Why an HSA Needs to be Part of Your Retirement Strategy

The following is adapted from Keep It Simple, Make It Big.

When you think retirement investments, you probably don’t think about your health savings account (HSA). After all, an HSA is not technically a retirement account. It’s earmarked for healthcare. 

But guess what: retirees spend a lot on healthcare!

A longitudinal study of retirees from 1990 until now finds that, on average, Americans spend about $27,000 per person from age 70 to death.

Many people pay for those costs using after-tax dollars. With an HSA, though, you could avoid being taxed, saving thousands of dollars. And if you play your cards right, you can even find ways to spend your HSA money on non-healthcare costs.

For these reasons, an HSA is an important part of any retirement strategy.

Triple-Tax Free

The biggest benefit of an HSA is that it allows you to accumulate a bucket of money that will never, ever, ever be taxed. The HSA is the Holy Grail of tax strategies. 

First, it avoids all federal income and payroll taxes when you contribute—an even better up-front tax-deal than an employer-sponsored 401(k) or personally maintained IRA. 

Second, like all tax-favored accounts, there are no federal taxes on the year-to-year income and gains in the account as it marinates. 

Third, the real kicker: like a Roth IRA or 401(k), if the money is distributed for appropriate expenditures in a compliant way, there are no federal taxes when it’s spent.

It’s triple-tax free! No federal taxes, not even FICA and Medicare, so long as it’s payroll deducted. Never. 

(One caveat: States have the option to tax contributions and gains. At present, three states tax contributions and two states tax earnings.)

What’s the Catch?

There are plenty of catches to an HSA, but none need to be too onerous. 

First, a person or family must have a qualifying healthcare plan. These are available in the individual market and increasingly at major corporations. One in four employers that offers health insurance includes an HSA eligible option.

These plans have high deductibles—a minimum of $1,400 for an individual and $2,800 for a family in 2020. That’s why the tax-free savings is blessed. Instead of sending the money to an insurance company tax-free to later have it potentially pay out for you tax free, you are paying yourself and retaining the money and the risk tax free.

Next the money needs to be spent on a qualifying healthcare item. The full list is available in IRS Publication 502. It’s a fun read and you’ll find that along with the predictable health expenses it includes such items as acupuncture, service dogs, and weight-loss programs. 

This is the same list used by the older and more familiar flexible spending account (FSA) that provides our frame of reference for the HSA. If you ever need the money for healthcare spending, it’ll be there for that traditional use. The big difference is that the FSA is a “use it or lose it” account—money unspent in each year is lost forever. The utility of the HSA is that the money can be invested and accumulate year over year. Even after you go on Medicare, you can continue using your HSA. You just can’t add any new money to it.

Using an HSA for Non-Healthcare Expenses

With healthcare being such a major expense in retirement, an HSA already serves an important purpose, but it gets even better. Under current rules, a distribution is tax free if it’s used to cover a qualified healthcare expense. There is no requirement, however, that this expense and distribution occur in the same calendar year. 

This means that you can choose to pay for healthcare expenses out-of-pocket while you let your HSA continue to grow and compound tax-free. Then, in retirement, you can go back and get reimbursed in a lump sum for those past healthcare expenses (as long as you keep the receipts). You can then spend that money on whatever you want!

Let’s put some numbers on it. (Note that this example does not represent actual or future performance of any specific investment or product and should not be used to predict or project investment performance.) 

Imagine a hypothetical 45-year-old who put in the max family contribution of $6,750 for twenty years and earned rate of return of 6 percent, compounded annually. At that rate—a hypothetical number that is certainly not guaranteed—she would have $248,302 after twenty years, when it’s time for Medicare. She would have contributed $135,000. 

If she spent $2,600 annually out-of-pocket and saved the receipts, she’d have $52,000 that could be withdrawn at any time for any reason. 

If, however, she had used the HSA to cover the $2,600 each year, she’d only have $151,556 at retirement. She’d also have to use all of it for future healthcare expenses. Not terrible, for sure, but depending on the person’s financial status, it might not be as favorable as the first option.

In this way, you can build a substantial tax-free nest egg for retirement spending—even if it’s not directly for healthcare.

The Power of an HSA

An HSA might seem too good to be true, but I assure you it’s not. HSAs are so powerful that a recent study in the Journal of Financial Planning (“Could a Health Savings Account Be Better Than an Employer-Matched 401(k)?”) actually recommended that people max out their health savings accounts prior to investing in their employer plans.

There are few retirement investments that are never taxed, and since you’re basically guaranteed to spend tens of thousands of dollars on healthcare in retirement and can use the HSA for past out-of-pocket expenses as well, there’s no reason not to make an HSA part of your retirement strategy.

For more advice on HSAs as a retirement investment, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a Certified Financial Planner with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Michael Lynch is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton CT 06484 CRN202210-272651

The Stock Market Will Crash—More Than Once—During Your Retirement

The following is adapted from Keep It Simple, Make It Big.

Imagine you’re climbing Mt. Everest: what is your goal?

Your first thought might be, “Get to the top.”

This is intuitive, but when you get to the top, are you done climbing? No, you still need to climb back down.

So the goal is to not only reach the peak but then also to make it down safely to tell the tale. I am told that descending the mountain is more dangerous than the climb up.

Retirement is the same way. Investing over the working years is the initial climb. The start of retirement is the top of the mountain, but you’re not done yet. You need to make it to the end of your retirement.

And just as descending the mountain is more dangerous than the upward climb, making it through retirement can be more challenging than the initial savings. If a stock market decline happens early in retirement or often and deep enough, it can wipe out an investment portfolio and seriously impair a person’s retirement. 

To make it to the bottom of the mountain—to the end of your retirement—you must be prepared to face multiple stock market crashes in your retirement.

The Ups and Downs of the Market

In investments, the past is never a prediction of anything specific about the future. Past returns should never be relied upon for proof that any given investment is appropriate, good, or will perform well in the future. 

That said, financial markets themselves are broad, complex systems that have years of well-studied and documented history. And just because specific downs and ups cannot be predicted with accuracy, you can take the fact that there will be ups and downs to the bank. 

Once you know what is normal, it can relieve some stress. It’s like the two scariest rides at the California Disneyland when I was a kid: Space Mountain and the Matterhorn. These rides were scary because riders were in the dark and couldn’t see the track. 

Understanding normal market fluctuations will show you the track. You may still lose your stomach from time to time, but it won’t be as scary, and you can create a system that will prevent you from losing your mind.

How Often Do Declines Happen?

Looking at 117 years of the widely quoted Dow Jones Industrial Average, we can see how frequent declines are, with 5 percent pullbacks occurring, on average, three times a year, 10 percent pullbacks once a year, and 20 percent drops once every four years. Yet over this period the Dow returned 7.32 percent without dividends reinvested.

For the S&P 500, a broad index that contains the 500 largest publicly traded US companies, volatility is also the norm, not the exception. In an average, twelve-month span, it will decline 14 percent. These downs are the price paid for the ups. Over the last thirty-nine years, ending in 2018, it ended positive twenty-nine years, with an average return of 8.4 percent compounded. This is without dividends reinvested.

Now few people only invest in large US equity positions. Most also have bonds and other equity classes. But this is the most-quoted market and the one that defines most returns.

So while you can expect periodic declines, over the long run, you can expect growth. As long as you can hold on to your assets through the down markets, they will usually regain their value.

Three Plus One Equals Four

Given this reality, I often counsel people to think in units of four years. On a calendar-year basis, markets end the year up three years and down one.

If you retire at 65 and live to 95, you will have thirty years in retirement.

Divide 4 into 30 and you get 7.5. This means that on average there will be between seven and eight times in retirement when the US stock portion of your account is substantially negative on a calendar-year basis. It also means you will have twenty-two years that should be positive, again, based on historic relationships.

When the down year arrives, you face a choice. You can be sad because your portfolio is down or happy because you only have five drops more to go! 

More importantly, if you can understand these relationships and believe in them, you can confidently build an income reservoir (a pool of money that is liquid and not tied up in stocks), switch your withdrawals to stable low-return assets, and avoid either downgrading lifestyle or depleting a portfolio. This is the key to a financially successful retirement.

Make it to the Bottom of the Mountain

To make it to the bottom of the mountain, you must expect and plan for market downturns. 

The key is to avoid selling low, as this will deplete your principal investments. By creating an income reservoir, you give yourself breathing room. I recommend having three to five years of income in your reservoir, so that even in the case of an extended downturn, you are not forced to sell off stocks at a low point.

It would be nice if the stock market only went up, but that’s simply not realistic. By expecting multiple downturns throughout your retirement, you can better plan how you’ll get through the declines so that you can make it to the bottom of the mountain safely. 

For more advice on preparing for retirement, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a Certified Financial Planner with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Michael Lynch is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton CT 06484 CRN202210-272647

The 5 Tax Buckets for Retirement Investment

The following is adapted from Keep It Simple, Make It Big.

I’ve yet to meet someone who truly enjoys paying taxes. Even if you appreciate all that your taxes help to pay for in our country, you still probably don’t like paying your taxes for the simple reason that it’s so confusing.

This is especially true for retirement investments. There are many different types of retirement investments, and each one seems to have its own complicated tax rules. 

