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Retirement Planning: Paying for Unexpected Expenses in Retirement

How to Pay for Unexpected Expenses in Retirement without Blowing Up your Financial Plan.

As a Certified Financial Planner™ I create retirement spending plans for a living.  The plans I create strive to re-create the feeling of a “salary” for my retired clients.  We identify a sustainable distribution strategy based on their resources and their needs, then make sure that the income is distributed on a monthly basis.  We revisit the retirement plan periodically to make sure that funds are not depleting too quickly.  It can get a lot more complicated than it sounds, but that’s the idea.  Such plans work very well for most people, most of the time.

However, let’s not kid ourselves – retirement planning is very different than being on a salary at work.  For one thing, there is that big pool of money sitting out there.  And sometimes it starts singing the siren’s song – “Spend me!  Spend me!”.  And the song becomes especially enticing when large and unexpected expenses come up.  It is all too easy to simply tap the retirement funds and make the need go away.

But there are two problems with this approach.  The big one is taxes.  If you are in the 25% tax bracket (and let’s say 5% state tax bracket) then you need to withdraw $13,000 to cover a $10,000 need.  And you might even kick your income up to the point where you have to pay an even HIGHER tax rate.

The second issue is sustainability of assets.  Let’s say your detailed financial plan computed that you can sustain distributions of $3,000 per month.  Combined with your pension and social security, your annual “income” in retirement was planned to be $85,000 – let’s say this is just a little less than what you were earning before you retired.   According to the plan, if you earned a modest return, and allow for a modest inflation adjustment, your money would last for the rest of your life if you followed this strategy.

But what happens if you start making unplanned withdrawals?  You not only have to pay taxes, but that money is no longer working for you, earning interest and dividends to fuel future distributions.  That $13,000 over a 25 year retirement at a 3.5% yield would have generated a total of $11,375 in additional income.  Once it is removed from the account, it is no longer generating income, which means your future distributions will be more principle, less earnings.  Your account will deplete faster.

OK, you say, but I need $10,000 for a new roof!  What do I do? 

The question is – what would you have done BEFORE you retired?  Maybe you would have been maintaining an emergency fund.  Good idea to maintain one in retirement – and this would be a fine solution to the problem.  If you happen not to have cash set aside, you may have taken out a home equity loan.  So…why not do this in retirement?

What?  Carry a mortgage in retirement?  Does that really make sense?  Well, maybe it does.

I ran the numbers to compare two scenarios.  In the first case, you withdraw $13,000, pay $3000 in federal and state taxes to get the $10,000 you need.  Total cost:  $3000.

In the second scenario, you take out a home equity line of credit and borrow the $10,000.  Based on your monthly retirement cash flow you figure you can pay the loan back over 5 years making payments of $186 per month.  Assuming a 3.9% loan (about average right now) you would pay a total of $1199 in interest over the 5 years.  But more importantly, that $13,000 is still in your retirement account, earning money to help sustain your future distributions.

In summary, a sound plan will have built in sufficient extra cash flow to allow for some unexpected monthly expenses.  So it might be best to pay for those expenses out of that same monthly cash flow, rather than taking large, tax-expensive “one time” distributions.

Don’t have a plan?  Find a FEE ONLY financial advisor near you at www.napfa.org.

An Online Makeover for Financial Pathways

You may have noticed a new look to the blog, but that’s not all that’s new on our website. Financial Pathways entire website has had a major makeover. We’ve been working closely with Roland Reinhart of Reinhart Marketing on the facelift. While you are here anyway, why not take a look, let us know what you think.  Better yet, share with your friends!  Use the Like buttons below to share the page with your friends and online contacts.   Let them know that you value what we do!

Ten Reasons You Need a Financial Plan

A Sound Plan Can Answer Important Questions about Your Financial Life

I may be biased (ok, I AM biased…), but I think everyone needs a financial plan.  And most people would benefit from having a professional plan created by a Fee-Only Certified Financial Planner™.  What does a plan do for you?  Quite simply, answers all the financial questions that lead to uncertainty and stress in your life.  Here is a short list of questions most commonly addressed in the plans we create for our clients. 
10 Reasons you need a financial plan - Certified Financial Planner James Kinney

