02/24/14

Retirement Planning Tips by Age

BY: PAUL NORR, The Informed Investor Blog, February 19, 2014

There are many age-related financial and planning milestones that clients will encounter in their sixties. Here is a list of some of the common ones that you should keep in mind.

59 ½ – Penalty Goes Away
This is the age at which one can withdraw money from traditional IRAs, 401(k)s or similar retirement plans without restrictions and without an added 10% tax penalty. Withdrawals will still be taxed at normal tax rates. For most people, it is not wise to draw down retirement accounts at this relatively young age unless they have specific financial needs. Usually, the value of maintaining tax-preferred savings exceeds the benefit that may come from early spending.

60 – Survivors
This is the first year to collect a Social Security survivor benefit if a spouse or ex-spouse (if married for at least 10 years and never remarried) has died.

62 – Social Security – First Call
The earliest age that someone could collect Social Security retirement benefit. Most people should not file for benefits at this early age although certain spousal strategies may be an exception.

62 – Pension Alert
This is a common age at which pension benefits kick in. Pension features vary significantly from company to company or between industry and government.  Carefully evaluate the features of your pension today if you are fortunate enough to have one.

63 ½ – Bridge to Medicare
Not an official milestone but might be an important age for laid-off workers who are offered COBRA health care benefits. COBRA benefits typically last for 18 months and 65 is the age at which one can begin Medicare medical coverage. Therefore, 63 and a half is the earliest age at which, if one were laid off and covered by COBRA health care benefits, that COBRA benefits would provide a health care bridge all the way until they are eligible for Medicare.

65 – Medicare
Medicare eligibility age. Most people should sign up for Medicare benefits within a 7 month window around this birthday in order to avoid lifetime surcharges on Medicare benefits. There are a few exceptions to this requirement such as active employees who are still covered under a large employer health plan.

66 – Social Security Magic Age
Sixty-six is the ‘magic age’ for Social Security when many options become available. For most boomers, 66 is the official full retirement age . At this age a number of creative Social Security strategies for couples become available such as File and Suspend and Restricted Filing. If you are second-guessing your decision to file for earlier benefits, 66 is also the first age at which you can suspend benefits in order to allow delayed retirement credits to build up.

70 – Social Security – Last Call
Don’t delay any longer. This is the age at which there is no additional benefit to delay filing for Social Security benefits.  You have maximized your lifetime monthly Social Security benefit but should file immediately.

70½ – Required Distributions Ahead
Owners of retirement accounts such as IRAs, 401(k)s or other similar retirement plans are required to start taking specified required minimal distributions (RMDs) from these accounts when you turn seventy and a half. You actually have until the following April to make take the first year distribution. After that, each year’s distribution must be taken by Dec. 31 of that year.

The total required distribution is based on the total values of all of a person’s IRAs and retirement plans as of Dec. 31st of the earlier year. The total distribution may all be taken out of any one account or may be split among the accounts in any manner that one chooses

 

To Your Successful Retirement!

Michael Ginsberg, JD, CFP® 

02/10/14

Don’t put off saving for retirement Pick one: immediate gratification or future satisfaction

By Robert Powell, MarketWatch, The Wall Street Journal, January 18, 2014

If ever you’ve been faced with the choice between immediate gratification and future satisfaction then you have no doubt experienced the inner conflict over what researchers refer to time preference.

And that conflict can often lead to self-control problems, especially when it comes to building an adequate nest egg for retirement. Non-savers, as you might imagine, prefer immediate gratification while savers, no surprise, prefer future satisfaction.

But why do some people have trouble with self-control and others not so much? And, more important, what can you do if you’re having trouble with self-control — that is, saving for retirement?

A problem of nature and nurture

Regarding the first question, at least one expert said the difference between households with self-control and those with little or no self-control stems partly from nature and partly from nurture. “Genes do matter, and some people have better mental control technologies than others because of the way brains are wired,” said Hersh Shefrin, a professor at the Leavey School of Business at Santa Clara University. “For some, regions of the brain that provide ‘oversight’ are more active in some people than others.”

In addition, Shefrin said, the data also shows that higher levels of education appear to matter. “The more educated are better at setting budgets,” he said. “The direction of causality might be two way here, so it might be more than the fact that better educated people learn how to set budgets effectively.”

Read Shefrin’s paper on the subject, Born to Spend?

How people value costs now and in the future

Other researchers have a different point of view. “One simple answer is how people value costs that occur in the future vs. those in present,” wrote Kyoung Tae Kim, Jae Min Lee, and Eunice Hong, all Ph.D. students or candidates at Ohio State University, in an email to me. “People might have different discount rate (different time preference). For example, people who are present-oriented discount future much (high discount rate) while people who are future-oriented discount present heavily (low discount rate).”