If you’re not careful, you could be hit with an unexpected tax bill, or you might end up paying more than you need to. 

To make sure you don’t get blindsided or end up overpaying, you need to understand how your various investments are taxed. To help simplify things, there are five major tax buckets you should know.

Bucket #1: Tax Me as I Go

These are often called after-tax investments. Professionals will also refer to them as “non-qualified” accounts. Income generated from investments in these accounts will be taxed as ordinary income in the year in which it’s generated. 

Any dividends generated will be taxed as well, and growth is taxed as capital gains when the investment is sold and the gain realized. Capital gains and dividends are taxed at lower rates than income. (For those in the 12 percent federal tax bracket or lower, the rate is zero). Also, losses can be used to offset gains and even ordinary income in future years.

These accounts are typically bank savings, money market, CDs, mutual fund accounts, and stocks and bonds held in a brokerage account. You face no access restrictions on using these accounts.

Bucket #2: Tax Me Later

These accounts tend to be a person’s favorite while working. The reason: Contributions are pre-tax—they lower your taxable income dollar for dollar—and growth is tax deferred. They produce fewer smiles in retirement, however, as each dollar withdrawn is taxed as ordinary income at the person’s highest tax rate, even the growth attributable to capital gains.

These are our retirement accounts, the 401(k), 403(b), and 457 plans and traditional IRA.

They come with many access restrictions.

A 10 percent penalty is imposed if money is accessed before age 59½, for example. Exceptions include disability, a first-time home purchase, qualified education expenses, birth and adoption expenses up to a limit, separation of service for 457 plans, separation of service and age 55 for 401(k) and 403(b) plans, and systematic withdrawals at age 55 for IRAs. Most recently, the penalty was removed temporarily as a response to the COVID-19 virus.

At age 72, mandatory minimum distributions commence. Account holders must start taking out income and paying taxes whether they want to or not. The amount is based on life expectancy.

Bucket #3: Tax Me Never Again

In this bucket, contributions are made post-tax. The growth is not taxed, and the gains, if accessed correctly, will also not be taxed.

These are Roth IRAs and Roth 401(k)s, 529 plans, cash value life insurance, and municipal bonds.

These accounts come with far fewer restrictions than their pre-tax kin but still have some limitations. 

Roth IRAs have contribution levels tied to income limits, and if you withdraw gains before age 59½, there is a 10 percent penalty, plus income taxes will be due (with some important exceptions for first-time home purchases, medical expenses, and education expenses). You can, however, withdraw your contributions (the money you put in, not the growth) tax- and penalty-free at any time for any reason at any age. 

Section 529 plans are education savings vehicles. Their monies must be spent on qualified education expenses, otherwise penalties and taxes will apply.

The restrictions on cash value life insurance depend on the insurance company. If the policy is completely surrendered to access cash, ordinary income taxes will apply on the gains in the contract. Also, withdrawals may cause policy to lapse, at which point withdrawals greater than contributions will be subject to income tax. Life insurance must be carefully managed.

Bucket #4: Tax Me Later, but Only on the Gains

In this bucket, investments are made with after-tax dollars, and the growth of the investments occurs on a tax-deferred basis. When the money is withdrawn and spent, gains or growth will be taxed as ordinary income.

This tax characteristic applies to after-tax contributions to 401(k)s, non-deductible IRAs, and fixed- and variable-deferred annuities. The key is that there is no upfront tax break, but all growth is sheltered from tax until it’s withdrawn.

There are many complicating restrictions. If money is accessed before age 59½, a 10 percent penalty will apply to gains on both annuities and IRAs. For annuities, gains come out first, the opposite of Roth IRAs. There are no contribution limits on annuities, but IRA contributions are limited to current IRS limits.

Bucket #5: Tax Me Never Ever

This is the triple tax-free bucket. Like Bucket #2, contributions are made pre-tax. Even better, they avoid FICA taxation if made through payroll. Then, like Buckets #2 and #3, the investments grow on a tax-deferred basis. Finally, like Bucket #3, the money comes out completely tax free if the rules are followed.

At present, the only legal option for such wonderful treatment is a Health Savings Account (HSA).

As you can imagine, there are plenty of catches and restrictions to get no-taxation. To contribute to these accounts, one must have a qualifying high-deductible health plan with a minimum deductible of $1,350 for an individual or $2,700 for a family plan.

Contributions to the account are limited by the IRS. Limits in 2020 are $3,550 for an individual and $7,100 for those with a family plan. If you are 55 or over, you can add another $1,000. These funds can be invested in mutual funds and other securities. 

Withdrawals are tax free if used for qualifying health expenses per IRS publication 502. The list is quite expansive and includes Medicare Part B and supplemental premiums in retirement. Withdrawal does not have to occur in the same year as the expense. Once on Medicare, people can no longer contribute to HSAs. They can still use the accounts—they just can’t put any new money in.

Which Buckets to Use

Most retirement investment strategies will make use of several of these buckets. 

Obviously, Bucket #5 is the best, since you’re never taxed, but because you can only use this money on healthcare costs, you’ll need to use other buckets as well.

Bucket #1 is good for money that you want easy access to, since there are no restrictions on when or how you can use the money. 

Bucket #2 is a good option for lowering your taxes now, and it’s especially smart if you think you’ll be in a lower tax bracket later in life. 

In contrast, Bucket #3 is a good move if you’re currently in a lower tax bracket and expect to be in a higher one when you retire.

Bucket #4 usually isn’t people’s first choice, but it can be helpful if you want to save more than current limits on your other accounts, like a Roth IRA, allow.

Which buckets you choose will ultimately depend on your particular situation, but by understanding the various taxation methods, you can make a more informed decision.

For more advice on taxes on retirement investments, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a Certified Financial Planner with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Michael Lynch is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton CT 06484 CRN202210-272644

Should You Take Early Social Security?

The following is adapted from Keep It Simple, Make It Big.

As retirement approaches, you start thinking about it more and more, and you might begin wondering whether you should take early Social Security.

With Social Security, when you collect determines what you get. The earlier you take it, the less you receive. Benefits are permanently reduced by an assigned percentage for each year benefit is taken before full retirement age.

Originally, the full retirement age was 65. To shore up the system’s finances, it has been increased based on birth year. It’s 66 for those born between 1943 and 1954, and it phases up for those born between 1954 and 1960, two months for each year, topping out at 67 for those born 1960 and later.

You can take your benefits earlier, starting at age 62, but whether you should depends on your particular situation.

Can You Collect Early?

In deciding whether you should take early Social Security, you must first determine whether you can. You may not be able to collect early even if you desire to do so. 

First, you must be at least 62.

Second, to qualify for benefits, you must have paid into the system for forty quarters, or ten years, or be attached to someone who has. Spouses are eligible for 50 percent of the primary earner’s benefit, and divorced spouses are eligible for benefits based on their ex’s earnings, if they were married for ten years, are at least 62 years old, and are not remarried.

Third, you must not have an earned income in retirement of more than $1,470 a month or $17,640 in 2019. (Note: In the year a person reaches full retirement age, they can earn up to $3,910 a month.)

Technically, you could still collect early with more earned income than this, but it would be very unwise to do so, since the heavy penalty imposed on your Social Security benefit would substantially reduce or eliminate the real value of earnings. The penalty is $1 for every $2 earned over the limit.

How Much Do You Need It?

If it’s possible for you to take early Social Security, you must then consider how much you need the money. If you can wait, it’s usually a good idea to do so, because you can receive far more if you wait to your full retirement age.

For example, a person with a full benefit of $2,500 at age 67 will collect only $1,750 at 62. That’s a permanent reduction of nearly a third. There’s a substantial penalty for early withdrawal!

The flip side of being punished for retiring early is that the government will pay you to wait longer as well. For those born after 1960, the benefit at age 70 will be 124 percent of the full retirement benefit you would get at 67, and 154 percent of the benefit you could have claimed at age 62. So by waiting until age 70, a person can turn the $2,500 into $3,100 a month. 

Don’t delay past 70, however, as that’s the last year you’ll enjoy an increase.

How Long Do You Expect to Live?

Your life expectancy can also impact whether you choose to take early Social Security. As a rule, a person must live ten to twelve years from commencing benefits to break even. 

So if someone waits until 70 to take benefits but passes away at 72, they’re not going to break even. They would have been better off taking early Social Security at 62.

In contrast, say a person waits until 66 to take full benefits and then lives until age 78. They made the right decision and received more money in the long run.

Since life expectancy at age 70 is 14.3 years for men and 16.44 for women, on average, there is usually value in waiting. However, if you are facing health problems or have reason to believe you will have a lower than average life expectancy, it can make sense to take early Social Security.

Get the Right Advice

Everyone’s situation is different, and it can be wise to seek advice.

However, don’t rely on the helpful person at the Social Security Administration to assist in this decision. That is not their job. They are not trained to give advice. 

That said, they are human, and it’s a human impulse to help. In their attempt to be helpful, they may accidentally give you bad advice. An Inspector General’s investigation found that widows were claiming the wrong benefit 80 percent of the time!

So if you need help, seek out a financial advisor instead. They can help you make the right decision for you.

There is no one right answer to whether you should take Social Security early, but by thinking about how much you need it and how long you expect to live, you can make a decision that works for you.