  1. Am I Saving Enough?  For College?  For Retirement?  The goal of “I want to retire in comfort” or “be financially secure” is difficult to define with any precision.  What does that mean in terms of dollars and cents?  What does it mean you should be doing TODAY?  Your financial plan turns fuzzy goals into concrete measurable objectives.
  2. When Can I Begin to “Slow Down”?  Not everyone defines “retirement” as the end of all paid employment, but almost no one I know over the age of 60 envisions a future involving long hours at the office for the rest of their lives.  So how long DO you need to keep running in the rat race?  Your plan clearly defines the possible
  3. Are my Investments Allocated Appropriately?  Remember 2008?  Retirement hopes and dreams were dashed as folks who were almost ready to retire saw their equity-heavy nest eggs decimated by a crashing stock market.  Fast forward to 2014 and many investors are still skittish, but finding that sub 1% money market returns don’t provide the income and growth they need to fund retirement.  We help our clients find their own ideal balance between investment risk and the returns they need to achieve their goals.
  4. Am I adequately insured?  Is your family protected if you die?  What happens to your finances if you can no longer work for a living due to injury or illness?  If you or your spouse needs chronic long term medical care?  If you are sued?  Your plan includes a thorough review of insurable risks, and suggests action where appropriate.
  5. How do I make the most of my employer pension and Social Security?  Choices you make when claiming your pension and social security benefits can be worth tens of thousands of dollars over your lifetime.  Married couples in particular should not take these choices lightly!  Your financial plan can help you get the most out of your government and employer benefits. 
  6. What can I do to minimize my state and federal taxes?  Planning ahead can save you tens or hundreds of thousands of dollars in taxes over your lifetime.  Taxable accounts, tax deferred accounts, annuities, tax free investments, Roths – your plan ensures that all of these tools are utilized in an optimal manner throughout your lifetime to keep your money in your pocket (instead of the governments).
  7. Is my current lifestyle sustainable?  Sometimes we build a lifestyle – homes, cars, vacations that we have become accustomed to – only to discover that the resulting expenses prevent us from preparing for the future!  Do you have more house than you can afford?  Are you spending too much, not saving enough?  A financial plan strives to establish a consistent lifestyle that can be enjoyed based on available resources throughout your life.  Sometimes small changes today are needed to avoid a major crash later in life.
  8. How Do I Use My Retirement Savings to Replace Income in Retirement?  You save your whole life so that you can support yourself in retirement.  When the time comes, you don’t want to squander your precious resources.  Your financial plan provides a year by year plan for distributing assets in retirement, along with a Retirement Income based investment strategy based on your own individual needs.  Regular annual reviews and adjustments help make sure that you do not run out of money.
  9. If something happens to me, what happens to my assets?  When was the last time you met with an attorney to review your will?  What does it say?  What if you are unable to manage your own affairs due to illness or disability?  Are your wishes regarding medical care laid out?  Are your assets titled correctly, consistent with your wishes and provisions in your will, and in a manner that will minimize taxes to your heirs?  Your plan considers many estate planning issues you might never even have considered!
  10. What if Things Don’t Go According to Plan?  A sound plan recognizes that things will most likely not go according to the plan.  There should be built in cushions – in case income is less than expected.  In case investments don’t perform.  In case cost of living is higher than planned.  In case of major medical or other unexpected expenses.  Monitoring the plan on an ongoing basis is important.

Financial Pathways is a NAPFA registered Fee-Only advisor.  A fee-only advisor sells only advice, not product.  So your plan will always be based on your own best interest!  To learn more about the fee-only difference, visit www.napfa.org.

James Kinney, CFP, accepted into National Association of Personal Financial Advisors (NAPFA)

Local Financial Advisor Joins Leading Association of Fee-Only Financial Planners

James Kinney, CFP® of Financial Pathways accepted for Membership in the National Association of Personal Financial Advisors (NAPFA)

ARLINGTON HEIGHTS, IL.  James Kinney, Certified Financial Planner™ and founder of Financial Pathways of Bridgewater NJ has been accepted for membership in the NATIONAL ASSOCIATION OF PERSONAL FINANCIAL ADVISORS (NAPFA).  With membership, Kinney becomes affiliated with an organization of more than 2400 of the most qualified financial advisors in the nation who deliver objective, Fee-Only advice.

Membership in NAPFA and the NAPFA-Registered Financial Advisor designation are available only to Fee-Only financial advisors who meet NAPFA’s stringent membership qualifications.  Those standards require advisors to receive compensation only directly from their clients, to act in clients’ fiduciary interests at all times, and to provide comprehensive planning services.  In addition, NAPFA has some of the industry’s most rigorous education and training requirements.  All candidates for membership are required to submit a complete comprehensive financial plan for a full-scale peer review.  Furthermore, NAPFA’s continuing education requirements exceed those of any other association of financial advisors.

“I congratulate Jim for demonstrating his dedication to provide effective, transparent, client-centered services by upholding the high standards that NAPFA sets for all its members,” said NAPFA chair Linda Leitz.

