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

Required Minimum Distributions

Credit: Stuart Miles

In my line of work, I get to surprise people all of the time. Sometimes my advice or the conclusion of my financial analysis evokes an elated and relieved response. Sometimes it does not, but instead confirms a painful reality or brings about sadness and temporary distress (not to worry: I’m happy to develop a new plan or strategy for my clients who find themselves in temporary distress).

One of the most frequent surprises I get to deliver is the news that in the year you become 70 ½ years of age, if you have certain retirement investment accounts like a 401(k), Traditional IRA, or qualified (tax-deferred) annuity, you are required to start taking minimum distributions, whether you want to or not! Technically, you could choose not to take your minimum distributions and agree to pay one of the most onerous IRS penalties of 50% of the amount you should have withdrawn, but since I’ve never had any takers on that strategy, let’s push forward assuming you will take your required minimum distributions (RMDs).

The amount that has to be distributed is based on IRS life expectancy tables and the age of your spouse (or designated beneficiary). It’s a relatively simple multiplication problem consisting of your account’s previous year-end value and your applicable life expectancy factor, but there are so many tables and beneficiary circumstances to consider that I’d suggest you let your financial advisor or CPA do it for you. There are some brokerage firms and custodians that will actually calculate your RMD for you on your brokerage statements when they become required, but please note that brokerage firm calculations will only be relative to the accounts you have with them. If you have multiple accounts that require RMDs, you’ll need to be careful, and make sure you take enough in total and from each account to avoid the before-mentioned “bear” of a tax penalty.

This required distribution can be a good surprise. If you’re not already withdrawing from your retirement account, this distribution can feel like a little extra income that could be used for anything from family trips to home renovations. I should mention, though, that your distribution does not have to be spent! You have to withdraw it and you have to pay taxes on your withdrawal, but you’re welcome to top off your savings account or reinvest the proceeds in your after-tax brokerage account.

This required distribution can be a bad surprise if you didn’t know you had to do it (or forget to do it), but even if you’re on top of things, it still stinks because the tax man cometh. Uncle Sam wants to wish you a happy birthday from age 70 ½ on, and to commemorate the occasion, he’s going to want ordinary income taxes from your distribution amount to help fill his empty coffers.

If you’ve read this post, there is no reason to let RMDs surprise you. If you are 70 ½ or older, please double check with your financial advisor and CPA to make sure you are taking your RMDs. If you’re almost 70 ½, I’d urge you to meet with your financial advisor and make sure you have a game plan in place for your RMDs as there is often an opportunity for meaningful and significant tax and cash flow planning. If you’re nowhere near 70 ½, I bet you can think of someone you care about who is and would appreciate you looking out for them.

-Tom

The Lightning Round

Credit: FreeDigitalPhotos.net

Thanks for all of the questions you submitted. Please know that I am always happy to try to help with any questions you may have, whether they are related to one of my posts or not. Now, without further ado, here are my responses to 5 questions submitted by readers just like you...

1. What’s the best way for my friend to handle a credit card with a big balance? She’s thinking about transferring the balance to another credit card with a lower interest rate. Is that a good idea? After she pays it off, should she close it? My friend read somewhere that it doesn’t matter as long as it’s not your oldest credit card. Thoughts?

- Becky                        

                         

The best and only way to eliminate credit card debt is to pay more than the minimum. Pack your lunch instead of going out with your co-workers, temporarily decrease your cable package, wait an extra week between nail appointments, or pass on joining that fantasy football league with the buy-in. You must do whatever it takes to pay more than the minimum payment or else the high interest rates can eat you alive! Other options that are often suggested to handle credit card debt include taking out a Home Equity Line of Credit (HELOC) to pay off the debt, temporarily borrowing from your 401(k) or retirement plan (if the plan allows it) to pay off the debt, or even transferring the debt to a different credit card with a lower interest rate. Given the right financial situation, these techniques could be effective and save you interest, but I would urge caution with all of these options because you are only “robbing Peter to pay Paul.” If your friend is going to transfer the balance to another credit card, she should make sure there is no fee for transferring the balance from another card that could negate any interest saved. Eliminating credit card debt should arguably be everyone’s first financial priority, because once the debt is gone, the money you would have otherwise spent to cover your debt and interest payments can easily be saved to build up your cash and establish a rainy day fund.