For more advice on Social Security, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a Certified Financial Planner with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Michael Lynch is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton CT 06484 CRN202210-272648

A 3-Pronged Approach to Health Insurance for Retirement

The following is adapted from Keep It Simple, Make It Big.

Surprise! You will spend more on healthcare in retirement than before. According to the Bureau of Labor Statistics, households headed by people age 25 to 34 spent just over $250 a month out-of-pocket on healthcare in 2017. This jumped to more than $500 a month on average by age 65.

Really, this isn’t that surprising. While many expenses (like housing costs, if you’ve finished paying your mortgage) will likely decrease by the time you retire, healthcare is one you can expect to increase as you age.

You might think that Medicare will be enough to cover your increased costs, but it’s not. It’s only one prong in the ideal three-pronged approach: Medicare, long-term care insurance, and a health savings account (HSA). 

#1: Medicare

Medicare is the national health insurance program for senior citizens. It is a key prong in your health insurance approach, so here’s a quick guide to the ABCD’s of Medicare.

Medicare Part A is mandatory, funded by payroll taxes, and covers hospital use. It’s not comprehensive, and seniors need to be aware of its limitations. Here are some key details as of 2020:

• It has a per-benefit period deductible, $1,408.

• If you are in a hospital more than 60 days, you must pay $352 a day in co-insurance.

• For hospital stays 90 to 150 days, the coinsurance is $704 a day.

• Over 150 days, it pays nothing.

• It doesn’t pay for care needed while traveling out of the country.

• It doesn’t pay for blood.

• It doesn’t cover out-patient prescription drugs.

Medicare Part B is often referred to as physician insurance. It is optional but highly subsidized by the general taxpayer. Its monthly premium is deducted from your Social Security check. It is $144.60 a month in 2020. It too has limitations, including:

• The annual deductible is $198.

• There is a co-insurance payment of 20 percent.

• It doesn’t cover dental care.

• It doesn’t cover eyeglasses, hearing aids, or eye exams.

Medicare Part C, or Medicare Advantage (formerly Medicare+Choice), allows seniors to choose an HMO, PPO, or HSA company to provide the combined benefits of Part A and Part B. Plans can offer more comprehensive benefits, and most do. They can charge for them, and many do. 

The benefit of Part C is that it eliminates the need for Medigap Coverage (a highly regulated supplement to cover the gaps in Part A and Part B programs, with an average premium of $155). 

Medicare Advantage programs are not available everywhere and are more prevalent in densely populated areas.

Medicare Part D is the drug benefit plan. It is voluntary and has some restrictions: 

• Seniors with incomes greater than $12,123 must pay a monthly premium ($32.50 on average).

• They will pay a maximum deductible of $435. Part D will then cover 75 percent of drug costs between the deductible and $6,350.

• With total spending over $6,350, Medicare will cover 95 percent.

• In addition, a $2 co-pay applies for generic drugs and $5 co-pay applies for brand-name drugs. If you’re in a nursing home, co-pays are waived.

All in, an average person might pay $332 for Medicare monthly ($144.60 for Medicare B, $32.50 for Medicare D, and $155 for Medigap). 

#2: Long-Term Care Insurance

An American’s largest risk in retirement is outliving his or her money, and for most Americans, if they are forced to pay for the custodial care of a spouse or themselves, they have a good chance of running out of money. 

The average cost of home healthcare workers is $22 an hour nationally, and the average annual cost of nursing-home care in the United States is $89,297 a year for a semi-private room and $100,375 for a private room. It’s much higher in many places. In New York, for example, the average cost of a semi-private room is $145,088. 

Do you have an extra $100,000 in your annual retirement budget to pay for a second residence or house staff? If not, you need to consider transferring a portion of this risk.

Long-term care insurance, either as a standalone plan or as a rider on a life insurance or annuity contract, provides tax-free money to pay for a person’s custodial care should they have trouble performing two of five basic activities of daily living (toileting, bathing, dressing, eating, and transferring) or if they suffer from a brain disease such as Alzheimer’s.

Long-term care insurance is necessary because Medicare will not pay for custodial care. Medicare will pay for skilled in-patient rehabilitative care, provided some restrictions are met, but it will pay for non-rehabilitative home care, adult day care, assisted living, or skilled nursing facilities over one hundred days.

#3: Health Savings Account (HSA)

For those who have time to plan, health savings accounts (HSAs) are often an attractive option for early retirees. They combine a high-deductible catastrophic insurance policy with a double-ended tax-free IRA.

Here are the important details:

• Insurance kicks in after you pay a minimum deductible of $1,350 for an individual or $2,700 for a family.

• Individuals can contribute an amount up to $3,550 to a savings account in 2020. The limit is double for families. If a person is over 55, they can contribute another $1,000. That is the limit for both individual and family plans.

• The maximum 2020 out-of-pocket, including deductibles and co-payments but excluding premiums, is $6,900 for an individual and $13,800 for a family.

The reason an HSA is an attractive option is it’s triple-tax free. The contributions are pre-tax, meaning they lower your taxable income. Then, there are no federal taxes on the year-to-year income and gains. Finally, as long as you spend the money on qualified healthcare costs, there are no federal taxes when it’s spent either.

These plans can be a great relative value for many Americans, as they allow people to pay lower premiums, invest the savings in a tax-free account, and accumulate it for the future when the money will be needed. Then, once on Medicare, they can continue using the account—they just can’t put any new money in.

However, these plans must be compared to others available in the marketplace and matched to your unique health needs. The investment features are great, but they should be secondary considerations to your overall healthcare needs.

Preparing for Your Healthcare Needs

Much of retirement planning is preparing for the unknown, but one certainty is that your healthcare costs will increase, so it’s important to plan for this eventuality. 

Medicare will cover a lot of your healthcare needs, but not everything. To avoid being blindsided and bankrupted by unexpected costs, take a three-pronged approach that combines Medicare with long-term care insurance and potentially a tax-advantaged HSA, if it works for your healthcare needs.

For more advice on preparing for healthcare costs in retirement, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a Certified Financial Planner with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Some health insurance products offered by unaffiliated insurers. Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Michael Lynch is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton CT 06484 CRN202210-272650

8 Roadblocks On the Road to Retirement

In traffic on Monday morning, or in the middle of a long, pointless meeting, many an American has thought, “I can’t wait to retire.”

Nearly everyone looks forward to retirement. So what are we all waiting for? Why aren’t we all retired? 

One word: money.

Before we can retire, we must save up enough money to live comfortably for decades. It’s a challenging task, and many people struggle to save enough. 

When saving for retirement, we face eight common roadblocks. By understanding these roadblocks, you can better overcome them and ensure you don’t wait longer than needed to retire.

#1: Taxes

(Royalty free image: https://unsplash.com/photos/5616whx5NdQ, Credit: Unsplash / walkingondream)

Taxes are unavoidable and necessary. They can also be difficult to understand, making them a major roadblock. 

You need to pay your fair share of taxes, but you don’t want to overpay. When it comes to retirement, the primary decision you must make is whether you want to defer your taxes until retirement, or pay as you go.

As a general rule of thumb, if you expect to have a lower tax rate later in life, you should defer your taxes. If you expect your tax rate to be greater, then you should pay now.

#2: Not Saving Enough, Spending Too Much

(Royalty free image: https://unsplash.com/photos/Q59HmzK38eQ, Credit: Unsplash / rupixen)

Parkinson’s Law states, “Work expands to fill the time available for its completion.” The financial translation: one’s expenses expand to consume all available income. 

To save enough for retirement, you must break this law and drive a wedge between income and expenses.

In your working years, set a goal to save 10 to 20 percent of your income. You can start low and increase the percentage every year at annual salary increase time. 

The earlier you start saving, the faster it will become a habit. Think of retirement savings as an expense, and automate these investments as much as possible.

#3: The Corrosive Effects of Inflation

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Even at modest rates, inflation destroys the purchasing power of the dollar over long periods of time. 

Do you know anyone who paid more for their last car than their first house? That’s inflation.

Inflation is a problem because, in retirement, a portion of your income is often fixed—like income from pensions, bonds, or CDs. With inflation, this income essentially decreases over time. 

For example, in a thirty-year retirement, if inflation runs at the recent five-year trendline of 1.86 percent, $1 the day you retire will be worth only $0.58 your last year of retirement. 

#4: Taking Too Much Investment Risk

(Royalty free image: https://unsplash.com/photos/9BatP4ovW2I, Credit: Unsplash / jpvalery)

Like it or not, modern American economic life makes investors out of most of us. If you want to save for retirement, you almost always need to invest, but if you have limited investing knowledge, it’s easy to accidentally take on too much risk.

People make three common mistakes: (1) speculating instead of investing, (2) failing to allocate investments over many asset classes (bonds, stocks, etc.), and (3) failing to diversify investments within asset classes (multiple stocks).

To avoid taking on too much risk, don’t chase get-rich-quick-schemes, and be sure to diversify, choosing different investments among multiple asset classes.

#5: Not Taking Enough Investment Risk

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You don’t want to take on too much investment risk, but taking on too little is also a mistake. If you don’t take on some investment risk, you won’t earn a high enough return to beat inflation.

