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Beyond 401(k) and IRA

beyondYou’re contributing as much as you’re allowed to a 401(k) or other employer-sponsored retirement plan. If your income allows it, you’re also contributing the maximum annual amount to your Roth or traditional IRA. But you still want to set aside more money beyond 401(k) and IRA, to make sure your retirement is everything you hoped for. What options do you have? Here are some things to consider…

Before moving beyond – are you really maxing our your 401(k) and IRA?

IRAs and employer-sponsored retirement plans like 401(k)s have some real advantages when it comes to saving for your retirement. So, before you go any further, make sure you’re really contributing all you can.

In 2015, most individuals can contribute up to $18,000 to a 401(k) plan, and up to $5,500 to a traditional or Roth IRA. If you’re age 50 or better, though, you can make up to an additional $6,000 in “catch-up” contributions to your 401(k) in 2015, and an additional $1,000 to your traditional or Roth IRA. What’s more, if you file a joint tax return with your spouse, your spouse may be able to make a full IRA contribution, even if he or she has little or no taxable compensation. (See Spousal IRAs for Stay at Home Parents for more details.)

Taxable investment accounts

Your other primary option is to invest through a taxable investment account. The lower federal income tax rates that apply to long-term capital gains and qualifying dividends go a long way toward taking the bite out of holding investments outside of a tax-advantaged retirement account like a 401(k) or IRA. And, a taxable investment account offers one enormous advantage: You have a tremendous amount of flexibility. You can choose from a virtually unlimited selection of investments, and there’s no federal penalty for withdrawing funds before age 59 1/2.

Investment options worth mentioning:

  • Mutual funds or separately managed accounts (SMAs) managed for tax efficiency intentionally minimize current taxable distributions
  • Indexed mutual funds and exchange-traded funds (ETFs) trade infrequently and therefore tend to have low annual taxable distributions
  • Tax-free municipal bonds and municipal bond funds generate income that is free from federal and/or state income tax

Always keep the big picture in mind

Your investment decisions should be based on your individual goals, time frame, risk tolerance, and investment knowledge. You should evaluate every investment decision with an eye toward how the investment will fit into your overall investment portfolio, and whether it will meet your general asset allocation needs. A financial professional can be invaluable in helping you evaluate your options.

For many, it can be useful to have some of your money invested in the three different types of tax-treated accounts: tax-deferred, such as a 401(k) or traditional IRA; ultimately tax-free, such as Roth IRAs; and taxable investment accounts, which take advantage of the flexibility of withdrawal and low capital gains rates. With a three-pronged approach you can plan your tax impact when you need to withdraw money. Instead of only having purely taxable withdrawals from a 401(k) plan, you might take only a portion of the withdrawal to be taxed in that fashion, and a portion to be taxed at capital gains from your non-deferred account. This provides you with the best of all worlds!

Identity Theft Protection

thiefWhether they’re snatching your purse, diving into your dumpster, stealing your mail, or hacking into your computer, they’re out to get you. Who are they? Identity thieves.

Identity thieves can empty your bank account, max out your credit cards, open new accounts in your name, and purchase furniture, cars, and even homes on the basis of your credit history. What if they give your personal information to the police during an arrest and then don’t show up for a court date? You could be arrested and jailed.

And what will you get for their efforts? You’ll get the headache and expense of cleaning up the mess they leave behind. Not to mention the potential loss of money, even jobs, that goes along with this problem.

You may never be able to completely prevent your identity from being stolen, but here are some steps you can take to help protect yourself from becoming a victim.

Check Yourself Out

It’s important to review your credit report periodically. Check to make sure that all the information contained in it is correct, and be on the lookout for any fraudulent activity.

You may get your credit report for free once a year, from each of the three national credit reporting agencies. To do so, contact the Annual Credit Report Request Service online at or call (877) 322-8228.

It’s important to use – this is the FREE service that allows you to get your report(s) once per year from each agency. Other services claim to provide this service for free but you usually wind up paying something for it, possibly without even knowing. Be careful as you use these services – they offer many “pay” options such as credit monitoring, credit scores, and the like. Most of this you can live without. Just stick with the free report and review it carefully for any incorrect information or entries that appear to be fraudulent.

If you need to correct any information or dispute any entries, contact the three national credit reporting agencies:

Secure Your Number

Your most critical personal identifier is your Social Security number (SSN). Guard it carefully. Never carry your Social Security card with you unless you need it for a specific purpose (such as applying for a passport or driver’s license). The same goes for other forms of identification (such as health insurance cards) that include your SSN. Don’t have your SSN pre-printed on your checks, and don’t let merchants write it on your checks. Don’t give it out over the phone unless you initiated the call and it is to an organization that you trust. Ask the three major credit reporting agencies to truncate your SSN on your credit reports. Try to avoid listing it (where possible) on employment applications; offer instead to provide it during your interview.

Don’t Leave Home With It

Many of us carry our checkbooks and all of our credit cards, debit cards, and other cards with us all the time. That’s a bad idea – if your wallet or purse is stolen, the thief will have a treasure chest of new toys to play with.

Carry only the cards and/or checks you’ll need for any one trip. And keep a written record of all your account numbers, credit card expiration dates, and the telephone numbers of the customer service and fraud departments in a secure place – at home. It may be useful to make a photocopy (or as I do, a computer-scanned image) of all of your credit cards, driver’s license, insurance cards, etc., and keep those images in a safe place where you can get to them quickly in the event that your cards are stolen.

In addition, using a smart-phone application may be handy, but make sure that you have good security on your phone – no using “1234” as your passcode, for example.

Keep Your Receipts

When you make a purchase with a credit or debit card, you’re given a receipt. Don’t throw it away or leave it behind – it may contain your credit card number (this is much more rare these days), plus it is your sole defense in the event of fraud within the store. And don’t leave it in the shopping bag inside your car while you continue shopping either; if your car is broken into and the item you bought is stolen, your identity could be stolen as well.

Save your receipts until you can check them against your monthly statements, and watch your statements for purchases you didn’t make, or for amounts that don’t match. When you’re finished matching them, shred them!

When You Toss It, Shred It

Before you throw out any financial records such as credit or debit card receipts and statements, canceled checks, or even offers for credit cards you receive in the mail – shred the documents, preferably in a cross-cut shredder. If you don’t, you may find that the panhandler going through your dumpster was looking for more than just discarded leftovers. These cross-cut shredders are very affordable (starting around $50) and available at most discount stores and office supply outlets.

Keep A Low Profile

The more your personal information is available to others, the more likely you are to be victimized by identity theft. While you don’t need to become a hermit in a cave, there are steps you can take to help minimize your exposure:

  • to stop telephone calls from national telemarketers, list your telephone number with the FTC’s National Do Not Call Registry by registering online at
  • to remove your name from most national mailing and e-mailing lists, as well as most telemarketing lists involving credit or insurance, register online at
  • when given the opportunity to do so by your bank, investment firm, insurance company, and credit card companies, opt out of allowing them to share your financial information with other organizations.
  • You may even want to consider having your name and address removed from the telephone book and reverse directories. This is becoming more of a reality for everyone these days as landlines go the way of the buggy-whip.

Take a Bite Out Of Crime

Whatever else you may want your computer to do, you don’t want it to inadvertently reveal your personal information to others. Take steps to help assure that this won’t happen.

Install a firewall to prevent hackers from obtaining information from your hard drive or hijacking your computer to use it for committing other crimes. This is especially important any more since we nearly all use a high-speed connection that leaves you continuously connected to the internet, such as cable or DSL. Moreover, install virus protection software and update it on a regular basis as well.

Try to avoid storing personal and financial information on a laptop; if it’s stolen, the thief may obtain much more than the value of your computer. If you must store such information on your laptop, make things as difficult as possible for a thief by protecting these files with a strong password – one that’s at least eight characters long, and that contains uppercase and lowercase letters, as well as numbers and symbols.

“If a stranger calls, don’t answer.” Opening emails from people you don’t know, especially if you download attached files or click on hyperlinks in the message, can expose you to viruses, infect your computer with “spyware” or “malware” – software that captures information by recording your keystrokes – or lead you to “spoof” websites (websites that impersonate legitimate business sites) designed to trick you into revealing personal information that can be used to steal your identity.

If you wish to visit a business’s legitimate website, use your stored bookmark or type the URL address directly into your browser. If you provide personal or financial information about yourself over the internet, do so only at secure websites – to determine if a website is secure, look for a URL that begins with “https” instead of “http” or a padlock icon in the bottom of the browser’s status bar.

