Archive for Investment Education

Roth IRA vs. Traditional – Which Is Right For You?

Roth IRA

Have you saved for 2016?

 

April 15th looms and for those of you who haven’t saved for 2016, time is running out.  As if that pressure isn’t enough, you have to decide what kind of retirement account to use.

 

Roth IRA

Roth IRAs allow you to put up to $5,500/year in ($6,500 if you are 50 or over).  The money you put in has no tax write off today, but the growth is tax free when you withdraw at retirement.   You need to have the money in the account for a minimum of 5 years or until age 59 ½, whichever is longer in order to access the growth tax and penalty free.

 

Money you contribute to a Roth can be accessed at any time with no taxes or penalties. So, if you put $10,000 in a Roth IRA and the account is worth $20,000, you can withdraw the first $10,000 without taxes or penalties regardless of your age.

 

Not everyone can contribute to a Roth IRA.  Like any benefit the IRS gives, there are income limits on who gets to enjoy them.  The income limits start at $117,000/year for single folks and go up to $187,000/year for married couples in 2016.  (Click here for more details.)

 

Traditional IRA

Traditional IRAs are the original players in the retirement account game.  The money you contribute (same limits as above) can be deducted from your income taxes as long as you don’t have access to a workplace retirement plan and fall under IRS income limits.  (Visit the the IRS website for the income limitations.)

 

Growth in the Traditional IRA does not generate a current tax bill, but you will pay taxes at your regular income tax rate when you withdraw the money at retirement.

 

Which is best?

It’s hard to say because we don’t know what your tax rate in retirement will be compared to now.  If you know you tax rate is higher now than in retirement, go for the tax-deferred option.  If you suspect you will have same or tax rates in general will be higher in your retirement, you might like the Roth better.

 

Since we don’t know future tax rates any more than future investment returns, it’s a good idea to have a mix of both Traditional and Roth retirement accounts.  That way, you are ready for anything!

 

Is my pension company trying to rip me off?

pension

This blog is NOT meant to make you scared about your pension.  I personally LOVE when clients have a pension and rarely suggest they take a lump sum payout if offered.

However, it happens occasionally that people come to me with an offer from their former employer to buy out the pension obligation that is currently being paid.  Now, this can look pretty exciting at first glance.  There is usually a nice 6-figure number in that letter that can be all yours if you just give up your monthly lifetime pension payment.

Not so fast, I say.  If a company is making this offer, you can be sure it’s not to benefit you – it’s to benefit their bottom line.

There is one easy way to figure out whether the offer is a good one.  If you have a financial calculator, or access one on the web, you can figure the average rate of return the pension company expects you to get by investing the lump sum on your own.  If that rate of return seems too high for a risk-free investment (like you currently have with your pension), the lump sum they are offering you it too low.

For example, let’s say Joe is 65 years old and getting a $1,500/month pension payment.  Assuming he lives until age 90, at a 2% risk-free rate of return (the current yield on a 10 year US Treasury bond), the present value of the lifetime payments is $354,000.

If his company is offering $200,000 to buy him out of his lifetime payments, they are saying the Joe could get a 7.75% annual rate of return with no risk.  Not possible in today’s interest rate environment.

So remember whenever someone offers you a big check – if it sounds too good to be true it probably is.  This is the time it will be worth it to pay for an hour of a financial adviser’s time to help you with the decision.

Learning to Love Stock Market Drops

That’s right, it’s February and my theme of the month is love.  “Why so obvious and cliché?” you ask.  Well, you try writing 52 blogs a year.  You’ll find yourself grasping for any holiday theme, too.

 

What investors and financial advisers don’t typically love is when the stock market goes down. No one likes seeing their balances drop.  Financial advisers don’t like for their clients to be unhappy.  So, what’s to love about stock markets going down?  Here are three things:

 

  1. It’s all on sale, baby!  When is the last time you ran to Nordstrom for a 50% higher price sale?  Never, right?  Ninety nine percent of the time, we like to buy stuff when it costs less than normal.  The other 1% is when stocks are cheap. When the stock market goes down, that is our cue to buy, but most people want to sell and keep their money in a Folger’s can.  Remember Warren Buffet’s fabulous quote: “Be fearful when others are greedy and be greedy when others are fearful.”  In other words, when the stock market is down, if you have extra cash, buy some stocks!