Playing it too safe guarantees one thing: you’ll lose money safely. If people define safety as something that can’t lose value, they limit their investment options to government bonds, CDs, money markets, and fixed annuities. 

These play important roles in most financial plans, but when they play the dominant role, the actual risk is that real, after-tax returns will lag behind inflation. 

#6: The Three D’s: Disability, Death, and Divorce

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Life brings both unexpected sorrows as well as its share of joys. If you plan only for the best-case scenario, you will be unprepared when sorrows hit.

As revealed at the 2003 Fifth Annual Joint Conference on Retirement Research Consortium, one in six Americans in the final stretch of work, those ages 51 to 61, saw their retirement plans disrupted by a disability, divorce, or death of a spouse.

Obviously, we hope these things don’t happen, but we need to have plans in place for how we or our loved ones will live if faced with disability, divorce, or death.

#7: Procrastination and Delay

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The sooner you start investing, the better. 

Consider this example. At 22, Sally starts investing $200 a month into her 401(k), earning an average of 10 percent annually, which she reinvests. She invests for ten years (total of $24,000). At retirement, she has $1.2 million.

Sue starts investing at 32, also $200 a month, compounding at 10 percent annually. She invests until 67 (total of $88,000), but she has only $685,000 at retirement!

The best time for you to get started might have been a decade back. But the next best time is today. 

#8: Failing to Plan

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The biggest roadblock is simply a failure to plan.

According to the 2003 Employee Benefit Research Institute Retirement Confidence Survey, Americans spend more time planning for vacations than planning for retirement!

Don’t rely on rules of thumb, such as, “You need $1 million in your 401(k),” “You will need only 70 percent of your income in retirement,” “You won’t need life insurance after you retire.” You are unique. Your situation is unique. The price of failure is too high.

You need to determine what your ideal retirement is, and then create a plan to get there. 

This article was adapted from the book, Keep It Simple, Make It Big, written by Michael Lynch.

Michael Lynch is a CERTIFIED FINANCIAL PLANNERTM professional with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC.  6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Michael Lynch is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. CRN202210-272637

Corporate Bonds vs. Municipal Bonds

The following is adapted from Keep It Simple, Make It Big.

Bonds are an important part of any investment portfolio. With greater stability and lower risk than stocks, they are essential for shorter-term investments and for stable ballast to a long-term portfolio. 

Even if you know you should invest in bonds, though, you might not know which bonds to choose. Not all bonds are the same, and which ones you choose can have a big impact on your returns.

There are two major categories of non-federal bonds: corporate bonds and municipal bonds. The main difference between the two is that, with corporate bonds, you are giving money to a corporation, while with municipal bonds, you’re giving money to the government.

As a result of this key difference, the two types of bonds are taxed differently and tend to have different interest rates. Deciding which is the better choice for you will depend on your individual circumstances, particularly your tax bracket.

Corporate Bonds

Bonds, sometimes referred to as fixed-income investments, are debt instruments. With corporate bonds, you provide money to a corporation to use for a fixed time period. In exchange, the corporation agrees to pay a set interest rate. Once the period has expired, say five, ten, or twenty years, the corporation returns your money.

Returns from corporate bonds are taxed in two ways: the interest is treated as ordinary income; the gains are taxed as capital gains.

Consider this example:

Joe purchases a $1,000 ten-year bond issued by General Electric with an annual interest payment (called a coupon) of 6 percent. He purchases it five years after it was first issued, and though it has a face value of $1,000, he only pays $800 for it. (Joe likely gets his discount for one of two reasons. Either interest rates have risen since the bond was issued or GE’s credit profile has declined.) 

Every year, Joe receives $60 in interest from GE. This is added to the first page of his tax return, and he pays ordinary income taxes on it.

He holds the bond to maturity, at which time GE sends him a check for $1,000, earning him a capital gain of $200. This will be taxed at the favorable capital gains rate—probably lower than income tax rates.

Municipal Bonds

With municipal bonds, you are providing money to a government. Bonds issued by states and municipal governments are free of federal tax. If they are issued in the state in which you live, they are generally free of state tax as well.

There are two types of tax-advantaged municipal bonds: general obligation bonds and revenue bonds.

General obligation bonds are backed by the general taxpayers and the full faith and credit of the issuing government and its ability to generate the general tax revenue to pay bondholder’s interest. They are approved by the voters. They may support such things as schools or other capital projects.

Revenue bonds are issued by a municipality to support some project that is expected to generate revenue, such as toll roads or airports. Bondholders are repaid by the revenue from the specific project. No revenue, no payment.

Many revenue bonds are exempt from federal taxation, but some are not. You need to check. For instance, the federal government will not allow a tax exemption for municipal bonds that are issued to replenish an underfunded pension or to fund essentially private projects even if nominally public owned, such as sports stadiums. 

Since municipal bonds are tax free, they can pay a lower interest rate per level of perceived risk than a corporate bond. 

How to Choose Between Corporate and Municipal Bonds

In general, the higher one’s tax rate, the more attractive municipal bonds become. 

To decide if a municipal bond is appropriate for you, you should calculate the taxable equivalent yield of a corporate bond, which you do by dividing the municipal bond’s interest rate by one minus your marginal tax rate: 

Municipal Bond Interest Rate ÷ (1 – Marginal Tax Rate) = Equivalent Yield of Corporate Bond

Consider Doreen’s choice. She has $100,000 she wants to use to purchase a lot in a lake community in five years when her children are old enough to be strong swimmers. She wants her money to work for her but does not want to take the risk that the stock market will be down when she needs the money. 

For her, bonds with a five-year maturity are a good option. She is in the 22 percent federal tax bracket, and her state taxes her at 5 percent, for a total marginal tax rate of 27 percent. A corporate bond will pay her 7 percent interest. A municipal bond will pay her 5 percent.

In which should she invest?

In her case, the equation looks like this:

0.05 ÷ (1 – 0.27) = 0.0685 (or 6.85 percent)

Therefore, for her, a municipal bond paying 5 percent is equivalent to a corporate bond paying 6.85 percent. 

The corporate bond is 7 percent, so for Doreen, it is a better deal, if it has an equivalent risk as the municipal bond.

Alternatively, if she was in the 37 percent federal tax bracket and 5 percent state, the equation would be: 

0.05 ÷ (1 – 0.42) = 0.086 (or 8.6 percent)

In that case, she should jump on the municipal bond, since it has a higher equivalent yield than the corporate bond.

Which Type of Bond is Right for You?

It’s tempting to say that municipal bonds are better because they’re tax-free, or that corporate bonds are better because they have higher interest rates.

The truth is that there is no one right answer here. It depends on the bonds’ interest rates and your marginal tax rate. 

Even if at one point corporate bonds were the right choice for you, municipal bonds might be better later, if you move tax brackets or if interest rates fluctuate. So this is a decision you should revisit periodically.

Bonds are a great investment option, but it’s worth doing a little calculating to be sure you are choosing the type of bond that will give you the best returns.

For more advice on bonds, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a CERTIFIED FINANCIAL PLANNERTM professional with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC.  6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. CRN202210-272627

Creating a Picture of Your Ideal Financial Future

The following is adapted from Keep It Simple, Make It Big.

What is the best way to save for retirement?

This is the question I am asked time and time again, but there’s no simple, one-size-fits-all answer. Your answer to this question will be unique to you. 

Before you can answer this question, you need to create a picture of your ideal financial future. Only after you determine where you want to go, can you begin thinking about how to get there. 

To create a picture of your ideal financial future, you need to ask yourself two different, important questions.

#1: What Does Money Mean to You?

This is an important question, yet one that few people ask themselves. It’s the first question I ask participants in a retirement-oriented class I teach. 

I’ve been helping people build, protect, use, and transfer wealth for nearly twenty years. I know that there are many answers and that each answer has important implications for how one designs a financial plan, an approach to life, and ultimately financial independence. 

Here are some common answers and approaches, although some may not be readily admitted.

• Freedom

• Security

• Time with family

• Power

• Control

Each of these is legitimate and each of them will lead to a slightly different approach to work, leisure, investing, and protecting wealth. 

A person who values freedom, for example, may place a premium on the spending side of financial life, keep a close eye on expenses, and invest a high proportion of after-tax income. This enables them to quit a job temporarily or even permanently, and not get boxed into bad situations. 

This is quite popular these days as the Financial Independence Retire Early (FIRE) movement demonstrates. How they invest their savings will depend on their overall risk preferences and ability to tolerate the downs of ownership investments. But they better have a plan to stay independent and therefore free.

A person who values the power that money provides—and it can provide a lot—will have a different relationship to work, spending, and investing. For most, work is the source of at least some power and plenty of income that facilitates spending, which itself provides both real and perceived power. 

Someone who values the power of money will likely work longer, save and invest much less, and consume a higher portion of income. These choices will drive a need to work longer to support the lifestyle. How this person saves and invests will again be driven by many factors, but the need for consumption will require a commensurate need for near-term liquidity to pay the bills.

#2: What is Your Ideal Retirement?

This second question I ask is simple, yet it often elicits some blank stares, so I follow it up with specifics that assist people in moving through their checklists.

Where are you living?

• Your current home

• Condo in Florida

• Trailer in Mexico

• Hacienda in Spain

• House in California

• Apartment in Greenwich Village

What are you doing?

