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AARP Article

Managing Your Money Manager

Demand these things from your financial adviser

How do you know if your financial adviser has your best interests at heart? They all say they do. Then some of them turn around and sell you products with high (often hidden) costs that line their pockets at your expense. The government estimates that individual retirement accounts alone lose $17 billion a year to “me-first” investment advice from salespeople who wring large commissions and fees from their trusting clients. That’s money that could have been used to brighten your life.

Last year, the U.S. Department of Labor issued a new investor protection rule covering advisers who handle IRAs and 401(k)s. It would require them to act as fiduciaries—meaning that, when giving advice, they would have to put your financial interests ahead of theirs. If they sell you a mutual fund with a high commission when low-commission versions are available, their actions would be not only dishonorable, they would be against the law.

Not surprisingly, the brokerage and insurance industries hope to kill the rule. But because it was supposed to be implemented this month, financial firms necessarily prepared to comply. Fees dropped at some firms, and new, low-commission products were introduced. Then the Trump administration proposed putting off the start date until June, pending further review of the rule. What happens now?

Most likely, some of the reforms will last because the industry knows you want them. Others might be lost. Either way, here’s your path to getting trustworthy advice.

Ask the person managing, or offering to manage, your investments to state in writing that he or she will act as a fiduciary at all times, for retirement and nonretirement accounts. That’s especially important for less sophisticated investors who depend heavily on professional advice. Knowledgeable clients already demand fiduciaries for all their money.

Ask the adviser to compare the costs and benefits of leaving your retirement money in your 401(k) versus investing it through the firm’s IRA. You want a good-faith estimate, in writing, of what you’ll pay in direct fees or sales commissions, plus any payments the adviser’s firm quietly receives for selling particular mutual funds or annuities, says Ron Rhoades, director of Western Kentucky University’s financial planning program. Don’t settle for generalities; get specifics. True fiduciaries will give them to you.

Consider choosing an adviser who charges flat fees — such as a percentage of managed assets or a fixed amount per year — rather than those who also take commissions. Fee-based advisers can be expensive, too, so you still have to check. But commissioned advisers are those most likely to push complex products, such as annuities whose sky-high costs dwarf any benefits.

Don’t be blinded by titles like “financial adviser” or “wealth manager.” If they’re not fiduciaries, the advisers can earn commissions on sales, and they’re legally entitled to put your interests last. Even if they are fiduciaries, they still might persuade you (wrongly) that costly investments are in your best interest. The industry isn’t fighting the fiduciary rule for nothing. Remain on guard.

(Originally published in The AARP Monthly Bulletin.)

AARP Article

How to Make Your Money Last

Take advantage of Uncle Sam’s help to save at every age and stage

(The following article is taken from the 2016 edition of How to Make Your Money Last: The Indispensable Retirement Guide. The book was updated in 2020.)

“Saved more money.”

That’s the number one response retirees and people nearing retirement give when asked, “Financially speaking, what do you wish you’d done differently?” This realization, of course, usually hits most of us after we’ve blown through Plan A (the retirement fairy who’ll magically take care of everything) and Plan B (work till I drop). But since we can’t count on our health or our jobs to see us through, those of us who are lucky enough to still be employed should proceed directly to Plan C: Squeeze that paycheck like a sponge to fund our retirement accounts.

Fortunately, the government has bestowed a great gift on all retirement savers, even those nearing the end of their working lives: the tax-favored retirement plan. The contributions to these plans, as well as their earnings, are tax-deferred and even, in some cases, tax-free.

Many people close to retirement see little point in funding these accounts. “Why put money in a retirement plan now?” they ask. “I’ll be taking it out in a few years.” Two crucial reasons. First, these could well be your highest-earning years, making the tax benefits especially valuable. Second, you’ll be withdrawing the funds incrementally, not all at once. You may live another three decades — ample time for your preretirement contributions to grow tax-deferred. So be smart and get those tax breaks while you can.

Gimme (tax) shelter

Tax-favored retirement savings plans come in two types: traditional and Roths. The vast majority are traditional IRAs, 401(k)s and similar plans. The income taxes on your contributions, up to an annual limit ($18,000 in 2016, plus $6,000 for taxpayers 50 or older), are deferred, and the earnings grow tax-deferred as well. When you start withdrawing the money (which you cannot do before age 59 1/2 and must do by 70 1/2, unless you’re still on a company payroll), it is taxed as ordinary income. That’s the deal: No taxes now but definitely taxes later, when — the assumption goes — you’ll likely be in a lower tax bracket.

