Wednesday, December 7, 2022

RMDs: The Mandatory “Flipped Switch”

In my book, Flipping a Switch, I refer to required minimum distributions (RMDs) as “the mandatory flipped switch” (i.e., transition). This is because, unlike many other decisions in later life that involve choices, there is no choice about RMDs. They must begin starting at age 72, unless taxpayers want to pay a hefty 50% tax penalty.

 

In conversations with older adults at classes that I teach, many tell me that RMDs are affecting their income taxes in a big way. 


They never expected to accumulate the wealth that they did and, instead of being in a lower tax bracket in later life, as they were told they would be, they have a higher taxable income and/or tax bracket than when they were working.




As we approach December 31, RMDs are on the radar screen for many older adults. Below are 11 essential “need to knows” about RMDs and related tax planning decisions whether you are taking RMDs now or will soon be in the future:

 

Key Deadline Dates- Two key deadlines for RMDs are December 31 for routine annual RMD withdrawals at age 72+ and April 1 for legally postponed RMD withdrawals (i.e., the required beginning date for a taxpayer’s first RMD and the “still working exception” for a current employer’s retirement savings plan).

 

Key Ages- Taxpayers can make withdrawals from tax-deferred accounts without a 10% penalty starting at age 59½ and must begin RMD withdrawals starting at age 72. Withdrawals made at any age are taxed as ordinary income.

 

Calculation of RMDs- RMDs are based on a taxpayer’s current age divisor and their account balance on December 31 of the previous year. For example, the divisor for age 72 is 27.4. Someone age 72 with a $100,000 account would need to withdraw $3,650 ($100,000 ÷ 27.4, rounded).

 

Timing of Withdrawals- RMDs can be taken as one withdrawal or a series of withdrawals during the course of a year. Some people arrange automatic monthly payments through their retirement plan custodian to simulate a “paycheck” while others take their RMD quarterly or in one lump sum. It is a good idea to consider investment performance and portfolio rebalancing needs when taking RMDs.

 

New RMD Table- A new Uniform Lifetime Table took effect for RMDs beginning in 2022. Compared to the table that was used previously, the age-based divisors are slightly higher and the RMD withdrawal amounts are slightly smaller. Of course, people can always withdraw more than the minimum amount it they are willing to pay higher taxes. There is also a separate life expectancy table for couples where a spouse is more than ten years younger than the account owner.

 

RMD Percentages- The updated RMD table has life expectancy-based divisors for age 72 to age 120. As a taxpayer’s age increases, the percentage of their account balance that must be withdrawn increases. At age 72, RMDs (divisor of 27.4 ) are 3.65% of an account balance. At ages 80, 90, and 100, the percentages are 4.96%, 8.20%, and 15.63%, respectively.

 

Tax Penalty- The penalty tax for missing or incorrect RMD withdrawals is one of the largest tax penalties in the tax code: 50% of the amount that was supposed to have been withdrawn but was not. For example, if someone was supposed to withdraw $10,000 and only withdrew $5,000, the penalty excise tax would be $2,500 (50% of the missing $5,000).

 

Tax Leniency- The IRS can waive penalties for RMD shortfalls due to “reasonable error.” Taxpayers must withdraw the RMD that should have been taken and file Form 5329 with an attached letter to explain the situation.

 

First RMD- Taxpayers can take their first RMD by April 1 of the year following the year they turn 72. However, if they do this, they will have two distributions the following year for the current tax year and previous tax year. Factors to consider when making this decision are health status, financial need, and income and tax bracket in both tax years.

 

Combining Accounts- Taxpayers can total multiple traditional IRA account balances, including rollover IRAs, and take a distribution for all IRAs from only one account or any combination of accounts. People will often do this for portfolio rebalancing reasons. RMDs for IRAs cannot be combined with other types of accounts (e.g., 401(k)s and 403(b)s), however, nor can RMDs for personal IRAs and inherited IRAs be combined.

 

RMD Withdrawal Uses- Once they make withdrawals, taxpayers can do whatever they want with RMD money. Common uses are income tax estimated payments, living expenses, fun entertainment expenses (e.g., travel), charitable gifting, and re-saving the money in a taxable account or a Roth IRA if they have earned income (salary/wages and/or self-employment earnings) and are under the maximum income limits.