And when it comes time to upgrade to a new computer, remove all your personal information from the old one before you dispose of it. Using the “delete” function isn’t sufficient to do the job; overwrite the hard drive using a “wipe” utility program (several are available on the market). The minimal cost of investing in this software may save you from being wiped out later by an identity thief. There are also services that will take your old computer and recycle it, giving you a certification that the data is being wiped from the device before redeployment.

Lastly, Be Diligent

As the grizzled old duty sergeant used to say on the television show “Hill Street Blues” – Be careful out there. The identity you save may be your own!

Diversification: I Know I Should, But Why?

diverse cups of somethingAny discussion of the tenets of long-term investing includes the recommendation for diversification. This concept is delivered almost without thought – after all, as children we are taught “Don’t put all your eggs in one basket!”. But have you ever stopped to consider just why we should diversify?

Of course, in the example of the saying about the eggs, it’s simple spreading of risk: if you have all your eggs in one basket and you drop that basket… all your eggs have broken! By spreading your eggs into a second basket, if one basket is dropped, only those eggs in that basket will break, and you’ve still got one basket of good, unbroken eggs.

What if we add a third basket? A fourth? As you might imagine, it soon becomes too clumsy to carry so many baskets (potentially one for each egg). One person couldn’t possibly manage twelve baskets effectively just to harvest a dozen eggs. So, while diversification makes sense to a degree, you always must keep in mind that it can be applied to an extreme and you lose the efficiency of the basket, plus your costs increase.

Enough about eggs for now though. Why do we preach diversification in investing? The root of this concept (at least in the modern age) come from something called “Modern Portfolio Theory”, which was developed by a fellow named Harry Markowitz. The overall theory is pretty weighty so we won’t cover it completely here (although I’d be happy to discuss it with you if you wish). The gist of the benefit of diversification follows.

Decisions about investments are always made in an environment of uncertainty. This is because, even though we have a belief that our investments will hold their value and will increase in value over time, there is no certainty that this will be the case. We can study the past performance, the present activity, and many pieces of information about the particular security – but we have no surety that the increase we hope for will occur.

This uncertainty is due to the continuous up and down volatility in investment prices. As an example, if a stock is worth $20 now and was worth $15 last week, we have no idea if it will be worth $30 tomorrow or possibly even $10. This shouldn’t be a surprise: how many times have you seen something in the news that seems like a good thing for the economy, like an interest rate cut – only to see the market drop like a stone at the release of the news? The opposite happens just as often.

So – what’s a guy to do? Enter diversification.

Diversification – Your Key to Reduce Volatility

It’s not hard to understand that every dollar you save in taxes and overall costs of investments equates to an increase in your bottom line total return. What may be difficult to follow though, is that diversification of risk can reduce volatility, and therefore reduce loss. An example may be the best way to get this point across.

Let’s say you have $1,000 in your overall portfolio, and through the year you have achieved a 20% gain. Shortly thereafter, your investment experiences a correction, amounting to a 20% loss. Most folks would think that you’ve just held ground and broke even in your account – but most folks would be wrong to think so. What happened is that your account gained 20% to a value of $1,200, and then the account lost 20% or $240 (.20 times $1,200), so in the end you have actually lost a net amount of $40. Just for grins, the result is the same if you work things in the reverse as well: a 20% loss gives you a balance of $800, and then a 20% gain ($160) gives you a final balance of $960, for a loss of the same $40.

For purposes of comparison, let’s look at another situation: a 10% gain followed by a 10% loss. From our previous example, we know that this isn’t just “holding ground” – we have lost a total of $10 in the process. We started with $1,000 and gained 10% to a value of $1,100, and then experienced a 10% loss ($110), for a final balance of $990.

What’s truly important to note about these two examples is the relationship of the volatility (the percentage size of the gains and losses) to the actual dollar loss realized. In the first case, the volatility was double that of the second (20% versus 10%), but the resulting loss was quadrupled!

If we took the first example and changed the volatility to a 40% swing in either direction, the resulting loss is even greater – a gain of 40% gives us $1,400, and the following loss of 40% ($560) brings us to a final balance of $840, for a loss of $160, which is sixteen times the loss we suffered in the 10% example. If you’re a mathematician, you’ll notice the relationship here: the level of volatility that we experience results in an exponential loss in the account. If we had a 50% gain followed by a 50% loss, our overall loss would be twenty-five times the loss in the 10% example, and so on.

It doesn’t take long to understand why it is important to keep volatility in your portfolio low: the smaller the “swings” of volatility, the lower your potential loss. When you increase the “swings” of volatility by a factor of one, your potential losses increase exponentially.

So – if I’ve done my job and explained this properly, the question on your mind at this point should be: “How do I get myself some of this low volatility?” And if you’ve been reading carefully up to this point, the answer should be obvious: diversify.

And how do we do that? Much the same as the eggsample from earlier, you want to find a place (or group of places) to invest your money that will result in less volatility. All investments are affected by various things around them – oil and gas companies are impacted by the cost of crude oil, banks are impacted by interest rates and the credit crunch, department stores are impacted by inflation, employment, and the seasons. What we look for are investment vehicles that are diverse enough to not all be impacted by the same kinds of things in the same magnitude at the same time. Therefore we diversify into different capitalization-weightings, different countries, and different sectors, all in an effort to reduce the overall risk of loss (volatility) in our portfolio.

For example – by investing in the S&P 500 index, we are diversifying across many different companies, sectors, and industries in the US marketplace. In addition to this investment, we might add a holding in the EAFE index (Europe, AustralAsia and Far East), further diversifying across different countries, companies, sectors and industries. By doing so, if something happens that makes United States Steel’s stock to lose 20% in value, the impact on our portfolio is minimized, since US Steel is only a very small portion of our portfolio. By the same token, if an event should occur that caused the stock market in Singapore to suddenly crash, and this event was limited in its exposure to just Singapore, then as before, since we’re diversified among many countries, our exposure to volatility is minimized.

I hope this explanation helps you to understand one of the very basic pillars of investing discipline. I would be remiss, though, if I didn’t point out that diversification can also have a negative impact on your gains. When you reduce the volatility in your investments, you’re not only reducing the downside swing, but the upside swing as well. What we give up is the “once in a lifetime” homerun-type of investments.

For example, if you happened to put all of your money in Google at it’s initial offering in August of 2004, by the end of that year you could have doubled your money. In the diversification example using the S&P 500, you would have had a small percentage of your portfolio in Google, and your overall return from August to December in 2004 would have been 10.8%. For an example on the other side of the coin, if you had placed your nest egg in Enron stock in late 2000, by mid 2001, you could have virtually nothing left, while the S&P 500 had fallen by a mere 17% during the same period. Reducing volatility, while it causes you to give up the spectacular gains, will also save you from the spectacular crashes. And we all know which one happens more often.

Do You Have The Will?

chaplain making out willsStatistics show us that approximately 70% of all Americans don’t have a valid will. Are you one of them? With that statistic, chances are that you don’t. This means that in a circle of four people, three probably don’t have a will.

This situation begs an obvious question: Do I need a will? One simple way to determine if you need a will is if you can’t truthfully answer “No” to both of the following questions:

Do you care who gets your money and property when you die?
Do you care who is appointed guardian of your minor children if you die?

If you answered “Yes” to either or both of those questions, you need a will! Otherwise, state laws will determine the outcome of those situations – and it’s not likely that you would have made the same decisions that the state would.

Why should you have a will?

A will is appropriate for anyone, not just the rich, no matter how much money or property you have. A will is your instructions for how you’d like your belongings and assets distributed at your passing. Without a will, the courts will decide to whom your property will go – without regard to your wishes. The courts, according to state law, have a specific succession path that they will follow in distributing your assets. They won’t account for the fact that you loaned some money to your first child when they purchased their home, and as such you had intended to “equal things out” with the other two kids at your passing, for example.

In addition, anyone with minor children should definitely have a will. Only you (and presumably your spouse) should be making the decisions about who will care for the children as their guardian in the event of your untimely death. No one wants to think about death as a near-term event – but it happens every day. If it should happen to you and you don’t have a will in effect, your family and loved ones will be thrown into a confusing world of decisions that they aren’t prepared to make, on top of the very difficult situation that they already have in dealing with your death.