Roths, on the other hand, are funded with after-tax dollars. But all the earnings grow tax-free, so when you take out the money, it doesn’t count as current income and hence is totally tax-free. If you don’t need the money, you never have to take it out; a Roth can grow tax-free for the rest of your life and be left tax-free to your heirs. (Another upside: If you do need the money, you can withdraw your own contributions at any age without penalty.)

But the contribution limits for IRAs, whether Roth or traditional, are fairly low: The 2016 maximum is $5,500, or $6,500 if you’re 50 or older. There are also income limits, albeit generous ones: You can contribute the maximum if your adjusted gross income in 2016 does not exceed $117,000 or, for married couples filing jointly, $184,000.

Which plan is which?

The type of tax-favored plan you participate in is determined by your employment situation, so there’s not much angst around that choice. What is absolutely vital is that you participate in whatever plan you qualify for and sock away as much as you can afford. The money you invest now will be your nest egg later. Here’s a quick rundown.

  • If you work for a company with a tax-deferred plan, a percentage of every paycheck can be deducted automatically from your pretax salary and invested in the plan. It’s typically deposited in mutual funds provided by investment firms, brokerages, banks and insurance companies. Many employers match a percentage of your contribution, a freebie no employee should pass up.

    In general, for-profit businesses offer 401(k)s; public schools, universities and other nonprofit institutions offer 403(b)s; and certain state and local governments provide 457s. (The names correspond to sections of the tax code.)

    According to Vanguard’s 2014 study “How America Saves,” workers in their mid-50s to mid-60s contribute an average 8.8 percent of their earnings to these plans. At 65 and up, they save 10.1 percent. As an annual goal, that may be too ambitious; still, try raising your current contribution by 2 or 3 percent (an amount that should be relatively painless when deducted automatically from your paycheck). Vanguard reports that women, mindful of their longevity, save a larger percentage of their pay than men at the same income level.

  • If you work for a company and meet certain income requirements, you can fund a personal IRA in addition to a company plan. The full IRA contribution ($5,500, or $6,500 if you’re 50 or older) is tax-deferred if your modified adjusted gross income in 2016 does not exceed $61,000 or, for married couples filing jointly, $98,000. You can earn more than those amounts and still open a personal IRA in addition to a company plan if you have freelance income on the side and use it to fund the IRA.

  • If you have no employee plan, you can open a traditional IRA. The same contribution limits mentioned above make an IRA stingier than the 401(k), but the tax break it offers should not be left on the table. Moreover, if your spouse has no earnings, you can make maximum contributions in both your names — as long as the amounts are covered by your earnings. Tax-favored retirement plans cannot be funded with unearned income (Social Security, pensions, interest, dividends or rent). If your part-time job pays, say, $4,500 per year, that’s where your contribution tops out.

  • If you’re self-employed and earn a substantial income, you can start a SEP-IRA (simplified employee pension, handled like an IRA) with a maximum contribution of $53,000 in 2015. If you work with your spouse, you can each fund a SEP-IRA. However, any employees who’ve worked for you at least three of the past five years must also be included in the plan.

If and when you change jobs, your plan travels with you. Your key objective is to preserve the tax umbrella over it. There are five ways to accomplish this.

1. If your new employer also offers a 401(k), you can transfer your money tax-free into the new employer’s plan. This option has the advantage of consolidating your retirement savings in a single account.

2. You can usually keep the old 401(k) if you like, as long as the balance is at least $5,000. The pros: You’re in a familiar investment; the fees may be lower than elsewhere; and you can usually make withdrawals without penalty if you’re between 55 and 591/2. The cons: There may be limits on how and when you can withdraw the money; the fees may be higher than at a no-load (no sales charge) mutual fund; you could lose track of the old 401(k); and an heir could miss out on tax advantages that might otherwise be available.

3. Most commonly, people transfer the money from the old plan, tax free, into a “rollover IRA.” There’s no limit on the amount you can roll. You can choose the IRA offered by your plan’s current administrator — an attractive option if it’s managed by a no-load mutual fund group such as Vanguard, Fidelity or T. Rowe Price; a discount broker such as Charles Schwab or TD Ameritrade; or a low-cost firm that specializes in retirement plans. Or you can roll your old plan into an IRA administered by a different firm, preferably one of those just mentioned. Definitely switch if your current 401(k) is invested with a firm whose advisers charge sales commissions, even if you don’t use those advisers. The IRAs of such firms often contain high-cost mutual funds. Also switch if you’re in a 403(b) or 457 plan whose only investment option is a fixed or variable annuity. And run away — fast — from the friendly “advisers” who call, email, mail and even visit your office with recommendations for your rollover account.