• Working at Walmart

• Volunteering at church, temple, or synagogue

• Tending your garden

• Surfing in San Diego

• Taking care of grandchildren

• Traveling the country in a motor coach

Where is your money coming from?

• Social Security

• Employer-sponsored pension

• IRA

• Tax-deferred annuity

• Personal investments

• Part-time income

• Children

This last bullet produces laughter and rolling eyes. I know this as I have been one of those children who at times caused the money to move in the wrong direction—from parent to child.

Setting aside us deadbeat children for a moment, the answers to these big questions are exactly what you need to flesh out to create a picture of your ideal financial future. 

Preparing for Your Ideal Financial Future

By answering these two questions, you can begin preparing for not just retirement, but your ideal financial future.

So set aside time with your spouse, loved ones, or just yourself to brainstorm your future. Bring yellow pads and ask yourself and each other these questions. Don’t prejudge. Big goals motivate. Don’t ask, “Why?” Ask, “Why not?”

Begin the process of dreaming the big dreams and defining your retirement goals, and you can begin moving toward your ideal financial future.

For more advice on creating a picture of your ideal financial future, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a CERTIFIED FINANCIAL PLANNERTM professional with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC.  6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. CRN202210-272636

4 Strategies to Conquer Financial Risks

The following is adapted from Keep It Simple, Make It Big.

Everything in life carries risk, and investing is no exception. Even if you take no nominal risk with your money—you stuff $100 bills into a nuclear-war-proof safe in your basement—you are still subject to one of the most pernicious risks: the loss of purchasing power of money through inflation. 

Financial risk can never be completely eliminated, so you must instead find ways to manage it. Managing your risk is the key to enjoying a life and retirement free of financial worry. 

In general, risk can be addressed in four ways. The options available will depend on the nature of the risk, its likelihood, and likely financial consequences. Which option, or combination of options, you select is a personal choice. It will, however, impact those who depend on you.

#1: Avoid Certain Behaviors

The first way to address financial risks is to avoid certain behaviors.

Consider the risk of dying or being disabled in a motorcycle accident. A way to avoid that risk is to simply not ride a motorcycle.

With your finances, you cannot try to avoid all risks. That would require utilizing only “safe” investing or saving methods, and the problem with these methods is that they do not come with a high enough interest rate to match inflation. While you technically wouldn’t lose any money, you would lose a significant amount of purchasing power.

That said, there are certain behaviors you should avoid to minimize your financial risks.

First, don’t engage in speculation. Speculation is high-risk and is akin to gambling. There’s potential for big wins, but also potential for catastrophic losses. 

Second, don’t concentrate your wealth into a single stock. Concentration of company stock in a 401(k) plan is an all-too-common mistake. At Enron, a famous corporate blowup in 2001, 62 percent of the assets in employee self-directed 401(k) accounts was Enron stock. When Enron’s stock became worthless, so did 62 percent of the account balances in Enron employees’ 401(k)s. 

Enron was not the first company stock calamity and it won’t be the last. A stock doesn’t have to become worthless to punish overconcentrated investors. A sharp decline in value can have big ramifications, so avoid putting too much of your wealth in company stock.

#2: Adjust to Minimize Consequences

Your next risk-management strategy is to adjust to minimize consequences. In the motorcycle example, this would be wearing a helmet, gloves, and leathers, and not driving in poor weather.

The best way to minimize the consequences of financial risks is diversification.

You should diversify in two ways: (1) allocate investments over many asset classes and (2) diversify investments within asset classes.

Diversifying across asset classes means that you don’t put all of your money in, say, the stock market. Rather, you put some money in stocks, some in bonds, some in a life insurance policy, some in an HSA, and so on. 

Different asset classes react differently to economic changes, so by allocating investments over many different asset classes, you can help insulate yourself from market downturns. During the 2008 financial collapse, for example, those investors who had allocated some assets to US government bonds did better in comparison to those who were only invested in the stock market.

Diversifying investments within asset classes is also important to managing risk. If you are invested in only a single stock, for example, and something goes wrong, the consequences will be disastrous. With your money spread out across many stocks, a single stock’s decline won’t affect you as much.

It’s important to not only diversify in number but type. For instance, in the dot-com collapse in early 2000s, if you had fifty different stocks but they were all technology companies, you were in trouble. In contrast, investors who were allocated to other kinds of stocks, like foreign stocks, did not suffer as much loss in value.

#3: Transfer Risks to a Third Party

Your third option is to transfer risks to a third party. In the motorcycle example, this would be purchasing life, disability, motorcycle, and liability insurance.

It’s a good idea to transfer risks to a third party when a risk is unlikely but would have severe consequences if it were to occur. For example, a 30-year-old person is not likely to die, but if this person is the breadwinner for a family, the consequence of his passing might have catastrophic consequences for those he loves. Therefore, it’s wise for him to have life insurance.

We use insurance to prevent physical and human tragedies from becoming financial tragedies. This category of risk management includes all the various insurance policies that protect you from the financial costs of unexpected events—health insurance, life insurance, disability insurance, homeowners’ insurance, car insurance, and so on.

With this method, it’s important to note that risk must be transferred before it is imminent. In general, once insurance is needed, it cannot be purchased at a reasonable cost, if at all. So get insurance early, before you need it.

#4: Retain Risk

Your final risk management strategy is to retain risk, being prepared to accept the consequences. For example, in the motorcycle example, even with insurance and the proper equipment, if you’re injured, you will have to deal with some consequences, including insurance deductibles and copays.

You should retain risk in cases where a risk is unlikely and of little consequence, such as a dorm-room refrigerator breaking down. 

In deciding which risks to retain, you need to be honest with yourself. Just because you can retain a risk doesn’t mean it’s a good idea.

A few years back, I was listening to a popular personal finance radio show, and a woman called about a neighbor’s tree that had crushed her house in a storm. It was considered an act of God, so it was her responsibility, not her neighbor’s. 

The host told her to contact her insurer, and it would pay the bill. The caller, however, was out of luck. She’d paid off her house and cancelled her homeowner’s insurance to save money. Big mistake.

A frugal mentality can cost you more money in the long run, so be thoughtful about the risks you choose to retain. 

Manage Your Risk

“We know only two things about the future,” says Peter Drucker. “It cannot be known, and it will be different from what exists now and from what we now expect.”

You cannot predict the future, so you cannot totally avoid life’s risks. But you can—and must—manage them.

With a combination of all four of these strategies, you can better prepare for the risks of life and ensure they don’t turn into financial catastrophes.

For more advice on managing financial risks, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a CERTIFIED FINANCIAL PLANNERTM professional with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC.  6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. CRN202210-272625

5 Steps to Build a Retirement Investment System

The following is adapted from Keep It Simple, Make It Big.

Finance is a lot like fitness. No matter what you read, hear, or are pitched, there is no single solution, no silver bullet to getting in shape. Likewise, there’s no one solution for retirement investment.

Rather, you need a system. With a system of exercise and diet, applied consistently over many years, you can attain your health goals. In the same way, to reach your financial goals and live a comfortable retirement, you need a system of investment. 

Everyone needs a system. Without a system, your retirement dream could quickly turn to a nightmare, as you struggle to make ends meet. While each individual’s system will vary according to their needs, there are five steps that are universal.

Step #1: Establish Your Goal

The first requirement in your system is a goal. Life is like that. If you don’t care where you are going, any road will do. That should not be the case for your financial plan.

Start by thinking about what money means to you. It could be freedom, security, time with family, power, control, or something else. Whatever it is, it will affect your goal.

Then think about what your ideal retirement looks like. Where are you living? What are you doing? How much money do you need each month to have that ideal?

Here’s an example of a goal: based on a detailed expense projection, with family vacations factored in, a couple needs to generate $8,000 a month in pre-tax income. That’s the need.

Step #2: Evaluate Your Resources

After establishing your goal, you next need to evaluate your resources. Start with what you already have available, and then calculate what you still need to reach your goal.

For our example couple, let’s assume they receive $4,500 in Social Security each month and do not have a pension. Therefore, they need to generate $3,500 from investments. 

The first thing to figure out is the size of the portfolio required to generate this income. Most people do not want to invade principal, and it takes a lot of assets to generate enough income through interest.

So how much income can safely be withdrawn from a portfolio?

The widely, although not universally accepted, answer to this question is 4 percent a year. Pessimists on financial markets claim this may be too high. Other researchers relying on historical data show that a rate could be higher if careful systems are followed. 

For the purposes of this example, we will use 4 percent. It has been tested relentlessly with both real-world returns and academic laboratory modeling, and I consider it safe in my practice.

Using 4 percent, this couple would need a portfolio of $1,050,000. ($1,050,000 x .04 = $42,000 a year, or $3,500 a month.) 

Let’s assume that they have $1,200,000 among retirement plans, bank cash, and non-qualified investments. If they didn’t have enough, they’d have to reevaluate their goals or go to a more aggressive withdrawal plan that would rely on using principal. 

Step #3: Create an Income Reservoir

Safety needs to come first, and the first piece of safety here is to create an income reservoir. I often call this the operating account. This mandatory account is a pool of money that will help protect principal and be liquid when needed. 