I don’t think closing a credit card account is necessarily a good idea unless you think that’s the only way to prevent yourself from going into credit card debt again. Using a few credit cards responsibly can be a good idea, and some cards offer worthwhile incentives and rewards, but stay away from opening up all the "take an additional 10% off today’s purchase" cards that you're always harassed about at the checkout counter. Having too many credit cards, closing too many credit card accounts, and not having credit card accounts with long histories can affect your credit. If you have a card that you don’t want or no longer need, I’d cut it up and put the pieces in several different trash cans to minimize identity theft, but I normally wouldn’t recommend closing the account. 

2. What exactly is income streaming, when should we look at turning it on, and should we worry about it “running out” before we want it to?

- Jill                              

When you say “income streaming,” I imagine you are talking about an annuity. An annuity is a financial product that, for an initial investment or series of investments, entitles an investor to a stream of payments or a lump sum in the future for anywhere from a set period of time up to life. The future payments can be fixed or variable depending on what type of product you have. The benefits of an annuity are that it is a way to defer income taxes and guarantee a stable stream of income in retirement. The drawbacks are that annuities frequently come with high fees, limited investment options, and surrender charges if you pull out money in the first several years.

As far as when you should turn it on, it really depends on your specific situation and what type of annuity you have. Regardless, don’t turn on an annuity before age 59 ½ as you could face a 10% early-withdrawal penalty like you do with other tax-deferred retirement plans. If you have a lifetime product, don’t be as concerned about outliving your income stream, but if you don't have a lifetime product, wait (if possible) until you feel like you actually need the additional income. Please note that annuitizing, or turning on the annuity, is often an irrevocable decision, so consider it carefully before you decide. You may also want to consider the potential benefits of cashing in the entire annuity and exploring other investment options that may have lower fees and offer more flexibility.

3. I enjoy reading your blog, but could you tell me a little more about what you actually do?
      

 - Brett                            

Thanks for the question, and I am happy to talk about what I do for a living. I am a financial planner and a CPA. I work for a wealth management firm in Buckhead. My daily responsibilities include examining and evaluating clients’ investment strategies, reviewing and analyzing clients’ current financial situations in comparison with their life goals, and considering clients’ estate plans (wills, powers of attorney, health care directives, trusts, etc.) to make sure they are maximizing their tax planning opportunities and setting themselves up to leave behind a legacy they would be proud of. I help people figure out how to send their kids to college, when they can retire with a lifestyle they will be happy with, and how they can give to charity in the most advantageous ways. I am a jack of many trades, but my goal, and the goal of my firm, is to relieve our clients of the burden of worrying about their finances by getting them on a financial plan or path where they can achieve all their goals and live in a sustainable manner. I chose to work for the firm I did because we know there is a lot more to financial planning than investment management and insurance, and because we don’t work for commissions. This allows me to look my clients in the eye and give them advice with them absolutely knowing that I am advising them with their best interests in mind, not my end-of-year bonus. If I can ever be of assistance to you or anyone else you know, please let me know.

4. I have read a lot recently about the Black-Scholes Model. Can you explain it? Do you use it?

 - Anonymous                  

I know the basics and am capable-enough to have a conversation with you about Black-Scholes, but I’m not sure I can completely explain it. It was derived by some gentlemen who are a lot smarter than me and no doubt had a lot more time on their hands, but here goes…

The Black-Scholes Option Pricing Model was developed in 1973 by Fischer Black and Myron Scholes and is considered by many to be one of the most important concepts in modern financial theory. The equation derives the implied price of European-style stock options by essentially using five variables: the current stock price, the exercise or strike price of the stock option, the time until the stock option expires or matures, the annual risk-free interest rate (usually considered the interest rate on a U.S. Treasury Bill), and the annualized volatility (fluctuation of the stock price) of the stock. The formula is quite frankly disgusting, and I will show you a simplified version here. I can, and have, worked the equation with Excel, but I don’t stand a chance with pencil and paper. Luckily, there are some online calculators that can help you as well, but you need to make sure you are confident in the variables you enter before you rely on the output!

