Your Money Matters More

Retirement is Personal

Retirement is personal:  it can be an elusive goal or it can be a well -planned gift to yourself after a long career.  There are key milestones in this process. To avoid tax penalty waiting until you reach the age of fifty-nine and a half to take distributions from your qualified plan maximize your benefit. Contribute the maximum matched dollar value—the more the better—and keep it invested.  When you do reach fifty-nine and a half you have more options. Remember though, fifty-mine and a half is a number; retirement is a goal.

 

To avoid any penalty from a qualified plan your birthdays count. Once you are fifty-nine and a half, there is no longer a penalty to remove your money, but your money can still work for you if you leave it.  The penalty is considerable: it not only becomes taxable income, but there is an additional ten percent tax on the amount of the withdrawal. Conversely, if your money is not in a qualified plan these restrictions do not apply…you will have already paid tax each year as it accrued but you will have less to invest and you will have less accumulating tax defered. As always, talk to a Certified Financial Planner (CFP) before making any move.

Putting away the maximum dollar amount matched by your employer makes you less dependent on the rate of return as your investment accumulates funds. If you can add other moneys to this amount they too can grow tax deferred. The tax deferral allows you to accumulate money faster. For example if your 401(k) is being invested at the rate of $3,000 a year, you are not only saving the whole $3,000, but you are also compounding interest on that investment tax defered. If you are able to leave it until you are fifty-nine and a half, you will not pay tax until it is distributed.

Waiting until you are at the optimal age, you can take the entire amount or you can take any amount you need to live on and let the balance ride.  Determine with your CFP what supports your lifestyle. You can control your taxable income by controlling your distributions. The ability to combine your defined contribution plans gives you better economy of scale when it comes to selecting your investments, also.  

Although fifth-nine and a half is the point where penalties no longer occur, retiring later can have even greater benefit.  Your CFP can walk you through these options based on your personal financial standing. Begin planning as soon as possible to allow for the optimal benefit when using a defined contribution plan.  When the time is right—enjoy! 

Children are Expensive

 Children are expensive. That is a given: but the cost of higher education is growing at an unprecedented rate. A 529 Plan, a type of college savings fund, is a tax free way to accumulate money for college expenses. After the birth of a child, begin to put money away for college. The owner of the account can contribute for a named beneficiary. If for some reason the beneficiary chooses not to use it the owner can transfer it later to a different student. 

There are a wide selection of plans available. Each State has its own plan with some offering more than one, and an investor can choose from any of these. Each state provides its own residents additional incentives, but these tax incentives should be subordinate to the underlying returns of the investments of the plan. Always seek the advice of a Certified Financial Planner (CFP) when selecting a plan. 

Recent graduates have left college with a crushing debt load. An alternative to this is paying out of pocket. Making wise investments early allows compounding of returns to work for you. This is just one of the tools that your CFP has in their arsenal.  

Portfolio Construction

When developing a portfolio for the average investor the key points you need to consider are: time horizon, taxability, liquidity, risk and diversification. 

 

• The first thing you have to figure out is what time frame you are going to need the money.  The longer time you have before you need the money the more aggressive you can be.  Due to the time you have to ride out cycles of the stock market.  Saving for retirement is different than saving for the down payment for the purchase of a house.  You can invest for the long term if you have a number of yours until you need the funds.  By increasing the amounts of risk you are taking you can statistically increase your returns.

 

• The second thing to take into account is how the money is going to be taxed.  Investments that are in a tax-free environment can stand more ordinary income. With taxable income you can write-off losses that you incur.  Also capital gains are preferable to ordinary income in a taxable environment.

 

• The next area that you need to worry about is the amount of liquidity available with your portfolio.  The longer you have to invest the more able you are to use illiquid assets like real estate.  Real estate functions on a longer cycle than stocks.

 

• You can’t expect return without taking a little risk.  Risk translates volatility. The level of risk that you take is what you personally can tolerate.  Risk is measured in different ways including standard deviation and/or beta.  They are measured relative to the standard deviation and/or beta respectively of the market as a whole.

