IRA Basics for Retirement Savers

While taxpayers have until the tax filing deadline in April 2023 to contribute to an individual retirement account (IRA) for 2022, many people prefer to make all of their current year tax-saving moves before year-end. This leaves about two months to make an IRA deposit during the 2022 calendar year or up to six months if you wait until April.

Below is a discussion of IRAs and details about how they can lower your taxes and provide a retirement savings nest egg:

Description- An IRA enables workers with earned income (salary from a job or net earnings from self-employment) to save and invest for retirement. IRAs are not an investment, per se, but, rather, a special classification for tax purposes.  The actual investment can be in stocks, bonds, certificates of deposit, mutual funds, or virtually any security except one that is already tax-exempt (e.g., municipal bonds or bond funds).

History- In the early 1980s, federal legislation created a tax-deductible IRA for anyone with earned income. Significant changes in 1986 established income limits for participants in an employer-sponsored retirement plan that eliminated the tax deductibility of traditional IRA contributions for some people. The Roth IRA became available January 1, 1998. While contributions are not tax-deductible, Roth IRAs provide federal income-tax-free growth.

Contribution Limits- Federal tax law limits 2022 contributions to either a traditional or Roth IRA to $6,000 for a worker with earned income. An additional $6,000 can also be saved for a worker’s spouse (in a Spousal IRA), regardless of whether or not the spouse is employed. In addition, workers or spouses who are age 50 or older can make an additional $1,000 catch-up contribution ($7,000 total).

Account Custodians- IRA account custodians include banks, credit unions, brokerage firms, and mutual fund investment companies. Minimum deposits required to set up an IRA vary with the financial institution and type of investment that is selected. For example, a bank may require $500 to purchase a CD for an IRA and a mutual fund company may require a $1,000 minimum deposit.

Account Set-Up- It is easy to set up an IRA. Simply, choose the custodian where you want to open an IRA account, fill out an application, designate one or more beneficiaries, and make an opening deposit. Many mutual fund families require lower deposits for IRAs than for taxable accounts. IRAs that let investors choose among different types of investments are known as “self-directed” IRAs. Costs for IRAs, including initial fees and annual maintenance fees, can vary so it is important to shop around. 

Income Limits-     There are a number of 2022 income limits with respect to IRAs that taxpayers must pay attention to:

*  Roth IRAs are fully available to joint filers whose current adjusted gross income (AGI) is less than $204,000. There is a phase-out range between $204,000 and $214,000. Roth IRA deposits cannot be made if AGI exceeds $214,000.

*  Roth IRAs are fully available to single filers whose AGI is less than $129,000. No participation is allowed if AGI is more than $144,000. The phase-out range is between $129,000 and $144,000.

*  A working spouse who is not covered by an employer-sponsored plan may have a fully deductible Traditional IRA, even if his/her spouse participates in an employer-sponsored plan, if the household AGI is less than $204,000. The phase-out range is from $204,000 to $214,000.

* The maximum annual AGI for a traditional IRA, under which single filers can qualify for a full tax deduction, is $68,000 in 2022 with a phase-out range of $68,000 to $78,000. For married couples filing jointly, the income limit for a full IRA deduction is $109,000 with a phase-out range of $109,000 to $129,000.

Income Uncertainty Delay- Taxpayers who are uncertain about whether or not their 2022 income will exceed the Roth IRA contribution limit may want to wait until their income for the year (including investment account dividend and capital gain distributions) is confirmed sometime in early 2023. Otherwise, they run the risk of having to make an “excess contribution withdrawal” of an unwarranted deposit by the tax filing deadline or October 15 if they file for an extension.

No Income Uncertainty Delay- Taxpayers who know that their 2022 income will not exceed the Roth IRA contribution limit should consider making an IRA deposit early in each tax year. The earlier in each tax year that money is deposited in an IRA, the longer it will have to grow through compounding.

IRA Returns- Returns on IRA accounts depend on the securities selected and on the condition of financial markets over time. In addition, returns depend on whether a commission (load) is paid or if there is no commission (no-load fund) and the amount of annual management fees that are charged.

For additional information about IRAs, review this U.S. Securities and Exchange Commission website.

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.