I usually suggest three to five years of income. In this example, the couple needs $42,000 of income a year, so they need $126,000 to $210,000 for their income reservoir. 

How these monies are invested will depend on options available in employer plans—many have attractive stable value funds that can’t be replicated in IRAs—and the interest-rate environment. The key is that this is an expected income reserve, not emergency reserve, so each $42,000 needs to be available at the start of the year. Laddered CDs can therefore be used if the rates are attractive. 

For this example, let’s put $160,000 or roughly four years of expected income into this account. We now have $1,040,000 of the original amount left.

Step #4: Create a Retirement Account

The next account to consider is what I call a retirement account. This is an annuity, typically a variable annuity with an income rider, although it could be a fixed-indexed annuity with an income rider. 

There are two reasons to use annuities.

First, because they are expected over time to use both principal and returns to generate income, they can generate income at a rate greater than 4 percent, and in some instances, as high as 7 percent. This income will generally not inflate over time, but it will initially relieve pressure on the investment portfolio.

Second, they are hybrid accounts that combine liquidity and guaranteed income. Unlike an immediate annuity that requires people to give up substantial sums to “purchase” a lifetime stream of income, these products allow people to retain access to the principal, subject to the terms of the contract. Typically, there are surrender charges that limit full access to investment values for a number of years.

It’s important to be clear on the structure of the account. Money used to generate the income can’t be removed in lump sums without affecting the amount of income. This is true of investment accounts as well, but it’s more pronounced with annuities as the income guarantees are often greater than the account value.

For our example, let’s move $200,000 into a variable annuity with a 6 percent income rider. This will generate $12,000 a year or $1,000 a month of income.

Since this income is initially guaranteed, it reduces our target need from non-guaranteed investments from $3,500 a month to $2,500, or $30,000 a year. Our income reservoir now covers more than five years of withdrawal needs.

Step #5: Create a Capital Account

The remaining $840,000 is invested in a total return investment portfolio consistent with the couple’s tolerance for long-term volatility. I call this the capital account. 

If we assume a moderate risk tolerance, it will be between 60 to 70 percent equity. In years of positive market returns, this account will supply $30,000 a year of income. This is 3.6 percent of the account’s value, which is in the safety range of the 4 percent rule.

Many years, this account will earn far more than its target, and this money can be redeployed into the reservoir for future safety or to replace past withdrawals, used for one-time purchases, such as once-in-a-lifetime vacations, or left in the account to compound. In flat and down years, withdrawals can be stopped and taken instead from the reservoir account.

Customize the System

Any retirement system you choose must fit your personality. Fortunately, this five-step system is modular and easily customized for each person, depending on asset levels and tolerance for risk. 

More aggressive investors, for example, might forego the variable annuity. Or couples who do not care about having money left over after they’re gone might choose to take greater income early in retirement, when they’re both around to enjoy it.

By customizing this five-step system to your needs, you can better manage your assets and generate reliable inflation-adjusted income in retirement.

For more advice on creating a retirement investment system, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a CERTIFIED FINANCIAL PLANNERTM professional with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC.  6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000.

Representatives do not provide tax and/or legal advice. Any discussion of taxes is for general informational purposes only, does not purport to be complete or cover every situation, and should not be construed as legal, tax or accounting advice. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. Michael Lynch is a registered representative of and offers securities and investment advisory services through MML Investors Services, LLC. Member SIPC. www.SIPC.org 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000.CRN202210-272639

3 Common Financial Misconceptions About Retirement

The following is adapted from Keep It Simple, Make It Big.

Many Americans think they’ll have enough money in retirement, when the truth is, they won’t.

As Dallas Salisbury, president and CEO of Employee Benefit Research Institute, stated, “Almost half of workers (47 percent) who have not saved for retirement are at least somewhat confident about having enough money in retirement.”

Even if you’ve been diligently saving for retirement, there’s a chance you’re not saving enough, because the rules of the game have changed. Things that held true for your parents or grandparents, no longer apply today. 

In particular, there are three common retirement misconceptions you must be aware of, or you run the risk of not saving enough.

Misconception #1: I’ll Work Until 65 and Keep Working Part-Time

Americans plan to work longer than statistics show we actually do. The average person plans to retire at 65. The average retiree, however, calls it quits at 62. That’s three fewer years of earnings and savings and three more years of withdrawals and depletions. 

For many, early retirement is not a choice. Nearly one in two American workers was forced to quit working earlier than they had planned. Forty percent did so due to disability or health problems. A quarter did so due to changes at their employer. At best, a mere 35 percent left on their own terms.

The vast majority of Americans—four out of five—also say they will continue to work part-time in retirement. Reasons given include health insurance benefits, needing the money to purchase life’s essentials, wanting the money for life’s extras, or enjoying work.

The reality is that far fewer will be able to work in retirement than plan to do so. Although four in five expect to work in retirement, a mere one in three suit up and get to work.

Misconception #2: I Won’t be Retired More Than Twenty Years

In addition to retirement starting far earlier than many expect, it tends to last longer as well.

According to the 2004 ING Retirement Readiness & Middle America Survey, nearly one in two Americans expects to be retired for fewer than twenty years. Sixteen percent expect to live less than fifteen years after saying goodbye to paid employment.

In the past, this was a reasonable assumption. A baby boy born in 1935 could expect to live to 60, and a baby girl was expected to survive until 64. In contrast, a baby boy born in 2015 can expect to live until 78, and a baby girl is projected to reach 81.

With these ages, the assumption that your retirement will last fewer than twenty years still seems reasonable. However, today, if a couple both reach 65, one person can expect to live until age 93. There’s a one in four chance that one will live until 97.

Longevity is the reality we all face. On balance, this is a good thing, of course, but all silver linings have clouds. In saving for retirement, you have to be prepared for the potential of a thirty-year retirement.

Misconception #3: I Can Count on Social Security

Social Security was founded in 1935—when a baby boy could be expected to live to 60 and a baby girl to 64. Today, the Social Security system is struggling to support Americans as life expectancies increase. 

The costs of Social Security are quickly outpacing the income. According to the 2018 Annual Report of the Social Security Trustees, in order for the Social Security funds to remain fully solvent over the next seventy-five years, the payroll tax rate would have to increase 2.78 percentage points, or scheduled benefits would have to be reduced by about 17 percent for all current and future beneficiaries, or about 21 percent if the reductions were applied only to those who become initially eligible for benefits in 2018. 

Bottom line, if no action is taken—and there’s nothing pending—the trustees project a nearly 25 percent reduction in benefits will be required in 2034.

Are you prepared for a 25 percent cut in pay?

You need a plan if Uncle Sam uses any of the strategies available to erode the real value of your Social Security.

Planning for Retirement

Ultimately, when you plan for retirement, you must plan for the unknown. 

You may want to work until 65 and plan to keep working part-time, but there’s no guarantee that happens. 

You might expect to live to 80, but you very well could make it to 95.

A Social Security calculator may say you can expect X dollars in Social Security, but there could be significant reductions in the future.

If you want to ensure you’re saved enough for retirement, you need to plan for all these potential outcomes.

For more advice on saving for retirement, you can find Keep It Simple, Make It Big on Amazon.

Michael Lynch is a Certified Financial Planner with nearly twenty years of experience working with American families to craft plans that fund their dreams, educate their children, and finance their retirement. Michael has contributed to the Wall Street Journal and Investor’s Business Daily, and hosted Smart Money Radio for a decade. He’s served as an adjunct faculty member at Fairfield University and currently teaches financial planning to employees of corporations like Madison Square Garden and Yale New Haven Health Systems. Michael is a five-time Financial Planner of the Year for MetLife and a 2019 inductee to the Barnum Financial Group Hall of Fame. You can enjoy his latest articles and videos at www.michaelwlynch.com. CRN202210-272620

Replace “Or” with “And”

If you’re approaching retirement—or even made the leap from work to leisure already—you’ve been bombarded with stories, studies, and tales of how unprepared your compatriots—and by implication you—are to finance your golden years. Google “retirement crisis” and close to 390 million hits appear. No wonder nearly one in two Americans tell Gallup that they fear not having enough money to fund a comfortable retirement. 

You can relax. You certainly have problems in your future, but paying your bills isn’t among them. This so-called crisis is akin to the global overpopulation crisis of the 1970s that has not only disappeared but morphed into its opposite. The experts now fret that we aren’t having enough children. I’m here to tell you that if you’re reading this article, there is no “retirement crisis” in your future. Your problem will be giving yourself permission to enjoy your money. I’ve got a strategy for that. But first, let me support my countercultural assertions.

Let’s start with the half of working Americans who are worried about retirement. Gallup started collecting these data in 2001 and got similar responses. Those early folks are now retired. Guess what? Eight in ten report they are doing just fine.

This rosy picture is supported by the people at the Employee Benefit Research Institute (EBRI) who’ve been studying retirees for decades. A recent report found that eight in ten retirees report themselves as doing well.  Another EBRI study found that only 20 percent of retirees even make withdrawals from retirement plans prior to being required to do so. Once required to withdraw, eight in ten take only the minimum required.

No wonder: the older the American, the more likely she’ll be wealthy. Americans over age 70 have assets valued at $35 trillion. That includes Warren Buffet, of course, but not Elon Musk, Jeff Bezos, Mark Zuckerberg, or Peter Thiel’s $5 billion Roth IRA. Even after a lifetime of required withdrawals, a substantial portion of people die wealthier than they retired.

