The Widow’s Guide to Social Security Benefits (via Credit.com)
As a Certified Financial Planner™, I work with a lot of widows trying to navigate the tricky world of Social Security benefits after their spouse passes away. Social Security provides you, as a widow, with a choice between your own Social Security benefit based on your work history, and a survivor…
Jane M. Young, CFP, EA
When investing in mutual funds it is important to be aware of the associated fees. High fees can significantly impact your total investment return. All mutual funds have operating expenses and some have sales fees, commonly known as a load. When you invest in mutual funds you have a choice between load and no-load funds. A mutual fund load is basically a commission charged to the investor to compensate the broker or sales person. As the name implies, no-load funds do not charge a sales fee.
The first type of load fund is an A share fund, where you pay a front end sales charge plus a small annual 12b-1 fee. A 12b-1 fee is a distribution fee that covers marketing, advertising and distribution costs. The typical front-end load is around 5%, but can go as high as 8.5%. Class A shares offer breakpoints that provide you with a discount on the sales load when you purchase larger quantities or commit to making regular purchases. The 12b-1 fee associated with most A shares is generally about .25% annually.
The second type of load fund is a B share, where you pay an annual fee of around 1% plus a contingent deferred sales charge (CDSC), if you sell before a specified date. The CDSC usually begins with a fee of 5% that gradually decreases over five years. After five years or so the fund converts to an A share fund. The actual percentages and timeframes may vary between fund families. Most mutual fund companies have stopped offering B share funds because they are usually the most expensive option for the investor and the least profitable option for the mutual fund company.
The third type of load fund is a C share that charges a level annual load, usually around 1%. This is on-going fee that is deducted from the mutual fund assets on an annual basis.
Generally, any given mutual fund can offer more than one share class to investors. There is no difference in the underlying fund. The only difference is in the fees and expenses that the investor pays.
All load and no-load mutual funds charge fees associated with the operation of the fund. The most significant of these expenses is usually the management fee which pays for the actual management of the portfolio. Other operations related fees may include administrative expenses, transaction fees, custody expenses, legal expenses, transfer agent fees, and 12b-1 fees.
These annual fees are combined and calculated as a percentage of fund assets to arrive at the fund’s expense ratio. The expense ratio is an annualized fee charged to all shareholders. The expense ratio includes the fund’s operating expenses, management fees, on-going asset based loads(C shares) and 12b-1 fees. The expense ratio does not include front-end loads and CDSCs. According to Morningstar the average mutual fund expense ratio is .75%.
Jane M. Young CFP, EA
It’s time to move but you hate to sell your house when the market is down. Maybe you should rent your house for a few years? Or, on second thought, maybe not.
There are many factors to consider before deciding to rent your home. Do you have the temperament and the time to be a landlord? Are you comfortable with the idea of having someone else living in your home? Do you want to manage the rental yourself or do you plan to hire a property manager? If you manage the property yourself do you have time to learn about fair housing laws, code requirements, lease agreements, escrow requirements and eviction procedures? Who will take care of repairs and maintenance and are you ready for tenant calls in the middle of the night? If this sounds a bit daunting, a property manager may be your best option. A property manager will cost you about 10% of the rent. Be sure to include this in your cash flow analysis.
Before renting your home do a realistic cash flow analysis. Add up your projected expenses and deduct them from your projected rental income to see if renting will result in a profit or a loss. If you project a loss, does your projected appreciation on the home while it’s rented compensate you for the time and money it will cost you? Do you have funds to cover a negative cash flow? Your expenses may include your mortgage payment, property taxes, insurance, home owner’s association dues, maintenance and repairs, legal and accounting fees and property management fees. A rule of thumb for maintenance and repairs is about 1 – 2% of the market value of your home, depending on the home’s condition. You may need to spend money up front to attract good quality tenants.
When calculating your rental income, you need to decrease your projected rental income by about 8% to allow for vacancies. In Colorado the average rental vacancy rate has been around 7-9 percent over the last five years, based on U.S. Census data. When a renter moves or is evicted it can take several months to get a new renter in place.