A third reason to have a will is for tax benefits. By utilizing your will to pass along your assets that have grown in value through the years (as opposed to making gifts during your lifetime), your heirs will receive the property at a “stepped up” value as of the date of your death (in most cases). For example, let’s say you own a piece of farmland that you purchased for $100,000 many years ago. Today, the land is actually worth something like $1,500,000 due to appreciation in land values. If you were to give this land to your son as a gift during your lifetime, and the son sold the land, he would owe capital gains tax on $1,400,000 (the growth of the value of the land), which would amount to something like $210,000 at a 15% rate. On the other hand, if you bequeathed the property to your son via your will (assuming that your overall estate was worth something south of $5.45 million), then there would be no tax owed, either on the transfer of the property or when your son sells it, if he sells immediately. This is because the act of inheriting property causes a “step up” in the value of the property, and so the tax basis of the property is $1,500,000, leaving no capital gain to tax (assuming again that the son sells the property for $1,500,000).

So – how do you get started? As mentioned above, there are a few things you need to consider when setting up a will. Some of the most difficult decisions generally surround the idea of guardianship for the children. Think through this decision carefully, along with your spouse (if you have one), and then talk to the person or persons you’ve chosen to be guardians. I generally recommend that you choose a guardian for the children and a trustee to manage funds that have been set aside for the children’s care (two different people). This way you have a separation of powers, and two heads working together for the benefit of the kids. In addition, many times if there is only a guardian who has the additional duty of administering funds, the guardian may tend to over- or under-utilize the funds on the children’s behalf. Having a separate trustee to help with this process can make sure that the funds are used as you intended.

The second person that you need to name in your will is an executor. This individual will be responsible for administering your will and your estate when you pass. Depending upon the circumstances, this person may need to be very skilled in working with others (your beneficiaries) to ensure that your instructions are properly enacted.

The specific instructions that you wish to have carried out completes the picture. In some cases, especially those including children, you’ll want the will to establish one or more trusts, requiring the naming of a trustee or trustees. This will help to ensure that your funds are used as you intended. You’ll also need to think about how the rest of your assets, money, and property might be distributed.

Start by gathering the names, addressses and dates of birth for you, your spouse, your children, other beneficiaries, your proposed guardian(s), and your proposed executor(s). I used plurals for guardian(s) and executor(s) because it can be very helpful to have “backup” people named for the event your original choice predeceases you.

Next, gather together your debt information – mortgages, car loans, credit cards, student loans, and any other loans you might have. Then list your assets – property, stocks, bonds, accounts, homes, personal property, etc.. Take pains to specifically identify each item of debt and assets, so that it is very clear which item you are referring to.

Lastly, gather copies of other existing legal documents, including divorce decrees, prior wills, trusts, prenuptual agreements, and any other document that might affect the legal distribution of your assets.

When you talk to your attorney, he or she will likely have other items that you need to gather, but this should head you in the right direction. And I do advocate using a lawyer – this is much too important for a “do-it-yourself” job. When you think about the consequences of doing it incorrectly, the cost for the attorney is a pretty small sum by comparison.

So – if you happen to be “one of the other three” in the circle of four, don’t delay. There’s no sense in putting your family and beneficiaries through the hassle of probate if you can help it – and you can. If you have the will.

Exception to the Divorced Spouse Remarriage Rule

remarriedGenerally speaking, when a divorcee is receiving a Social Security spousal benefit based on an ex-spouse’s record, the recipient must remain unmarried in order to continue receiving the ex-spouse benefit. (For more details on this, see Coordinating Social Security Benefits in Matters of Divorce and Remarriage.) In many cases,when a divorcee remarries, the spousal benefit based on his or her ex-spouse’s record will end.

However, there is an exception to this rule that I recently became aware of. It’s in part because the circumstances surrounding this exception have recently become more common – so let’s get to the exception.

The Exception

If the person who is receiving a spousal benefit based on an ex-spouse’s record marries someone who is currently receiving widow(er)’s, mother’s, father’s, divorced spouse’s, or parents’ benefits, the spousal benefit will continue. That’s a mouthful! Let’s play out an example:

Jane is divorced from Gerald. Jane has been receiving spousal benefits based on Gerald’s record for the past couple of years. Jane is engaged to marry Sheryl.  Sheryl’s husband Ed died several years ago, and she has been collecting a widow’s benefit (survivor benefit) based on Ed’s record for a couple of years now.

Since Sheryl is receiving the survivor benefit based on Ed’s record, the exception applies for Jane’s ex-spouse benefit, and Jane will be eligible to continue receiving this benefit after the marriage. If Sheryl was not currently collecting the survivor’s benefit (or one of the other excepted benefits), Jane’s ex-spouse benefit would end upon their marriage.

One important factor here is that Jane and Sheryl are both currently receiving the benefits (in Social Security parlance, they are entitled to the benefits). If Jane is not currently receiving the ex-spouse benefit when she and Sheryl get married, she would not be allowed to begin receiving the ex-spouse benefit based on Gerald’s record while she and Sheryl are married.

Likewise, if Sheryl was not receiving the survivor benefit or one of the other excepted benefits on the date of the marriage, Jane’s ex-spouse benefit would end upon their marriage.

RMDs From IRAs

distribution-centre-by-nick-saltmarsh1I’ve made the observation before – IRAs are like belly-buttons: just about everyone has one these days, and quite often they have more than one.

Wait a second, maybe they’re not quite like belly-buttons after all.

Oh well, you get the point – just about everyone has at least one IRA in their various retirement savings plans, and these accounts will eventually be subjected to Required Minimum Distributions (RMDs) when the owner of the account reaches age 70 1/2.

So what are RMDs, you might ask? When the IRA was developed, it was determined that there must be a requirement for the account owner to withdraw the funds that have been hidden from taxes over the lifetime of the account, in order for the IRS to begin benefiting by the taxes that are levied against the account withdrawals. A schedule was prepared which approximates the life span of the account owner.  This schedule prescribes a minimum amount to be withdrawn each year that the account owner is alive, until the account is exhausted.

A participant in a traditional IRA (Roth IRAs are not subject to RMD rules by the original owner) must begin receiving distributions from the IRA by April 1 of the year following the year that the participant reaches age 70 1/2. In other words, assuming that the participant reaches age 70 during the months of January through June of 2015,  the participant reaches age 70 1/2 during the 2015 calendar year.  Therefore RMD must be withdrawn by April 1, 2016. On the other hand, an individual who reaches age 70 during the latter half (July through December) of 2015 does not reach age 70 1/2 until the 2016 calendar year.  As such, RMD must be withdrawn by April 1, 2017.

After that first year’s RMD is withdrawn, the second year’s RMD must be taken by December 31 of the same year. In our examples above, the first participant must make a RMD withdrawal by April 1, 2016, and another by December 31, 2016. The second participant must make a RMD withdrawal by April 1, 2017 and another by December 31, 2017. For all subsequent years, the RMD must simply be withdrawn by December 31 in order to be credited for that year. If you don’t want to double up the distributions for your first and second RMDs, you can take the first RMD by December 31 of the year you reach age 70 1/2. By taking your first and second RMDs as originally described, you will be taxed on both distributions in that second year. This might result in adverse taxes to you.

Calculation of the RMD is fairly straightforward, although there is some math involved. For the first year of RMD, the participant could be age 70 or 71, depending on when the birthday falls. IRS determines your applicable age based on your age at the end of the year. According to the Uniform Lifetime Table (See IRS Publication 590 for more detail on other tables), the distribution period for a 70-year-old is 27.4, and 26.5 for a 71-year-old.

So if an individual participant has IRAs worth $100,000 at the end of the previous year and will be 70 at the end of the current year, dividing that balance of $100,000 by 27.4 produces the result of $3,649.64 – the RMD for that first year. For a 71-year-old, you would divide the $100,000 balance by 26.5 to render a RMD of $3,773.58.

Each subsequent year, you would take the balance of the accounts on December 31 of the previous year and divide by the distribution period from the Uniform Lifetime Table for your attained age for the current year, and make sure that you take a distribution of at least that amount during the calendar year.

Now, I made a point of indicating that you calculate your RMD based on the balance of all of your IRAs. This is because the IRS considers all of your traditional IRAs as one single account for the purpose of RMDs. You are required to take RMD withdrawals based on the overall total of all accounts. This withdrawal can be from one account, evenly from all accounts, or in whatever combination you wish as long as you meet the minimum distribution for all accounts that you own.

Another point that is extremely important to note: taking these distributions is a requirement. Failing to take the appropriate distribution will result in a penalty of 50% (yes, half!) of the RMD that was not taken. As you can see, it really pays to know how to take the proper RMD withdrawals – the IRS has very little sense of humor about it.

Understand that the examples I’ve given are for simple situations, involving the original owner of the account and no other complications. In the case of an inherited IRA or other complicating factors, or if the account is an employer’s qualified plan rather than an IRA, many other factors come into play that will change the circumstances considerably. If you need help on one of these more complicated situations, it probably would pay off in the long run to have a professional help you with the calculations.