Basics of Behavioral Economics

The field of behavioral finance blends economics and psychology and acknowledges that people are often irrational decision makers. Everyone has cognitive biases, which are flaws or errors in thinking that can lead to poor financial decisions. The first step to mitigating errors is to become aware of common biases to plan to proactively minimize them.

Below is a brief description and examples of twelve common behavioral finance biases:

 

Action Bias- When people prefer to do something- anything- versus doing nothing in situations where an action or decision is required. It is similar to someone being tossed a hot potato and wanting to quickly toss it on to someone else.

 

Anchoring Effect- When people cling to a fact or figure and thereby discount new information that does not fit their pre-conceived opinions (e.g., “the stock market is risky”). Anchoring is particularly dangerous when people know little about a product or service and ignore valuable purchasing clues. Example: comparing a sale price to a suggested retail price and thinking that the sale price must be a good deal. Marketers are well attuned to this error and often use it to their advantage. 

 

Attentional Bias- When people prefer to focus on some things and not others as a way to cope with an overload of information and other stimuli. As a result, they have “blind spots” and often overlook possible options and outcomes.

 

Bandwagon Effect- When people support an idea simply because it has become popular, regardless of their own beliefs or comfort level. The 2021 “meme stock” frenzy is a recent example of investors “following the crowd.”

 

Confirmation Bias- When people have beliefs and “decision rules” in their minds and search for, and pay attention to, information that confirms them. Like attentional bias, this error can result in “blind spots” as people ignore information that is inconsistent with their beliefs and, as a result, often believe even more strongly in their original position.

 

Framing Effect- When people draw different conclusions about available options depending on how that information is presented rather than simply facts of the situation. They may make different decisions (e.g., saving money for retirement) depending on how information is presented to them.

 

Loss Aversion- When people try to avoid losses and make decisions- or decide not to decide- to avoid regret. Research with hypothetical examples indicates that people respond differently (with about 2.1 times more intensity) to guaranteed losses than to guaranteed gains. Investors don’t want to realize a loss unless they absolutely have to.

 

Mental Accounting- When people separate their money mentally into different “accounts.” A dollar in one location is valued as more or less important than a dollar in another and, as a result, “the big picture” of one’s finances is ignored.  An example is carrying an 18% credit card balance when money available to repay this debt sits in a 1% bank account. 

 

Overconfidence Bias- When people over-estimate their abilities and knowledge and place too much emphasis on what they know, or think they know, based on personal experience. An example is confusing familiarity about a company or product, as a consumer or company employee, with investment knowledge.

 

Recency Bias- When people use recent information to make decisions that are biased towards the latest news. For example, after hearing about a string of burglaries on television, they might be extra cautious about locking their doors at night. Similarly, investment decisions may be biased based on how the stock market is currently performing.

 

Status Quo Bias-When people “stand pat” and do not want to make a change.  Making changes causes discomfort and fear and people try to avoid this.  An example that combines both mental accounting and status quo bias is not selling stock simply because it was inherited from your grandmother.

 

Sunk Costs Bias- When people forget that “sunk costs” (e.g., a previously purchased concert ticket) are “sunk” (i.e., already paid for) and make poor present decisions to justify past ones (e.g., driving in a blizzard to get to the concert).

 

In summary, traditional economics is based on assumptions that people behave rationally. In real life, however, many times they do not. Strategies to reduce behavioral finance errors include comparison shopping among three product or service providers before making a “big ticket” purchase and talking to others before making a large financial decision.

 

In addition, some behavioral finance errors can be used in a positive way. Take mental accounting. It can be a valuable trait, such as establishing “no touch” accounts for college, retirement, or other financial goals.

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.

 

 

Money-Saving Tips for Financially Challenging Times

With increasing costs for so many basic necessities, 2022 has been a tough year financially. Many families are trying to “claw back” (a.k.a., recover) the purchasing power that inflation has taken away through a financial “triaging” strategy of increased income, reduced spending, and/or changes in shopping habits and product and service purchases.

