The Right Answer

Credit: nongpimmy

With all of the great college football bowl games that have been on television recently, I have seen a lot of fans doing some pretty strange things. Some fans are flat out in costume. Some are chanting the same words over and over, while some are constantly jumping in place, and some even make animal sounds during kickoffs! I can’t help but think of that old Bud Light commercial showing fans doing similarly strange things in an effort to somehow help their teams win the game. The slogan reads, “It’s only weird if it doesn’t work.”

In my world of financial advice, people ask me questions all the time. Sometimes I know or can find the “correct” financial answer pretty quickly, but most of the time I need to develop some sort of probability analysis or perform a calculation or projection before I can offer the “correct” numerical solution. The thing is, my initial “correct” financial answer or “correct” numerical solution isn’t always right for the client who asked the question, and it’s not because of faulty research or incorrect math; it’s because it doesn’t yet factor in my client’s feelings or emotions. The slogan for the financial advice I try to give to people would read, “It’s only correct if it works for you.”

Let’s say someone has $10,000 to invest and asks me if they should invest it all in gold. Let’s say a retired person who has more assets than they likely need to continue to live comfortably is really concerned about the world situation and asks me if they should invest $10,000 of their assets in gold coins to put in their safe deposit box. My long-term investment advice would probably be the same to both parties, but it might not be the right answer for both parties.

One of the questions I’m asked most frequently is when someone should begin drawing their Social Security. Someone can choose to start at age 62 or wait until age 70 and likely receive a higher benefit for each year they waited, but it is not always an easy question to answer. If two 62-year-old clients with the exact same assets and retirement incomes asked me if they should start Social Security, but one of them is losing sleep because they are concerned that the government might change their benefits if they wait to start drawing Social Security, my Social Security advice would probably be the same to both clients, but it might not be the right answer for both clients.

If two people can finally pay off their low-interest student loans or make their annual IRA contributions, but one of them has really been struggling with the fact that they still have student debt, my cash utilization advice would probably be the same to both people, but it might not be the right answer for both people.

My point is that almost all financial decisions are double-edged. There is often an analytical or numerical “correct” answer and an emotional “correct” answer. When those are the same, it’s easy to decide what to do, but when they are different, it can be quite the conundrum. Some of the deepest and most meaningful conversations I’ve ever had with clients have come from discussions where financial expertise seemed to suggest one thing and emotional credence seemed to suggest another. I take the privilege of being a part of such conversations very seriously, and it is because of conversations like these that I know no software, no app, no robo-advisor, and no strictly commission-based broker can completely replace my role in helping people think through the tough financial decisions to find their right answer.

When you find yourself facing a tough decision where your emotions and finances seem to be pushing you in two different directions, proceed with caution! Be careful relying on what you’ve read, what you’ve heard, what your computer says, and what Bob told you he did that time in the break room. Remember, it’s only correct if it works for you, and I’m happy to try to help you find your right answer.

-Tom

Landing the Plane

Credit: potowizard

Many of you know that I love analogies. One of my favorites that I use with people who are nearing the end of their careers is that they should think about entering into retirement like landing a plane. Whether the gainfully-employed ride has been smooth sailing or more than a little turbulent doesn’t really change the fact that you need to be prepared to land the plane. The retirement landing can be graceful and you can reach your home destination smiling, or the landing can go pretty poorly and even end in a fiery crash of sorts. Most people prefer the graceful landing that ends with smiling, so if you’re thinking about retirement, I thought I’d share a few tips on how you might want to land your very own plane.

