Ways to Fund Early Retirement

After the tech bust and the recent stock market drops, many people gave up on the dream of being able to retire early.  But as this recent article in US News and World Report by Joe Udo explains, the dream of an early retirement is still very much possible.  All it takes is good planning and an income based portfolio focus like the one I advocate for clients.  I hope you enjoy this article, let me know what you think.

To Your Successful Retirement!

Michael Ginsberg, JD, CFP®


US News and World Report, Joe Udo, October 24, 2013

Early retirement is a dream for many people. The hard part is actually funding an early retirement. The typical working-age household has only $3,000 in retirement account assets, according to the National Institute on Retirement Security. However, it is possible to save regularly over many years and accumulate a comfortable nest egg. Such diligent savers might want to retire before they are 59 1/2, and will need to take steps to avoid paying the 10 percent penalty for early retirement account withdrawals. Here are five ways to pay for an early retirement:

Passive income. Passive income is a great way to fund your early retirement, but it takes many years to build up. Many retirees receive income from rental properties, dividend stocks and other investments. The best way to build a passive income is to do it over many years so you will become an expert at that particular field. Rental properties usually generate more income as rents increase and mortgages are reduced. The right dividend stocks will also keep raising their dividend every year, and eventually can pay out a substantial amount every year.

Substantially equal periodic payments. If your retirement account is very large, then you may want to use IRS rule 72(t) to avoid the 10 percent early withdrawal penalty. Once you start the SEPP, you will have to continue these withdrawals for at least five years or until age 59 1/2, whichever is later. There are three methods to calculate how much you need to take out. You will need to talk to a qualified tax professional to make sure the withdrawal process is done correctly.

Retire after 55. You can access your 401(k) penalty free at age 55 if you retire at any time during or after that year. This exception only applies to 401(k) and other ERISA-qualified plans, including the federal Thrift Savings Plan, but not IRAs. Contact your 401(k) plan administrator to see if this option is available. You have to leave your retirement fund at your employer’s plan if you intend to take advantage of this. If you roll over your 401(k) to an IRA this exception to the early withdrawal penalty no longer applies.

Roth IRA ladder. Another way to avoid the 10 percent early withdrawal penalty is to take advantage of the Roth IRA and build a ladder:

  1. Convert one year of living expense to a Roth IRA.  You will have to pay tax when you do this.
  2. Wait five years. Roth IRA conversions can be withdrawn without penalty after five years.
  3. Withdraw one year of living expense from the Roth IRA.
  4. Repeat every year until 59 1/2.

The downside of this plan is the five-year waiting period before the first withdrawal. Advance planning is required to make this work.

Part-time work. Withdrawing from your retirement fund before you are 59 1/2 isn’t always a good idea. Most of us have a difficult time funding our retirement already. The earlier you withdraw from your retirement fund, the more difficult it will be to make your savings last. A better idea is to work part time until you are 59 1/2, and let your nest egg compound. Some early retirees work only a few months to accumulate some cash, and then take the rest of the year off.

Generally, early withdrawals are not a good idea because your retirement fund will be reduced. Your nest egg is meant to provide a comfortable lifestyle when you are older, meaning you are able to pay for basic necessities without much worry. At 50 or 55, most of us still have the ability to work, and staying in the workforce is often a better way to go. If you reduce your expenses and work only part time, then you can gradually make the transition into retirement. Continuing to bring in income on a part-time basis will lower your stress level and give you more time to figure out what to do in retirement.



Paying for Long-Term Care Insurance with Tax-Free Funds

The high cost of long-term care can quickly drain your savings, absorb most of your income, and affect the quality of life for you and your family. Long-term care insurance (LTCI) allows you to share that cost with an insurance company. If you’re concerned about protecting your assets and maintaining your financial independence, (LTCI) may be right for you.

But LTCI premiums can be expensive, and cash or income needed to cover those premiums may not be readily available. The good news is that there are several tax-free options that can help you pay for LTCI.

Using a health savings account

A health savings account, or HSA, is a tax advantaged savings account tied to a high deductible health insurance plan. An HSA is funded with pretax contributions up to certain annual limits set by the IRS. Any growth inside an HSA is tax deferred, and what you don’t spend in one year can carry over to subsequent years. Just as importantly, withdrawals made from your HSA for qualified medical expenses are tax free.

Tax-qualified LTCI premiums are a qualified medical expense eligible to be paid from HSA funds. The maximum annual premium you can pay tax free is subject to long-term care premium deduction limits.