 

• Last but not least to be sure that your portfolio is diversified by having enough holding, by industry and by type of investment.  Income oriented investments tend to have different characteristics than appreciation driven investments.  International funds add an extra level of risk in the fact that there is an exchange rate in play in addition to the underlying stock making then inherently more volatile. 

You needn’t go it alone; contact a financial planning professional.

Buy Smart

    I have always had medical professionals as clients. One thing this has taught me is that being smart enough to pass med school doesn’t necessarily translate into financial intelligence. Doctors, as well as any professionals who have a steadily increasing salary at the start of their careers, can often make purchases that hurt their cash flow down the road once their income plateaus. This makes it all the more important to develop an emergency or “slush” fund early in your career no matter what your occupation. Then later in life, once your rainy day money has grown, the finer things are less of a strain on your bank account. The two main purchases that can set an individual up for financial distress are expensive cars and big houses. Making the right buys can lead to a life of comfort, if done correctly.

 

Fancy Cars 

 

When individuals jump up into the six figure income bracket one of the first things they want to do is buy an expensive new car. What they fail to realize is that when they drive their so called “investment” off the lot, it loses thousands in value immediately. Their new car will then continue to lose value until the wheels fall off. But Chuck, “How am I supposed to show off my financial superiority while I’m on the go?” It’s  simple. Buy used. Say you think you would look nice in a Mercedes-Benz SLK350. You’ve worked hard to bring in the money and its time to reward yourself. A new SLK350 costs over $55,000. A used last year model costs $36,000. Paying an extra nineteen grand for that “new car” smell seems quite ridiculous. Any other investment that declined in value by 35% its first year would make you furious. Even for individuals with more modest tastes, a Honda Civic loses four thousand in its first year off the lot which is still a 20% decrease. Do yourself a favor and let someone else be the sucker who has to unload their bad investment in a year’s time.

 

Living Large 

 

The other mistake many make is purchasing a house that is too big early in their careers. If your job is putting fat stacks in your slacks the worst thing you can do is tie yourself down to a house that will pull cash out of your pocket for the next fifteen to thirty years. We at Prospero Financial always push to develop a solid emergency account before purchasing an expensive home. Buying a less expensive home allows you to build that emergency fund faster.  You will then be able to make a larger down payment on your next home. This will give you more equity to build on. You will need 20% equity in the property in order to avoid private mortgage insurance and decrease your mortgage payment.

 As unpredictable as the housing market is, you want to make sure that your house and property are sellable when the time comes. Choosing your neighborhood wisely can make a huge difference in the future. Picking the right house in that neighborhood can be just as important. The most expensive house in a neighborhood will be the hardest to sell. When prices in housing go up your palace might increase in value, but a home is worth nothing if there’s no one to buy it. The cheapest house in the neighborhood can be just as tough. Look for a home that is in the upper middle price range for the neighborhood you are moving into and you will have made a safe choice if you ever need to liquidate the property. Lastly, when  it comes time to sell a house, you need to leave yourself at least six months time to keep from leaving money on the table. Selling a home can be profitable, as long as you make smart decisions along the way.

Related articles

The Millennial Home Buying Guide

Should You Buy a New Home or Older Home?

Not Ready To Retire Yet?

 I was looking around my networking group and it seemed to be made up of a large group of people on their second or third careers due to company downsizing. They probably had a retirement plan, 403(b) for not-for-profit entities or 401(k) for any other entities, after leaving a previous employer.  They may be spending this to maintain their lifestyle and that's probably alright as long as that doesn't go on for very long. It is better to reduce your lifestyle then drain your retirement plans.  You not only don’t have the money for the retirement years you also don’t get the growth on that money that you withdraw from these accounts.   

Not only do you pay tax on the withdrawls but this can be doubly bad if you're paying tax penalties on an IRA or 401(k).  The IRS may charge a 10% premium to withdraw funds.  This is if you haven't reached the age of 59½.  There are several exceptions to the age 59½ rule. Even if individuals receive a distribution before they are age 59½, they may not have to pay the 10% additional tax if they receive a distribution from a retirement plan (other than an IRA) after leaving a job and are age 55 (age 50 for qualified public safety employees).  Or they are receiving a series of distributions in equal payments based on your life expectancy.  These are not the only exceptions but those most likely to apply.    