Looking for ways to improve your cash flow to counterbalance the higher costs associated with inflation? Consider the following ideas for nine spending categories from The Smart Senior’s Financial Answer Book and other sources:

 

Prescription Drug Discount Cards- Recent research studies found that the cost of medications has risen faster than the rate of inflation and that 1 in 4 adults find it difficult to pay for their medication. As a result, some cut their pills in half or skip doses. Prescription drug discount cards can often help to reduce drug costs and are available at no cost online via websites or apps. Examples include SingleCare, GoodRx, ScriptSave, WellRx, and Blink Health.

 

Energy Bills- Saving electricity can help reduce utility bills. Three commonly recommended practices to reduce electricity use are: 1. replace traditional incandescent light bulbs with LED bulbs that use less energy and last longer, 2. turn off lights when a room is unoccupied, and 3. unplug electronics, individually or by using a power strip, when they are not in use. Estimated cost savings for the latter is $100 to $200 per year.

 

Appliance Use- Experts recommend buying money-saving Energy Star appliances. This is especially important for devices that are used continually, such as a water heater. Other suggestions include lowering water heater temperature from 130 degrees to 120 degrees, washing lightly soiled clothing in cold water, cleaning the lint trap of clothes dryers after each use, and only running full loads in a clothes washer or dishwashing machine.

 

Heating and Cooling- Recommended practices to save money include using ceiling fans as a substitute for (or compliment to) air conditioning, turning the thermostat down (winter) or up (summer) when away from home or asleep (this could total as much as much as 15 hours per day!), and using shades, blinds, or drapes to protect against heat and cold. The objective is to reduce the temperature difference between inside and outside air to reduce energy consumption.

 

Communications Services- Many people are reviewing their phone/television/internet provider “bundles,” dropping services they rarely use, and sometimes replacing current providers with other available options. Experts recommend asking current providers for special deals and “loyalty rewards” and ways to lower fees, comparing alternative service providers, and considering streaming services in lieu of cable or satellite dishes if there is appreciable savings.

 

Grocery Shopping- Money-saving tips that can add up to significant savings, especially if combined, include: buying store brands instead of national brands (if cheaper), cutting out expensive snacks and beverages (a.k.a., “junk food”), shopping with a smaller cart (if possible) or even a basket, using coupons (or double coupons) on needed grocery items, combining a manufacturer’s coupon with a store coupon or price break, earning free food or cash back by using a supermarket rewards/loyalty card, and reducing food waste at home by managing refrigerated leftovers.

 

Eating Out- Strategies to reduce costs at restaurants include drinking complimentary water instead of soda or other beverages, ordering an appetizer as a meal, and splitting an entrée, dessert, and/or appetizer with others. If individual portion sizes are large, take some food home for another meal. Also search for restaurant coupons online or at highway rest stops and earn free meals by joining a restaurant rewards/loyalty program.

 

Gasoline and Car Expenses- Some common recommendations to spend less money on gas include performing regular maintenance checks, keeping tires properly inflated, not hauling around a lot of unnecessary “junk” inside a car, and comparing at least three insurance companies for the best price (with available discounts) on auto and property coverage. Experts also note that the word “recommended” is different than “required” when it comes to the use of premium fuel. In addition, use an app like Waze or GasBuddy when traveling to find the cheapest source of gas when you need it.

 

Other Spending- Shop second-hand clothing sources such as thrift shops, consignment stores, and a wide variety of online clothing resellers. At department or discount stores, get rewarded for clothing and many other purchases with a shopping rewards app, points, cash-back certificates, or other loyalty discount. For entertainment expenses, look for lower-cost ticket options or, better still, free events sponsored by local governments, non-profits, or businesses.

 

Think of the above list as a menu in a New Jersey dinner. The “menu” of money-saving ideas is long and you cannot possible “consume” everything. Pick the ideas that best fit your spending patterns and lifestyle.

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.

Thirteen Miscellaneous Financial Nuggets from Recent Webinars

It’s that time again…time to recap “nuggets” from recent webinars and conferences that I attended. Below is a list, in no particular order, of insights, facts, and recommendations that stood out to me as being original, significant, and/or useful:

New Definition of Retirement- The word “retire” does not necessarily mean “stop working.” Instead, it means “not having to work.” Retirement is not a uniform experience for everyone. Ironically, people with the most capacity to choose leisure are frequently choosing labor. Many people stick with activities that they are comfortable and competent with.

