the system is solvent for at least 25 years), any pensions (if you’re lucky to have such an employer-sponsored plan) and any income from jobs or that new career.

Endowment Spending: Pretend You’re Like Harvard or Yale

Consider adopting the same approach that keeps large organizations and endowments running.  They plan on being around a long time so they target a spending rate that allows the organization to sustain itself.

1. Figure Out Your Gap:  Take your budget, subtract the expected income sources and use the result as your target for your withdrawals. Keep this number at no more than 4%-5% of your total investment portfolio.

2. Use a Blended Approach: Each year look at increasing or decreasing your withdrawals based on 90% of the prior year rate and 10% on the investment portfolio’s performance.  If it goes up, you get a raise.  If investment values go down, you have to tighten your belt.  This works well in times of inflation to help you maintain your lifestyle.

3. Stay Invested:  You may feel tempted to bail from the stock market.  But despite the roller coaster we’ve had, it is still prudent to have a portion allocated to equities.  Considering that people are living longer, you may want to use this rule of thumb for your allocation to stocks: 128 minus your age.

If you think that the stock market is scary because it is prone to periods of wild swings, consider the risk that inflation will have on your buying power.  Bonds and CDs alone historically do not keep pace with inflation and only investments in equities have demonstrated this capability.

But invest smart. While asset allocation makes sense, you don’t have to be wedded to “buy-and-hold” and accept being bounced around like a yo-yo.  Your core allocation can be supplemented with more tactical or defensive investments.  And you can change up the mix of equities to dampen the roller coaster effects.  Consider including equities from large companies that pay dividends.  And add asset classes that are not tied to the ups and downs of the major market indexes.  These alternatives will change over time but the defensive ring around your core should be reevaluated from time to time to add things like commodities (oil, agriculture products), commodity producers (mining companies), distribution companies (pipelines), convertible bonds and managed futures.

4. Invest for Income: Don’t rely simply on bonds which have their own set of risks compared to stocks. (Think credit default risk or the impact of higher interest rates on your bond’s fixed income coupon).

Mix up your bond holdings to take advantage of the different characteristics that different types of bonds have. To protect against the negative impact of higher interest rates, consider corporate floating rate notes or a mutual fund that includes them.  By adding Hi-Yield bonds to the mix you’ll also provide some protection against eventual higher interest rates. While called junk bonds for a reason, they may not be as risky as one might think at first glance. Add Treasury Inflation Protected Securities (TIPS) that are backed by the full faith and credit of the US government.  Add in the bonds from emerging countries.  While there is currency risk, many of these countries do not have the same structural deficit or economic issues that the US and developed countries have.  Many learned their lessons from the debt crises of the late 1990s and did not invest in the exotic bonds created by financial engineers on Wall Street.

Include dividend-paying stocks or stock mutual funds in your mix.  Large foreign firms are great sources of dividends. Unlike the US, there are more companies in Europe that tend to pay out dividends. And they pay out monthly instead of quarterly like here in the US.  Balance this out with hybrid investments like convertible bonds that pay interest and offer upside appreciation.

5. Build a Safety Net: To sleep well at night use a bucket approach dipping into the investment bucket to refill the reserve that should have 2 years of expenses in near cash investments: savings, laddered CDs and fixed annuities.

Yes, I did say annuities.  This safety net is supported by three legs so you’re not putting all your eggs into annuities much less all into an annuity of a certain term. For many this may be a dirty word.  But the best way to sleep well at night is to know that your “must have” expenses are covered.  You can get relatively low cost fixed annuities without all the bells, whistles and complexity of other types of annuities.  (While tempting, I would tend to pass on “bonus” annuities because of the long schedule of surrender charges). You can stagger their terms (1-year, 2-year, 3-year and 5-year) just like CDs.  To minimize exposure to any one insurer, you should also consider spreading them around to more than one well-rated insurance carrier.

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