Investments


We’ve talked here before about participating in your employer retirement plan to maximize the employer match. This money is free to you, all you have to do is participate in the plan and make sure you contribute enough out of your paycheck to maximize the employer portion. If you don’t, your employer will not give you that money, a benefit of your job that you will be missing out on.

If you do have a job that an employer match is a benefit that you have access to, it’s a great way to pump up your retirement savings. However, not everyone has this option, or you may just need another way to increase your retirement savings and don’t know how you can afford to do so.

Last Friday, U.S. News – Money had a post, “How to Max out Your Retirement Plan Contributions” by Jeff Rose. He had some good information about how you might increase your retirement savings without feeling too much financial pain.

Rose also talks about maximizing any employer match you might receive, but he has a couple other ideas that might work for you as well:

“If you think that you can find $50 more a month to save for retirement, add that to your contributions. This should be a regular contribution that permanently raises the amount of your deposits. After a few months, when you are comfortable, look for another $50 or $100 a month that you can contribute to your retirement account. Step up your contributions regularly until you reach your goal of maxing out your retirement account each month.”

“If you end up with a raise, immediately appropriate a good portion of that raise to your retirement account contributions. Do this as quickly as possible in order to avoid the problems that can come with lifestyle inflation. Instead of getting used to spending more on things you don’t actually need, spend part of it on shoring up your retirement nest egg.”

Savings of any kind can be difficult to incorporate into your budget, and it’s difficult to stay consistent with it over a long period of time. But it is possible to do so without making any dramatic increases or stressing your budget too much. The extra dollars you are able to save for your retirement now can make a big difference to your future retirement income.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.
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We don’t talk much here about investments specifics. It’s a topic we feel is much too detailed and variable to give broad based advice. There are a lot of general, rules of thumb investment advice out there, but we feel there isn’t one right answer for everyone, there aren’t even a few right answers. So, since each specific situation requires its own specific answer, we tend not to talk about it. However, today, we’re going to talk briefly about a certain financial planning rule of thumb.

Last week, over at U.S. News – Money, there was a post by Roger Wolhner entitled “Using the ‘Four Percent Rule’ for Retirement Planning.” The four percent rule is a very well-known rule of thumb in the financial planning community. For those who don’t know what it means, the four percent rule says that in general, you can safely take up to 4% of your portfolio balance annually in withdrawals without running out of money in retirement (30 years or more).

Just like with any rule of thumb, the four percent rule is not set in stone, and it may not work for everyone. Wolhner gives some great example of situations where the four percent rule doesn’t necessarily pan out:

  • “What if you need more than 4 percent annually?
  • What do you do if you live to be 100 or 110?
  • What if you get really spectacular returns in your first few years of retirement so that by the time you’re 95, you find you have a much bigger surplus than you expected? You may realize that you could have afforded a more comfortable lifestyle during retirement.
  • What if, in the first few years of your retirement, the stock market drops by 45 percent?”

Have you ever considered how much you will need to draw down from your portfolio once in retirement? If you’re nearing retirement, take a look at what you think your income is going to need to be. After looking at what you might make through other sources of income (pensions, Social Security, etc.), how much more income will you need? If you pull that needed income from your portfolio, what percentage of the total balance will it account for?

We can’t tell you whether the four percent rule will work for your situation. However, we will say that if you think you will need to pull more than four percent, be very cautious about it. Over withdrawing from your portfolio can lead to balances dropping at a rapid pace when your returns can’t keep up. Be sure to know your situation well and understand that how much you withdrawal will have an effect on your future.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

Last week, we revisited the idea of converting traditional IRA dollars to a Roth IRA. We discussed who we feel would do well to convert and who shouldn’t convert. This week we will speak to those who are considering converting (deadline for a 2012 conversion is 12/31/12).

Partial Roth Conversions

For many people, converting all of the dollars in your traditional IRA is infeasible. Maybe you don’t have enough cash on hand to pay for the taxes generated or maybe the conversion will push you into a higher tax bracket. Whatever the reason, don’t let it stop you from doing a conversion this year.

A partial Roth IRA conversion is just how it sounds: instead of converting your entire traditional IRA, you convert only a portion of the dollars to a Roth IRA. This option can be very attractive to many, especially those that may have a large traditional IRA account.