If you rent you can take a tax deduction for depreciation against your rental income. To calculate your annual depreciation, take the value of your home, on the date you begin renting, less the value of land and divide it by 27.5. Unfortunately, this is just a temporary gift from the IRS. When your home is sold you must recapture all of the depreciation at 25%.
Other potential drawbacks to renting your home include the possibility of major damage inflicted by a tenant, drawn out eviction processes, negligence or safety lawsuits and costly maintenance issues.
An additional consideration, if you have a capital gain on your home, is the loss of the capital gain exemption of $250,000 for individuals and $500,000 for a couple if you haven’t lived in your home for 2 or the last 5 years.
Jane M. Young
As we approach retirement, there is a common misconception that we need to abruptly transition our portfolios completely out of the stock market to be fully invested in fixed income investments. One reason to avoid a sudden shift to fixed income is that retirement is fluid; it is not a permanent decision. Most people will and should gradually transition into retirement. Traditional retirement is becoming less common because life expectancies are increasing and fewer people are receiving pensions. Most people will go in and out of retirement several times. After many years we may leave a traditional career field for some well-deserved rest and relaxation. However, after a few years of leisure we may miss the sense of purpose, accomplishment, and identity gained from working. As a result, we may return to work in a new career field, do some consulting in an area where we had past experience or work part-time in a coffee shop.
Another problem with a drastic shift to fixed income is that we don’t need our entire retirement nest egg on the day we reach retirement. The typical retirement age is around 65, based on current Social Security data, the average retiree will live for another twenty years. A small portion of our portfolio may be needed upon reaching retirement but a large percentage won’t be needed for many years. It is important to keep long term money in a diversified portfolio, including stock mutual funds, to provide growth and inflation protection. A reasonable rate of growth in our portfolio is usually needed to meet our goals. Inflation can take a huge bite out of the purchasing power of our portfolios over twenty years or more. Historically, fixed income investments have just barely kept up with inflation while stock market investments have provided a nice hedge against inflation.
We need to think in terms of segregating our portfolios into imaginary buckets based on the timeframes in which money will be needed. Money that is needed in the next few years should be safe and readily available. Money that isn’t needed for many years can stay in a diversified portfolio based on personal risk tolerance. Portfolios should be rebalanced on an annual basis to be sure there is easy access to money needed in the short term.
A final myth with regard to investing in retirement is that money needed to cover your retirement expenses must come from interest earning investments. Sure, money needed in the short term needs to be kept in safe, fixed income investments to avoid selling stock when the market is down. However, this doesn’t mean that we have to cover all of our retirement income needs with interest earning investments. There may be several good reasons to cover retirement expenses by selling stock. When the stock market is up it may be wise to harvest some gains or do some rebalancing. At other times there may be tax benefits to selling stock.
Jane M. Young
Generally the typical investor is better off investing in stock mutual funds than in individual stocks. A mutual fund is an investment vehicle where money from a large number of investors is pooled together and invested by a professional manager or management team. Mutual fund managers invest this pool of money in accordance with a predefined set of goals and guidelines.
One of the primary benefits of investing in stock mutual funds is the ability to diversify across a large number of different stocks. With mutual funds, you don’t need a fortune to invest in a broad spectrum of stocks issued by large and small companies from a variety of different industries and geographies. Diversification with mutual funds reduces risk by providing a buffer against extreme swings in the prices of individual stocks. You are less likely to lose a lot of money if an individual stock plummets. Unfortunately, you are also less likely to experience a huge gain if an individual stock skyrockets.
Another benefit of stock mutual funds over individual stocks is that less time and knowledge is required to create and monitor a portfolio. Most individual investors do not have the time, expertise, or resources to select and monitor individual stocks. Mutual funds hire hundreds of analysts to research and monitor companies, industries and market trends. It is very difficult for an individual to achieve this level of knowledge and understanding across a broad spectrum of companies. Mutual fund managers have the resources to easily move in and out of companies and industries as investment factors change.
Most individual investors appreciate the convenience of selecting and monitoring a diversified portfolio of mutual funds over the arduous task of selecting a large number of individual stocks. Stock mutual funds are a good option for your serious money. However, if you really want to play the market and invest in individual stocks, use money that you can afford to lose.