1. Get Your Cash Up – When working, I recommend most people keep around three to six months’ worth of their core living expenses in cash. In retirement, I’ve found that most people prefer a little more. If you have a particular cash number that helps you sleep better, go for it, but otherwise I normally recommend one to two years’ worth of your core living expenses in cash. That may sound a little crazy to you, but when your paycheck goes away (or goes down) when you do retire and there is a cyclical pullback in the stock market, you might feel differently.
2. Have a Plan for Where Your Income Will Come From – If you have a pension, that’s really great, but where is the rest of the cash you need to fund your lifestyle going to come from? Randomly pulling cash from various investment accounts and haphazardly deciding when to turn on an annuity or start drawing Social Security is usually not a good strategy. You need a plan! There are tax implications and timing implications that need to be considered if you want to land as efficiently and effectively as possible!
3. Strive to be Debt-Free – This may require using a decent chunk of your assets, or you might even decide that you want to work a year or two longer so you can do this, but if you can go into retirement debt-free, it is huge! Imagine how it feels to still get that mortgage bill you’re used to when you’re not getting that pay check you’re used to. Being debt-free going into retirement not only really seems to help many of my clients psychologically, but it also helps take pressure off cash and investment accounts. If your monthly mortgage payment is making up a sizable chunk of your fixed expenses, and you can make it disappear before you lower your landing gear, I’d be willing to bet you’ll feel a lot better.
4. Make the Big Purchases Before You Retire – What? I’m telling you to spend money? Well, sort of. This may also sound a little batty, but if you are going to need something such as a new car or a new roof in the next couple of years, I’d probably suggest you go ahead and accelerate that purchase while you’re still working and making the big(ger) bucks. Assuming your retirement income will be a little lower than your working income, I’ve found that going ahead and taking care of some of the big ticket items can make your landing feel a little smoother. Put simply, big expenses can hurt the psyche and the pocketbook, but they seem to hurt less if you’re still working.
5. Get to Know Your New Boss/Co-Worker – I’m certainly not a therapist, but I am observant enough to have noted that some people’s transition to a little more family time seems to go better than others. Sure, you’ll have to get used to spending a lot more time with your husband or wife, but that knife cuts both ways; they will have to get used to spending a lot more time with you, too! Working to improve your relationship with your spouse and developing some mutual and separate activities before you retire are probably really good ideas. I’ve heard it said that retirement is twice as much spouse and half as much money! I don’t know about that, but you get the point. Consider some relationship planning before you exit your plane and head to baggage claim.
6. Think About What You’re Going to Do Once You’ve Landed – I know I said I’m not a therapist, but you need a plan for you when you retire. My busy, ambitious, and hardworking clients who eat, sleep, and bleed what they do for a living tell me that retiring can feel like jumping off of a moving train. The emotions of that jump and coming to a relative stop can be a tough adjustment. Take a trip, sleep in for a few weeks, do the crossword, but have a plan for after that. Things such as volunteer work, periodic consulting, gardening, car restoring, or woodworking can be good things. You’re going to want to have something to do. Retiring is a treat for some, but I’ve seen it be a difficult pill for others to swallow. Do as you wish, but I’d suggest you have some hobbies and groups lined up before you bid your boss adieu.

 

I don’t know about you, but I think the landing is one of the most important parts of a flight. If you’re beginning your descent and could use a little help making your approach, please let me know. This has been your captain speaking.

 

-Tom

Retirement Cash Flow Strategies

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For most people, cash flows in retirement look different from cash flows while working. The difference is a transition that I have helped many clients through. Cash flow strategy is one of the most important parts of planning for retirement, but it can be complicated since cash flows frequently come from different sources, start at different ages, and carry varying tax implications. People who develop a good plan and stick to it can often add stability and peace of mind, take advantage of tax saving opportunities, and even generate more income in retirement. Let’s look at a few areas:

• Pension Annuity vs. Lump Sum – For retirees who get to choose a pension payment option, this can be one of the most important decisions they ever make. Actuarially speaking, there’s a good chance that your employer is thinking they are offering you the same amount of money whether you elect an annuity or the lump sum, but there are still things to consider. A lump sum offers a surge of money at retirement that can be more easily passed on to your heirs and better protect your purchasing power against inflation if it is properly invested, but a majority of clients I work with seem to find comfort in choosing the annuity option. In most cases, the monthly annuity amount will remain the same until the day you die. This may not help you against inflation, but if you live long enough, it could eventually mean more total money for you. In the meantime, an annuity feels like a paycheck, which is what retirees are used to, and the mental comfort that brings is the main reason I am usually a supporter of a pension annuity election. I also advise most clients to select a “joint and survivor option” if it is available so that a surviving spouse won’t lose their loved one and the benefits of their loved one’s annuity at the same time. This tactic usually costs the spouse whose pension it is a little bit of cash each check, but it can be a tremendous comfort to the other spouse.
• Required Minimum Distribution Planning – I’ve discussed this before, but age 70 ½ is an important half-birthday! I won’t take you back through all of the details we covered in my post “Required Minimum Distributions,” but I will say that you should factor this into your retirement planning. If things are a little tight on you before you have to start these distributions, or if the distributions are going to put you in a higher tax bracket once they begin, it may make sense to start prudently withdrawing from your retirement accounts before 70 ½. This could save you tax dollars and allow you a steadier lifestyle throughout retirement as opposed to cutting it close in your 60s and rolling in cash in your 70s. It’s just a thought, but one you should consider if you’re over 59 ½ (there could be penalties if you withdraw from retirement accounts before 59 ½).
• Social Security Strategy – Many people, including me, are concerned about the long-term solvency of the program as we know it going forward, but there are some Social Security strategies you should consider if your retirement cash flows are doing just fine when you turn 62. If you decide to claim Social Security retirement benefits at age 62 (the earliest applicable age), you are deemed to be collecting benefits “early,” and will only receive around 75% of the benefit you would receive at your “full retirement age.” (Currently, full retirement age is usually between age 66 and 67 for most people, but take a look at this chart to find your specific full retirement age.) If you wait until your full retirement age, you can receive 100% of your benefit, but if your retirement cash flow is still doing just fine at your full retirement age, it might be worth waiting until age 70, when you could receive around 132% of your benefit! That’s around 8% growth per year from age 66 to age 70, and that’s not a bad investment return if you ask me! Putting off claiming Social Security could provide you with more money in retirement if you live long enough, but at the same time, you could be shooting yourself in the foot if you end up passing away relatively young. I would suggest you consider your health and family history, and then consider how much Social Security income at age 62 would help before you decide to delay filing. If you do decide to delay, you can always start before your full retirement age or age 70 if you need to with a partially higher amount of benefits, but it’s probably not worth having beanie weenies in your 60s so you can have filet mignon in your 70s.

I hope you’re beginning to see that if you consider your spending and saving now versus later, the importance of starting off strong, your humble abode(s), your health insurance, and your retirement cash flow strategies, that there are many things you can do to put yourself in the position of having a chance to retire early. That being said, I’ve met plenty of people who could retire early but don’t and plenty of people who did retire early and wish they hadn’t. Some even went back to work! The How to Retire Early Series will conclude next week with a look at why you might not want to retire early even if you followed the advice of my previous posts and could. I hope you’ll check it out.

-Tom

My Uncle’s Living Expenses

Credit: Stuart Miles

Throughout the course of my blog, I have frequently suggested that you take the time to gather some data and take a good, hard look at the sources of your living expenses. The results of such an exercise might be shocking, concerning, enlightening, comforting, or something in-between. Whatever the results, today I thought we’d practice this exercise together as we take a look at my uncle’s living expenses.

Looking at the chart below, you can see that my uncle spends a significant amount of his money in several categories. Now all these numbers are rough, but it looks like around 21% goes to medical expenses, 20% goes toward paying off a note payable (he owes some people some money they gave him a long time ago), and 20% goes toward his security system. I can’t believe more than 60% of his expenses are allocated just to those three categories! Continuing on, I can see that he has some sort of debt, since he spends 6% of his total yearly expenses on interest payments. He also gives around 13% to charities or to people less fortunate than he is, so I guess that’s nice. He’s only spending 3% of his total expenditures on transportation, and only 2% on education. That seems a little low to me, but what do I know? Finally, I guess the other 15% is all meshed together into other, smaller categories of living expenses.

Now be nice to my uncle because I really do think he means well, but I also think he could benefit from looking at the sources of his living expenses as a whole a little more often. When I break down someone's living expenses like this I try to help them figure out where their money is going if they aren’t sure, I try to help them figure out where they can cut back if they need to cut back, and I try to figure out ways to improve their overall financial standing by addressing specific expense categories such as my uncle’s interest payments. As you might imagine, this process can be personal and painful, but it can also be eye-opening.

So if you were my uncle’s financial planner and you knew he was spending too much, what would you advise? Would you solely go after his debt? Would you tell him to cut back on his giving to charity? Would you have him try to cut back on his enormous medical, note payable, and security system expenses? I’m serious, what would you do?

By now, I hope you know I would never share my uncle’s financial information with you or anyone else I am not authorized to speak with. After all, always keeping my clients’ personal and financial information strictly confidential is part of my job. That being said, I was able to share the details of my uncle’s expenditures with you today because you’re related to him, too, and his expenses are a matter of public record. In other words, he’s my uncle, he's your uncle - he’s our Uncle Sam!