 

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

 

Wednesday, November 30, 2022

Financial Planning During Uncertain Times

There is no question that we are living in very uncertain times (e.g., inflation, stock market volatility) and few things make people more uneasy than uncertainty about the future.



What to do? Below are eight suggested strategies to deal with uncertainty:

 




Check Emotional Reactive Responses- People often make poor decisions when they are emotionally stressed. The stressful event sucks up their mental “bandwidth” and they can overlook viable options that are available to them. A good way to “slow yourself down” and prevent hasty decisions is to develop a personal habit of  writing down three possible ways to handle an uncertain situation and the pros and cons of each option. Also take the time to conduct the research (online and/or via personal contacts) necessary to inform the list of three options.

 

Develop a Proactive Mindset- This means acknowledging, learning about, and planning for possible future outcomes rather than ignoring the possibility that they could happen. An example is retirement planning. Among the uncertainties that older adults face (and younger adults need to plan for) are longevity (having savings last a lifetime), health care risks, long-term care expenses, the impact of inflation over time, and retirement savings withdrawals.

 

Get Comfortable Planning Again- When people are uncertain, they often do….nothing. Like the proverbial “deer in the headlights,” there is a tendency to “stand pat” and “see what happens.” Unfortunately, many people have been in “financial limbo” for over two years. The key to start making plans again is to “start small” with short-term goals such as a vacation in a nearby state with the ability to cancel reservations without penalty beforehand, if necessary. Of course, investing for long-term goals should, ideally, have been occurring without interruption during the pandemic.

 

Build Financial Resilience- Multiple sources of income can help. For example, a salary or steady self-employment earnings, rental properties, investment returns, and/or a “side hustle” (freelancing). Marketable job skills that can be transferred to another work setting are also important. A third resiliency resource is a low consumer debt-to-income ratio (total of monthly payments ÷ net monthly income) and a fourth is an adequate emergency fund (3 to 6 months of essential living expenses). Finally, personal characteristics, such as focus and optimism, are also resiliency resources.

 

Keep History in Mind- The U.S. stock market and economy in general have a long history of “bouncing back” after “shocks” including wars, natural disasters, recessions, inflation, and political changes. The worst 20-year time frame return for the Standard & Poor’s 500 index, a benchmark for large U.S. company stocks, was 6.4% for the twenty years ending in May 1979. The worst 15-year time frame return was 3.7% for the fifteen years ending in August 2015.

 

Have an Investor’s Mindset- Be prepared, psychologically, to see your net worth decline during stock market  downturns and plan to simply “ride it out” and stay invested. To avoid having to pull money out of stocks at an inopportune time, place some money in less volatile cash equivalent assets such as a money market fund. This is especially important for retirees and asset segmenting is often referred to as a “bucketing” strategy. Remember that a “paper loss” is very different than a realized capital loss that occurs when investments are sold.

 

Make Small Changes- If inflation or job changes are pinching household finances, it is time to revisit cash flow. The most precise way to do this is to track income and spending for a month or two and then calculate the percentage of income spent on various expense categories such as housing and gasoline. Many budgeting apps can do this math very efficiently. With data in hand, the next step is to identify expense cutting strategies. Examples might include ordering water with restaurant meals, eliminating a streaming service (if you have several), and telecommuting one more day.

 

Get Information and Support- In times of uncertainty and stress, it is useful to hear the perspectives of other people. For example, 60-something baby boomers sharing their experiences with high inflation in the late 1970s/early 1980s with young adults who are experiencing it for the first time. Experts also recommend building and maintaining a social support network (i.e., people who care about you) and reaching out to local non-profit and government agencies for financial support, if needed. To find the names of local non-profits, call 211 or visit www.211.org.


This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

 

 


Tuesday, November 22, 2022

My Ten Key Take-Aways From the 2022 AFCPE Symposium

Attendees at the same professional conference have different take aways depending on their lifestyle, job responsibilities, subject matter knowledge/skill set, and other personal characteristics. We all filter new information through these lenses. When information comes at a “teachable moment,” interest in, and attention to, a presentation dramatically increases.

