Personal Finance: Another Perspective

Personal Finance: Another Perspective Retirement Planning 5: Questions and Answers

Questions 1. What are some strategies for the Accumulation stage of retirement? 2. What are some strategies for the Retirement stage of retirement? 3. What are some strategies for the Distribution stage of retirement? 4. How do I determine the taxable / retirement split from the hourglass? 5. Why do I have to look at all the details with mutual funds. Can’t I just use the Morningstar Star rating to pick my mutual funds?

Questions (continued) 6. What are the tax implications of the different between the Roth and the traditional IRA/401k/403b? 7. Should I have and use both traditional and Roth retirement vehicles in my retirement plan? 8. What is the most important thing I can do now to prepare for retirement?

1. Strategies for Accumulation • What are some examples of possible strategies for the “Accumulation” stage of retirement? • 1. Live on a budget and save 20% of everything you make after school • Of that 20%, put half or 10% into retirement vehicles for your retirement • 2. Follow the priority of money (for saving and investments) • Get free money first, then tax advantaged money (tax eliminated and tax deferred), and then tax-efficient and wise investing

Accumulation (continued) • 3. Depending on your tax and investing views, maximize the amount of money in Roth vehicles versus traditional retirement vehicles • Put as much new money as possible into Roth vehicles • With sufficient money saved in Roth vehicles, you can plan for and minimize your taxes during retirement

2. Strategies for Retirement • What are some examples of possible retirement strategies for the “Retirement/annuitization” stage of retirement? • 1. Determine your minimum acceptable level of retirement income (your survival amount) • Try to get that part of your monthly expenses annuitized, i.e., paid to you each month for life • The process is: • a. Determine how much money you will have with Social Security each month • b. Determine any funding you will have from defined benefit plans each month

Retirement (continued) • c. Determine the difference between these amounts and your minimum acceptable level of retirement income, and obtain an immediate annuity at retirement that would give you that amount • That way you will have your minimum amount for living expenses covered for the rest of your life • Then, depending on the size of your retirement assets and your risk levels, you can annuitize more if you have a lower risk tolerance, or annuitize less, if you have a higher risk tolerance

Retirement (continued) • 2. With your spouse, determine how to take your distributions from your retirement accounts • Work first to annuitize sufficient to give you your minimum survival level discussed earlier • Make sure you use wisdom and judgment in your decisions • Invest the remainder consistent with your risk level

3. Strategies for Distribution • What are some examples of possible “Decumulation / Distribution” strategies for the decumulation stage of retirement? • 1. Use money from your deferred retirement accounts first, until you get to a target level for taxes to be paid • Additional money beyond your target level of taxes can be taken out of your Roth (tax eliminated) vehicles tax free. Use them wisely • 2. If you are required to take minimum distributions from your tax-deferred accounts and you don’t need the money, you can roll those distributions into another qualified plan, i.e., another Rollover IRA without taxes or into a Roth IRA

Distribution (continued) • 3. Watch the percentage of your total portfolio that you take out each year, i.e., your distribution percentage. • If you take out a maximum distribution of 3.5%-3.9% of your portfolio each year (or less), your money is more likely to last your lifetime • 4. Use the time on your missions to transfer money from your tax-deferred accounts to Roth accounts • If you are under the income limits, you can transfer funds to a Roth at a low level of taxes

Distribution (continued) • 5. While it is important to help your kids who are having financial problems, realize that your first priority is to take care of you and your spouse and to make sure you have the financial resources to do that adequately first during retirement • Make sure you plan to cover your medical costs and expenses and the impact of inflation • Once you are set up well financially, then worry about your children’s finances • They are responsible for their own finances • Parents who continually help their adult children financially will find their adult children always need help

4. How do I Determine the Taxable / Retirement Split? • The split between taxable and retirement assets is determined by: • a. Your personal goals, and • b. Your available retirement vehicles • Personal goals might be: save 20%, and half or 10% goes into retirement vehicles; build your emergency fund; save for children’s education and missions, etc. • The goal would determine the category: retirement (retirement), missions (taxable), education (retirement), down payment (taxable), etc. • Note that education funds are similar to retirement in that you cannot take out the funds without a penalty