4. If you have multiple retirement plans, roll them together into a single IRA. Separately, they’re a pain to keep track of and likely add to your costs.

5. If you want to buy individual stocks (an imprudent move), roll your retirement plan into a self-directed IRA with a discount or full-service brokerage firm or financial adviser.

Note: The money you move should go directly from your old plan to your new one without passing through your hands. (Your new plan’s trustee will explain.) If the check goes to you, it’s counted as a taxable withdrawal unless you deposit it into your personal bank account, write a new check, and send it to the new plan within 60 days. Too much can go wrong, so don’t do it.

Should you convert to a Roth IRA? You can roll any amount of money from a traditional IRA, 401(k) or similar plan into a tax-free Roth IRA regardless of how much income you earn. There’s a cost to this transfer, however — perhaps a big one. You pay current income taxes on the money you move even though you don’t withdraw any of the cash.

You might want to switch to a Roth if: 1) You won’t need the money until your later age, if ever. 2) You plan to leave all or most of your Roth to your heirs and want them to receive it tax free. 3) You expect to be in the same, or higher, tax bracket when you retire, although you can’t know for sure. 4) You’re young enough that future growth in your investments could more than offset the cost of paying current income tax. 5) You can pay the taxes due from outside funds without having to tap your tax-sheltered retirement account.

For the average person, however, the size of the current tax from a Roth conversion might overwhelm any likely benefit he or she would get from future tax-free growth.

When there’s no more paycheck

So you’re officially retired? Congratulations — we think. Your income now will derive from many possible sources, including Social Security, pensions, and taxable savings and investment accounts, as well as the tax-favored plans discussed here. It can be hard to know which funds to tap when. Your goal is to make your collective nest egg last as long as possible. The key? Use it tax-efficiently.

The general rule is to spend taxable savings (money held in regular investments) before dipping into an IRA (our term here for your tax-deferred savings, since you’ve likely consolidated them in a rollover IRA). You should also tap your savings — taxable first, then tax-deferred — if doing so enables you to put off collecting Social Security until age 70, the point at which you will get the highest possible monthly benefit for life.

That said, there are times when you should tap your IRA first:

  • When you’re in a low tax bracket and your heirs are in a high one. The IRA money is worth more if you take it now.
  • When you want to shrink your IRA so that, upon reaching 70 1/2, your required withdrawals need not be large. This strategy could save you from paying higher income taxes on your Social Security benefits when IRA withdrawals start.
  • If you’re in the 15 percent tax bracket. You might want to withdraw money from the stock funds in your IRA, even if you don’t need the cash, and pay income taxes on it now. Then you can reinvest the money in stock funds in your taxable account. That way any further increase in their value will be taxed at the low capital gains rate.
  • If you have both taxable and tax-deferred accounts for long-term investments. Keep stocks in the taxable account. That way, any profits will be subject to the low capital gains rate. Taxable bonds, such as Treasury funds, belong in the tax-deferred account. Interest income is always taxed as ordinary income.
  • If you have both a Roth and a tax-deferred IRA. Normally, spend the latter first. The longer the Roth can grow tax-free, the better. But tap the Roth first if you’re in a high tax bracket and expect it to drop in the future.

(Originally published in The AARP Monthly Bulletin.)

AARP Article

Securing Income for Life

A bucket investment strategy may help savings last longer

We all know — or think we know — that the older we get, the more our money should be kept safe. We gradually hold less in stocks and more in bonds.

But is your caution risking your future? Yes, says Michael Kitces, director of research for the Pinnacle Advisory Group in Columbia, Md. On average, we’re living longer and not earning much on quality bonds and bank CDs, he says. If we huddle around investments that cannot grow, the risk rises that we’ll run out of money.

What if we reversed the conventional rule and gradually held more money in stocks, rather than less, after we retired?

When I first heard that idea, I said, “Nuts. High risk.” But as I read the new research, I changed my mind. It’s actually an approach that could make your retirement savings last longer and, potentially, leave more for heirs.

Lower your risk

Think of it as a “three-bucket” strategy, Kitces says.

In one bucket you hold cash to help cover expenses for the current year. That’s grocery money. Keep enough to pay bills not covered by other income, such as Social Security, a pension or part-time work.