Timing of Delay Credits

credit for delayingWhen you delay filing for your Social Security benefits past Full Retirement Age (FRA – age 66 if you were born between 1943 and 1954) you earn Delay Credits for each month that you delay. The credit amount is 2/3% per month, or a total of 8% for every 12 months of delay.

When you file for benefits after delaying, these credits are applied to your PIA. The timing of the application of your credits is not immediate, though. Delay credits are added to your benefit only at the beginning of a new year, so this can cause a bit of confusion as you begin receiving benefits.


For example, Janice was born on September 14, 1949, so she will turn age 66 on September 14, 2015. Janice’s PIA is $1,000. If you’ll remember from this post (When is Your Social Security Birthday), Social Security considers Janice to have reached FRA on October 1, 2015. Janice intends to delay filing for her Social Security benefits until her 68th birthday in order to accrue 16% increase to her benefits.

So upon reaching her 68th birthday, Janice contacts SSA and files for her benefit to begin in October, 2017. Beginning in October, Janice will receive a benefit that is equal to her PIA plus 10%, a total of $1,100 per month. She will receive this benefit for October, November, and December of that year.

Then beginning in January, Janice will receive an increase up to the full amount of delay credits, 16%, for a total benefit of $1,160 per month. Janice will continue to receive this benefit for the remainder of her life, unless at some point in the future she becomes eligible for a Spousal or Survivor Benefit that is greater than her own benefit.


There are two exceptions to the way that delay credits are applied: upon reaching age 70 or at your death. If you start your benefits at age 70, no matter what month of the year it is your full delay credits are applied to your benefit on the first month. Likewise, upon your death all delay credits are applied to your survivor’s available benefit no matter what month the survivor begins to receive the benefit.

Vacation Home Rentals and Your Income Taxes

vacation homeYou may have a vacation home that you only spend a small amount of time at each year, and the rest of the time you rent the home out to other folks who wish to vacation in your little slice of heaven. The rents that you receive is considered taxable income, to the extent that it exceeds the applicable expenses. Plus, if the vacation home is partly used for your own purposes, the expenses (allocated to the time the property is rented) cannot exceed the amount of rent income from the property (you can’t claim a loss).

Recently the IRS issued their Summertime Tax Tip 2015-03 which details some tips you should know about Vacation Home Rentals for your tax reporting purposes.

IRS Tips about Vacation Home Rentals

If you rent a home to others, you usually must report the rental income on your tax return. However, you may not have to report the rent you get if the rental period is short and you also use the property as your home. In most cases, you can deduct your rental expenses. When you also use the rental as your home, your deduction may be limited. Here are some basic tax tips that you should know if you rent out a vacation home:

  • Vacation Home.  A vacation home can be a house, apartment, condominium, mobile home, boat or similar property.
  • Schedule E.  You usually report rental income and rental expenses on Schedule E, Supplemental Income and Loss. Your rental income may also be subject to Net Investment Income Tax.
  • Used as a Home.  If the property is “used as a home,” your rental expense deduction is limited. This means your deduction for rental expenses can’t be more than the rent you received. For more about these rules, see Publication 527, Residential Rental Property (Including Rental of Vacation Homes).
  • Divide Expenses.  If you personally use your property and also rent it to others, special rules apply. You must divide your expenses between the rental use and the personal use. To figure how to divide your costs, you must compare the number of days for each type of use with the total days of use.
  • Personal Use.  Personal use may include use by your family. It may also include use by any other property owners or their family. Use by anyone who pays less than a fair rental price is also personal use.
  • Schedule A.  Report deductible expenses for personal use on Schedule A, Itemized Deductions. These may include costs such as mortgage interest, property taxes and casualty losses.
  • Rented Less than 15 Days.  If the property is “used as a home” and you rent it out fewer than 15 days per year, you do not have to report the rental income. In this case you deduct your qualified expenses on schedule A.
  • Use IRS Free File.  If you still need to file your 2014 tax return, you can use IRS Free File to make filing easier. Free File is available untilOct. 15. If you make $60,000 or less, you can use brand-name tax software. If you earn more, you can use Free File Fillable Forms, an electronic version of IRS paper forms. Free File is available only through the website.

You can get forms and publications on at any time.

Additional IRS Resources:

Traveling for Charitable Purposes

a horse named charitySometimes charitable work involves travel – such as for the Red Cross, for example. Did you know that your travel expenses for charitable work can be a tax deduction? Recently the IRS sent out a Summertime Tax Tip (2015-12) that outlines some valuable information about this deduction.

Tips on Travel While Giving Your Services to Charity

Do you plan to donate your services to charity this summer? Will you travel as part of the service? If so, some travel expenses may help lower your taxes when you file your tax return next year. Here are several tax tips that you should know if you travel while giving your services to charity:

  • Qualified Charities.  In order to deduct your costs, your volunteer work must be for a qualified charity. Most groups must apply to the IRS to become qualified. Churches and governments are qualified, and do not need to apply to the IRS. Ask the group about its IRS status before you donate. You can also use the Select Check tool on to check the group’s status.
  • Out-of-Pocket Expenses.  You may be able to deduct some costs you pay to give your services. This can include the cost of travel. The costs must be necessary while you are away from home giving your services for a qualified charity. All  costs must be:
    • Unreimbursed,
    • Directly connected with the services,
    • Expenses you had only because of the services you gave, and
    • Not personal, living or family expenses.
  • Genuine and Substantial Duty.  Your charity work has to be real and substantial throughout the trip. You can’t deduct expenses if you only have nominal duties or do not have any duties for significant parts of the trip.
  • Value of Time or Service.  You can’t deduct the value of your services that you give to charity. This includes income lost while you work as an unpaid volunteer for a qualified charity.
  • Deductible travel.  The types of expenses that you may be able to deduct include:
    • Air, rail and bus transportation,
    • Car expenses,
    • Lodging costs,
    • The cost of meals, and
    • Taxi or other transportation costs between the airport or station and your hotel.
  • Nondeductible Travel.  Some types of travel do not qualify for a tax deduction. For example, you can’t deduct your costs if a significant part of the trip involves recreation or a vacation.

For more on these rules, see Publication 526, Charitable Contributions. You can get it on at any time.

IRS YouTube Videos:

IRS Podcasts:

Personality Influences Financial Decisions

The recent volatility in the stock market has everyone a bit uneasy – even folks who have worked with a trusted financial adviser for years. But if you’ve never worked with an adviser before, you may be surprised to find that one of the first things he or she will do is ask you to fill out a risk analysis questionnaire. This questionnaire is designed to help you understand your financial decisionsdecisions and the process of making decisions. It’s all tied to your personality, your own unique world-view.

Why is risk analysis important before you make decisions with your money? Risk tolerance is an important part of investing – that should be understood at the outset. But the real value of answering a lot of questions about your risk tolerance is to tell you what you don’t know – how the sources of your money, the way you made it, how outside forces have shaped your view of it and how you’re handling it now will help shape every decision you make about money now and in the future.

The most important thing a risk analysis questionnaire can tell is what’s important about money to you. Trained financial advisers can determine your money personality through a process of questioning discovery. Planners can then guide investors within their money personality. Do you want certainty? Are you willing to take a little risk or let it roll because long-term results are more important than short-term volatility? Or will you take more risks with your money because you can always make more of it?

A financial planner tries to see through the static to find out what you really need to create a solid financial life. But it might make sense to ask yourself a few questions before you and your planner sit down:

  1. What’s important about money to me?
  2. What do I do with my money? What do I plan to do with my savings?
  3. If money was absolutely not an issue, what would I do with my life?
  4. Has the way I’ve made my money – through work, marriage, windfall – affected the way I think about money in a particular way?
  5. How much debt do I have, what kinds of debt, and how do I feel about it?
  6. Am I more concerned about maintaining the value of my initial investment or making a profit from it?
  7. Am I willing to give up that stability for the chance at long-term growth?
  8. What am I most likely to enjoy spending money on?
  9. How would I feel if the value of my investment dropped minimally for several months? How about significantly over several months? What is a significant drop in value to me?
  10. How would I feel if the value of my investment dropped minimally or stayed constant (no growth) for several years?
  11. If I had to list three things I really wanted to do with my money, what would they be?
  12. What does retirement mean to me? Does it mean quitting work entirely and doing whatever I want to do or working in a new career full- or part-time? Or would I take on volunteer work in retirement?
  13. Do I want kids? Do I understand the financial commitment?
  14. If I have kids, do I expect them to pay their own way through college or will I pay all or part of it? What kind of shape am I in to help with paying for their college education?
  15. How’s my health and my health insurance coverage?
  16. What kind of physical and financial shape are my parents in? Are they enjoying retirement, and what does retirement look like for them?