Convert taxable annuity to tax-free long-term care insurance

Generally, withdrawals from a nonqualified deferred annuity (premiums paid with after-tax dollars) are considered to come first from earnings, then from your investment (premiums paid) in the contract. The earnings portion of the withdrawal is treated as income to the annuity owner, subject to ordinary income taxes. IRC Section 1035 allows you to exchange one annuity for another without any immediate tax consequences, as long as certain requirements are met. But, what you may not know is that the Pension Protection Act (PPA) extends the tax-free exchange of annuities for qualified stand-alone LTCI or combination annuity/LTCI policies. This effectively allows you to purchase LTCI with annuity cash values that would otherwise have been taxable to you if withdrawn.

However, there are some potential drawbacks:

  • You may incur annuity surrender charges when transferring your annuity.
  • Transferring your annuity means you won’t have the potential income the annuity could provide.
  • While premiums for qualified LTCI are tax deductible as qualified medical expenses, annuity payments used to pay for long-term care are not tax deductible.
  • Not all long-term care policies allow you to pay premiums in a lump sum, so you may have to make partial 1035 exchanges from the annuity to the LTCI company, but not all annuities allow partial 1035 exchanges.

HELPS may help

Another opportunity to pay for LTCI on a tax-free basis may be available to qualifying retired public safety officers. Part of the Pension Protection Act of 2006, the Healthcare Enhancement for Local Public Safety (HELPS) Retirees Act, allows certain retired public safety officers to make tax-free withdrawals from their retirement plans to help pay for LTCI for themselves and their respective spouses and dependents.

Eligible retired public safety officers include law enforcement officers, firefighters, chaplains, and members of a rescue squad or ambulance crew. Public safety officers must have attained normal retirement age or they must be separated from service due to a disability. HELPS does not extend to 911 operators, dispatchers, and administrative personnel. In addition, if an eligible participant dies, the exclusion from tax for withdrawals does not extend to surviving spouses or other beneficiaries of the participant’s retirement plan.

Eligible government retirement plans include qualified trusts, Section 403(a) plans, Section 403(b) annuities, and Section 457(b) plans. Up to $3,000 per year may be withdrawn on a pretax basis, and the money must be paid directly from the retirement plan to the LTCI company. However, not all retirement plans may allow for these withdrawals, and some state laws may not allow the tax-free treatment of distributions.

HSAs, the PPA, and the HELPS Act have opened the door to long-term care coverage for people who might otherwise have a hard time affording it. Your financial professional may be able to provide more information on these and other ways to help you plan for the potentially high cost of long-term care.

To Your Successful Retirement!

Michael Ginsberg, JD, CFP®



What Each Spouse Should Know About Finances – When one partner is in charge, the other can be at risk

Wall Street Journal, October 6, 2013, By RACHEL ROSENTHAL

In the typical division of labor in many households, one spouse manages the bills and the assets.  This is natural and healthy, financial planners say.  But both spouses should have at least a baseline understanding of the family finances, the experts add—and this seldom seems to be the case.

Just 28% of couples were “completely confident” that either spouse alone was prepared to steer their joint retirement finances, according to a recent study by Fidelity Investments.  Disability, divorce or death can thrust new responsibilities on spouses when they are ill-prepared. But talking about such “what ifs” can stir up uncomfortable questions and issues, so many couples avoid doing so.

“There’s a tendency to say, ‘Tomorrow, tomorrow, tomorrow,’ ” says Dorian Mintzer, a retirement-transition coach, speaker and author. Most couples “want to avoid confrontation and don’t want to think about their own mortality,” she says, even though “talking about it can free you up and help you try to plan what’s ahead.”

Here is what couples should do so that each partner will be able manage their financial affairs responsibly if they have to.

List of Assets

The best way to start the conversation is to make an inventory of assets, says Christine Palmer Hennigan, a certified divorce financial analyst and representative of Hornor, Townsend & Kent Inc., an investment firm in Horsham, Pa. Knowing what you own, and its value, will help you make informed decisions about how to distribute those assets when confronted with an unplanned transition, she says.

Start the list with financial accounts, including 401(k)s, individual retirement accounts, brokerage and checking accounts. Include where the accounts are held, whose name is on what account, and logins and passwords for any online accounts and assets.   Add insurance policies, indicating where those policies are held, whether the premium has been paid and whom to seek for advice about the policy.  Make a note of the beneficiary listed for each account or policy. Too many newlyweds forget to change the beneficiary of their 401(k) to their spouse from, say, their mother, says Stuart Ritter, a vice president and certified financial planner at T. Rowe Price Group TROW +1.01% .

In a prominent place on this list should be the couple’s emergency fund and how to access it. Both spouses also ought to understand how their partner is compensated, including stock options and other deferred compensation.