Below are my ten key take-aways from the 2022 AFCPE Symposium:

 

AFC Certification Milestone- The AFCPE accredited financial counselor (AFC®) certification began in 1992 and celebrated its 30th anniversary. There are 3,000 AFCs and 1,600 candidates and the AFC® (along with the CFP®) is one of only 10 accredited professional designations in a personal finance space with about 200 certification acronyms. A job analysis is conducted every five years to make sure the AFC® is in synch with the work of real life financial practitioners.

 

Financial Atomic Habits- Self-improvement is like compound interest…it grows over time. Never underestimate the power of small, daily improvements and try to get 1% better every day. Goals provide direction and must be achieved to succeed. Habits, on the other hand, are skill-based and focus on processes; i.e., systems that move people forward. The four stages of a habit are cue, craving, response, and reward. Habit stacking ties a new habit to an existing one.

 

Women and Money- The documentary film, Savvy, by director Robin Hauser and her follow-up discussion provided a powerful look at the state of women’s finances. There is disturbing evidence that young women are abdicating financial decisions to others and, when investing, are not necessarily understanding it. Also, women recover more slowly from divorce than men do. Hauser stated that all women need to keep on top of their finances and have a way to earn money.

 

Financial Podcasts- A team of Cooperative Extension educators shared their podcasting experiences. Not surprisingly, their listenership metrics improved following podcast promotional efforts. They also recommended using fun and flashy titles to attract listeners. An example given was “I’ve Got the Power” for a podcast about the use of powers of attorney in estate planning. Resources and additional information beyond broadcast content can be shared in podcast show notes.

 

Social Media Practices- A participant in a networking chat recommended concentrating on three social media platforms and using them well. This includes frequently posting content that is valuable to others. Video presentations can be especially effective in financial education. People want to physically see things being done rather than having them explained (e.g., budgeting by allocating money to different expense categories). It makes them think “I can do this too.”

 

Bias and Stereotypes- If you have a brain, you have biases. Nobody escapes them and there can be a fine line between stereotyping and dehumanizing others. It is much easier to reduce stereotypes when you have personal connections with a diverse group of people. Also, if you have a proactive strategy to mitigate biases, you can use your conscious mind to overcome your unconscious mind so you slow down and think about a situation.

 

National Financial Capability Study- Results of the 2021 NFCS were compared with earlier waves of this triennial study. There was a decrease in financial knowledge, compared to the first (2009) wave, and higher financial knowledge was associated with increased financial capability. Like earlier NFCS waves, there were disparities among subgroups. There was also evidence that younger investors were more likely to invest in complex investment products (e.g., options, margin trades, and cryptocurrency) than older investors, but there is a disconnect between their actions and knowledge.

 

Success Traits- Keynote speaker Ryan Law stated that change is hard because people need to create new pathways in their brain, The place to start is to write down a change you want to make; i.e., begin with the end in mind. Five steps to be successful are 1. Get specific (define what success will look like), 2. Identify a strong “why” for making a change, 3. Take tiny steps (so you think “I can do this”), 4. Use implementation intentions, and 5. Use support and tracking data. A good analogy for change is hammering away at a rock. As a result of many incisions over time, it will eventually break.

 

Useful Tidbits- Three other content nuggets stood out: 1. Some students take out loans for more than they need to provide money to give back to their family, 2. For every negative interaction with someone, it takes five positive interactions to counteract it, and 3. Change and opportunity both happen in life; it is what people do with both of these challenges that counts. This advice for practitioners also stood out: “meet people (clients) where they are, but don’t leave them there.”

 

My Most Teachable Moment- The most impactful session for me was “Are Your Clients Leaving Cash on the Table?” about maximizing VA benefit compensation. At the same exact time of the workshop, my husband (who has left a lot on the table) was accessing VA benefits for the first time in the 50 years since his military discharge. After decades of using my work-based benefits, he contacted the VA to get hearing aids. It was very interesting to learn about Veteran Service Officers or VSOs that help VA benefit claimants, disability ratings, and that “many scars from service are not visible.”

 

Those are my ten key take-aways from #afcpe2022. What are yours? Let’s keep the summary conversation going.


