Thursday, December 29, 2022

Financial Security and Happiness in Later Life: Reflections from Recent Webinars

Being the author of a book about transitions in later life, I am always looking for new information about this topic. I recently attended a number of webinars about retirement planning.

Below are 10 of my top take-aways:


Knowledge is Power- While new state financial education mandates are getting lots of media attention (and rightly so), financial education works for everyone! This includes topics of interest to older adults in later life such as required minimum distributions (RMDs), taxes on Social Security benefits, and Medicare premiums. Recent research provides clear evidence of the positive effects of financial education on financial behaviors.


Limited Investment Alternatives- Stocks have not been doing well during most of 2022 but neither are bonds, cryptocurrencies, or cash equivalent assts (money market funds and CDs) that are losing purchasing power to inflation. The best thing that older investors- in fact, all investors- can do right now is to maintain a diversified investment portfolio and “tough it out” and not panic and sell securities at a loss.


Recovering Losses is Difficult- In one webinar, an example was given of stock originally purchased for $100 a share and sold in a panic at $66.66 a share, a 33% loss. In order to get back to $100 a share, an investor would have to have a 50% gain because $33.33 is 50% of $66.66. Also, the sequence of investment returns matters. The 4 L’s of retirement income optimization are Longevity, Lifestyle, Legacy, and Liquidity.


Decumulation is Different- One webinar presenter noted that “investing for distribution in retirement is different from investing for accumulation” and used the analogy of climbing a mountain (investing for retirement) and “making it safely down the mountain” (not running out of money during your lifetime). Key risks in retirement include longevity, health care expenses, taxes, and inflation.


Reverse Mortgages Uses- In addition to providing a lump sum or regular income payments in later life, reverse mortgages have other uses. For example, they can serve as a “delay bridge” so people don’t have to withdraw  assets during market downturns. Borrowers age 62+ can also use reverse mortgage proceeds to pay premiums for a long-term care insurance policy so they don’t lapse it (due to increasing premiums) before it is needed.


The Great Resignation- Millions of Americans quit jobs in 2021-2022 and remote work went “from the margins” to mainstream in many industries. Key reasons for older adults to leave jobs included increased asset prices (many of which have plummeted since 2021) and health/safety reasons. Ageism can make it difficult for older adults to earn their previous salary if they decide to return to the labor force. Many have to settle for less.


It’s What You Keep- Retirees with tax-deferred savings in traditional IRAs and 401(k)/403(b) and similar employer savings plans cannot forget about taxes due on this money. It is not all theirs to keep. Sometimes, mandatory RMD withdrawals can even push them (or their heirs) into a higher tax bracket. An option that some people consider is donating these assets. When a charity is a beneficiary of retirement accounts upon someone’s death, no taxes are due and the full amount of the account balance can benefit recipient non-profit charities.


Diminished Capacity is a Concern- One webinar speaker suggested having a “trust circle” of trusted family and friends when you have a major financial question or decision. Many financial services firms also request the names of trusted third parties for older clients. Shockingly, 1 in 6 people age 60+ have experienced some type of financial abuse (i.e., withholding, stealing, or restricting the use of money or financial information).


Inflation Impact- Older adults are uniquely impacted by inflation because they are often living on a fixed income and are unable to earn more money to mitigate the impact of inflation. Some people are buying inflation-adjusted TIPS (Treasury Inflation-Protected Securities) and Series I bonds for inflation relief. The spread between TIPS and regular Treasury securities is the market’s best estimate of future inflation. Retirees worried about inflation can bump up the assumptions used in their financial planning projections and analyses.


Your Future Self- Many people avoid planning for later years of retirement and focus on beautiful imagery (travel, beaches, etc.). A speaker advised putting your fears and plans on paper and put “structures in place” to address them. Start by making a list of five things you do now that you want to continue doing. For example, if you really enjoy working, maybe you shouldn’t retire at all in the traditional sense. Play pickleball or golf on the side. Also, discuss your preferences with others. Without dialogue, nobody knows what you are thinking.

