Financial Planning
Overview
We provide extensive retirement planning services including work vs. retire “gap analysis”; 401(k), 403(b) and 457 retirement plan rollover analysis; retirement cash flow reviews; inflation adjusted withdrawal strategies; and required minimum distribution calculations.
Financial Goals
The primary financial goal of most people is to have enough financial security to be able to retire with a safe income stream that increases with inflation to keep them healthy and happy for their lifetimes (sometimes their kids’ lifetimes as well.) The initial step of retirement analysis is to determine ‘critical capital’; or the amount needed in dollars to provide a flow for life. The amount needed should include inflation (and we think a provision for retirement health care), as well as future taxes in retirement, such as the taxes on eventual IRA distributions. Flows like Social Security and pensions are factored in, and the critical capital is calculated using a conservative rate of return. This step helps us determine what amount of money you need after taxes to live a good life, factoring in inflation, for as long as you may live. (Actually, we make the calculation based on an infinite time frame, rather than try to predict your life expectancy: it’s easier and although unrealistic, has a nice ring to it.)
Critical Capital
Once we determine Critical Capital, we can find the right vehicles for achieving success in obtaining it. In our opinion, the major enemy in retirement is inflation, and the major enemy in pre-retirement is taxes. We think qualified tax-deferred saving vehicles like 401(k), 403(b), 457 plans, and IRAs are powerful wealth accumulation tools. The use of tax-deferred vehicles allows a high level of saving efficiency due to the tax savings. With the prospect of high future income tax rates, we also include Roth IRAs into our calculation, including the prospect of a Roth Conversion (where you turn an existing IRA into a Roth). Roth’s have the advantage of tax-free withdrawals and allowing tax-free investment compounding. For those at Critical Capital (you have enough to retire), we help facilitate a rollover to an IRA when advisable and model a mix of assets to make an income stream (or build capital, as the case may be). For those with a ‘gap’ in Critical Capital, we provide options on reaching the goal, including increasing savings, modifying assets, or changing retirement dates. This step is intended to get you to and through retirement with lower taxes and lower risk.
Risk in Retirement Planning
Another key notion of retirement planning is the aspect of risk. Risk, in investment terms, is defined as the volatility of a portfolio’s return. Volatility is the level that a portfolio’s return moves, in both directions, up and down. In the early phases of your financial life, when you are accumulating wealth, risk is beneficial. Dips present buying opportunities, and rises present rebalancing opportunities. As you get to the point where the amount you’ve invested generates more income and reinvestment than you contribute (a point we call ‘critical mass'), then risk starts to diminish the benefit of the buying opportunities and you should change the allocation to lower the risk. When you are withdrawing from the investment pool (like from an IRA when you reach 70 ½), downside risk can be fatal to the portfolio’s health. An essential function of retirement planning that we provide is to look carefully at the withdrawal rate and the risk level of the investments to achieve that withdrawal rate.
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Frequently Asked Questions
Is there an easy way to figure out my ‘Critical Capital’?
Of course, there are many ways to compute retirement needs, ranging from a very accurate highly analytical analysis of year by year expense to simple rules of thumb. A rule of thumb we think is effective is to take the amount you think you will need before taxes and after any pensions or social security in the year of retirement and multiply it by 25. For example, if you think you need $120,000 a year, and will receive a pension of $30,000 and Social Security of $20,000 (total $50,000), you’d need $70,000 a year, and a nest egg of $1,875,000. If you made 7% (a conservative estimate on a balanced portfolio), you could withdraw 4% a year, give yourself a 3% inflation raise a year, and never run out of money. We’ve seen smaller multiples, like 20 (which assumes you have an after-inflation rate of 5%), but these can fail (a snazzy term for ‘run out of money’). The 25 multiplier has a very high success rate and works well in past trials. It can also scare you with the big number you need.
What are the pros and cons of IRA rollovers?
A lot of product sales people and companies tout IRA rollovers as the only solution to retirement planning. IRAs provide some big benefits in terms of investment flexibility (virtually unlimited) and beneficiary payout (‘stretching' IRA distributions to kids). So for retirees over 59 ½ or retirees who won’t need extra retirement funds before 59 ½, we find the IRA rollover to be the most cost efficient flexible retirement tool for Qualified plan payouts. However, for employees of private companies between the ages of 55 and 59 ½, or for public safety officers (police and fire) between 50 and 59 ½, keeping some of their money in their plan (401(k) or 457) allows the flexibility of a penalty free discretionary withdrawal before 59 ½. Another situation that warrants consideration is where a person has employer stock in their 401(k) plan and the stock has appreciated. Here, there’s a special tax treatment call Net Unrealized Appreciation (NUA) that can be a great tax benefit. So rollovers are good for most of us, with some limited exceptions.
Is it my best bet to leave my IRA as long as possible until I’m 70 ½ before taking distributions?
A common misconception of retirees is that they have to keep accumulating. There are three phases of financial life: getting money (accumulating), keeping money (preservation) and spending money (distribution). The tax laws force distribution from an IRA or Qualified plan at age 70 ½ (or face a 50% penalty!). A problem we see with some retirees is that they leave their IRAs alone too long without distribution (keeping their mind in accumulation or distribution mode), and then are faced with a large distribution and large tax bill. Let’s take an example: Bill and Nita retire at 55. Between the two of them, they get pensions of $60,000 a year. When they reach 62, they’ll collect Social Security benefits of about $28,000 (for both). They have rollovers from their 401(k) plans totaling $500,000. If they leave their IRAs alone, and make 7% (we’ll be conservative, that way it’s more fun to be wrong), they’d have about $1,426,000 at 70 ½. The RMD (Required Minimum Distribution) would be about $54,000 a year. This has two negative outcomes: one, it throws an extra $54 thousand into taxable income (at higher brackets), and two (and maybe more importantly), it means that they lived without extra funds for 15.5 years so they could increase their income by about 40% when they’re over 70! We’d at least suggest they take about 3-4% of their IRAs a year (that would be $15,000-20,000 in the beginning, increasing to $24,000 - $31,000 by 70 ½). This way, they have a consistent stream of income (including a nice raise at 62), plus some money when they’re young enough to enjoy it. All too often, we see people accumulate and accumulate, only to leave it on their death to their kids, who then pay a pile of taxes and blow the money. Somebody is going to spend it, it may as well be you (just spend the interest, not the principal!)
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