This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

 

 

Tuesday, November 15, 2022

Auto Insurance: Strategies to Save

One of the largest items in household budgets is car insurance. According to Bankrate, the average annual cost of car insurance in June 2022 was $1,771 per year ($148 per month) for full coverage and $545 for just the minimum coverage required by state law.

Of course, individual insurance premiums vary widely according to multiple factors (e.g., driver characteristics, type of vehicle, location of vehicle, and the current economic climate for labor and parts costs).

Do you want to save money on car insurance without sacrificing needed coverage? Below are ten general tips for purchasing an auto insurance policy:


¨    Don’t Skimp on Liability Coverage- Remember that liability coverage is the most important part of an auto insurance policy because there is no upper limit on a potential liability judgment. It can be whatever the results of a lawsuit are if you are in an auto accident and a court decides that you are at fault. Awards in the millions of dollars are not unheard of and minimum amounts required by states are inadequate.

 

¨    Watch Your Numbers- Increase liability coverage to at least 100/300/50. Limits of $250,000 per person, $500,000 per accident, and $100,000 of property damage coverage (250/500/100) are even better or, better still, a $1 million umbrella liability policy if you have a significant net worth (assets minus debts). In addition, raise your “uninsured motorist” coverage (which covers you if a driver with no liability insurance or inadequate liability insurance hits you) to 100/300/50 or higher. In some states, including mine (Florida), more than 1 in 5 drivers is uninsured!

 

¨    Revisit Your Deductibles- Check with your insurance agent on policy premium costs and consider raising the deductibles on your policy (e.g., collision and comprehensive coverage) to the highest level that you can afford to pay in case of an accident. Do this (e.g., a $500 to a $1,000 deductible), however, only if there is significant savings. Make sure that you have the deductible amount (e.g., $1,000) saved in your emergency fund in case you need it.

 

¨    Revisit Your Coverage- Evaluate the cost and payoff for collision and comprehensive coverage if you drive an older (7 to 10+ years) car. Check the Kelly Blue Book website to find out what your car is worth. If it got totaled, that is approximately how much you would get from your insurance company, after the deductible. Taking collision and comprehensive coverage off of insurance policies for older cars is a way to keep premiums down.

 

¨    Take Advantage of Available Discounts- Ask your insurance agent for available discounts. For example, I have 14 listed discounts on my auto insurance policy including: safe driver, multiple policy (auto insurance bundled with homeowners and umbrella policies), full payment, anti-theft devices, antilock brakes, age 55+, responsible payer, homeowner, electronic stability control, and preferred package (I have no idea what this is, but I’ll take it!).

 

¨    Choose Your Car Carefully- Buy a make and model of car that is less costly to insure and equip it with money-saving features; e.g., air bags, antilock brakes, and alarms. High performance sports cars are naturals for high-priced coverage and standard sedans are usually the cheapest to insure. The location where a car is garaged also matters. Factors considered by insurance companies include traffic volumes, claims reporting rates, and theft/vandalism rates.

 

¨    Keep Your Driving Record Clean- Never drive when impaired (e.g., alcohol, drugs, lack of sleep) and try to stay off the road during bad weather conditions (e.g., snow and ice storms). Also consider taking a Defensive Driving course (e.g., the “55 Alive/Mature Driving” class offered by AARP). Make sure that teen divers in your family take driver’s education training and maintain a good academic record.

 

¨    Avoid Unnecessary Duplication- Ask your insurance agent about this. An example is coverage for auto-related medical expenses if you have a good comprehensive health insurance policy. However, if you drive at lot of non-family members around (e.g., carpooling), you may want to keep medical payments coverage. Otherwise, an injured passenger without health insurance may have to sue you for negligence to get coverage under your liability.

 

¨    Shop Around- Get information about premiums, coverage, and claims service from a number of insurance companies or agents. Also ask about available policy discounts. A few phone calls could save $50 or $100. 

 

¨    Keep Personal Information Current- Notify your insurance company if you, or an insured household member, substantially change your driving patterns; move to a different city or state; buy or sell a car; marry; or turn 21, 25, or 29. For example, former commuters who are now working from home and recent retirees may see a drop in their premium because they are incurring less risk of being in an accident by driving less often.