For diehard stock investors, there are some advantages to investing in individual stocks. Many stock mutual funds charge an annual management fee of between .50% and 1% (.25% for index funds). With individual stocks, there is a cost to buy and sell the stock but there is no annual management fee associated with holding stock.
Another advantage of individual stocks is greater control over when capital gains are recognized within a non- retirement account. When you own an individual stock, capital gains are not recognized until the stock is sold. In a high income year, you can delay selling your stock, and recognizing the gain, to a year when it would be more tax efficient. On the other hand, when you invest in a stock mutual fund you have no control over capital gains on stock sold within the fund. Capital gains must be paid on sales within the mutual fund, before you actually sell the fund. Mutual funds are not taxable entities, therefore all gains flow through to the end investor.
Jane M. Young
Let’s compare some differences between stocks and bonds. When you buy a bond you are essentially lending money to a corporation or government entity for a set period of time in exchange for a specified rate of interest. When you invest in the stock market you assume an ownership position in the company whose stock you are purchasing. As a result, the value of your investment will fluctuate based on the profit or loss of the underlying company. With the purchase of a bond the value of your investment hould not fluctuate based on the financial performance of the issuer, assuming it remains solvent. You will continue to receive interest payments according to the original terms of the agreement until the bond matures. Upon maturity the amount of your original investment (principal) will be returned to you along with any interest that is due. As a general rule, stocks are inherently more risky than bonds, therefore investors expect to receive a higher return.
Bonds may appear to be safe but they are not without risk. Currently, there is some risk associated with low interest rates that may not keep up with inflation. This is especially true with many government bonds. Two additional risks typically associated with bonds include default risk and interest rate risk.
Default risk is the risk that the issuer goes bankrupt and is unable to return your principal. Most bond issuers are assigned a rating to help investors assess the potential default risk of a bond. Generally, investors are compensated with higher interest rates when taking a risk on lower rated bonds and receive lower interest rates on higher rated bonds.
Interest rate risk is based on the inverse relationship between interest rates and the value of a bond. When interest rates increase the value of a bond will decrease and when interest rates decrease the value of a bond will increase. If you hold an individual bond until maturity your entire principal should be returned to you. You have the control to keep the bond until maturity and avoid a loss. However, if you need to sell before maturity you may lose some principal. The loss of principal is greater for longer term bonds. This needs to be weighed against the benefit of a higher interest rate paid on longer term bonds.
Bond mutual funds can provide diversification and reduced default risk because your money is pooled with hundreds of other investors and invested in bonds from a large number of different entities. If one or two entities within the mutual fund go bankrupt there will be minimal impact on each individual investor. However, with mutual funds you have less control over interest rate risk. When interest rates increase, bond fund managers often experience a high rate of withdrawals forcing them to sell bonds at an inopportune time. This usually results in a loss of principal, the severity of which is greater for longer term bond funds.
Jane M. Young CFP, EA
You can begin taking Social Security at age 62 but there are some disadvantages to starting before your normal retirement age. The decision on when to start taking Social Security is dependent on your unique set of circumstances. Generally, if you plan to keep working, if you can cover your current expenses and if you are reasonably healthy you will be better off taking Social Security on or after your normal retirement age. Your normal retirement age can be found on your annual statement or by going to www.socialsecurity.gov and searching for normal retirement age.
Taking Social Security early will result in a reduced benefit. Your benefits will be reduced based on the number of months you receive Social Security before your normal retirement age. For example if your normal retirement age is 66, the approximate reduction in benefits at age 62 is 25%, at 63 is 20%, at 64 is 13.3% and at 65 is 6.7%. If you were born after 1960 and you start taking benefits at age 62 your maximum reduction in benefits will be around 30%.
On the other hand, if you decide to take Social Security after your normal retirement age, you may receive a larger benefit. Do not wait to take your Social Security beyond age 70 because there is no additional increase in the benefit after 70. Taking Social Security after your normal retirement age is generally most beneficial for those who expect to live beyond their average life expectancy. If you plan to keep working, taking Social Security early may be especially tricky. If you take benefits before your normal retirement age and earn over a certain level, the Social Security Administration withholds part of your benefit. In 2012 Social Security will withhold $1 in benefits for every $2 of earnings above $14,640 and $1 in benefits for every $3 of earnings above $38,880. However, all is not lost, after you reach full retirement age your benefit is recalculated to give you credit for the benefits that were withheld as a result of earning above the exempt amount.