Another way to avoid the 10% penalty is to prove hardship. A retirement plan may (but is not required to) allow participants to receive hardship distributions. A distribution from a participant’s elective deferral account can only be made if the distribution is because of an immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need.  

You should consult your tax Advisor before you undertake this.

Black Monday Revisited

Volatility

With the volatility of this market I'm reminded of the October 19, 1987 decline of the market referred to as “Black Monday”. This one was not as severe from a points standpoint it was from a percentage standpoint. The market plummeted 500 plus points which in itself doesn't seem like much but it represented over 22% of the market. Two hundred points up or down seems like an average day. Imagine getting up and your portfolio is worth three quarters of what it was the day before. Some important safeguards came into play after this debacle. For example computerized trading, was supposed to protect the big pension traders from losses, but had the opposite effect. When this type of thing happened it contributed to this kind of downfall. Today computer trading is suspended after the market moved fifty points.

Federal Reserve

The new chairman of the Fed Alan Greenspan in his first year wisely thought to loosen the money supply as opposed to what happened in the 1929 Depression in which case they thought that was wise to tighten the money supply thus causing the Depression. So the resulting rollercoaster ride we have been through in this year does not compare to the large downturn that was experienced in the past. The volatility of the market although big in points is minimal in percentage. The market should be positive for the year in results and no-harm-no-foul in percentage and volatility.

So as Christmas approaches we should be thankful for the little things that are available to us and Ben Bernanke should be thankful that he's not facing the same thing as Greenspan faced in his first year.

Cost of Credit Card Debt: Which Card to Pay Off First?

My wife sat down last night to pay down some of our credit card debt, and she questioned me as to what ones to pay down first and the real cost of each.  This is a question I’ve been asked numerous times by young doctors who had a substantial number of school loans and large credit card debt.

What to Consider

The first thing to consider is the impact this has on your taxes.  In other words, can you deduct the interest or not? You need to determine what is and what isn’t deductible; then you can rank them in the order of debt pay-down.

• Deductible:  Mortgages and home equity loans. You have to apply your tax rate and reduce the amount you pay in interest by this amount.  For example, if you are in the 33% tax bracket, roughly a third of your interest is deductible.  So if you are paying 6% on a home equity line of credit, then in reality you are only paying 4% after tax.  This means you put this into a worksheet at 4%.
• Not Deductible:  Automobile loans and credit cards.These loans can be entered into the worksheet at the rate shown on your statement.
• Rank Debt According to Cost. Primarily, once you have translated everything into after-tax dollars, the second phase is to rank everything according to cost.
• Gradual Pay-Down of Debt. And the third phase is to whittle away with any extra dollars you have.  As you pay off debt, these dollars will grow until you are debt-free.

The Road to Success

To successfully begin credit card management and other debt management, you can pay these debts off in the order shown on your worksheet.  When you get done with one, move on to the next until it snowballs and your cash load builds. During this period and going forward, make every effort to pay cash for purchases when possible.

On the surface, this formula sounds simple.  Unfortunately, it’s very easy to put more debt on a card once it is paid down.  Obviously, this is not advisable.  It is also inadvisable to have debt transferred to a zero-interest credit card for reasons I stated in a previous credit card article.

Cut out the Credit Cards

Use of debit cards could outpace use of credit cards for the first time since I can remember.  This is a clear sign that people are more cognizant of living within their means than ever before.  And it makes sense with the current condition of the economy.

A debit card combines the convenience of a credit card with the budget restraint of a check.  And I think this is a good thing.  However, this trend is bittersweet; given the fact the banks can’t get the leverage as borrowers fall behind in credit card payments.  It may make the recession last a little bit longer. 

Overall, I believe it’s good for people to show fiscal responsibility regarding their finances.  Even though it may have the effect of making the recession last longer, I still believe it is still a responsible thing going forward.