In contrast to most financial professionals, NAPFA members receive no commissions or other rewards for selling financial products.  Those forms of compensation create potential conflicts of interest that may serve to undermine an advisor’s objectivity and fiduciary responsibility.  It is for this reason that all NAPFA members must sign the Fiduciary Oath that explicitly promises to “place the clients’ interests first.”

Ms. Leitz continued: “By offering true fiduciary care to our clients, NAPFA members are leading the charge toward a financial planning community that rivals other professionals in its desire and ability to foster consumer trust.  We welcome Jim to our ranks and look forward to his contributions to our organization.”

For more information about Fee-Only financial planning and NAPFA visit www.napfa.org or call toll free 1-800-366-2732.

About NAPFA.  Since 1983, The National Association of Financial Advisors (NAPFA) has provided Fee-Only financial planners across the country with some of the strictest guidelines possible for professional competency, comprehensive financial planning, and Fee-Only compensation.  With more than 2400 members across the country, NAPFA has become the leading professional professional association in the United States dedicated to the advancement of Fee-Only financial planning.

About Financial Pathways.  Financial Pathway Advisors, LLC of Bridgewater New Jersey has been providing comprehensive financial planning, advice, and investment management services to individuals and families in central and northern New Jersey since 2007.  Financial Pathways is a Registered Investment Advisor with the State of New Jersey Division of Banking and Securities.  Learn more about Financial Pathways at www.financialpathways.net.

What percentage of my salary should I save in my 401k?

A recent topic of conversation was “What percentage of my salary should I save in my 401k?”

I originally answered this on NerdWallet.com…

It is often suggested that people who save 10% of their salary throughout their career will be well positioned for retirement. I tend to agree, with caveats. (some say the number should be 15%). But how much YOU should save depends. If you are 45 years old and have never saved before, YOUR number will be much higher because you have lost ground to make up. If you have a generous employer pension (there are still a few) – then your number will be less than someone who needs to rely entirely on their own savings.

“Saving as much as you can afford” can be good advice, but leaves open the possibility of a “cop out”. If you really should be saving 15% of your salary, but are unwilling or unable to make the necessary lifestyle adjustments, it is then too easy to say “I am only saving 5% – but its ok because it is as much as I can afford”.

Best bet is to spend a little time with a Certified Financial Planner(tm) to talk about your lifetime financial plan, then make decisions based on an objective and permanent plan.

Another useful guideline was developed by Fidelity. It said a person should have saved 1 times salary by the time they are 30, 3 times by 40, 5 times by 50, and 10 times salary by the time they retire. It is an intesting rule of thumb (as with most such rules, there are limits to its usefulness).

James Kinney, CFP

Quoted in the WSJ? How Cool is THAT?

I often share some of what I feel are my more useful blog posts with financial self-help sites.  I recently shared my post on Retirement Savings Rules of Thumb on Nerd Wallet. Low and behold, a few days later I find myself quoted in no less prestigious an industry publication than the Wall Street Journal.  Now that is really cool.

Reflections On Ten Years of Planning

2014 represents my 10th year in the financial planning profession.  My how time has flown!

In 2004 I had just recently sold my interest in Shore to Shore Inc., a successful business venture which had occupied me for the previous 13 years.  Thanks to the proceeds from the sale of that business I was faced with a marvelous opportunity – I had the luxury of time in the middle of my life to sit back and say “what do I really want to do with my life?”  What a rare blessing that turned out to be!

When I sat back and envisioned my future, I had two thoughts.  One, I always wanted to teach.  Two, I wanted to help individuals with their problems, rather than work in the corporate world.  Teaching turned out to be easy.  I was quickly able to land adjunct gigs with local universities teaching business courses, so I quickly got that out of my system.  I toyed around with going back to school for a PhD and pursuing a career in academia, but upon further research and inquiry decided that was not for me.

Fate often provides the answer that we we don’t clearly see for ourselves.  A friend in town (who happens to be a CFP) invited me to breakfast one day and suggested I come and join his financial planning practice.  I had experience growing a business, had a sound financial background – if I could help him get his business on a growth track, he would teach me the ins and outs of the planning business.  I took him up on his offer and the rest is history.

I worked with Peter for about two years, helped him build a state of the art website, helped clients with planning work, streamlined some business operations, and went back to school to prepare for my CFP certification.  After some time however, we decided to part ways.  In January of 2007 I started Financial Pathways with a handful of clients, a couple million dollars in assets under management, and a vision of how financial planning ought to be done!