One of the toughest aspects of getting a financial plan going is recognizing how your personal style, mindset, and life situation affect your investment decisions. A financial professional will understand this challenge and can help you think through your choices. Your resulting plan – from investments to insurance, savings to estate plans – should feel like a perfect fit for you.

Everything But The Retirement Plan!

drawing retirementConventional wisdom says that when you leave a job, whether you’ve been “downsized” or you’ve just decided to take the leap, you should always move your retirement plan to a self-directed IRA. (Note: when referring to retirement plans in this article, this could be a 401(k) plan, a 403(b), a 457, or any other qualified savings deferral-type plan).

But there are a few instances when it makes sense to leave the money in the former employer’s plan.  You have several options of what to do with the money in your former employer’s plan, such as leaving it, rolling it over into a new employer’s plan, rolling it over to an IRA, or just taking the cash.

The last option is usually the worst. If you’re under age 55 you’ll automatically lose 10% via penalty from the IRS (unless you meet one of the exceptions, including first home purchase, healthcare costs, and a few others), plus you’re taxed on the funds as if it were ordinary income. For the highest bracket, this can amount to losing nearly 50% or more of the account balance to taxes and penalties.

In addition, by cashing out you’re derailing the retirement fund that you’ve put so much effort into setting aside. If you cash it out, you’ve got to start over from scratch and you’ve got less time to build the account back up. A 2005 change in the tax law requires your old employer to automatically roll over your account into an IRA if it is between $1,000 and $5,000 (if you don’t choose another option), to keep folks from cashing out. If your account balance is more than $5,000, the old employer is required to maintain your account in the old plan until you choose what you’re going to do with it.

Another option has become available for your old account: you can roll these funds over into a new employer’s retirement plan, as long as the new plan allows it. In many cases this may make good sense, especially if the new plan has good investment choices and is cost-effective.

If the new plan doesn’t suit you or you’d like more control over your investment choices, you can always roll the funds from your old employer’s plan into an IRA. You’ll then be able to decide just how you want to allocate the investments, choosing from the entire universe of available investment options, rather than the limited list that many plans have available. Caution is necessary when doing this type of rollover, as a misstep could cause the IRS to treat your attempted rollover as a complete distribution, having the same tax effect as cashing out. Always choose a direct transfer to the IRA (rather than a 60-day rollover) and seek the help of a professional if you are unsure about how to deal with this situation.

But when would you leave the funds at the old employer? If the old employer’s plan is a well-managed, low-cost plan, and you’re happy with how your investments have done, then you might just want to leave it where it is. In addition, if you happen to be over age 55, you have the option available to access the funds immediately without penalty, rather than waiting until age 59 1/2 – but only if you leave the funds in the original employer’s plan. Plus, if your plan is a 457 plan (generally only available to governmental employees, such as with a state or local government), you may be able to tap the plan upon your ending employment without penalty as well.

Another good reason to leave the fund at the old employer is if you believe that there is a high probability that you may return to employment with this same employer. Especially in the case of working for a governmental unit, it probably makes sense to leave those funds in the old plan when you think there is a better than average possibility that you may return to work with the government (even another agency). This is because there are benefits available in some governmental plans that you would be giving up if you moved your account to an IRA, and you’re not likely to be able to move those funds back when you return.

So – hopefully this quick conversation has helped to clear up some questions, and perhaps it has brought up some new questions for you.

Social Security Trustees Report – 2015

truss-teesEvery year, the Trustees of the Social Security and Medicare trust funds release reports to Congress on the current financial condition and projected financial outlook of these programs. The 2015 reports, released on July 22, 2015, show that, despite some encouraging signs, both programs continue to face financial challenges that should be addressed as soon as possible, with the Disability Insurance Trust Fund needing the most urgent attention.

What are the Social Security trust funds?

The Social Security program consists of two parts. Retired workers, their families, and survivors of workers receive monthly benefits under the Old-Age and Survivors Insurance (OASI) program; disabled workers and their families receive monthly benefits under the Disability Insurance (DI) program. The combined programs are referred to as OASDI. Each program has a financial account (a trust fund) that holds the Social Security payroll taxes that are collected to pay Social Security benefits. Other income (reimbursements from the General Fund of the Treasury and income tax revenue from benefit taxation) is also deposited in these accounts. Money that is not needed in the current year to pay benefits and administrative costs is invested (by law) in special Treasury bonds that are guaranteed by the U.S. government and earn interest. As a result, the Social Security trust funds have built up reserves that can be used to cover benefit obligations if payroll tax income is insufficient to pay full benefits.

(Note that the Trustees provide certain projections based on the combined OASI and DI (OASDI) trust funds. However, these projections are theoretical, because the trusts are separate, and one program’s taxes and reserves cannot be used to fund the other program.)

Trustees report highlights: Social Security

  • The combined trust fund reserves (OASDI) are still increasing and will continue to do so through 2019 (asset reserves increased by $25 billion in 2014, with year-end reserves totaling $2.8 trillion). Not until 2020, when annual program costs are projected to exceed total income, will the U.S. Treasury need to start withdrawing from reserves to help pay benefits. Absent congressional action, the combined trust fund reserves will be depleted in 2034, one year later than projected in last year’s report.
  • Once the combined trust fund reserves are depleted, payroll tax revenue alone should still be sufficient to pay about 79% of scheduled benefits in 2034, with the percentage falling gradually to 73% by 2089. This means that 20 years from now, if no changes are made, beneficiaries could receive a benefit that is about 21% less than expected.
  • The OASI Trust Fund, when considered separately, is projected to be depleted in 2035 (one year later than projected in last year’s report). At that time, payroll tax revenue alone would be sufficient to pay 77% of scheduled OASI benefits.
  • The DI Trust Fund is in worse shape and will be depleted in late 2016 (the same as projected last year). The Trustees noted that the DI Trust Fund “now faces an urgent threat of reserve depletion, requiring prompt corrective action by lawmakers if sudden reductions or interruptions in benefit payments are to be avoided.” Once the DI Trust Fund is depleted, payroll tax revenue alone would be sufficient to pay just 81% of scheduled benefits.
  • Based on the “intermediate” assumptions in this year’s Trustees report, the Social Security Administration is projecting that there will be no cost-of-living adjustment (COLA) for calendar year 2016.

What are the Medicare trust funds?

There are two Medicare trust funds. The Hospital Insurance (HI) Trust Fund pays for inpatient and hospital care (Medicare Part A costs). The Supplementary Medical Insurance (SMI) Trust Fund comprises two separate accounts, one covering Medicare Part B (which helps pay for physician and outpatient costs) and one covering Medicare Part D (which helps cover the prescription drug benefit).

Trustees report highlights: Medicare

  • Annual costs for the Medicare program have exceeded tax income annually since 2008, and will continue to do so this year and next, before turning positive for four years (2017-2020) and then turning negative again in 2021.
  • The HI Trust Fund is projected to be depleted in 2030 (unchanged from last year, but with an improved long-term outlook from last year’s report). Once the HI Trust Fund is depleted, tax and premium income would still cover 86% of program costs under current law. The Centers for Medicare & Medicaid Services (CMS) has noted that, under this year’s projection, the HI Trust Fund will remain solvent 13 years longer than the Trustees predicted in 2009, before passage of the Affordable Care Act.
  • Due to increasing costs, a Part B premium increase is likely in 2016. However, about 70% of Medicare beneficiaries will escape the increase because of a so-called “hold harmless” provision in the law that prohibits a premium increase for certain beneficiaries if there is no corresponding cost-of-living increase in Social Security benefits. If there is no COLA for 2016, the increased costs may be passed along only to the remaining 30% not eligible for this hold-harmless provision–generally, new enrollees, wealthier beneficiaries, and those who choose not to have their premiums deducted from their Social Security benefit. If so, these individuals could see the base premium rise to $159.30 in 2016, up sharply from $104.90 in 2015.

Why are Social Security and Medicare facing financial challenges?

Social Security and Medicare accounted for 42% of federal program expenditures in fiscal year 2014. These programs are funded primarily through the collection of payroll taxes. Partly because of demographics and partly because of economic factors, fewer workers are paying into Social Security and Medicare than in the past, resulting in decreasing income from the payroll tax. The strain on the trust funds is also worsening as large numbers of baby boomers reach retirement age, Americans live longer, and health-care costs rise.

What is being done to address these challenges?