In the second bucket, you own short- and intermediate-term bond mutual funds, with dividends reinvested. You gradually add to your bonds during your preretirement and immediate post retirement years. By age 60 or 65, these first two buckets might hold 70 percent of your retirement investments. Every year, you take money from the bond bucket to replenish your cash. If interest rates rise, you’ll be using your dividends to buy higher-rate bonds, which will partly offset your market losses. (Prices of existing bonds fall when interest rates rise.)

The remaining 30 percent of your money goes into the third bucket, invested in mutual funds that own U.S. and international stocks. You don’t expect to touch these stock funds for 10 to 15 years.

As time passes and you sell bond shares to pay your expenses, that bucket shrinks. The percentage of savings that you hold in stocks will gradually rise. You won’t have to sell when the market drops. In fact, your dividends will be buying you more stocks on the cheap. By the time your bond bucket runs low, your bucket of stocks will have grown in value, maybe by a lot. That’s money for your later years.

When withdrawing cash from your bond funds, follow the 4 percent rule for making money last for life. Start with an amount equal to 4 percent a year of all your savings (counting both stocks and bonds) and raise it by the inflation rate in each subsequent year. For example, say you have $100,000 — $70,000 in bonds, $30,000 in stocks. Your first withdrawal would be $4,000, and would rise from there. (If you take more than 4 percent, your savings might run out too soon.)

If your investments are mainly in a 401(k) or individual retirement account, it’s easy to switch between stocks and bonds. If not, you’ll have to consider taxes when you make a change or use new savings to bring the stock or bond bucket to the right size.

What makes this three-bucket strategy low-risk? First, your bonds secure your grocery money for at least 15 years. Second, if the market crashes when you first retire, you have only a modest amount in stocks and can afford to wait for a recovery. (People who sold after the 2008 crash came to regret it.)

Focus on growth

Wyatt Lee, portfolio manager for the mutual fund group T. Rowe Price, agrees that relying on “safe” investments won’t work. “You need a substantial amount of equities to maintain your income for life,” he says. Assuming a 30-year retirement, you’d spend half your money in the first 15 years and half in the second 15 years. The later money should be invested for growth.

Lee takes a more familiar approach — reduce your exposure to stocks as you age. But he starts out high. At age 65, he advises a stock fund allocation of 55 percent. Your 4 percent withdrawals would come from both stocks and bonds. At 75, you’d still have 42 percent in stocks. If a bear market hit just when you retired, you’d take a larger loss than with Kitces’ approach. You’d gain it back but might be more tempted to sell.

Follow Kitces or Lee. Either way, you can’t give up on stocks.

(Originally published by The AARP Monthly Bulletin.)

AARP Article

How to Financially Protect Your Spouse

When faced with decisions about pension benefits, shortsighted choices now can cause harm in the future

I had lunch recently with a friend whose husband, a teacher, retired five years ago. “We made a big mistake with his company pension,” she told me. “We took the wrong one.”

Pensions come in two versions — a larger check that covers only the lifetime of the person who earned it, and a smaller check that also covers the lifetime of his or her spouse. They chose the larger check to give themselves more money to spend. Now, they both wish they’d taken the version that covered her, too. The prospect of losing his pension income if he dies first has left her a little scared.

Unfortunately, that’s a common story — and not only for pension decisions. Caring partners each want the other to be financially protected, if left alone. But sometimes they make shortsighted choices or accidentally cut a spouse out of money that he or she needs by failing to submit the right paperwork. Here are four things couples should think about that can save a spouse from financial harm:

Leave a larger income

When will you start taking Social Security? A relative of mine, who retired (with pension) at 60 and now has a different and well-paying job, intended to take his Social Security at 62. When I heard that, I yelped. His wife has savings and a pension of her own, and they don’t need extra money now. If he waits until 66 to collect, his Social Security check will be 33 percent larger (plus inflation adjustments) than if he starts at 62. It will be a fat 76 percent higher if he waits until 70.

Money Matters

It’s common to say, “I’ll take Social Security at 62 so that, if I die early, I won’t have lost income that I should have had.” That could be a two-way mistake. First, if you’re healthy, you’ll probably live longer than you expect. By waiting to file for Social Security, you’re storing up extra income for your retirement’s later years. Second, married people shouldn’t think only of their incomes today. If the husband, say, was the main breadwinner, the longer he waits before collecting, the larger the income he’ll leave to his surviving spouse, if he dies first.