 

This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

 


Thursday, November 10, 2022

Roth IRA Q&A

Roth IRAs are a popular investment for retirement savings. They are available to workers with earned income (i.e., salary, bonuses, or self-employment) under phaseout limits that are adjusted annually for inflation.


Below are answers to nine commonly asked questions about Roth IRAs:

 

 What is a Roth IRA?  A Roth IRA is a personal retirement account that lets people benefit from tax-free interest growth, providing they meet certain conditions. Contributions (deposits) are made with after-tax income (i.e., money that has already been taxed). A Roth IRA is not an investment  “product” per se but a special account that people put investment products into. Examples include mutual funds, bonds, individual stocks, certificates of deposit, and other investments that are available through financial institutions.

 

 Why is it Called a Roth IRA?  Roth IRAs were named after U.S. Senator William Roth (from Delaware) who spearheaded the effort to create them. They became a retirement savings option starting in 1998.

 

 How Does a Roth IRA Differ from a Traditional IRA? Traditional IRAs are made with before-tax dollars (i.e., money that has not been taxed) and withdrawals are taxed as ordinary income. Required minimum distributions (RMDs) must begin starting at age 72. Earnings in a Roth IRA can be withdrawn tax-free once an investor reaches age 59 ½ and an account has been in place for at least five years. Taxpayers who want to hedge IRA tax benefits may decide to split their annual deposit between Traditional and Roth accounts.

 

 What is the Maximum That People Can Contribute? In 2022, workers can contribute up to $6,000 (or the amount of earned income, whichever is less). Workers age 50+ can contribute an additional $1,000 as a “catch-up” contribution, for a total maximum deposit of $7,000. Deposits can be made in a single lump sum or in smaller increments throughout the year.

 

 What is the Minimum That People Can Contribute? Workers can make deposits up to the annual maximum limit. The minimum deposit amount is typically determined by plan custodians (e.g., a bank or mutual fund). There is nothing wrong with contributing only $500 or $1,000 to a Roth IRA if that is all that someone can afford.  Any savings is always better than no savings.

 

 What is the Deadline to Make a Roth IRA Deposit? Roth IRA deposits can be made as early as the first business day of each year. Conversely, taxpayers have until the tax filing deadline (on or about April 15th of the following year) to contribute. For example, April 2023 is the deadline to contribute to 2022 Roth IRAs.

 

 Are There Income Restrictions on Roth IRAs? Yes – income for single taxpayers must be less than $129,000 (MAGI – modified adjusted gross income) to deposit the full $6,000 (or $7,000) maximum amount. Income above that results in reduced contributions until it exceeds $144,000 MAGI. At that point, someone is no longer eligible to contribute. The phase-out range for Roth IRAs for married couples filing jointly is up to $204,000 (for a full contribution) to $214,000 (above which, no Roth IRA contribution is allowed).



 Where Can People Go to Start a Roth IRA? Taxpayers can contact just about any financial institution (e.g., banks, brokerage firms, mutual funds, and insurance companies) to select investments for a Roth IRA.  Many investors choose no-load mutual funds that offer a variety of options with low fees. Most mutual fund companies require a minimum investment to start a Roth IRA, typically between $500 and $2,500. Some companies allow an investor to start an IRA account with less money than is required for a non-IRA account.


 Where Can People Learn More About Roth IRAs? Cooperative Extension’s Investing for Your Future home study course is a useful resource. Unit 7, “Tax-Deferred Investments,” includes information about Roth IRAs and Units 4-6 discuss various investment products that can be used to fund a Roth IRA. Other useful resources are the Roth IRA Calculator from Bankrate and Roth IRA Basics from Investopedia.


This post provides general personal finance or consumer decision-making information and does not address all the variables that apply to an individual’s unique situation. It does not endorse specific products or services and should not be construed as legal or financial advice. If professional assistance is required, the services of a competent professional should be sought.

 

RMDs: The Mandatory “Flipped Switch”

In my book, Flipping a Switch , I refer to required minimum distributions (RMDs) as “the mandatory flipped switch” (i.e., transition). This...