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, December 21, 2022

Demystifying Financial Jargon

No question about it: financial planning can be confusing. 

One factor that can be daunting to many people is the technical jargon used by professionals and financial media outlets. Below is a simple description of terms that are commonly used in financial reports and presentations:

Inflation- This is the erosion of purchasing power over time.  For example, $100 at the beginning of the year buys less than $100 at the end of the year.  If the annual inflation rate is 5 percent, the $100 you spend on groceries in January buys only $95 worth of food in December.  The inflation rate also affects savings. If a savings account earns 1 percent interest during a year with a 5 percent inflation rate, you lose 4 percent of the purchasing power of the money in savings. 

Interest Rate – The percentage charged by banks or credit card companies for loaning money or the percentage paid by banks for borrowing your money held in savings accounts, checking accounts, or certificates of deposit.  Actions by the Federal Reserve’s Federal Open Market Committee (FOMC) influence the interest rates charged to consumers. In 2022, the FOMC has been gradually increasing interest rates in incremental steps in an attempt to lower inflation.

Consumer Price Index (CPI) – The Consumer Price Index (CPI) is a measure of inflation used by the U.S. Bureau of Labor Statistics. It is updated monthly. Changes in the price of goods and services (e.g., energy, food, cars) are tracked and recorded.  Because people may not buy the same “basket” of goods measured by the CPI, and because inflation affects people differently, the CPI may overstate or understate the true rate of inflation for individuals and families. 

Median Income- The median is the exact halfway point (midpoint) in a distribution of numbers from the lowest to the highest. In other words, half of the numbers are below the median and half are above it. The median household income in the United States was $67,521 in 2020, down from $69,560 in 2019. Median income is typically used to report household financial status because average income figures are skewed by a small percentage of extremely high earners.

Dow Jones Industrial Average (DJIA) – The Dow Jones Industrial Average is a price-weighted average of prices of stocks from 30 industry-leading U.S. companies. It is widely quoted each day at the close of market trading as a barometer of stock market activity. Because the DJIA uses such a small number of stocks, it is often criticized for not representing the entire stock market, which is why other indexes, such as the Standard and Poor’s 500 and Russell 3000, also are used.

Dollar-Cost Averaging- This term is used to describe the process of investing the same amount of money on a regular basis regardless of market performance. For example, $100 in a mutual fund or 5% of pay every payday in an employer retirement savings plan.  Dollar-cost averaging works best if investment deposits are “automated,” such as authorizing 401(k) plan payroll deductions or automatically debiting a bank account monthly for mutual fund share purchases.

Buy and Hold-  A long-term passive investing strategy where investors purchase stock, stock mutual fund, or exchange-traded fund (ETF) shares, particularly from companies with a history of steady earnings or growth, and keep them for a number of years regardless of market performance. Buy and hold investing can often outperform actively-managed investing because trading expenses are reduced and capital gains taxes are deferred.

Time Diversification- The reduction in risk that often accompanies the lengthening of an investor’s time horizon. What matters most in investing is not market timing, but time in the market. Historical evidence indicates that long-term investing can reduce the risk of losing money and enhance potential returns. Time decreases the amount of volatility (i.e., ups and downs in prices) of investments. As the time frame increases to 15 to 20 years, extreme volatility flattens out.

Rule of 72-  To estimate how long it will take to double a sum of money (any amount), at a given rate of return, divide 72 by the interest rate.  For example, money will double in seven years at 10%, eight years at 9%, nine years at 8%, ten years at 7%, and 12 years at 6%. The Rule of 72 can also be used in reverse to calculate the interest rate required to double money.  Simply divide 72 by the specified time period.  For example, 72 divided by 8 years = 9% interest. 

For additional definitions of financial and investing terms, review this glossary from Rutgers Cooperative Extension.