 

Inflation Rate- Annual inflation rates reached four-decade highs during the first half of 2022. The core inflation rate strips out food and energy but includes housing, used cars, airline tickets, and more. Inflation is measured by the consumer price index (CPI) based on data from household spending surveys conducted by the Bureau of Labor Statistics. The Federal Reserve is increasing interest rates to slow down the economy in an effort to combat high inflation.

 

Lack of Retirement Planning- Many people spend time planning meetings that last an hour, weddings that last a day or a weekend, and higher education (4-5 years). However, when it comes to planning what they will do over what could be a 30-year retirement, many people “just show up.” A benefit of planning is increased likelihood of a desired outcome.

 

Life Expectancy- On average, retirement has almost tripled in length and can last 20, 25, even 35 years for some. In 1935, if you lived to age 65, you had a life expectancy of 6 years. In 2018, the life expectancy of a 65-year-old was 17 years. The needs of 60-something retirees are very different from those in their 80s or 90s. There are a lot of nuances.

 

Retirement Stages- There are six distinct stages of retirement, although not everyone experiences every stage, depending on their lifestyle. The stages are 1. Euphoria (new-found freedom from…and checking off “to do” items), 2. What, That’s It? (a disillusionment when unstructured time becomes unfulfilling), 3. Re-engagement (figuring out how to spend time), 4. Grandparenthood (a new center of attention), 5. Adult Caregiving, and 6. Widowhood (loss of someone’s “co-pilot”).

 

Bitcoin Basics- According to algorithms laid out in a 2008 white paper by Satoshi Nakamoto, there will be a finite number of bitcoins. Only 21 million bitcoins will ever exist, and one estimate is that the year 2140 is when all bitcoins will be in circulation. Advantages include user anonymity, accessibility, and high return potential (albeit with high risk). Bitcoin disadvantages include extreme volatility and no government regulations or support in the event of a loss.

 

Blogging Tips- Bloggers should post at least once a week and use keywords (for easier searchability) and graphics (to attract users and keep them online longer). They should also try to get backlinks, which are external links that lead to a website. Backlinks are an important factor for high search engine optimization (SEO) rankings. Blogs should also include a disclaimer stating that posts are for educational purposes only and do not constitute personalized advice.

 

Financial Literacy- This is one of few topics today that crosses political party lines and has bipartisan support. As of May 2022, 13 states have financial education mandates. An increasing body of rigorous research with randomized control trials has found clear evidence of positive effects  (e.g., increased credit scores, lower loan delinquency) of financial education on financial behaviors. An understanding of personal finance is a key to success for a person’s entire life. Three key points: financial education is good for students, parents want it, and teachers are prepared to teach this subject.

 

Decision-Making- If someone does not make a decision due to procrastination, an inability (or lack of interest) to narrow down options, fear of making a mistake, or any other reason, a decision has still been made. To quote a phrase attributed to Harvey Cox, “Not to decide is to decide” because someone has still made a choice.

 

Money Conversations with Children- Many parents want to have money conversations with their kids but don’t know how to get started. Experts recommend using “life as it happens” (e.g., a shopping trip or a visit to a bank) to talk about financial topics (e.g., using coupons to save money and compound interest) . It does not have to be a special time.

 

Sequence of Returns Risk- This is a stock market downturn late in someone’s working years or early in retirement. If money is withdrawn during this “fragile” time, asset value can be difficult to recover. To avoid this risk, older adults are advised to build a cash cushion (2-3 years of expenses above guaranteed income) to avoid having to sell securities.

 

Financial Stress- It is not just a high level of debt that causes people financial stress. It is also the absence of protection when bad things happen. This speaks to the need to boost financial resiliency through savings, insurance, community resources, and other methods. COVID-19 showed that people hit the hardest by negative events had the fewest resources.

 

Tax Diversification- Ideally, retirees should have savings in tax-deferred, taxable, and tax-free accounts (e.g., Roth IRAs and municipal bonds or bond funds). Each has a different type of tax treatment. Tax diversification provides an opportunity to strategize to manage taxes better in retirement. For example, to manage taxable income so it is below the limits for the IRMAA Medicare premium surcharge for high earners and the 3.8% net investment income tax (NIIT).

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.