Kim, Lee, and Hong recently examined the Survey of Consumer Finance from the 1995 to the 2007 and found that about one in five American households have self-control problems when it comes to saving, though even more have self-control problems when it comes to making loan payments or paying off monthly credit card balances.

For instance, nearly 53% of households have a problem with loan payments (they’ve been late making a loan payment during the past year; or they’ve been late making a loan payment for two or more months in a row; or they’ve declared bankruptcy; or they don’t pay off their monthly total balance owed on their credit card account) and slightly more that 56% households have a problem with credit cards (they have a balance still owed on their credit cards after their last payment).

By contrast, about one in five (21%) of households have a problem saving (they aren’t saving for retirement or they aren’t saving regularly by putting money aside each month). Read their paper, Assessing the Effect of Self-Control on Retirement Preparedness of U.S. Households.

How to alleviate self-control problems

Not surprisingly, Kim, Lee, and Hong found that households with self-control problems were less likely to be on track for an adequate retirement than households without self-control problems. And those households, said the authors, must find ways to “alleviate” their self-control problems, especially in the field of saving decisions and debt.

How might a household do that?

Well, Kim, Lee, and Hong said households ought to consider what they and others call “commitment” devices. “Goal clarification, self-evaluation, and deadline setting reduce self-control problems and increase the chance of getting on track for an adequate retirement,” Kim, Lee, and Hong said in an email. What are those devices? Here’s how they defined them.

Goal clarification: “People procrastinate about their retirement planning even though it is a very crucial issue even for young retirees,” Kim, Lee, and Hong said. “People should visualize and compare all possible retirement goals. It would be helpful to alleviate self-control problem including its procrastination about retirement preparedness.”

Self-evaluation: “It is very fundamental and important for people to assess and evaluate their current financial status including budgeting, income statement, investment and the like,” they said. “In my financial planning class, some of students’ (real) clients have serious problems related to tacking their financial records. More accurate self-evaluation would be helpful to reduce self-control problems and to increase saving motive for retirement.”

Payment deadline setting: “It would be useful to reduce credit card revolving and to avoid late loan payment,” the authors wrote.

Use of financial planning services: To better understand these commitment devices, people might consider a comprehensive financial plan from a certified financial planners. One recent study showed that households using a financial planner for their saving and investment decisions are more likely to have an adequate retirement than nonuser households.

Kim, Lee and Hong also recommended using “commitment devices” that make you feel more responsible in managing your money matters. Plus, they suggested using smartphone apps or Internet sites such as Mint.com to keep track of your “financial circumstances so that you know what is going on with your money.” And, the authors said, establishing a retirement plan and putting in place high default rates can help with self-control problems.

John Ameriks, a principal and head of active equity in Vanguard Equity Investment Group, is a fan of planning tools and exercises. “But I think another big point for those who know they have ‘self-control’/savings problems is to consider setting up automatic savings and investing mechanisms wherever possible, such as paycheck deduction, automatics deposits and transfers, or any other long- term pre-commitment devices to help ensure that some degree of saving and wealth accumulation actually occurs.”

These folks, said Ameriks, should at the same time “very carefully consider how they are using credit cards and other debt — and do away with things that could tempt them to overspend.”

There might also be a need for another sort of commitment device, according to Sherman Hanna, a professor at Ohio State University. “One of my Facebook friends posts daily progress on his weight loss goals — weigh-ins, minutes of exercise, and the like,” said Hanna. “I would imagine that anything comparable in the financial realm might help increase the chance of reaching one’s retirement goal.”

To be fair, commitment devices can help with your self-control problems, but they aren’t a panacea.

“All of the techniques mentioned (above) are sensible, but just reading about them won’t be enough to instill new habits,” said Shefrin. “Cultivating new habits really does take work.”

Cure the disease or treat the symptom?

Ameriks views the question of why some people have trouble with self-control and others don’t as one for which there is no clear answer. “The development and malleability of personality and behavioral characteristics is a large area of social science research,” said Ameriks, who is co-author of Measuring Self-Control Problems.

In that study, Ameriks and others co-authors “identified effects on saving/wealth accumulation that were intended to be robust to the issue of whether personality characteristics were intrinsic or learned and changeable.”

And so while Ameriks is fond of planning apps and services, he said “my sense is we really don’t have good evidence as to whether real planners are made or born; and in particular whether ‘self-control’ is a characteristic that significantly evolves among adults.”