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, December 15, 2022

Investment Insights for Uncertain Times

The year 2022 has been a time of great uncertainty for investors with periods of extreme volatility (i.e., sharp price movements of securities, both up and down). Times like these are a good time to revisit what we know to be tried and true about investing from decades of investment performance data. This knowledge can help calm frayed nerves and keep investors focused on their long-term goals.

Below are eight investment insights to consider during these uncertain times:


Volatility is “The Price of Admission”- Successful investing requires having an “investor’s mindset.” This means being able to accept market volatility and not expecting investments to provide a guaranteed returns (like a certificate of deposit) and no loss of principal. An analogy is that volatility is a “fee” charged to investors, who must be willing to “pay” it (i.e., remain invested) to gain access to potentially superior long-term returns.


Consistency Counts- Long-term investing is a good antidote for high inflation because it has potential to provide returns that exceed what inflation and taxes take away, thereby maintaining purchasing power and preserving wealth. The key is to hang tough when there is bad economic news. While it is emotionally difficult to “stay the course,” market downturns actually provide a great buying opportunity similar to deep discounts on products sold online or at department stores. A recent book by financial blogger Nick Maggiulli advises readers to Just Keep Buying (i.e., making investing a habit).


Goal-Setting Matters- Research by the Consumer Federation of America found that people with a plan saved more successfully than those without a plan. A plan was defined as “a savings plan with specific goals.” Another study found that retirement provided a powerful motive for regular saving/investing. This speaks to the importance of setting goals and saving/investing for multiple goals (e.g., retirement, college, a car) concurrently with different “buckets” of money.


Some Investments are Already Diversified- Diversification is the process of investing in different securities to hedge the risk of loss affecting any one of them. Researching, purchasing, and monitoring multiple individual securities requires time and investment expertise. A much simpler, as well as less expensive, way to achieve diversification is to select a stock index mutual fund or exchange-traded fund that provides broad stock exposure. Examples include total stock market index funds that track U.S. stock indexes and total world index funds that provide exposure to stocks issued worldwide.


Compound Interest is Not Retroactive- People cannot earn interest on money that is not invested, which often happens when people get a late start investing and/or “sit out” stocks during market downturns (i.e., in an attempt to practice market timing). The latter helps explain results of a Dalbar study of the difference in performance, as well as the growth of, $100,000 between the average equity investor and the Standard & Poor’s (S&P) 500 index between 1/1/92 and 12/31/21.The S&P index returned 10.65% resulting in $2,082,296 after 30 years. Average investors earned 7.13% and accumulated $789,465. Bottom line: investors under-perform market indexes when they are out of the market too often.


The First Million is the Hardest- Like the game show Who Wants to Be a Millionaire?, initial rounds of the investment “game” do not double large sums of money. However, you must get through them for compound interest to double larger amounts later. Most people do not become millionaires until their 50s or 60s after they have been investing for 30 or 40 years. Late starts and “sitting out” down markets only delay investment growth. Once you accumulate $1 million, the next million might only take a decade or so (Rule of 72: money earning an 8% average return would double in about 9 years).


Financial Capital Can Replace Human Capital- Economists refer to the knowledge, skills, productivity, and other personal attributes that people bring to a job as “human capital.” Human capital helps people earn a living, but it wanes over time as people age. Investing can help people turn their human capital into financial capital. For example, withdrawing 4% of an $500,000 investment portfolio in later life is equivalent to earning $20,000 ($500,000 x .04).


Financial Independence is the Ultimate Goal- Financial independence (FI) is the state where people can pay their bills and have the quality of life that they desire without having to work for others. Many people try to achieve FI before they retire, whether this occurs in their 50s and 60s or 30s and 40s (FIRE proponents). FI occurs when monthly investment income (supplemented with guaranteed income sources, if any) exceeds monthly living expenses. The classic book Your Money or Your Life refers to the time when income from investments surpasses expenses as the “Crossover Point.”

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, 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.


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