When a Partial Conversion Makes Sense

There are a few situations where a partial conversion can make the most sense:

  • When you can’t afford the tax on a full conversion – Since you will be paying income tax on the converted dollars, converting an entire account can create a pretty hefty tax bill for you. If you feel conversion makes sense for you, but you only have enough cash on hand to pay the tax on a partial conversion, go ahead and do the partial conversion. You don’t have to wait until you have enough cash on hand to do a full conversion.
  • When a full conversion pushes you into the next tax bracket – This point can get complicated depending on your income, deductions, etc. If you have a $50,000 IRA you want to convert, but you are $20,000 away from the next tax bracket, adding those extra dollars in income will push you into the next tax bracket. You will then be paying more in taxes on those dollars (which no one wants!). Instead, figure out how much you can convert while still keeping yourself within your current tax bracket.
  • When your current income/tax situation allows you to convert without paying any tax – For some people, between their income, deductions, etc., converting traditional IRA dollars to a Roth IRA will not cost them anything in taxes. This is because their current income vs. deductions, etc. eliminates all their tax liability, allowing some wiggle room for conversion dollars to be added to their income. If you are in this situation and are interested in converting, don’t let the opportunity pass you by!

Tips for a Partial Conversion

Before making the final decision to do a partial conversion, please take the following into consideration:

  • Reevaluate your situation every year. If you convert $10,000 this year, don’t assume you should do the same next year. You may be able to convert more or may have to do less.
  • Talk with your tax advisor before making a move. Partial conversions can become complicated, especially for those with more complex tax situations. Never make a conversion unless you know for sure that the tax consequences will be.
  • Keep your Traditional IRA and Roth IRA Conversion at the same investment institution. This often simplifies both paperwork and reporting and makes partial conversions over several years easier to manage.
  • Keep recharacterization in mind. If you make a partial or full conversion by the 12/31/12 deadline, and for any reason decide it was not the right decision, you have until 10/15/13 to recharacterize that account, which simply means the converted dollars will be moved back into your traditional IRA and you will not owe any tax.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

 

Two years ago, we did a post about the pros and cons of converting your traditional IRA dollars to Roth IRA dollars. We wanted to revisit that topic again now, as the deadline for converting an IRA is 12/31/12, and you may have to do some leg work before you’re ready to make a move.

This week, we just want to revisit our previous post. Next week we’ll discuss partial Roth IRA Conversions in more detail, since we feel like for many people, a partial conversion will be more realistic.

Post from 10/11/2010 (Updated to reflect 2012 information):

 Roth IRA Conversion – Why you should or shouldn’t convert

 Last week, we talked about Roth IRAs and why they are good investment vehicles. Today, we’ll talk about Roth IRA conversions.

The biggest issue in a Roth IRA conversion is tax. Since traditional IRAs are usually funded with tax deductible contributions, when you distribute the money from the IRA, you will owe income tax on it. The same goes for conversions. Since you are converting those funds into an after-tax Roth IRA, you must pay income tax on the amount you convert. This is a consideration that must be carefully reviewed before you decide to make any conversions.

Who Shouldn’t Convert

If you are in the following situations, converting your traditional IRA to a Roth IRA probably isn’t a good option for you.

  •  If you don’t have enough cash on hand to pay the tax – You will have to pay 100% of the taxes owed on your 2012 conversion with the filing of your taxes (April 15, 2013). However, withholding the money you owe in taxes out of the conversion dollars is not advisable, so if for any reason you don’t believe you will have enough cash on hand to cover the taxes, don’t make the conversion. In other words, if the only way you’ll be able to pay the tax is by withdrawing the funds from the portfolio, it’s not worth doing.
  •  If converting pushes you into a higher tax bracket – If $15,000 of additional income will take you into the next highest tax bracket, and you are thinking about converting a $20,000 IRA, you’ll be paying additional dollars in taxes due to the higher rate. However, if conversion fits your needs, you can convert part this year and part next year to avoid paying at a higher tax rate.
  •  If you know your tax bracket will decrease – If you want to convert, but expect a decrease in income over the next few years, that will bring you into a lower tax bracket, it probably makes sense to wait. That way you can still convert the money and pay less in taxes.
  •  If you plan on leaving the funds to a charity – If you plan on leaving your IRA to a charity after your death, you should leave the money in a traditional IRA. The charity will receive the money from the IRA tax-free, so it doesn’t make sense for you to convert to a Roth.