Another potential downfall to taking Social Security early, especially if you are working or have other forms of income, is paying federal income tax on your benefit. If you wait to take Social Security at your normal retirement age, your income may be lower and a smaller portion of your benefit may be taxable. If you file a joint return and you have combined income (adjusted gross income, plus ½ of Social Security and tax exempt interest) of between $32,000 and $44,000 you may have to pay income tax on up to 50% of your benefit. If your combined income is over $44,000 you may have to pay taxes on up to 85% of your benefit.
The decision on when to take Social Security can be very complicated and these are just a few of the many factors that should be taken into consideration.
Jane M. Young, CFP, EA
Build a Portfolio to Support Your Investment Timeframe
Investment timeframe is a major consideration in developing an investment portfolio. Start with an emergency fund covering about four months of expenses in a cash account with immediate access. Next, put aside money that is needed over the next few years into fixed income vehicles such as CDs, bonds or bond funds. Invest long term money into a combination of “stock based” mutual funds and fixed income investments based on your tolerance for investment risk and volatility. Historically, stock has significantly out-performed fixed income investments but can be volatile during shorter timeframes. Stock is a long term investment; avoid putting money needed within the next five years in the stock market.
Diversify, Diversify, Diversify
Once your emergency fund is established and funds have been put away for short term needs, it’s time to create a well-diversified investment portfolio. We cannot predict the next hot asset class but we can create a portfolio that will capitalize on asset categories that are doing well and buffer you from holding too much in asset categories that are lagging. Think of the pistons in a car, as the value of one asset is increasing the other may be falling. Ideally, the goal of a well-diversified portfolio is to have assets that move in opposite directions, to reduce volatility, while following a long term upward trend. It is advisable to diversify based on the type of asset, investment objective, company size, location and tax considerations.
Avoid Emotional Decisions and Market Timing
The best laid plans are worthless if we succumb to our emotions and overreact to short term economic news. Forecasting the short-term movement of the stock market and trying to time the market is fruitless. We can’t control or predict how the stock market will perform but we can establish a defensive position to deal with a variety of outcomes. This is accomplished by maintaining a well-diversified portfolio that supports our goals and investment time horizon.
The stock market can trigger our emotions of fear and greed. When things are going well and stock prices are high we become exuberant and want a piece of the action. When things are bad and stock prices are low we become discouraged and want to get out before we lose it all. The stock market is counterintuitive, generally the best time to buy is when the market is low and we feel disillusioned and the best time to sell is when the market is riding high and we feel optimistic. We need to fight the natural inclination to make financial decisions based on emotions. Don’t let short term changes in current events drive your long term investment decisions.
No one knows what the future holds so focus on what you can control. Three steps toward this goal are to create a portfolio that meets your investment time horizon, create and maintain a diversified portfolio and avoid emotional decisions and market timing.
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Jane M. Young, CFP, EA
I have met with numerous widows over the last few years to get a better understanding of what they are experiencing and to learn how I can best support and assist them. Below I have shared some of the most meaningful and consistent messages and comments I heard from these brave women. I hope this is helpful to both men and women who have recently lost a spouse and family members of someone who has recently lost a spouse.
Please join us for lunch, at Pinnacle, for our next Fireside Chat on July 11th at 11:30. We will discuss Long Term Care Insurance. As always this is purely educational and free of charge. Please call Judy at 719-260-9800 to RSVP. Please let us know if there are any topics that you would like us to discuss at future Fireside Chats.
Jane M. Young CFP, EA
Due to the high costs, lack of flexibility, complexity and unfavorable tax treatment variable annuities are not beneficial for most investors. Traditional retirement accounts and Roth IRAs meet the tax deferral needs for most investors. In some instances a variable annuity may be attractive to a high income investor who has maximized all of his traditional retirement options and needs additional opportunities for tax deferral of investment gains. This is especially true for an investor who is currently in a very high tax bracket and expects to be in a lower tax bracket in retirement.