 

  1. It’s not unusual and it won’t last long.  First, a little vocabulary lesson.  A bear market is when stocks decline 20% off their previous highs.  A correction is when stocks are 10% lower than their previous highs.  Corrections typically happen once per year and bear markets once every 3.5 years.  The average correction recovers its value after 10 months and a bear market on average bounces back after 15 months.

 

  1. Celebrate your diversified portfolio.  You weren’t 100% in the stock market anyway, were you?  Your bonds are helping offset your (temporary) stock market losses.  Your financial adviser had you positioned with anywhere from 15% to 40% bonds, depending on your risk tolerance and time horizon, right?  Oh, you don’t have a financial adviser helping you with those decisions?  Time to contact Kristi for a 15 minute phone consultation!

 

If these topics sound like they would be of interest to your employees, sales conference, or professional organization, contact me at 303-324-0014 or kristi@sullivanfinancialplanning.com for more information.

IRA Contributions – To Roth or Not to Roth? That is the Question!

Well, maybe it wasn’t a burning question until you opened this blog.  But, April 15th is coming up, so it’s time to start thinking about whether or not you will contribute to an IRA and if so, what type?

 

I know it’s not popular in the press these days, but I am a fan of contributing as much as possible to your 401(k) or other work retirement plan before the IRA.  This is assuming that your workplace retirement plan has low costs and a decent investment menu.  Again, the press would have you believe this doesn’t exist, but there are many quality 401(k) plans out there.   Hey, I never was the popular type, anyway.

 

So, if you have maxed out your 401(k), or your employer doesn’t offer a retirement plan, now it’s time to look at IRA options.  Individual Retirement Accounts (IRAs) can be opened at just about any institution that handles money.  My favorites are the discount brokerages (Schwab, Fidelity, eTrade, TD Ameritrade, or Vanguard) for their low costs and variety of investment options available.

 

Traditional IRAs and Roth IRAs both let you contribute up to $5,500 per year (or $6,500 if you are aged 50 or older).  You or your spouse must have earned income equal to or more than your contribution amount.  You have until April 15th, 2016 to contribute to your IRA for 2015 taxes.

 

With Traditional IRAs, you may be allowed to deduct your contributions from your income taxes.  This depends on your income (starting at $61k for singles and $98k for married couples the deduction is phased out) and whether or not you have access to a workplace retirement plan.  Growth in a Traditional IRA is tax-deferred and will be taxed as ordinary income when you withdraw at retirement.

 

Roth IRA contributions do not give any up front tax deduction at all, but the growth is tax free as long as you keep the money in the account for 5 years or until age 59 1/2, whichever is longer.  Not everyone gets to put money in a Roth IRA, though.  For couples, the phase out begins at $183k income in 2015 (increasing to $184k in 2016). For singles, your Roth contribution allowance starts disappearing at $116k in 2015 ($117k in 2016).

 

Which IRA is best for you?  Call me for a 15 minute consultation and we can talk it over.  Also, for more details on IRA rules, see this handy sheet from our friends at the IRS.  https://www.irs.gov/pub/irs-news/IR-15-118.pdf

 

 

If these topics sound like they would be of interest to your employees, sales conference, or professional organization, contact me at 303-324-0014 or kristi@sullivanfinancialplanning.com for more information.

Wild is a Mild Word to Describe the Stock Market Lately

I don’t like to feed into the media hysteria when it comes to stock market drops.  As I say repeatedly to clients, friends, in this blog, and to my cat, stock market recessions are a normal part of the economy.  They last on average 12-18 months, so the pain is temporary.  Drops in the stock market are buying opportunities, not signs to sell at a loss.

By the way, I’m not saying we are in a recession.  You never know you’re in a recession until it’s almost over!

However, my loyal readers may be feeling uneasy, so I shouldn’t ignore your concerns, either!