I don’t want to wade into the ballyhooing of politics, but I do think some of you might find the pie graph above a little more interesting now that you know it was from a CNN report covering the United States government’s 2011 fiscal year. Switch out my uncle’s “medical expenses” for Medicare, Medicaid, and some children’s health insurance programs, my uncle’s “note payable” for Social Security, my uncle's "security system" for defense spending and international assistance, and my uncle's "charity" for safety net programs, and our government’s living expense picture should become a little more clear. It could just be me, but I imagine clamoring for more military spending or more health insurance versus spending more on education, for example, might give people pause when they look at the government’s federal budget as a whole, and keep them from getting so caught up in an impassioned speech or a fiery, late afternoon news show.

You may have caught on to my ploy from the very beginning, but I hope some of you are a little surprised and maybe even flabbergasted. Sure, take a look at Uncle Sam’s spending and reflect quietly on the sources of expenditures for our country if you’ve never done that before, but let me reiterate that the main purpose of this post was to demonstrate to you the true value and potential impact that looking at your living expenses as whole can offer.

I don’t claim to always have the answers for your budget, and certainly not Uncle Sam’s, but if you take the time to figure out the sources of your living expenses and look at their relative percentages, I bet we could get off to a really good start!

-Tom

Social Insecurity

Credit: David Castillo Dominici

Perhaps it was something I ate. Perhaps I tied my necktie just a little too tight this morning. Perhaps it’s the fact that I’ve gone without football for months now…

If you read my blog for some primarily “sunny” financial advice and occasional humor, I thank you. I must, however, warn you that today is going to be a little bit different. You see, I’m feeling a little like Alfred Hitchcock, Stephen King, and Edgar Allan Poe. I’m feeling like I need to share a piece of information that might not sit so well with you, but the sooner you hear “the horror,” the sooner you can come up with a different plan. Here goes:

You probably should not rely on your Social Security benefits to get you through retirement.

Why would I say such a thing? Well for starters, how much Social Security income are you expecting?

Go to the below Social Security Administration website and enter in your date of birth, current annual earnings or the amount from the last year you had earnings, and the month and year you expect to retire. Select “today’s dollars,” and take a deep breath.

Social Security Administration Website

Not very much, is it? I asked you to select “today’s dollars” because not many people see benefits continuing to increase long-term (as the "inflated (future) dollars" selection would have shown) with the current federal budget deficit.

Now that you know what to expect, could you live off that in retirement? No matter how much money you have made, the maximum 2012 Social Security benefit for a worker retiring at full retirement age (67 years old) is only $2,513/month. I know that’s about $30,000 annually, but is that enough for rising costs, your eventual declining health, and caring for your family? But wait, it gets scarier.

Even though you have paid into the system for years, Social Security income can be taxable! For 2012, if you file an individual tax return and your "combined income" is over $34,000 or if you file a joint tax return and your "combined income" is over $44,000, up to 85% of your Social Security benefits may be taxable. The only slightly good news is that your “combined income” is a sum consisting of your adjusted gross income, your nontaxable interest, and only ½ of your Social Security benefits.

The final scary point to consider is the future of Social Security. With people living longer, health care costs continuing to rise, and the Baby Boomers now receiving their Social Security benefits, the system as we know it is strained. Recent government estimates project that by as early as 2016, parts of the Social Security program could be unable to meet their obligations. The only way that could change would be by the government issuing more debt, increasing taxes, or more likely, cutting the amount of benefits. I’m not trying to predict what Social Security will be like in the future; I’m just warning you that the future monthly income number you saw for yourself could be overstated.

Retirees have probably already learned this lesson or are unfortunately learning this lesson the hard way, but if you are still working, you need to realize how little your probable Social Security income will be compared to your working income. Pensions are becoming more and more a thing of the past, so if you want to enjoy anything close to your current lifestyle in retirement, it’s up to you to build up your investments and save for retirement now.

Well I’m glad that’s off my chest! Please don’t worry too much though because I will soon be covering Individual Retirement Accounts, a potential tonic for your retirement income woes. Either way, next week I promise to be back to my old self and will post on something happier - how to save for a vacation!

-Tom