Don’t feel guilty if you have a few dollars saved when you read about your destitute compatriots. They likely aren’t destitute. All those stories you read that ten percent of seniors are in poverty and one in three rely solely on Social Security for income? They are bogus, according to American Enterprise Institute fellow Andrew Biggs, who takes the time to fact check the reports.

Those reports are based on surveys, yet Biggs and other researchers dug into IRS data—on what people and institutions report and on the taxes they actually pay—and found as far back as 2008 that retirees self-reported far less income than hit their bank accounts. Retirees reported collecting $250 billion from investments. But IRS data on the same people show that $450 billion hit tax returns.

Biggs, cites other research by Census Bureau economists and the IRS using similar methods shows reported median retiree household income as $41,000 versus actual income of $52,000, a 27 percent jump. This drops the percent of retirees relying on Social Security for at least 90 percent of their income to 14 percent. The poverty rate for seniors drops to less than 7 percent. (By way of comparison, the U.S. government says 16 percent of children live in poverty.)

There are no doubt pockets of financial pain among American seniors. But the norm is financial and life success, not failure and misery.

Back to you. It’s likely that you resemble most of my boomer clients. You are a responsible citizen who took advantage of the myriad saving and investing opportunities that emerged over your working life. You funded you employer-sponsored defined-contribution plans and Roth IRAs when they appeared from a massive tax overhaul in 1997. You may have a pension, which certainly helps. But if not, you’ll likely have made it up from personal savings.

Here’s my general impression, not knowing your situation. You’ll do well to replace “Or” with “And.” This is advice I recently blurted out on a check-in call with a long-time client, who was asking questions about what to do with required minimum distributions from retirement plans. 

Do whatever you want, I said.

Here’s what I mean. In this case, I knew that my clients like travel and dining out. I used a food example and counseled, when perusing the appetizer menu at their favorite restaurant, don’t ask whether to get the oysters, clams casino, or Caesar salad. Instead put an “and” in the sentence and order the oyster, clams casino and the Caesar salad.

I’m not trying to fatten you up, I explained. You don’t have to eat it all, take the leftovers home and replace a future meal. If it will make you happy in the moment, order it and swipe your card with a smile. It’s not going to break you.

This feels unnatural. I got it. When we were building wealth, most of us did so by deftly using the “or” and avoiding the “and” with ourselves and our family. We couldn’t have it all, after all, so we needed to make choices, economize, and save. We could put the pool in the backyard or take the expensive summer vacations. If we did both, we’d be among those who don’t have the dough to retire.

Your discipline in the accumulation phase, combined with smart investing, built a nice pile of money. For many pre-retirees and those who’ve already called it quits, that pile has now taken on a life of its own, compounding nicely. It’s time to spend. That’s out of your comfort zone. The very habits that made you successful work against your enjoying your success to the full.

Back to my clients. We continued our brainstorming, applying the “or and” concept to travel. You’re planning a cruise, I said.  It’s not a question of first-class airfare or an upgraded stateroom. It’s first-class airfare and a premium stateroom. Take the same approach when purchasing excursions. Take the helicopter to the glacier and go salmon fishing. You’re only likely to be in Alaska once. It’s only money. If you don’t spend it, your kids will. They may in fact pay extra to fish for salmon from the helicopter on the way to the glacier. All with your money. Ponder that.

Speaking of kids, you can bring them and the grandkids into the “and” if that makes you happy. You can either snowbird for Christmas (spend the holiday in a warmer climate) or spend it with your children. Do both: snowbird with your children by sending them tickets and putting them up. Consider it an advance on their inheritance.

Don’t get hung up on these examples. They may very well not fit your desires, tastes, or budget. I get it. Absorb the concept and apply it to your life. If you’re reading Retirement Daily, chances are you have enough to put the “and” in your retirement. Take the leap. Do it. You won’t spend you last dollar. So why are you worried about conserving it?

Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton, CT, where he focuses on his clients’ finances so they can focus on their lives. He teaches consumer-oriented financial planning courses for leading organizations, including Madison Square Garden and Yale New Haven Health Systems. He is a member of Ed Slott’s Elite IRA Advisor Group and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. You can find more articles and videos at michaelwlynch.com. He can be reached at mlynch@barnumfg.com or 203-513-6032.

Securities, investment advisory services, and financial planning services are offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only, does not purport to be complete or to cover every situation, and should not be construed as legal, tax, or accounting advice. Clients should confer with their qualified legal, tax, and accounting advisors as appropriate

The Four New Rules of Debt in Retirement

Nothing great in life is accomplished without the assistance of strangers. This holds true for personal finance, where leveraging two forms of OPM—other people’s money and other people’s mistakes— often provides the surest route to success.

This embrace of debt always sits uneasy in middle America. We’re trained from birth to abhor debt. Like primal instincts that prompt us to jump when we hear rustling in bushes in the small chance that it really is a venomous snake or something worse, this debt aversion is no doubt an adaptive trait for people with low levels of assets and low levels of income. But just as modern realities have changed smart retirement income planning from its former fetish of living on the income generated from conservative assets, low interest rates combined with relatively large investment accounts change the smart approach to debt.

In this spirit, here are four new rules of debt for the astute pre-retiree to adopt.

1. Your mortgage is not a problem.  

Chevrolet, baseball, and apple pie. It’s in this tradition of good wholesome American living that people aspire to be mortgage-free. I’m all for paying off mortgages, given the right set of facts. But the mortgage-free retirement is a relic of the past.  In many instances, it’s no longer necessary.

In the old world, our grandparents and parents purchased a house, took a 30-year mortgage with a substantial interest rate, and paid this off in a straight line. 

One house, one spouse, one mortgage. This is a great plan. It reduces expenses during peak earning years, creates money for saving and investing, and eliminates an expense in retirement, namely the principal and interest payment. (Note that you always will have a house payment in the form of taxes and maintenance. In this vein, the principal is typically not an expense, but just an internal financial transfer.)

It’s not likely your plan, however. My clients who approach retirement with mortgages usually have good financial reasons for doing so. Today’s rock-bottom interest rates, elevated home values, and aggressive mortgage industry transformed the mortgage from a one-and-done event into a flexible financial tool. When confronted with large expenses that could not be saved for, such as rapidly escalating college tuition bills, the best place to get the money was to leverage the house. Due to government policy, this strategy combined rock-bottom rates with the potential for tax deduction and became the smart money move.

Even folks who didn’t need the cash out made the smart play to refinance their liability as rates dropped, freeing up cash flow for retirement investing. Lowering a mortgage payment and putting the funds in a retirement plan can be a double play, gaining from the difference between paid and earned interest rate as well as from the substantial income tax deduction on home mortgage interest.

So, as we sit in the waning days of 2021 with 30-year mortgage rates hovering at 2.5 percent, the required payment on each $100,000 of debt is a mere $395. Of this, $187 is principal in the first payment. Principal isn’t even a real expense, but rather a transfer from your bank account to your home equity. So the planning issue is, can you easily make the payment? If you answer yes, you can relax. It’s not a problem. Retire with a mortgage.  It’s the smart move.

1. Interest is way cheaper than taxes.

Like most people, I hate to say no. I’m a lover not a fighter. I find honey usually gets better results than vinegar. Yet, one place I have no problem putting my foot down is when pre-retirees tell me they plan to pay off their modest mortgage, $100,000 or more, with a withdrawal from their retirement plan.

Friends don’t let friends drive drunk and fiduciary advisors don’t let clients pay off low-interest mortgage debt with high-tax assets. I don’t allow it. I argue. I reason. I fight. I throw my body across the door to block the exit.

Paying off a low-rate mortgage from a pre-tax retirement plan is the financial equivalent of remaining on Mount Saint Helens when you know the volcano is set to erupt. Not smart. If interest is 3 percent and combined federal and state income taxes approach 30 percent of the withdrawal, you should view paying the bank as a gift from on high.

It’s understandable that you want to be “debt free,” but understand that the cost is the interest. The principal is simply moving money from one of your pockets to another, akin to transferring your wallet from your back to your front pocket. It makes you feel good, but that’s it.

Fasten your seatbelt. I’m going to apply this financial logic to places you may not want to go. 

Finance the car, boat, kitchen, or motor home.

Assuming that your source of funds available for large purchases is your pre-tax retirement plan, I strongly urge you to finance the new or certified used car at low interest rates. If you’re making substantial purchases at Home Depot to keep that house of yours well-maintained and up to date, I urge you to take the zero percent or low percent interest offer on the house credit card.

Again, the interest is usually less expensive than the taxes. Way, way, way less. It does depend on the person, however.

Examine where you sit in the tax brackets. Make sure you optimize your 12 percent or 22 percent bracket. You can accelerate the payoff of the debt as your income tax optimization permits. You are not hostage to the creditor’s repayment schedule. But use other people’s money. Rely on the kindness of strangers. It’s smart.

1. Your retirement plan may be the place to turn for funds.

Let’s go back to the basics. The cost of debt is the interest payment. The principal is something that you got advanced and presumably added to your happiness if not your net worth. The debt scolds will tell you never to borrow against your retirement plan, making up tales of being double taxed and risking a degraded future.