About two years later, I get an email from a stranger asking if I had any opportunities for a Certified Financial Planner looking to make a career change.  I didn’t think I did, and although I brush off calls like this all the time, something made me say “we can always talk”.  That conversation led to my adding Luba Globerman to my team – after working together successfully for a year or so I offered her a partnership in the firm, a decision I have never regretted.

Forward to the dawn of 2014 – Financial Pathways continues to grow.  We have almost $21 million under management (almost 10 times the tiny portfolio I started the firm with in 2007). We remain committed to those same values that I brought with me to the firm:

1. Financial planning and advice should never be confused with a sales pitch!

2. Everyone can benefit from financial planning, not just the very wealthy.

And I can say without any doubt that this path was the best choice I could ever have made.  I love my clients, and I truly enjoy helping them solve their financial problems.  Every day brings new challenges and new opportunities, new people to help.

So what’s next for Financial Pathways?  Starting in 2014 Financial Pathways will be strictly fee-only in compensation structure – we will no longer accept ANY commission payments or incentives from financial product firms.  While we have always put our clients interests ahead of our own when we offer advice, this will drive home our commitment, particularly to prospective clients, that we do not harbor any hidden vested interests. We are currently in the process of applying to the National Association of Personal Financial Advisors (NAPFA) for membership in their organization of fee-only Certified Financial Planners(tm).

I would like to take this opportunity to thank my clients – especially those early clients who have been with me for this entire journey – for your faith and trust!  I should also thank my wife for supporting me again when I went to take this plunge into unknown territory 10 years ago.  And most of all, very special heartfelt thanks to Peter Passalacqua of Frontier Financial Planning for so unselfishly sharing his wisdom and experience with a rookie upstart.  Without his support none of this would have been possible.

The Last Shall be First and the First Shall be Last

No I am not quoting the Bible.  This is simply a testament to how fast markets can change their tune.

Last year was a gangbusters month for owners of U.S. and developed market stocks.  Other investments from real estate to bonds to precious metals and emerging market stocks turned in a “fair to middlin” to downright awful performance.

No sooner did we turn the page to a new calendar year than the market seemed to change its tune.  Suddenly, all that was considered “untouchable” last year became the place to be – and stocks seem to have lost their luster.

Consider the following chart showing the results of various investment classes:

Investment

2013

2013 rank January January Rank
Real Estate Investment Trusts

2.42%

6

4.24%

1

Gold

-28.09%

11

4.09%

2

Utility Stocks

13.02%

4

2.97%

3

Preferred Stocks

-0.59%

8

2.60%

4

U.S. Total Bond Market

-2.14%

9

1.64%

5

U.S. High Yield Bonds

5.89%

5

0.59%

6

Small Cap Stocks

36.07%

1

-3.10%

7

Emerging Market Bonds

1.56%

7

-3.15%

8

Large US Stocks

32.31%

2

-3.46%

9

International Developed Mkts

22.12%

3

-4.62%

10

International Emerging Mkt Stocks

-3.14%

10

-6.61%

11

(results are estimates derived from proxy invesments and are not intended to offer precise measurement)

Note that of the top 5 investment classes in January, 3 were losers in 2013.  And the others (REITs and Utlities) were highly volatile and largely unfavored by investors.

Further it is interesting to note that the top 3 investments for 2013 are all near the bottom of the list, with negative returns, in January.

So what can we learn from this?  Well, it doesn’t tell us anything about the future, except that market sentiments can change on a dime.  This is why making investment decisions based on what the market did yesterday, last month, or last year is a bad idea.

It also goes to show how prevailing sentiment can often be dead wrong.  You would have been hard pressed to find an “expert analyst” in December who would have been willing to predict that U.S. bonds would be one of January’s top performing investment classes.  Almost to man they were preaching “avoid bonds because the improving economy will cause the Fed to reduce bond purchases and interest rates to rise”.  Well, they were right about the Fed reducing bond purchases, but nonetheless, interest rates are DOWN and bond prices are UP!   Now will the bond doomsayers ultimately be justified in their fears?  Possibly, but only time will tell.

Oh, and for the observant who noted that “the last is still last” – congratulations!  You have seized on the markets boogy man du jour.  The emerging economies are having “issues” and that is one of the primary problems facing the global stock market last month.  China’s growth is slowing while they try to reduce financial risk in their economy.  Brazil, Argentina, Turkey, and South Africa are facing serious financial and economic challenges.  Thailand is in political turmoil, and with the Federal Reserve moving to turn off the money spigots, there is increasing fear that money flows into the emerging markets will dry up.  At this time, only maybe Turkey and (perrenially) Argentina might rise to the level of crisis, but the market is worried that problems will escalate and morph into contagion.