People who should consider converting

Here are some situations where conversion to a Roth IRA might make sense.

  •  If your tax bracket will be increasing – As the opposite to the tax bracket point above, if you are expecting to be in a higher tax bracket in the future and are interested in converting, you should do it now to avoid paying more tax (if you can currently afford the tax and it doesn’t push you into a higher tax bracket!).
  •  If you don’t need the Required Minimum Distributions (RMD) – If you don’t anticipate needing to take the RMD from your traditional IRA account at age 70½ for income purposes, converting to a Roth may be a good move. You can protect your account balance by letting it grow undisturbed by yearly RMDs, and you will still have access to the money should the need arise, but you’ll get it tax-free!
  •  If you plan on your IRA being inheritance for your heirs – A Roth IRA will provide a better inheritance vehicle because your heirs will receive the money income tax free. If you are thinking about your IRA as more of an estate planning tool, another consideration should be what tax bracket your heirs will be in. If they will be in a higher tax bracket than you when they inherit an IRA, they will be paying income tax on the distributions. You may want to consider converting to pay the taxes now so your heirs can have an income tax-free inheritance.

We just want to emphasize again that the tax consequences of a Roth IRA conversion should be carefully considered before making a move. If you have questions or need help figuring out the taxes on a conversion, talk to a tax professional.

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

 

Last week, we discussed how you should figure out your personal “Latte Factor” and to “Pay Yourself First.” Once you have done so and you’re ready to make your savings a reality, how do you make sure that you are really putting money aside every month? The answer is in the next step of the plan outlined by David Bach in The Automatic Millionaire—make your finances automatic.

 

Even if you have made the decision to save for your future by “paying yourself first” and you desire to do so, will you have the time and discipline to sit down at least once every month to set that money aside? Maybe you do, but for many people, even if they want to save, they will just never get around to it. But making savings “automatic” solves that problem.

 

Do you have a 401(K) or 403(B) through your work? If so, is it difficult to remember to put money into that account? Likely not, since most accounts through employers are set up to be funded by being automatically deducted from your paycheck. So not only do you not have to think about it, you learn to live without that money since you’re paying yourself first.

 

What if you don’t have access to a retirement plan through your employer? Most investment/savings accounts have the option to set up automatic savings to be invested. While the initial set up may take some time (contact your bank or investment company to find out how), once you have done so, you will be putting your desired savings away into accounts for your future without even thinking about it.

 

Making your savings automatic will also help in another aspect. If you leave your savings sitting in a checking account for months with no interest, and then transfer it when you get around to it, you will miss out on the interest that would have compounded on that money. So, try to set up your automatic savings at least once a month, but preferably whenever you get a paycheck. According to Bach, “Over time, money compounds. Over a lot of time, money compounds dramatically!”

 

While making your savings automatic is not necessary to becoming a millionaire as long as you make the commitment to “Pay Yourself First,” it will save you a lot of time and make sure you aren’t missing out on interest.

 

In two weeks, we will have our last post of Bach’s plan, which will discuss how to deal with debt while becoming an “Automatic Millionaire.”

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

As promised, here is our first detailed post about our book recommendation The Automatic Millionaire by David Bach.

As we said last week, The Automatic Millionaire is not a get rich quick scheme, or a financial plan that requires a lot of time and money. Bach outlines a simple plan that can help people at any income level become millionaires over the course of their career by making some easy decisions about money.

Today, we will discuss Bach’s first two outlined steps to becoming a millionaire: the “Latte Factor” and “Pay Yourself First.”

The “Latte Factor”

 

Bach’s “Latte Factor” is likely something we’re all familiar with. It battles the myth that you must make more money in order to be rich. What if you could save $3.50 a day? That’s $1,277.50 a year in savings, not including the affect of compound interest on that money.

Think you can’t afford $3.50 a day? How about more? The “Latte Factor” shows you where you can afford to make adjustment to your spending. Obviously, the idea is that if you get your coffee elsewhere (home or work), you can save about $3.50 a day by not stopping on your way to work for a latte at the coffee shop. But it doesn’t have to be a latte. The idea is that once you examine your spending, you will likely find some way you spend money daily that you can live without. Maybe it’s $3.50, maybe it’s $10.00, maybe even more.