Check your individual retirement account beneficiary

Whoever you name on your IRA’s beneficiary form will get the money, whether it’s fair or not. Say that you divorced and remarried, named your new spouse as your heir in your will, but forgot to take your ex’s name off the IRA form. Your ex will get the money, even if the divorce decree said otherwise. You should clean up all your beneficiary forms when you divorce or marry, to avoid accidentally disinheriting a spouse.

Have the power of “I do”

Who will inherit the savings in your 401(k) or similar plans? Here, spouses have super-protection. When you marry, your spouse is entitled to every penny in your 401(k), from the moment you both say “I do.” That’s federal law. The beneficiary form is irrelevant, and so is your will. If you want a different outcome — for example, to leave part or all of your 401(k) to children of a previous marriage — you can ask your spouse to waive his or her rights. The waiver has to be in writing, notarized or witnessed by a plan representative, and filed with your plan.

This can’t be done in advance of the wedding — only a spouse can waive these rights. If you have a prenuptial agreement, it should include a promise to sign. And get thee to a notary right after the honeymoon or even before. In my personal case, there was a notary at the ceremony. My lovely husband signed even before the music struck up.

Guarantee lifetime benefits from a variable annuity

These annuities combine an investment with a guaranteed lifetime income. But the income normally lasts only for the buyer’s lifetime and ends if he or she dies. Any spousal benefits might cover only the annuity’s current investment value or a death payout, says annuity expert Kevin Loffredi, a vice president of investment research firm Morningstar. If you want the annuity to cover both lives, you generally have to pay more or accept a lower income guarantee. Couples often don’t realize that their annuity cuts out the survivor, says Mark Cortazzo of annuityreview.com, which evaluates variable annuities. Some salespeople also have no idea. If you venture into one of these complex contracts, think “spouse first.”

(Originally published in The AARP Monthly Bulletin.)

AARP Article

Divorce after 50 Will Cost You Money

As gray divorce surges, more 50+ people prepare for a leaner life

Families and friends are often shocked when long marriages — including long, bad marriages — fall apart. You endured each other for 30, even 50, years, so why give up now?

I’d say it’s for all the reasons that younger people divorce. The partners bore each other, harbor grudges, seek a different kind of life or fall in love with someone else. Being surprised at gray divorce strikes me as a form of ageism — as if one or the other of a couple (perhaps both) are somehow too old for disappointment, folly or hope.

Whatever the reason, older couples are definitely doing it. The divorce rate among people 50 and older doubled between 1990 and 2010, at a time when the rate for the general population was pretty flat. As an age group, they accounted for roughly 25 percent of all 2010 divorces, according to a study by Susan Brown and I-Fen Lin of the National Center for Family & Marriage Research at Bowling Green State University in Ohio.

A greater willingness to end unhappy marriages suggests that older couples today have more financial resources to fall back on. People usually have to see a way forward financially, no matter how slim, before splitting up. Women, in particular, are more apt to have paychecks and 401(k)s.

How the property is divided depends on state law and your personal negotiation. The starting place, after long marriages, is half the money for each. You can roll your share of your ex’s individual retirement account into an IRA of your own, tax-free. The same is true of a 401(k) or similar plan. If there’s a traditional pension, you can choose a lump sum or a portion of each monthly lifetime payment when your ex retires. Attorney Maria Cognetti, president of the American Academy of Matrimonial Lawyers with a practice in Camp Hill, Pa., advises dependent spouses to take the monthly payments if they don’t know much about investing. The lump sum might not last as long as they thought.

If the amount of property is modest, dependent spouses, usually wives, will probably get alimony. Cognetti advises women to try to settle their claim in negotiation, even if it’s for a little less money than they want. That provides certainty. You don’t know what a judge will decide in court.

When estimating your budget as a single person, take a deep dive into your Social Security options. If the marriage lasted at least 10 years, you can collect on your ex’s account. Spousal benefits can be claimed as early as age 62, provided that your ex has filed for benefits, too. If not, you can claim if your spouse is eligible for benefits and you’ve been divorced for at least two years, says Robin Brewton of SocialSecuritySolutions.com. Note that filing at 62 locks you into a lower check. You’d do better by waiting until your full retirement age, probably 66. If your ex dies, you can collect survivor’s benefits.

However you slice it, life will likely be financially leaner for you both. That’s divorce’s bottom line — at any age.

(Originally published in The AARP Monthly Bulletin.)