Both reports urge Congress to address the financial challenges facing these programs in the near future, so that solutions will be less drastic and may be implemented gradually, lessening the impact on the public. As the Social Security Board of Trustees report states, “Social Security’s and Medicare’s projected long-range costs are not sustainable with currently scheduled financing and will require legislative action to avoid disruptive consequences for beneficiaries and taxpayers.”

Some long-term Social Security reform proposals on the table are:

  • Raising the current Social Security payroll tax rate (according to this year’s report, an immediate and permanent payroll tax increase of 2.62 percentage points would be necessary to address the revenue shortfall)
  • Raising the ceiling on wages currently subject to Social Security payroll taxes ($118,500 in 2015)
  • Raising the full retirement age beyond the currently scheduled age of 67 (for anyone born in 1960 or later)
  • Reducing future benefits, especially for wealthier beneficiaries
  • Changing the benefit formula that is used to calculate benefits
  • Changing how the annual cost-of-living adjustment for benefits is calculated

Regardless of the long-term solutions, Congress needs to act quickly to address the DI program’s imminent reserve depletion. According to this year’s report, in the short term, lawmakers may reallocate the payroll tax rate between OASI and DI (as they did in 1994). However, this may only serve to delay DI and OASI reforms.

You can view a combined summary of the 2015 Social Security and Medicare Trustees reports at You can also access a full copy of the Social Security report from that page. You can find the full Medicare report at

Selling your home? Here’s the income tax facts

home for saleSummer is a time when many folks choose to move to a new home. It makes a lot of sense, especially if you have children in school – this way if the move is to a new school district, the children will not have to switch schools during the academic year.

Selling your home can have consequences for your income taxes. Recently the IRS issued their Summertime Tax Tip 2015-13, which details ten key tax facts about home sales. The text of the Tip is below:

Ten Key Tax Facts about Home Sales

In most cases, gains from sales are taxable. But did you know that if you sell your home, you may not have to pay taxes? Here are ten facts to keep in mind if you sell your home this year.

  1. Exclusion of Gain.  You may be able to exclude part or all of the gain from the sale of your home. This rule may apply if you meet the eligibility test. Parts of the test involve your ownership and use of the home. You must have owned and used it as your main home for at least two out of the five years before the date of sale.
  2. Exceptions May Apply.  There are exceptions to the ownership, use and other rules. One exception applies to persons with a disability. Another applies to certain members of the military. That rule includes certain government and Peace Corps workers. For more on this topic, see Publication 523, Selling Your Home.
  3. Exclusion Limit.  The most gain you can exclude from tax is $250,000. This limit is $500,000 for joint returns. The Net Investment Income Tax will not apply to the excluded gain.
  4. May Not Need to Report Sale.  If the gain is not taxable, you may not need to report the sale to the IRS on your tax return.
  5. When You Must Report the Sale.  You must report the sale on your tax return if you can’t exclude all or part of the gain. You must report the sale if you choose not to claim the exclusion. That’s also true if you get Form 1099-S, Proceeds From Real Estate Transactions. If you report the sale, you should review the Questions and Answers on the Net Investment Income Tax on
  6. Exclusion Frequency Limit.  Generally, you may exclude the gain from the sale of your main home only once every two years. Some exceptions may apply to this rule.
  7. Only a Main Home Qualifies.  If you own more than one home, you may only exclude the gain on the sale of your main home. Your main home usually is the home that you live in most of the time.
  8. First-time Homebuyer Credit.  If you claimed the first-time homebuyer credit when you bought the home, special rules apply to the sale. For more on those rules, see Publication 523.
  9. Home Sold at a Loss.  If you sell your main home at a loss, you can’t deduct the loss on your tax return.
  10. Report Your Address Change.  After you sell your home and move, update your address with the IRS. To do this, file Form 8822, Change of Address. You can find the address to send it to in the form’s instructions on page two. If you purchase health insurance through the Health Insurance Marketplace, you should also notify the Marketplace when you move out of the area covered by your current Marketplace plan.

401(k) Mistakes (also applies to other Retirement Plans!)

mistakeThese days you’re pretty much on your own when it comes to planning for your retirement. Granted, many state and local governments have a pension plan, but beyond that, precious few employers provide a pension these days. Typically retirement benefits only include a 401(k) or other deferred retirement plan, which means it’s up to you! For the purpose of brevity, I’ll refer to 401(k) plans throughout this article; please understand that most of the information applies to 403(b) plans, 401(a) plans, and 457 plans as well as Keogh, SIMPLE, and SEP IRA plans.

For most of us, the 401(k) is the default account that must take on the role that the pension plan did for previous generations. Paying attention to and avoiding the following mistakes can help you to ensure that you have a financially-secure future.

#1 – Choosing Not to Participate
It’s amazing how many folks, young or old, don’t participate in their company’s 401(k) plan. If your employer matches your contributions, you’re effectively giving money away. You wouldn’t do that with a raise or a tax cut, would you? And even if your employer doesn’t match your contributions, the tax savings should be enough to spark your interest… If you’re not presently participating in your company-offered 401(k) plan, bear in mind that time is your greatest ally when it comes to building up your savings. Starting early and making regular contributions to your account will have an enormous impact on the results when you’re ready to begin using these funds in retirement.

For example, if you only put $1,000 into your account at age 25, with a compound rate of return of 6%, by age 65 your account would be worth over $10,000. By the same token, if you’d waited until age 30 to make that $1,000 deposit, by age 65 it would only have grown to $7,600. That’s roughly a 30% difference only because you delayed for 5 years!

If you put $1,000 aside each year beginning at age 25, at the example 6% return when you reach age 65 this would have grown to $154,000+. And if you delay 5 years, the result is $111,000, a difference of $43,000 for your extra $5,000 of deposits.

#2 Not Having a Plan
Blindly allocating your investments can have significant consequences as well. I have reviewed retirement plans where the participant believed that they were doing the right thing by “diversifying” across every fund choice in their plan. This results in diversification all right, but doesn’t take into account the time horizon for the investment, your own risk tolerance, and other factors. And most importantly, the diversification is not necessarily among different types of assets, only among different funds in most cases.

An acquaintance, age 26, had a conservative portfolio of investments in his account – amounting to more than 80% in bonds and fixed instruments. At that age, even the most conservative of investment plans should have you above a 50% ratio in equities, in order to take advantage of long-term stock market returns. Granted, stocks are more volatile than bonds and fixed income investments, but with a longer time horizon, bonds and fixed income investments can barely keep up with inflation, let alone provide any measure of growth. In addition, the longer time horizon provides the time to ride out any “bumps” in the market that may take place.

It makes good sense to analyze your potential investment choices, consider your time horizon, your risk tolerance, and ultimately your investment “mix”, in order to create a plan for your investments that will carry you toward that holy grail of investment success – a fruitful retirement.

#3 Set It and Forget It
While we shouldn’t obsess over every single market move every single day, we also shouldn’t make our investment and contribution decisions once and then leave them for 20, 30 or 40 years. Over time, your various investments are going to grow at different rates, eventually causing one or more of your holdings to become overweighted (with regard to your planned “mix”).

I generally recommend reviewing your quarterly statements just to see how things are going in your account, and choose one of the quarters to make rebalancing moves annually as needed. These rebalancing moves don’t need to be done until one or more of your investments gets to a 5% or more variance from your plan.

#4 Taking Out a Loan
This falls into the category of things you *can* do but shouldn’t. Kinda like jumping off a cliff. What happens here is that your contribution program goes on hold as you pay back the loan, and if you don’t pay it back, you’ll owe tax and penalties. In addition, you’re paying back your tax-deferred fund with after-tax dollars, which will eventually be taxed again when you withdraw the funds at retirement. In only the most extreme of circumstances should you consider this kind of loan – honestly, you’ll regret it if you do it in most cases.

Strategies of Successful Investors

successFor a golfer looking to improve his game, it can be useful to study the top golfers’ strategies and methods. Investors can, in much the same way, learn from the “money masters”, the top group of the most successful investors. You might not have their resources or years of experience, but understanding their philosophies can help you in your own approach to investing.

Think Like an Owner, Not Like a Trader
This philosophy is as commonsense as the investor who is so famous for following it: Warren Buffett. Any list of the most successful investors of all time has to include the chairman of Berkshire Hathaway, and he’s typically at the top of the list. The Oracle of Omaha is well-known for his down-to-earth approach to sizing up investment opportunities.

Buffett invests in businesses however (not stocks), and prefers those with consistent earning power and little or no debt. He also looks at whether a company has an outstanding management team. Buffett attaches little importance to the market’s day-to-day fluctuations; he has been quoted as saying that he wouldn’t care if the market shut down completely for several years. However, he does pay attention to what he pays for a business; as a value investor, he may watch a company for years before deciding to buy. And when he buys, he makes a big play and plans to hang on to his investment for a long time.