To be sure, Ameriks understands the desire to treat the disease, self-control problems, not the symptom, inadequate saving. “But I think there is some debate as to whether a ‘safe and effective cure’ is out there,” he said. “So addressing the practical issue, not enough saving, is valuable as we work toward finding good answers on how to help deal with the underlying issue.”

 

To Your Successful Retirement!

Michael Ginsberg, JD, CFP® 

02/3/14

How to retire early — 35 years early

Blogger who retired at 30 says it’s time to rethink spending

By Andrea Coombes, Market Watch, The Wall Street Journal, January 17, 2014

For many Americans, the idea of an early retirement is pure fantasy — many surveys suggest that a good portion of us are convinced we’ll never be able to retire at all. But what if retirement saving isn’t quite as insurmountable an obstacle as you think?

The idea that retirement — even early retirement — is within anyone’s grasp is a big part of the appeal of a popular personal-finance blog called “Mr. Money Mustache,” written by a 39-year-old man named Pete, who lives with his wife and 8-year-old son in Longmont, Colo. (The blog recently had 417,000 monthly unique visitors, and has had a total of 4 million unique visitors since it launched in April 2011.)

Pete, who prefers not to divulge his last name to protect his family’s privacy, retired when he was just 30. His wife retired with him, and for the past nine years they’ve been stay-at-home parents. Their investment income supports their lifestyle, but they also work when they want, on their own terms.

One secret to their success? They live on very little for a family of three: about $25,000 a year. They own a car, but mostly bike. Dining out is an occasional luxury. And shopping for stuff? That’s best avoided. But their philosophy goes beyond mere scrimping, says Mr. Money Mustache. It’s about enjoying life with less.

MarketWatch asked Mr. Money Mustache about his philosophy on spending, how he retired early, and his take on retirement planning. Our Q&A is below. And if you’re wondering about the name?

“Mr. Money Mustache is meant to be a bit of a character — a financial superhero,” Pete said. “He’s me, but a slightly bossier and more opinionated version of me. I find that people gladly obey the commandments of Mr. Money Mustache, even while they would scoff if plain old Pete, the former software engineer, stepped up and started giving them advice.”

How old were you when you decided to try to retire early, and how long did it take you to get to the point where you could retire?

It was a gradual process. I brought some frugal instincts along with me from childhood, so I always tended to save a bit of money rather than spending it all. My wife has been a pretty reasonable spender since the time we met, as well. So I graduated from college in 1997, we eventually moved in together, and, after several years of full-time work, some cash was starting to build up in our investment accounts, and we wondered if there was something useful we could do with it.

Sometime around 2002, we decided we wanted to be parents eventually, and that it would be great if we could retire from our relatively demanding careers in the tech industry before any babies came along. This really increased our motivation to spend less and invest more, and we cranked things up. At the end of 2005, our savings were sufficient to generate passive income that we could theoretically live off forever, so we quit the regular jobs and have been winging it ever since. And we now have an amazing 8-year-old-boy.

How did you decide how much money was enough to retire?

Based on a long-lasting hobby of reading books on stock investing, I realized that you can generally count on your nest egg to deliver a 4% return over most of a lifetime, with a good chance of it never running out. In other words, you need about 25 times your annual spending to retire. So we tracked our spending and our net worth, and when we hit the magic number we declared ourselves “retired.”

For more on Mr. Money Mustache’s take on the 4% rule here, read this blog post.

Did you have a written retirement plan in place early on, or more of a ballpark figure you were trying to save up?

We did most of the saving before we knew all that much about early retirement. But once the picture became a bit clearer, we had a clearer goal. For the last few years, the mantra was “$600,000 in investments, plus a paid-off house.” This is enough to generate $24,000 of spending money, which goes quite far if you have no rent or mortgage to pay.

How important is it for people to have a written retirement plan, in your opinion?

It doesn’t matter to me if it’s written, verbal or mental. But I do encourage people to open their minds to how real and possible an early retirement can be. It isn’t a vague, fluffy concept like, “someday,” “never” or “when I’m 65.” Retirement (or financial independence) simply means that you have your living expenses covered by nonwork income. In the worst case, this requires 25 to 30 times your annual spending, socked away into investments. If you’re eligible for a pension or Social Security, it’s even easier.

For more on how Mr. Money Mustache invests (hint: he’s a fan of low-cost, broad-based stock index funds), read this blog post. 

Do you work with a financial planner or manage your finances on your own?