Generally, money in retirement accounts should not be invested in variable annuities. The investor is already receiving the benefits of tax deferral.
A variable annuity may also be an option for someone who is willing to buy an insurance policy to buffer the risk of losing money in the stock market. For most investors, due to the long term growth in the stock market, this guarantee comes at too high a price. However, some investors are willing to pay additional fees in exchange for the peace of mind that a guaranteed withdrawal benefit can provide. A word of warning, guaranteed minimum withdrawal benefits (GMWB) can be very complex and have some significant restrictions. Do your homework, make sure you understand the product you are buying and read the contract carefully.
According to a study conducted by David M. Blanchett – the probability of a retiree actually needing income from a GMWB annuity vs. the income that could be generated from a taxable portfolio with the same value is about 3.4% for males, 5.4% for females and 7.1% for couples. The net cost is about 6.5% for males, 6.1% for females and 7.4% for couples.
Jane M. Young, CFP, EA
What is a Variable Annuity?
A variable annuity is a contract with an insurance company where you invest money into your choice of a variety of sub-accounts, similar to mutual funds. Non-qualified, variable annuities provide tax deferral on gains until the funds are withdrawn. Upon distribution your gains are taxed at regular income tax rates as opposed to capital gains rates. Variable annuities generally charge fees twice those charged by mutual funds. Additionally, you will be to subject to substantial early withdrawal charges if you purchase an annuity from an advisor who is compensated through commissions. Most variable annuities provide the option to buy a guaranteed death benefit option and/or a Guaranteed Minimum Withdrawal Benefit. These do not come without a cost and can be very complex. Below are some advantages and disadvantages of Variable Annuities.
Advantages and Disadvantages of Variable Annuities:
Advantages:
Disadvantages:
Please join us for lunch and an interactive discussion on annuities vs. mutual funds at Pinnacle Financial Concepts, Inc. on May 16th. Our Fireside Chat will run from 11:30 to 1:00. Please call 260-9800 to RSVP. There is no charge and our Fireside chats are always purely educational!!!
Jane M. Young, CFP, EA
1. Dream – Take a few minutes to look at the big picture and think about what you want from life. How do you want to live, what do you want to do and how do you want to spend your time. Successful businesses have vision statements and strategic plans. Create your own personal vision statement and strategic plan.
2. Set Goals – What are your goals for the coming year? Start by brainstorming – fill a page by listing all the goals that come to mind. Think about different facets of your life such as family, career, education, finance, health and so forth. Review your list and prioritize three or four goals to focus on in the coming year.
3. Evaluate Your Current Situation – What did you spend and what did you earn last year? What was necessary and what was discretionary? Did you spend in a purposeful manner and do your expenses support your goals and strategic plan. How much did you save or invest in a retirement plan? Can you increase this in 2012? If you are like most of us, a category is needed for “I have no clue”.
4. Track Spending and Address Problem Areas – If you aren’t sure where you spent all that discretionary cash, track your expenses for a month or two. It can be very enlightening – Yikes! Identify a few problem areas where you can cut spending and really place some focus. Identify the actions you will take to cut spending in these areas. Set weekly limits and come up with creative alternatives to save you money.
5. Evaluate Your Career – Are you doing what you really want? Are you being paid what you are worth? Have you become too comfortable that you are settling for safe and familiar? Could you earn more or work in a more rewarding position if you took the time to look? Are you current in your field or do you need to take some refresher courses? Do you know what it will take to get a promotion or a better job? In this volatile job market you need to keep your skills current, to nurture your network and to maintain a current resume.
6. Maintain an Emergency Fund – Start or maintain an emergency fund equal to at least four months of expenses, including the current month. This should be completely liquid in a checking, savings or money market account.
7. Pay Off Debt – Establish a plan to pay off all of your credit card debt. Once this is paid off establish a plan to start paying off personal debt and student loans.
8. Save 10-15% of your income (take advantage of employee Benefits) – You need to save at least 10-15% of your income to provide a buffer against tough financial times and to invest for retirement. At a very minimum, you need to contribute up to the amount your employer will match. Additionally, be sure to take advantage of flex benefits or employee stock purchase plans that may be offered by your employer.