Don’t Forget That Markets Can Be Irrational
George Soros feels that markets can be irrational. However, rather than dismissing the ups and downs, the founder of the legendary Quantum Fund made his reputation by exploiting macroeconomic movements. He once made more than $1 billion overnight when his hedge fund speculated on the devaluation of the British pound.

Soros believes in capitalizing on investing bubbles that occur when investors feed off one another’s emotions. He is known for making big bets on global investments, attempting to profit from both upward and downward market movements. Such a strategy can be tricky for an individual investor to follow. However, even a buy-and-hold investor should remember that market events may have as much to do with investor psychology as with fundamentals, and use that information to your advantage. You probably wouldn’t apply Soros’s philosophy in the same way he does, but nonetheless it can be a valuable lesson to remember.

Use What You know; Know What You Buy
During his 13-year tenure at Fidelity Investments’ Magellan Fund, Peter Lynch was one of the most successful mutual fund portfolio managers in history. He subsequently wrote two best-selling books for individual investors.

If you want to follow Lynch’s approach, stay on the alert for investing ideas drawn from your own experiences. His books contend that because of your job, your acquaintances, your shopping habits, your hobbies, or your geographic location, you may be able to spot up-and-coming companies before they attract attention from Wall Street. However, simply identifying a company you feel has great potential is only the first step. Lynch did thorough research into a company’s fundamentals and market to decide whether it was just a good idea or a good investment.

Lynch is a believer in finding unknown companies with the potential to become what he called “ten baggers” (companies that grow to 10 times their original price), preferably businesses that are fairly easy to understand.

Make Sure the Reward is Worth the Risk
Perhaps the best-known bond fund manager in history, the co-founder of PIMCO Bill Gross makes sure that if he takes greater risk – for example, by buying longer-term or emerging-market bounds – the return he expects is high enough to justify that additional risk. If it isn’t, he says, stick with lower returns from a more reliable investment. Because bonds have historically returned less than stocks and therefore suffer more from high inflation, he also focuses on maximizing real return (an investment’s return after inflation is taken into account).

Choose a Sound Strategy and Stick To It
Even though all these investors seem to have different approaches, in practice they’re more similar than they might appear. Each of their investing decisions has specific, well-thought-out reasons behind it. They rely on their own strategic thinking rather than blindly following market trends. And they understand their chosen investing disciplines well enough to apply them through good times and bad.

Work with your financial planner to determine a strategy that matches your financial goals, time horizon, and investing style.

IRAs: Roth or Traditional?

compareThe question comes up pretty often: when contributing to an IRA, should you choose the Roth or Traditional? I often approach this question in general with my recommended “Order of Contributions”:

  1. Contribute enough to your employer-provided retirement plan to get the company matching funds. So if your employer matches, for example, 50% of your first 5% of contributions to the plan, you should at least contribute 5% of your income to the plan in order to receive the matching funds.
  2. Maximize your contribution to a Roth IRA. For 2015 that is $5,500, or $6,500 if you are age 50 or older.
  3. Continue increasing your contribution to your employer-provided plan up to the annual maximum. So if you have more capacity to save after you’ve put 5% into your employer plan to get the matching dollars, and you’ve also contributed $5,500 (or $6,500) to your Roth IRA, you should increase the amount going into your employer plan. Increase this amount up to the annual limit if possible. For 2015 the annual limit for employee contributions to an employer plan like a 401(k) is $18,000 (plus a catch-up amount of $6,000 if you’re age 50 or older).

Beyond those three items if you have more capacity to save, you may want to consider college savings accounts or tax-efficient mutual funds in a taxable account among other choices.

But the question I was referring to is this: Which is better – a Roth or Traditional IRA?

The answer, as you might expect, is a fully-qualified “It depends”. The are several important factors to take into consideration.

If you were to compare the two types of accounts side-by-side, at first glance you’d think that it doesn’t make any difference which one you contribute to – especially if you assume that the tax rate will be the same in retirement (or distribution phase) as it was before retirement (or accumulation phase). This is because you’d be paying the same tax on the distribution of the Traditional IRA after the investment period, simply delayed, that you would pay on the Roth contribution, only this part is paid up-front.

Clear as mud, right? Let’s look at the following table to illustrate. I have purposely not included any increases in value, as we’ll get to that a bit later. In the example, we’re using a 20% ordinary income tax rate.

Each year we had $1,250 available to contribute to either a Traditional or a Roth. We had to pay tax on the Roth contribution each year, but we were able to make the whole contribution of $1,250, tax-deducted on our Traditional account.

What happens when we factor in growth in the account? The following table reflects the next step in our analysis, with each account growing at 10% per year, and the values are as of the end of the year:

If you subtract the tax from the Traditional balance, you come up with the same number as the Roth account, since there is no tax on the Roth account at distribution. So, although you pay more in taxes, you had more contributions to your account, so it all comes out in the wash.

So far, I’ve not come up with a convincing argument for a Roth or Traditional IRA. Let’s make another change to our table, by assuming that the tax rate in distribution increased to 25%, and that we remain at a 20% rate during accumulation. The following results come from that change:

As you can see, this results in a nearly $1,100 increase in taxes at distribution, making the Roth IRA the preferred option. Conversely, if the ordinary income tax rate is lower in distribution, the Traditional IRA is a better option.

There are some other factors that we could consider and run calculations on, but for the most part we’ve covered the important bases. Depending upon your own situation, one might be better than the other, and the reverse could be true in slightly different circumstances.

However, strictly going by the numbers the Roth IRA is preferred when the income tax rate is higher in retirement, and it’s at least as good as the Traditional IRA if the rates remain the same. If the numbers were the only differences between the two accounts, this is not a strong argument for the Roth, because you’re just making a gamble as to what will happen with tax rates in the future.

Thankfully, there are more factors to bear on the decision. In my book An IRA Owner’s Manual I point out three very good reasons to choose the Roth IRA over the Traditional IRA (excerpt below). With those factors in mind, and given that most folks have a generally pessimistic view of tax rate futures in the US, it seems that the Roth IRA is the better choice in nearly all situations.

Three Very Good Reasons to Choose
The Roth IRA Over the Trad IRA

  1. Roth IRA proceeds (when you are eligible to withdraw them, at or after age 59½) are tax free. That’s right, there is no tax on the contributions you put into the account and no tax on the earnings of the account. You paid tax on the contributions when you earned them, so in actuality there is no additional tax on these monies.
  2. There is no Required Minimum Distribution (RMD) rule for the Roth IRA during your lifetime. With the Trad IRA, at age 70½ you must begin withdrawing funds from the account, whether you need them or not. For some folks, this could be the biggest benefit of all with the Roth IRA.
  3. Funds contributed to your Roth IRA may be withdrawn at any time, for any reason, with no tax or penalty. Note that this only applies to annual contributions, not converted funds, and not the earnings on the funds. But the point is, you have access to your contributions as a sort of “emergency fund of last resort”. While this benefit could work against your long-term goals, it may come in handy at some point in the future.
  4. (a bonus!) A Roth IRA provides a method to maximize the money you pass along to your heirs: Since there’s never a tax on withdrawals, even by your heirs, the amount of money you have in your Roth IRA is passed on in full to your beneficiaries, without income taxation to reduce the amount they will eventually receive – estate tax could still apply though.

As illustrated, if you believe ordinary income tax rates will remain the same or increase in the future, the calculations work in favor of the Roth IRA.

529 Plan vs. Student Loan

college 529 years agoWhen planning for the cost of college for your children, often parents and grandparents think of the 529 plan due to the tax benefits. Almost ten years ago the 2006 Pension Protection Act made the tax treatment of 529 plan college savings instruments permanent.  This will be familiar ground for most, but perhaps parents of future college students need to a refresher.

It will always be cheaper to save for college than to pay for loans. If you’re in the position of most folks – with enough assets that you figure your child won’t be considered for financial aid – then it pays in spades to save now. If you saved $150 a month into a 529 plan for 10 years at 4% rate of return, you’d have just over $22,000 saved up. If, on the other hand, you didn’t save that money and had to borrow $22,000, paying it back over the same 10 year period at 6% interest would require monthly payments of $245 – $95 dollars a month more. If you got lucky and the rate on the loan was the same 4%, the payments would still be $224 a month, almost 50% more than the amount you could have been saving.