I have always enjoyed managing my own finances. On the blog, I maintain a good-natured battle with the financial-planning industry in general, because they focus too much on retiring at a very old age with many millions in savings — just so you can continue to spend $100,000 a year until you die. It is much more efficient to get a handle on your materialism and spending so you can live more happily on a fraction of that amount, which can shave 20 years or more from the time you need to keep commuting in to that office.

How crucial is it, in your opinion, for people to have a monthly or annual spending plan or budget?

This really depends on your personality type. I’ve never had a spending plan or a budget at any point in my own life. Instead, it was a simple set of values to apply just before I make any purchase or commit to any expense: “Is this the best possible use for this chunk of money, if my goal is creating lifelong happiness for myself?”

Since I valued freedom and financial strength, this automatically ruled out quite a few purchases. For example, as a young man I was a major car enthusiast. But I didn’t run out to borrow money to buy an Acura NSX, because I valued having that money for other things more than I valued a fancy car. Nowadays I can finally afford a car like that without even borrowing, but I am happy to discover that the desire has disappeared.

See this Mr. Money Mustache article for details on the family’s spending in 2013.  

Some people might think so much cost-cutting is akin to living like Scrooge and not having any fun. How would you respond to that?

If you tell yourself that is how it will be, then you will create your own truth and life will not be fun. But if you understand the fundamentals of what it means to be a happy person, you realize that buying more stuff for yourself has no relationship at all to how happy you are. These fundamentals include things like close relationships with other people, health, rewarding work, a chance to be creative and help others.

Work on those things and you’ll start living a much better life immediately, and soon wonder where the odd compulsion to own a yacht with a submarine came from in your old self.

Surveys suggest there are a lot of people out there who are worried about retiring, who don’t have enough money saved, who feel like they may never retire. Can you offer people in that situation any words of advice in terms of how to turn their situation around?

The quickest way to turn things around is to realize that you are in much more control than you realize. The time to reach retirement depends on only one thing: your savings rate as a percentage of your take-home pay. And this depends entirely on how much you spend. So the moment you can learn to live a less expensive life, suddenly the clouds clear up and the financial picture brightens considerably.

Read Mr. Money Mustache’s 5 most important strategies for planning an early retirement. 

What would you say to someone in his 50s or 60s who maybe doesn’t have any credit-card debt, but is paying a mortgage and has about $100,000 saved for retirement? Is there any scenario where that person would be able to retire in, say, his early 60s?

That’s not a great starting point, but the turnaround can be incredibly fast once you realize where your money has been leaking out and change your life so that you can save much more of your income. Ten to 15 years is plenty of time for most people to go from zero to financial independence, so with a $100,000 head start and the kids all out of the house, this 55-year-old might be in a good place. Adding in Social Security income, the time to retirement would be even faster.

Do you think that the rule of thumb of needing about 85% of pre-retirement income in retirement is accurate, useful, dangerous, innocuous?

This is a good guideline for people who currently spend almost everything they earn, and plan to continue that habit in retirement. But for the rest of us, it is ridiculous!

A much more useful idea is to separate the idea of income from that of spending. Your income is determined by what you do for a living. But your spending should be decided based on your needs — the things and experiences that truly make you happy. As an example, my family’s needs and wants have always ended up adding to about $25,000 a year. So that’s how much we spent, whether we were making $25,000 or $200,000.

So as soon as our retirement income safely exceeded $25,000 a year, we were financially independent and we decided to retire.

I hate to get morbid, but the idea of how long one is going to live is sort of a crucial piece to a retirement plan. How are you handling this impossible-to-answer-yet-essential question? Are annuities and/or long-term-care insurance part of your long-term financial plan?

If you plan your retirement right, your expected longevity might actually have nothing to do with your planning. This is because the amount of money required to fund a 30-year retirement is almost identical to the amount to fund a person forever — an odd behavior of the equation for amortization of a large sum of money.

I’m not into annuities or any type of insurance myself, although those products do have value for some. Both of those ideas are based on statistics and probabilities, and when you do the math you can actually be safer handling things yourself. With a big enough collection of income-producing assets (stocks, rental property, etc.), your savings will easily outlive you, and probably be much larger by the time you die. This big chunk of savings also allows you to pay for unexpected expenses without rocking the boat too much — you have many years to adjust if you do hit a bump that forces you to deplete part of it for something like a medical expense.

You have said in the past that it’s important to “make your dollars work for you.” Does that mean the idea of an emergency savings account at the bank is overrated? Should people be investing more of their savings in the financial markets, via a taxable account, rather than using bank accounts?