I like this article from the Wall Street Journal (via www.fidelity.com) about what not to do during volatile stock markets.  The five “don’ts” are:

    1. Don’t panic
    2. Don’t fixate on the news
    3. Don’t be complacent
    4. Don’t get hung up on talk of a “correction”
    5.  Don’t think you or anyone else knows what will happen next

For more details, click through to the article:  https://www.fidelity.com/insights/investing-ideas/5-things-investors-should-not-do

 

If these topics sound like they would be of interest to your employees, sales conference, or professional organization, contact me at 303-324-0014 or kristi@sullivanfinancialplanning.com for more information.

 

Retirement Income Strategy – What’s the Best Order to Withdraw Assets? Method #3

This last method of spending down different accounts is probably the most popular.  Method #3 I’ll call the Pro-Rata System.  Simply put, you take a proportionate percentage out of each type of account every year.

For example, say you have 50% of assets in tax-deferred accounts, 25% in taxable accounts, and 25% in Roth accounts, and you’d like to take $40,000/year from your investments.  Twenty thousand dollars would come from your tax-deferred accounts, $10,000 from taxable accounts and $10,000 from Roth IRAs.

Pros:

  • More predictable tax bill throughout retirement.
  • Can prevent a big tax bubble at age 70 ½ by shrinking tax-deferred accounts before the Minimum Required Distributions start.
  • Tax bill is more manageable for retiree while giving heirs a chance of inheriting favorable taxable accounts and Roth IRAs.

Cons:

  • May take a little more calculation in the first years of retirement to get started.
  • Could result in a taxable income to heirs if the tax-deferred accounts are still a large portion of the estate at the retiree’s death.

Ultimately, the method you use depends on your priorities.  There is no right or wrong way.  Here are some patterns I have seen:

  • Those who are really concerned about passing wealth in a tax efficient way to heirs and don’t mind pre-paying taxes for their kids go with Method #1.
  • Retirees who are more concerned about their own financial stability in retirement and think inheritance is just gravy (or don’t want to pass anything at all) go with Method #2.
  • Method #3 is for people who just want to have a mix of taxes owed each year (income, capital gains) and a more stable tax bill over the course of retirement.  Inheritance would be okay, but isn’t the main priority.

If these topics sound like they would be of interest to your employees, sales conference, or professional organization, contact me at 303-324-0014 or kristi@sullivanfinancialplanning.com for more information.

Retirement Income Strategy – What’s the Best Order to Withdraw Assets? Method #1

A question that I am asked to address in many financial plans for pre-retirees is, “in what order should I take out my assets?”  In other words, does it make sense to tap tax-deferred plans first or last?  When should I start taking Roth money out?  How about my taxable (non-retirement account) investments?

First, the bad news:  To my knowledge, there is no one perfect way to do this.  I don’t have a fancy software program that allows me to enter different types of accounts and it gives me a year by year plan for how much money to take out of each.

The answer, as with so much of financial planning, is that it depends.   So, over the next few weeks, my blogs will focus on the 3 main ways to prioritize retirement withdrawals.

Method #1:  Spend taxable (non-retirement) accounts first, tax-deferred (Traditional IRAs and Traditional company sponsored plans) second, Roth money last.

Pros:

  • Allows tax-preferred accounts (IRAs, Roth IRAs, 401(k)s, 403(b)s) to grow longer.
  • If you never need to spend the Roth IRA money, that can be passed to heirs who can withdraw it income tax free.
  • In the early years of retirement when you are likely spending more (more travel, hobbies, etc.), your tax rate can stay lower by spending assets that have mostly been taxed already.

Cons:

  • If you have large tax-deferred accounts and delay taking withdrawals, your Minimum Required Distributions starting at age 70 ½ could balloon, bumping you into a higher tax bracket.
  • Your heirs may end up inheriting tax-deferred accounts that will add to their income tax bill as they are forced to withdraw that money during their working years.
  • Your tax bills will vary wildly from one stage of retirement to the next as you spend down different pools of money.  I find that most retirees like predictability in their expenses, especially taxes!

Stay tuned next week for Method #2!

If these topics sound like they would be of interest to your employees, sales conference, or professional organization, contact me at 303-324-0014 or kristi@sullivanfinancialplanning.com for more information.

Helping Transition Workers From Savers to Spenders

Saving to spending

Let’s take a moment of silence to remember the pension.  We dearly miss that well-loved, but ultimately unstainable stream of lifetime income that employers used to supply loyal workers in retirement.