The best time to start is yesterday, so the best thing to do is don’t delay. If you started putting money into a 529 plan when your child was first born, accumulating $22,000 by the time the child is 18 only requires $70 per month, assuming 4% rate of return. Wait just five years (until the child is 5), that payment increases to $108 per month. Wait until your child is 13, when you have only five years left in order to accumulate $22,000, you’d need to make 529 plan contributions of more than $333 each month.

Choose the right plan. The differences between your choices for a 529 plan alone are mind-boggling. You can choose a 529 plan that is specific to your state, or one of a myriad of other choices. You can choose a pre-paid tuition plan, or a savings 529 plan (my choice is always the savings type of 529 plan). In addition you need to consider other options for savings as well, such as a Roth IRA. Some options may provide tax benefits, others may not, but this is a critical choice to make as you make your savings plan work for you.


canoeOne of the more unique types of retirement accounts is the Simplified Employee Pension IRA, or SEP IRA for short.  This plan is designed for self-employed folks, as well as for small businesses of any tax organization, whether a corporation (S corp or C corp), sole proprietorship, LLC, LLP, or partnership.

The primary benefit of this plan is that it’s simplified (as the name implies) and very little expense or paperwork is involved in the setup and administration of the plan.  The SEP becomes less beneficial when more employees are added. There are additional options available in other plans (such as a 401(k)) that may be more desirable to the business owner with more employees.

SEP IRAs have a completely different set of contribution limits from the other kinds of IRAs and retirement plans.  For example, in 2015, you can contribute up to $53,000 to a SEP IRA. That amount is limited to 20% of the net self-employment income, or 25% of wage income if the individual is an employee of the business.

The account for each participant is an IRA, just like any other IRA (other than the contribution limits mentioned above).  You’re allowed to invest in any valid investment security offered by the custodian, rollover the plan (upon termination of employment) and direct the plan to your heirs however you wish, just like any other IRA.

Money contributed to the plan is excluded from the income of the employee/participant upon contribution, and any growth in the account is tax-deferred until distribution.  At the distribution of the funds, the funds will be taxed as ordinary income.  Upon reaching age 59½ you can access the funds without penalty – otherwise, unless you meet one of the early distribution exceptions, there is a 10% penalty imposed in addition to the income tax on the distribution.  At age 70½ you will be required to begin taking minimum distributions from the account, just like any other IRA.

Additionally, a SEP IRA can be established up to the filing date for your business entity – as late as April 15 of the following year if you like.  This is different from a 401(k), for example, which must be established during the tax year.

Have You Saved Enough for Retirement?

winding roadOne of the reasons that retirement funding is a mystery to most folks is the uncertainty that comes with trying to determine how much is enough – enough savings set aside so that we don’t run out of money during retirement.

The answer to this question begins with an understanding of your day-to-day living expenses, and how those expenses may change in retirement. This is a simple enough process, although it does take some effort.

The difficult part is to determine what the funding requirement is in order to provide the income you’ll need to cover your living expenses – for as much as forty years or more!

There is a rule of thumb (more on this later) that you can use to come up with a rough guess – but without using sophisticated computer modeling and analysis, your level of assuredness is limited.

According to a recent survey by the Employee Benefits Research Institute, 84% of future retirees believe that they will have plenty of savings to cover their needs in retirement. At the same time, less than one-third of those surveyed had gone through the effort to calculate how much they will need.

When looking at the actual savings numbers, only around 20% of the survey respondents had in excess of $100,000 set aside for retirement, and more than 10% indicated that they had nothing at all saved for retirement.

The rule of thumb that I mentioned before indicates that you should plan to withdraw no more than 3% to 5% each year from your retirement savings in order to not run out of money. This is what we refer to as a “sustainable rate of withdrawal”. (There are many opinions about what exactly is the appropriate sustainable withdrawal rate – at one time it was suggested that 4% is the right number, but this has been under considerable scrutiny of late. Working with the range of 3 to 5% will get you in the ballpark, nonetheless.) This equates to a requirement of $1 million in retirement funds in order to be able to withdraw $30,000 to $50,000 each year.

Don’t despair over these estimates, though. The rule of thumb is based upon 100 percent certainty, and if you happen to have that luxury, that’s fantastic. There are ways to increase your sustainable rate of withdrawal, while still maintaining a relatively high degree of certainty.

Improving the Level of Certainty

The first and possibly most important factor is to have a plan, and to monitor your plan closely. You can do this on your own, or in conjunction with a financial pro. Paying close attention to your plan and staying with it will provide you with the information in order to make certain that your plan stays on track.

Your plan should include some sort of projections or modeling to show what your future income could be based upon your sources of income – retirement savings, pensions, Social Security, and the like. This will help you to plan for your expenses in retirement – developing a budget in reverse, if you will.

Making adjustments to your portfolio holdings can have a positive impact on the level of sustainable withdrawal. It may seem to run counter to your intuition, but more risk in your holdings is good for your long-term holdings. It is important to maintain significant positions in the stock market in order to achieve a higher level of withdrawals over time. Without some exposure to risk, your funds will fall behind when compared to inflation of day-to-day expenses, not to mention high-inflation items like healthcare costs.

The third factor that can have an impact on your savings’ sustainability is the pattern of income that you’ll need in retirement. As you probably realize, over the span of the potential forty-plus year retirement, your income needs will likely change. During your first several years, you’re likely to spend considerably more than the overall average, as you travel more, take on new hobbies, and the like. Or, on the other hand you may continue to save during this time of your life.

Later on in your retirement, many folks take on lower expenses as they become more sedentary, not traveling as much and having fewer extraneous expenses. Declining health and lower energy level makes staying closer to home more attractive. In later years, health care costs can cause those expenses to increase. It is also important to maintain a realistic view of your own life span. It’s not at all unreasonable to project your retirement plan out to your late 90’s.

There are more factors that can have a positive impact on your sustainable withdrawal rate, but these are the primary ones. I want to reiterate that the most important factor is to make a plan, monitor it closely, and make the appropriate adjustments throughout your life.

What you’ll find is that, by putting some effort into developing a plan, you’ll have much more confidence in your ability to make your savings last. At the same time, if you find that you haven’t yet done enough, you have time to make adjustments in your efforts that will increase your odds.

Having made a plan, it’s also important to review and update it, on average once a year or so. This kind of review will leave you with the peace of mind that, in fact, you’re on track.

Delayed Retirement Credits for Social Security

these two dudes are delayingWhen you delay filing for your Social Security retirement benefit until after your Full Retirement Age (FRA), your future benefit increases due to a factor known as Delayed Retirement Credits, or DRCs. These credits accrue at the rate of 2/3% for each month of delay, which equates to 8% for every full year of delay.

It’s important to know a few facts about DRCs. For one – the delayed retirement credits are accumulative, not compounding. If your Full Retirement Age is 66 (if you were born between 1943 and 1954), you can accrue a full 32% in DRCs. This means that the amount of benefit that you would normally receive at FRA (which is your Primary Insurance Amount, or PIA) would be multiplied by 132% at your age 70. If your FRA is above age 66, your maximum delayed retirement credit is something less than 32% – as little as 24% if your FRA is 67.

Delayed retirement credits stop once you reach age 70, no matter when your Full Retirement Age is.

If you are delaying your benefit to achieve the delayed retirement credits and you die before reaching age 70, your DRCs stop at your death. Your surviving spouse will be eligible for a Survivor Benefit with delayed retirement credits as of the date of your death. Even if your spouse delays receiving the Survivor Benefit after your death, no more delayed retirement credits will accrue to that benefit.

For example, if you died at the age of 68 years and 6 months, your surviving spouse will be eligible for a Survivor Benefit that is 120% of your Primary Insurance Amount (PIA). If your PIA is $1,500 that means your surviving spouse is eligible for a benefit equal to $1,800.

The same is true if you decide at some point before your own age 70 to go ahead and file. I get this question every once in a while, since most examples of File & Suspend illustrate the individual doing a file & suspend at Full Retirement Age and then delaying benefits until age 70. But it’s not a requirement that you delay until age 70 – if you delay until, for example, age 67, you’ll achieve an increase of 8% since you waited a year before filing for your benefit.

You can file at any time after you’ve reached Full Retirement Age to achieve this 2/3% increase for each month. There’s no requirement to File & Suspend before filing for the delay credits either. It might be part of your strategy to File & Suspend if you’re delaying your own benefit but want to provide a Spousal Benefit for your better half. On the other hand, you might not want to File & Suspend if you plan to file a restricted application for Spousal Benefits based upon your spouse’s record.

Lastly, DRCs only affect your own retirement benefit. There are no delayed retirement credits for Spousal or Survivor benefits by delaying past FRA.