Yeah, I’ve always questioned the idea of an emergency fund. It’s a great tool for the financial beginner who lives from paycheck to paycheck, and for whom a broken water heater would make the difference between making ends meet and borrowing via a credit card. But once you get off the ground, your credit card is a monthly buffer and your investment accounts are the emergency fund.

So I have no savings account at all, and keep just a few thousand dollars in the checking account. If a huge unexpected expense ever came up that was greater than my income, I would put it on the credit card along with all other monthly spending. Then just sell some shares of an index fund and transfer that back to the bank before the credit-card automatic payment happened at the end of the month. And I’ve still never had to run a credit-card balance in my life.

The great part is that if your spending is much lower than your income, these emergencies become very rare, because there is always a surplus, which you have to sweep away into investments each month. So if the water heater dies, you buy a new one and just invest a little bit less that month.

To what degree would you say rental income was key to your ability to retire early?

A small degree — I haven’t had the most brilliant landlord career so far, so my results have been only average. But rental properties chosen wisely can return much more than stocks, which could really speed up a savvy person’s retirement program. In my own case, I probably saved only about one year of work by using rental houses along with stocks.

Would you say it’s better to use extra savings to pay down one’s mortgage, or to invest in the financial markets?

For people in a high tax bracket, 401(k) plans in low-fee index funds win this battle pretty easily, especially if there is an employer match. For investment in taxable nonretirement accounts, it all depends on the interest rate (and if you’re pretty well-versed in investing, the stock market’s valuation or P/E 10 ratio).

Right now, with stocks expensive and interest rates interest rates interest rates very low, it’s probably a somewhat uninspiring tie, in my opinion, and you could do either. But if mortgage interest rates were 6% or more, I’d start getting more excited about paying off a house.

For people with other debts, like student loans, car loans or credit-card debt, at higher rates, I’d prioritize debt payoff even more.

It sounds as though a lot of your success has to do with cutting costs. But I know that some of my readers are really tired of hearing the “cut out the lattes” idea. What would you say to those readers?

For most people, cutting costs is by far the most powerful way to increase wealth. This is because it is easy to burn off almost any amount of money — just ask the 78% of NFL players that have financial problems shortly after turning off the cash fire hose of a pro sports career. It is also possible to cut almost any budget in half, leaving the happy latte cutter saving 50% or more of her income.

But the key to making this work is not cutting out treats — it’s eliminating your desire for those treats in the first place. Driving my 2005 Scion hatchback would be a chore if I had a desire for a 2014 BMW. But since this little Scion is more than enough car for all of my wants (and I usually ride a bike anyway), I am actually winning and living a happier life even while saving $20,000 a year in depreciation and other costs. The handy part of all this is that anyone can eliminate the desire for any of the expensive luxuries currently dominating most of our spending.

Do you have any sorts of items you love to buy and won’t give up?

That’s a tricky question, because our lifestyle does include quite a few luxuries that are fun to have around. I enjoy nice coffee at breakfast and wine many nights at dinner, and the food we eat is very high-end these days. And we live in a pretty fancy house full of nice stuff and take a lot of trips. While I enjoy all of these things, I also make fun of myself for living such a decadent lifestyle, as a reminder that none of these things are essential components of happiness. I would give them up in a heartbeat if we couldn’t afford them — for example if we were in debt or if they compromised our ability to live a free life. But since life is an adventure and there is no need to seek perfection, we dabble in all of the normal treats of American life.

When it comes to spending, what about travel to foreign lands? A no-no because of the steep expense?

Travel can be as expensive or as inexpensive as you choose to make it. We do quite a bit of it these days, spending every summer in Canada and a good part of last winter in Hawaii, with other trips to quite a few other countries in recent years as well. But if you live like a local once you get there, going for the slow and authentic experience rather than flashy hotels and bungee jumping every day, it costs a lot less. One of my favorite trips was a winter driving trip from Colorado down to the Gulf Coast, where we brought along a tent and a kayak and hung out on as many beaches and waterways as we could find in the tropical belt of Texas for a month.

Why did you start your blog?

It was a 50/50 mix of inspiration and exasperation. My wife and I retired from real work at the end of 2005, but all of our friends and peers kept working around us. As their careers blossomed and earnings grew, I kept hearing these complaints about money being tight and retirement being an impossibility. But looking at their lifestyles, I could see exactly where the money was leaking out unproductively — even while they seemed to be missing it. So I decided to start the blog and share the ideas with the world, rather than annoying friends with unrequested financial advice.

 

To Your Successful Retirement!

Michael Ginsberg, JD, CFP®