Now what?  Employers have punted the responsibility of lifetime income and medical care to their employees.  They feel really good about providing a 401(k) with a match and the freedom to for employees to choose their own investment mix.  What power!  What exhilaration!

What crap!  What people really need as they approach retirement is a good education on how to be retired.   What are some methods for creating an income stream in retirement?  How does Medicare work?  How can I best utilize Social Security?

Unfortunately, the current system provides a way for employees to accumulate wealth for retirement, but no help at all transitioning from a saver to a spender.  Employees retire and are prey to the world of financial sales people who will happily sell them investment products, but give them no help in creating a holistic plan.

How can employers ease that transition?  How can they help employees be savvy consumers of financial services in retirement?  One way is to provide non-biased education to pre-retirees in the workplace.  This would involve hiring a financial professional for education ONLY, not bringing in a free speaker who will then use your employees as a prospecting list.

I provide a great pre-retirement class as well as 30-minute one-on-one appointments to start people on the path to successful retirement.  I charge by the day and there is NO follow-up sales pitch to employees.

Contact me at 303-324-0014 or kristi@sullivanfinancialplanning.com to talk about how I can help your employees move to a successful retirement.


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What is a Diversified Bond Portfolio?

Diversified Bond Portfolio

If you look back on my past blogs, I explain the different types of bonds with a fun example. To summarize, bonds come in different maturity dates and different credit qualities. The longer the maturity date, the better the interest you are paid, but the more risk to the bond price if interest rates go up. If you are invested in shorter-term bonds, you get paid less interest, but the prices move much less in response to changes in interest rates.

Bonds with lower credit qualities pay higher interest and their prices tend to move more like stocks. So, if interest rates go up, that means the economy is improving and often the price of low quality debt goes up. Translation, high-yield bond funds often rise in price when interest rates go up.

There are also Treasury Inflation Protected Securities (TIPS) issued by the US Government that rise in value with inflation (as measured by the Consumer Price Index). These bonds might go up in price around the same time as interest rates rise, but that’s not a guarantee.

So, to have a well-diversified portfolio for a rising interest rate environment, you should consider having some money in intermediate-term investment grade bonds, short term investment grade bonds, a little bit in high-yield bond, and a little in TIPS. How much in each? Well, that’s a good question for your financial adviser.


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What to Do About Investments if The Fed Raises Interest Rates

I’m going to spend the next couple of blogs talking about the horrifying (sarcasm) specter of rising interest rates.  This is in hopes that I won’t have to talk about it for the rest of the year.  Yeah, right.

If you spend any time watching/reading financial news prognosticators, (which you shouldn’t because it’s bad for your attitude and gives you pimples) you will hear a LOT about the impending doom of the Federal Reserve raising interest rates.  What should an investor do?  Sell bonds now?  Sell stocks now?  Sell bonds on Tuesday?  Buy stocks at the next full moon?

My take is that if you have a diversified portfolio that makes sense for your time horizon and risk tolerance, you should DO NOTHING in response to the Fed’s meetings, testimonies, beige book notes, actions, non-actions, bowel movements, or changes in hairstyles.

For one thing, rising interest rates means that someone finally thinks the economy is healthy.  This has historically meant a bump up in stock prices. Yay!

“But, what about my bonds?” you say in a trembling voice. First of all, remember why you have bonds in your portfolio.  Is it to make huge amounts of money each and every year?  No, it’s to provide stability during rough stock market times.

Second, think about the way your have your bond money invested.  If you are in individual bonds that you intend to hold until maturity, the change in prices from now until the maturity date don’t matter to you.  If the bonds are high quality, you’ll be getting your par value (usually $1,000/bond) back on that pre-determined date, so don’t worry about it.

If you are invested in bond funds, remember, the bond fund managers are getting new cash in all the time in the form of interest payments, maturing bonds in the fund, and new money from investors.  They can take all that new money and buy the newer, higher interest rate bonds with it.  The interest rate the fund pays goes up, and yes, the price of the bond fund may drop temporarily, but it will come back eventually.  Keep your shirt on.

Next week, how to position your bonds to whether a rising interest rate environment.

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