Taxable / Retirement Split? • Available retirement vehicles are based on what you are able to invest in. This is determined by whether you have a qualified retirement plan (QRP) currently at work and whether your current income is within IRA deductibility limits. • With a QRP and within 2012 IRA limits: You can put up to $17,000 per year into a QRP (401k/403b/457 Plan) and up to $5,000 into an IRA. • Your spouse can also contribute up to $5,000 into an IRA account • With QRP and outside IRA limits: You can contribute up to $17,000 to the QRP • You nor your spouse can contribute to an IRA

5. Why do I have to pick funds? Can’t I just use the Morningstar “star” rankings? • Some investors use Morningstar and other newsletters to do their homework for them. Shouldn’t that be enough? • Morningstar ratings are backward looking, i.e., they use historical data • Research has shown that the rankings have no predictive value for future performance • Funds with 4 and 5-star ratings typically have the highest inflows of assets. With more assets, it is harder to put all this new money to work effectively

Morningstar Star Ratings • 10 Year Results of Morningstar Ratings • Data • Of 248 stock funds rated 5-star in 1999, only 4 kept that rank after 10 years (1.7%) • Of the 218 domestic stock funds rated 5-star in 1999, all typically lagged behind their category averages and benchmarks over the period • Results • 5-star funds typically do not continue to lead their peers—they typically do worse • Use this ranking at your peril

Morningstar Star Ratings • We know the principles of successful investing: • Invest low cost, tax efficiently, be diversified, know what you invest in and who you invest with, invest long-term, etc, • Ratings should be one tool of this analysis—but only one tool • If you will follow the principles taught in this class, you will do a lot better than those who blindly follow Morningstar or other star rankings • See Sam Hamudi, “Investors have Stars in their Eyes,” Wall Street Journal, June 1, 2010, p. C7.

6. What are the tax implications between the Roth and traditional vehicles? • The tax implications are: • With the Roth you pay taxes upfront and outside of the retirement vehicle • You get no tax deduction now for assets to be put aside or saved for retirement • The benefit is you will have to pay no future taxes on assets in these vehicles • This includes no taxes on earnings, capital gains, interest or dividends • Now, regardless of earnings type, you will pay no taxes on these assets. Therefore, put your highest tax assets in these vehicles • Requires no minimum distribution

Tax Implications of Roth’s (continued) • With the traditional 401k/IRA/403b, you get an exclusion from total income now • This reduces your total income so you pay no taxes on the amounts in qualified plans • However, when you take the assets out at age 59½ for retirement, they are: • Taxed as ordinary income • This in essence converts long-term capital gains (which they likely were) into ordinary income, which is taxed at the highest rate • Requires minimum distributions after age 70½

7. Should I have both tax eliminated and tax deferred assets in my retirement plan? • Is there logic for having both traditional and Roth retirement vehicles in your Plan? • Yes. The US tax system is progressive. As you tax out more assets from your tax-deferred retirement vehicles you are taxed at a higher rate • However, for the first $17,400 in 2012 you are taxed at only 10%, and only 15% between $17,400 and $70,700 • By having both traditional and Roth vehicles you can manage your tax rates to a target percentage first, i.e., 10%. Then any additional funds can be taken from your Roth vehicles to ensure a low effective tax rate

8. What is the Most Important Thing I can do Now to Prepare for Retirement? • What is the most important thing I can do now? • Realize that you cannot spend your way to a successful retirement. It is critical that you begin saving now! Assume a $2 million goal at 8%. To save for this goal for the following years you would need to put the following amounts away each month: Years Till Retire Amount Years Amount • 40 Years $573 35 Years $872 • 30 Years 1,342 25 Years 2,103 • 20 Years 3,395 15 Years 5,708 • 10 Years 10,932 5 Years 27,219 • 1 Year 160,644

Most Important Thing to Do: Begin Now The key is to make it a priority and to start now!

Personal Finance: Another Perspective