9. Maintain a Well Diversified Portfolio – Maintain a well-diversified portfolio that provides you with the best return for your risk tolerance, your investment goals and your investment time horizon. Be sure to re-balance your portfolio on an annual basis. Avoid over reacting to short term swings in the market with money that is invested for the long term.
10. Don’t Pay Too Much Income Tax – Avoid paying too much income tax. Get organized and keep good records to be sure you are maximizing your deductions. Make tax wise investment decisions, harvest tax losses and maximize the use of tax deferred investment vehicles. Donate unwanted items to charity – be sure to document your donations with a receipt.
Jane Young, CFP, EA
Below are some general guidelines and rules of thumb for retirement planning. While general guidelines can be useful, I recommend that you do the work to run retirement calculations with well thought out figures that represent your unique situation. These should be revisited on an annual basis to be sure you are on track. Guidelines and rules of thumb can be misleading and may not fit every situation.
Jane M. Young, CFP, EA
Below are some questions you may want to consider when you start planning for retirement.
What does retirement look like?
When do you want to start cutting back on your work hours? Do you want to stop working altogether or try something new?
Do you want to take a break for a few years and return to work part time? What are the opportunities for someone of retirement age in your chosen field?
How will you feel in retirement? How much of your personal identity and self esteem is associated with what you do? How will you feed your need for a sense of accomplishment, friendships, social interaction and status? Are you ready for retirement? Maybe a gradual transition will be more comfortable.
Where and how will you live? Do you plan to move to a less expensive city or country? Are you going to stay in your home or downsize to something with less maintenance?
How will you spend your time and money? Do you plan to travel, write a book or play tennis?
How will your expenses change in retirement? (Downsize or pay-off house, travel, no kids and no 401k contribution)
Where are you today?
What are your current expenses and what are you earning? How will this change in the coming years? Do you need to make some improvements in your career/earning situation?
How much are you saving for retirement? Could you squeeze out just a little more? Most people need to be saving between 10 – 15%. If you are getting started late you should be saving more.
What can you expect from a pension or social security?
Are you maximizing your ability to contribute to retirement plans such as 401ks, 403bs and Roth IRAs? Are you taking advantage of opportunities for matching contributions from your employer?
How much do you have put away for retirement?
Is your portfolio well diversified to meet your retirement needs? Avoid being too conservation or too aggressive.
Jane M. Young, CFP, EA
1. Don’t react emotionally! This will result in a constant cycle of buying high and selling low. Once you sell, you lock in your losses. Stay the course and focus on what you can control.
2. Make sure you have an emergency fund of three to six months of expenses.
3. Evaluate your asset allocation to be sure it is consistent with the timeframe in which you need to withdraw money. The stock market is a long term investment; you should never have short term money in the stock market. Make adjustments to your allocation based on your long term goals and need for liquidity not on fear.
4. Maintain a well diversified portfolio.
5. Pay-off credit cards and high interest consumer debt. Be wary of variable rate loans, lines of credit and mortgages. The downgrade in the U.S. credit rating could hasten an increase in interest rates.
6. Get your personal finances in order. It’s always a good idea to understand your spending and keep expenses in line with your income and financial goals. This is a good time to tighten your belt to be prepared for unexpected emergencies.
7. Use dollar cost averaging to invest new money into the stock market. Volatility in the stock market creates great buying opportunities.
8. Don’t get caught up in the media hype. They are in the business to sell newspapers, magazines and television commercials. Avoid the new hot asset class they are trying to promote this week. Sound investment advice is boring and doesn’t sell newspapers.
9. Take steps to secure or improve your income stream. Are you performing up to speed at work? Are you getting along with co-workers? Should you take some classes to keep your skills current? Are you underemployed or under paid for your education and experience? Consider a second job to pay down excess debt.
10. Stay calm, be patient and focus on making sure your financial plan meets your long term goals and objectives. Stay the course, this too shall pass.
With the deadline to raise the federal debt ceiling drawing closer by the day — and the risk that the U.S. could default on its sovereign debt growing — individual financial planners are fielding lots of calls from worried investors.