Once you discover what your “Latte Factor” is (check out the book for a worksheet to help you decide what your personal factor is), make the decision to save that money instead of spending it. Even if you think, “How is this going to make me a millionaire?” consider it just a step: one small thing you can do to start you in the right direction. According to Bach” Becoming rich requires nothing more than committing and sticking to a systematic savings and investment plan.”

“Pay Yourself First”

 

The next step in becoming an “Automatic Millionaire” is to “Pay Yourself First.” Basically, this means when you get your paycheck before you pay anything else, pay yourself first by putting money aside for your future.

Sounds easy, but this is likely where many people fail. It’s much too easy to come up with reasons and excuses why you can’t save. You have bills to pay and situations always come up that require money. Then you find yourself strapped for cash, waiting for your next paycheck, and somehow no money ended up in your savings.

However, Bach believes Paying Yourself First is the most important step to becoming a millionaire. No, excuses, Pay Yourself First, and then your other financial commitments become secondary.

Paying Yourself First becomes more difficult when your paycheck has taxes automatically taken from it before you even see the money. However, if you have the option of a pre-tax retirement plan (401(K) or 403(B)) which can be funded by dollars directly deducted from your paycheck, then setting up automatic savings into this type of account is a way to Pay Yourself First before the government. If not, you can look into pre-tax accounts like a Traditional IRA to help Pay Yourself First. If you are unable to participate in a pre-tax account, at the very least Pay Yourself First by funding an after-tax account the day after you receive your paycheck and before other bills are paid.

However you want to handle it, Paying Yourself First is the most important step you can take. Savings then become a reality instead of something that you’ll do some day when you can afford it.

“Make it Automatic”

Even if you just follow these two steps, you will be on solid footing for your future. However, Bach adds another step: “Make it Automatic.” To avoid the need to spend excessive amounts of time and the need for a lot of discipline, making your finances “automatic” will help simplify the process and help ensure that it continues. We’ll discuss this step next week.

 

 

  • Disclaimer: The information on this blog is not meant for specific financial advice. The ideas/opinions stated are not suited for everyone, and readers should use their own judgment in applying them in their financial lives.

The last types of accounts we’ll discuss in our Planning for College series are Uniform Gift to Minors Act/Uniform Transfer to Minors Act (UGMA/UTMA). These types of accounts are different from the others we have discussed because they are considered an asset of the child, not the parent.

 

The above listed reason is UGMA/UTMA accounts major disadvantage, and also the reason why we don’t like these types of accounts. Not only will the account count as a student asset in federal financial aid calculations at the higher rate, but it will also take control of the account out of your hands.

 

While the child is a minor, you control the account. You can withdraw the money as you see fit, but when the child reaches the age of majority, 18 or 21 depending on the state, the UGMA/UTMA becomes completely under their control to do with as they please.

 

This can be a danger because the money you have worked so hard to save for your kid’s education can be used for whatever they choose. And considering there is no contribution limit (though gift tax limitation do apply), the account balance could be significant. Opening an UGMA/UTMA for your child’s education is putting a lot of trust in a young adult that may not be ready for the responsibility. If they withdraw all the money to spend elsewhere, there is nothing you can do to stop them.

 

Also, if your potential student doesn’t pursue higher education, it’s still their money. You can’t transfer it to another beneficiary or keep it for your own benefit as with the other education savings accounts. Additionally, withdrawals are not tax free when used for qualified education expenses. The income is usually taxed, though potentially at the child’s tax rate, not the parent’s. So, there aren’t any additional tax benefits to using UGMA/UTMA accounts for education.

 

As we said, we think there are much better options for education savings than an UGMA/UTMA account, but since they are popular accounts, we wanted to cover them. If you do choose to use an UGMA/UTMA account, keep in mind the dangers and don’t rely on the money for your sole source of education savings. They can be useful in preparing for college in buying computers, supplies, etc. before your child leaves high school.

 

Hopefully you enjoyed our Planning for College series. As we’ve stated, please do your own research before choosing what type of account is right for your situation. There is a lot more information out there that we haven’t covered!

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