So the financial planning lesson of the day – remain diversified.  Sure stocks are down in January – but lots of other investments did just fine (as long as you were in them).   Don’t become so enamored of stellar returns in a single market segment (like stocks) that you lose sight of the risks.  Always remember that what goes up the fastest is often the fastest to fall when sentiment changes, and what is underperforming today may be tomorrows superstar.

Beneficiary Designations for Children

Correctly designating retirement account beneficiaries is an often overlooked but critical part of your comprehensive financial plan.

If you may have a sizable amount of assets in your retirement accounts at death, how you designate the beneficiary on those accounts can have important consequences to your heirs.

If you have minor or young adult children, it might not be the best idea to name them as direct beneficiaries for the following reasons.

  1. Minors cannot legally own the asset until they reach the age of majority.  The asset must be controlled by a custodian until the child is of legal age.

 

  1. Very few 19 or 21 year olds are going to be wise stewards of their own money.  Unless you trust your children to spend the money wisely, it might be a good idea to put a few “strings” on their inheritance.

Parents get around these issues by making sure their retirement account beneficiary designation is working together with provisions in their will regarding distribution of assets to children.  When parents create wills they often create a trust which will control the disposition of the assets until the children reach a designated age.  The actual trust isn’t created until after death, and is often referred to as a “testamentary” trust or an “estate trust”.  All assets left to the children go into that trust, to be controlled by a close relative or trusted person, until the children reach a given age (often 30 or 35).

If your will has such a provision (and it is very common) it is critical that you name the trust, not the children, as the beneficiary (or contingent beneficiary if you are married).  If you name your children directly, the money will go to them directly (upon reaching majority) REGARDLESS OF WHAT YOUR WILL MAY SAY!   If you do not name a beneficiary at all, the IRA will go into your estate.  While that will result in the trust receiving the assets, there may be a significant and unfavorable tax consequence.

Unlike other inherited assets, the money in an inherited IRA will be subject to income tax (when the money is removed).   If you leave your IRA account to a named (human) beneficiary, they are allowed to take taxable distributions from the inherited IRA gradually over their entire life expectancy.  But if no beneficiary is named at all, the IRA will go into your estate by default.   If this happens, all the money will have to be distributed to your heirs (as taxable income) within 5 years.

This can be tricky legal ground.  Just having a trust provision in your will may not be enough to qualify for favorable lifetime distributions.  There are very stringent and specific guidelines from the IRS regarding the nature of a trust in order for it to qualify.  A qualified estate attorney can make sure that the trust as described in your will qualifies for favorable tax treatment.

What if you don’t have a will at all?  Get one.  How urgent is the issue?  If you are a single parent, you need to be especially careful about estate planning, and that goes double in cases of divorce.   If you are married and your spouse is primary beneficiary, this only becomes an issue if you both were to die at the same time.  However, this may not be a good reason to ignore the issue.   After the first spouse dies, it would be important for the surviving spouse to immediately update all their account beneficiaries – and this may not be a top priority at the time.   So it is far better to have your “ducks in a row” while you are still of sound mind and body.

Estate planning is a critical piece of your comprehensive financial plan.   Have any questions about your own arrangements?  Give us a call.  We can look over your current arrangements and make sure all your documents are working together toward the same objective.

Note that we provide financial, not legal advice.  We are not attorneys.  We can refer you to a qualified estate attorney for any legal work that may be indicated.

 

Be Careful Using Obamacare Subsidies!

I had a long conversation with John Perez at Kaufman Diamond CPA’s regarding the tax implications of Obamacare.  During that conversation, he pointed out a substantial danger to individuals buying insurance on healthcare.gov.

When you fill out an application for insurance, the system asks you to estimate your income for 2014.  If your income is low enough, the system will provide a subsidized price.  The subsidy deducts the presumed value of a tax credit that the individual will receive at the end of the year from the price of the insurance.

The problem is that the government in effect is giving you a tax credit IN ADVANCE based on your ESTIMATE of 2014 income.  The danger comes if an individual estimates their income too low – they may find that they do not qualify for that tax credit when they file their taxes in 2014.  If that happens, the government is going to demand that the subsidy be repaid in full.

This will be a crushing and devastating reality to many people – especially those in sales and business owners who find it difficult to estimate their income a year in advance.  The numbers are huge – subsidies for a family plan may be $700-800 a month – imagine filing a tax return at the end of the year and being told you owe the government $10,000!

So if you are using the health care exchange – PLEASE be very careful how you use the subsidies.  And please be very aware of the fact that if your income ends up being higher than projected, you may owe Uncle Sam a whole bundle of money next April 15 – so plan ahead!