The reason the Black-Scholes Model was so groundbreaking in the financial world (and the reason it won a Nobel Prize in Economics in 1997) was because it was a method that finally allowed everyone to mathematically estimate what the value of a stock option is. If, after running the Black-Scholes Model, the current stock price exceeds the implied stock value, it might be time for the stock option holder to strongly consider exercising the stock option. I know many people who sell their stock options as soon as they receive them, and I know many people who hold them dangerously close to the expiration date, but I don’t know many people who exercise them sometime in the middle. Black-Scholes is great, and I run it for clients from time to time to give them perspective, but let me offer two, much more simple theories of mine relative to stock options:

• Little pigs get fat and hogs get slaughtered- If your stock options are in the money (the current stock price is greater than your exercise price) by a fair amount, what are you waiting for? You can exercise the options and reinvest in a diversified portfolio that has much less risk and still has the opportunity to increase in value. Remember, if the stock price dips below your exercise price, your stock options are worthless.
• The time until your stock options expire is like a runway- If I’m trying to land a big jet, I want the longest runway possible for maximum flexibility and the opportunity to succeed, and I feel the same way about stock options. If you are a couple of years out from the options expiring, you have more control over your landing as you can consider tax implications and your current cash flow needs. Also, if your stock options are in the money, you can eliminate the worry and go ahead and receive some additional money you weren’t guaranteed to receive in the first place! Whereas, if you hold the options until they are a couple of weeks from expiring, you have given yourself a really small runway, and all I can say is that I hope the stock price is up for your sake. You shouldn’t rush pulling the trigger on stock options, but too many people go down with the ship by holding on until the bitter end.

5. I've got two for you... 1. Is it possible to roll a traditional 401(k) into a Roth 401(k)? If not, should I open another account but make it a Roth? I like the idea of paying my taxes now instead of watching them go up over time. 2. Can the second stage in your upcoming series include a couple of tips for just before you say "I do"? Good stuff!

 - Chad                            

I’m glad you’re thinking the way you are. Everyone is trying to figure out what taxes will be like going forward, but I’m beginning to believe more and more that the best-case scenario with the lowest tax rates is what we have now, regardless of what party is in power. If you share that belief, it means that you want to pay taxes now, not later; you want a Roth 401(k), not a Traditional 401(k). It is possible to roll a Traditional 401(k) into a Roth 401(k), but your ability to do that and exactly what avenues you will have to take to do that depend largely on your employer. At best, go ahead and try to combine your 401(k)s into a Roth 401(k), but realize you will have to pay income taxes now on the traditional portion you are rolling over. If your employer won’t let you do the Roth rollover, go ahead and try to combine your 401(k)s together for convenience sake, but know that your plan will have to keep up with the pre-tax (Traditional 401(k)) contributions and after-tax (Roth 401(k)) contributions separately. It is crucial that you make sure this consolidation is handled correctly in the beginning because you don’t want to have to go back and try to figure out how much tax you owe 20 or 30 years from now. For what it’s worth, I had a traditional 401(k) at my first job and rolled it into my new job’s 401(k). I did not convert the old 401(k) to a Roth, I just went with Roth 401(k) contributions going forward.

I love the idea for a post on some engagement or pre-marriage tips! I have actually thought about doing a post on ways to save money when planning a wedding, but I feared the nuclear fallout I might start between some of my bride-to-be readers and their fiancés. That being said, I will go ahead and offer a comment on one thing today that repeatedly bugs me: this mainstream idea that a guy is supposed to spend 3 months’ salary on an engagement ring. All I’ve got to say is that you should spend what you can and what you want to make the girl of your dreams say “Wow.” You don’t want her to ask you what bank you robbed. I know plenty of happy marriages with smaller rocks on the ring, and I know plenty of unhappy marriages or broken marriages with massive rocks on the ring. Getting engaged and married is not about ice sculptures, waterfall pictures, or exotic Venus Flytraps; getting married is about celebrating two people who have decided they want to be together for the rest of their lives.


Thanks again for all the questions. We’ll have another Lightning Round sometime soon!

-Tom