Atypical Assets

Experts also recommend itemizing and valuing physical assets such as your house, car, or boat, as well as assets not typically mentioned in a portfolio, like airline miles, hotel points and vacation timeshares.  “I had one client who collected Civil War memorabilia,” says Jerry Focas, an estate-planning lawyer in Towson, Md. “He had some really valuable stuff, and some junk that he just liked.” Mr. Focas says the client identified someone he trusts to help his family liquidate those assets should the need arise.

Mr. Focas says he advises clients to write up not just a list of assets but a detailed letter explaining how some of those assets should be managed. “Investment assets will to some extent take care of themselves,” he says, but other assets like collections, boats or rental properties can “have special maintenance needs.”

Ms. Hennigan suggests the list also should propose the order in which assets should be tapped either in retirement or in case of an emergency, with an eye toward maximizing the assets’ value and avoiding taxes or penalties for early withdrawals, for example.

Once the list and letter are finished, they should go in a safe place—but not until you’ve had the conversation: a frank discussion in which both partners talk about the assets and how the management of those assets fits into their financial security and long-term goals.

When Disaster Strikes

John Sweeney, executive vice president of retirement and investing strategies at Fidelity, says that when couples openly discuss how much they are willing to save and spend, it prepares them for when disaster strikes.  Says Mr. Sweeney: “When you encounter a bump in the road, you can say, ‘I’ve thought through this situation during a period of calm in my life,’ so there’s a whole lot less emotion and I can execute a plan.”

Ms. Hennigan, the divorce financial analyst, recalls a client who after her divorce was flummoxed by the investment portfolio that she assumed from her ex-husband. The portfolio was “very aggressive,” Ms. Hennigan says, and lost a lot more money in market downswings than a portfolio more aligned with her client’s risk tolerance would have.

“The fact of the matter was, she could have been in a portfolio that never had to lose money, and it cost her such stress and loss of assets,” says Ms. Hennigan. This could have been avoided if both partners had more openly aired their goals, she says.


To Your Successful Retirement!

Michael Ginsberg, JD, CFP®



After retiring, high earners may feel poor

Wall Street Journal – Market Watch, September 26, 2013

Most people understand, at least intellectually, that once they retire they’ll need to live on less income than they earned when they were working. A new report from the Employee Benefit Research Institute (EBRI), a nonprofit organization that studies retirement issues, offers some insights into just how much less it typically turns out to be. The bottom line: The more money you’re making now, the bigger the adjustment you’re likely to face.

The EBRI study looked at data for 3,358 individuals who were between the ages of 55 to 64 in 2000. EBRI researcher Sudipto Banerjee compared those people’s household income from 2000, when they were all under 65, with the same people’s income in 2010, when they’d all passed that threshold. (They excluded anybody who had income of $1 million or more in either period, since the rich are different from you and me.) Income in either group could include pensions, Social Security and earnings from work, along with other sources.

The survey found that the median post-65 household was bringing in 65.8% of the income it had been earning before 65. But when Banerjee broke the data down by income quartile, from lowest to highest, some interesting contrasts emerged. People in the lowest quartile (median pre-65 income: about $23,000 a year) actually saw their income rise after 65, by a little more than 10%. People in the next quartile up (pre-65 income: about $54,000) had about 80% as much income after 65 as they did before. But people in highest quartile, whose median income before 65 was $174,000 a year, earned only 50% as much after 65.

Banerjee attributes most of this difference to two factors: First, Social Security is a major component of most retirees’ incomes, and it’s designed to be progressive, replacing a higher share of the income of lower-earning workers; and second, it takes a very big pot of retirement savings to generate more than $100,000 a year in retirement income. (Indeed, although he doesn’t specifically cite them, the low interest rates that prevailed in 2010 may have depressed some retirees’ incomes in Banerjee’s study, just as they do now.)

Lots of other caveats apply to data like this: Many retirees, for example, simply don’t need as much income as they did during their working lives, especially if they’ve paid off their home. And those top-quartile retirees probably don’t need your pity: Their median post-65 household incomes of almost $87,000 would represent a very comfortable living in most of America.

But there are some broader implications worth pondering. Many financial advisers argue that to be successful, a retirement-planning strategy needs to replace 70% or 80% of a family’s pre-retirement income.  Studies like EBRI’s suggest that for many of the so-called mass affluent – people who make a good living, but not take-this-job-and-shove-it money—that may be an unrealistic target. The big pragmatic questions remain: How much do you really need in retirement? What will those needs really cost? And, more philosophically: Will your retirement goals lead you to make sacrifices in the present that you may wind up regretting later?


To Your Successful Retirement!

Michael Ginsberg, JD, CFP®