In some cases, they are right. I’ll get to that in the next rule. But in others, they are certainly wrong.

If you are approaching retirement with high-interest debt and decent income, it may be a smart move for you to leverage your employer-provided retirement plan at a much lower rate and kill the high-interest liability.

Again, the cost of debt is the interest paid, so a credit card at 15 percent costs $125 a month per $10,000 versus $33 per $10,000 for the same amount in a 4 percent 401(k) loan. And in the latter case, you pay the funds back to yourself. The real cost is lost investment return that the money would have earned if left invested. It’s a potential double digit return!

Don’t fret about bringing this liability into retirement. At this point, you may have two options to dispose of it responsibly.

First, you can keep paying the loan if the plan allows it. This allows you to finesse the liability to zero at the lowest possible cost.

If not, some plans will cancel the debt a few months after you retire, treating the payoff as a taxable distribution from the plan. Timed correctly, this can be at a much lower income tax rate than while working. 

You will need to do smart planning around this. Make sure the debt is canceled in a low-income year. You may have to retire in the fourth quarter to accomplish this. Taxes operate on a calendar year, so a few weeks can make a huge difference in the rate paid.

1. You may want to keep the pressure on.

Now it’s time for me to backtrack. I am both a student and a lover of people and my strategies accommodate human nature rather than abstract notions of the just and good.

Some of you are happy carrying a few dollars in high-interest credit card debt.

I know this from years of experience.

You’ll tell us financial people what we want to hear, proclaiming that you want to pay your debt down to zero. Yet you are in fact fine with some affordable level of revolving debt. Your actions make this clear.

It’s like my target weight. I’ll tell you I want to get back to 165 pounds.  When I’m 190, I’ll make the necessary moves to move the needle south. But at 180 or so, I’ll stall, and that needle will start moving north.

As my dad used to lecture, show me don’t tell me. Economists call it revealed preference.

If your comfort level with debt is $10,000, for example, it is a losing strategy to pay it down with asset withdrawals as you’ll only get right back to your comfort level. At that point, you’ve lost the asset and the debt is right back where it started. It’s better to pay the reasonable price to keep the pressure on. I learned this lesson in the first year of practicing as a financial advisor. 

A couple with debt kept professing a desire to be free of it, whatever it took. I’d put together detailed plans to destroy the professed albatross.  They’d knock it down a little by the mid-year review, but it’d be back in full fury for the annual checkup. At year three, I gave lip service to debt reduction and started an investment program to build wealth.  A few years later, the wife died and most of the debt with her. The investment assets created are still providing support nearly 20 years later. 

In a perfect world, we’d all arrive at retirement with a debt-free balance sheet. No argument here. It’s never smart to let the perfect be the enemy of the good or the good enemy of the good enough. When it comes to debt, you can carry some  and be financially independent at the same time. 

Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton, CT, where he focuses on his clients’ finances so they can focus on their lives. He teaches consumer-oriented financial planning courses for leading organizations, including Madison Square Garden and Yale New Haven Health Systems. He is a member of Ed Slott’s Elite IRA Advisor Group and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. You can find more articles and videos at michaelwlynch.com. He can be reached at mlynch@barnumfg.com or 203-513-6032.

Securities, investment advisory services, and financial planning services are offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only, does not purport to be complete or to cover every situation, and should not be construed as legal, tax, or accounting advice. Clients should confer with their qualified legal, tax, and accounting advisors as appropriate.  

CRN202411-1155517

Seven Simple Steps to Make it Big!

Think Big! Big Goals Create Big Motivation. Don’t ask, Why? Ask, Why Not?  Life is not a dress rehearsal.  Most people do the expected.  Don’t be like most people.  People experience two types of regret.  The first: Regret for things we did.  We all have these.  The second: Regrets for the shots we didn’t take, the things we didn’t do.  Consider your life so far. Chances are your type 1 regrets have diminished over time. The type 2 regrets are likely still nagging you.  Live your life to minimize type 2 regrets.  As Nike instructs, plan to Just Do It!

1. Put a Price Tag on Your Dreams, and Commit to Pay It.  Financial independence is a function of having enough passive income to support your life.  The current you needs to know what the future you’s life will cost. You may be financially independent and just don’t know it.  You may need to devote far more resources to the future you.  Put pencil to paper or a keyboard to a excel and calculate the cost.  Don’t forget inflation.
   
   

2. Line Up Your Income Spigots.  Document your current income sources.  Secure estimates of you and your spouse’s Social Security benefits. Remember, the future estimates are in current dollars.  Add in any employer pensions you may have, private income annuities and your accumulated investments earmarked for retirement.  For the latter, you must estimate the reliable income they will generate.  Start with 4 percent a year. 
   
   

3. Get Tax Smart. It’s not your account balances that count.  It’s the after-tax income that you can spend.  Roth accounts and taxable accounts are always worth more than pre-tax retirement plans and traditional IRAs.  Consider your current and expected future tax positions. Don’t forget your current and potential future state tax collectors. Consider a plan to build Roth and taxable accounts.
   
   

4. Tune Up Your Investments. Determine your tolerance for investment risk, meaning fluctuations in the negative direction.  Remember total stability means near zero pre-tax and inflation return and negative returns after these factors.  To live is to accept risk. There is no such thing as risk free investing.  Compare your current investment to your ideal mix and make the necessary changes.
   
   

5. Build Your Buckets. If you are like most of us, you need three things from your finances in retirement. 1. Stable principal. 2. Reliable income.  3. Growth of income.  These need conflict, as things that protect principal don’t grow and don’t produce reliable income.  Products that produce reliable income generally aren’t liquid and don’t offer much growth and investment that grow, also contract with disturbing frequency. The result: you need to create buckets of income allocation.
   
   

6. Contemplate Your Demise. None of us gets out of here alive. You’re no exception.  If your death would inflict financial pain on someone you love, consider acquiring some life insurance.  What great things do you want your money to accomplish after your gone? Update your beneficiary forms, wills and trusts. Don’t forget your health care directive and durable power of attorney form.  This may be your most important document if protecting your assets is a priority.
   
   

The 8th step.  If you want help with your simple game plan to make it big, email mlynch@barnumfg.com to start the conversation. 

Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC.  6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000 CRN202210-272520

Financing Summer Fun

Summer’s here, and along with the children at home, long days, and outdoor grilling come additional expenses that have the potential to bust a family’s budget. If not properly planned, a summer’s fun can leave parents paying off out-of-school debt before the back-to-school sales even start. 

Yet if handled well, parents (this also applies to grandparents) can not only survive the summer without adding any debt but also use its dog days to teach their charges valuable lessons. First, the ultimate source of money is not mom’s purse, dad’s wallet, or the even the U.S. Mint, but rather to work. Second, since money stems from work, work stems from time, and time is limited, so too is money. Third, limits require choices. Although no one can have it all, through smart choices we can maximize our financial and non-financial resources.  

That’s just what’s in it for your children. If handled properly, us adults can get valuable work accomplished for money that we would have handed out anyway.

Many parents trade an allowance for a set of chores. This is admirable and advisable, as it ties money to work and teaches children to chip in around the house. It falls short, however, as the cure for the summer-time blues because summer often requires additional money for camps, movies, vacations and other activities. 

Consider providing a summer bonus. Put children in charge of a summer clean up and sale. Most of us have plenty of junk around the house that we somehow never seem to get around to organizing, giving away, igniting or selling. One person’s junk is another person’s treasure. Explain to your children that your household detritus is in fact their summer bonus pool. All they must do is collect it, get approval to sell it (this is very important, as you don’t want your new computer sold at a deep discount), and find a way to make a deal with a willing buyer. 

 Common venues are the standard driveway tag sale, local flea market or now days the virtual Craigslist or Facebook Tagsale. Explain that any money earned is your child’s to keep—this will give them an incentive to price it correctly. Make it clear that this is the summer fun budget, a soon to be determined fixed amount of cash to pay for their supplemental fun. They’ll be no open access to your purse or wallet.

Parents are free to sweeten the pot. A 401K-like match works well. For every dollar they earn getting rid of your stuff, perhaps you’ll match it with $1. You can use this to teach the value of savings. Let your children know that they’ve earned the money, then put it in an account where they can’t get at it. Invest it wisely and show them the statements. 

Many parents will be surprised at their children’s reaction. We are all creative, and once people understand there’s money to be made in making smart choices, they quickly discover prudence. All of a sudden a book from a library rather than from Amazon doesn’t seem like such a bad deal. Children who understand that they get to keep the difference, will suddenly quit complaining about not being able to make regular visits to the $25 water park and instead enjoy a public pool or even better, a free neighborhood one.

With a little luck, both parents and children may end the summer with a little extra cash. 

 Mike Lynch CFP® is a financial planner at the Barnum Financial Group in Shelton, CT. He can be reached at mlynch@barnumfg.com or 203-513-6032.

These are the views of Mike Lynch and not those of MML Investors Services, LLC or its affiliated companies, and should not be construed as investment advice. Neither the named Representative nor MML Investors Services, LLC gives tax or legal advice. All information is believed to be from reliable sources; however, MML Investors Services, LLC makes no representation as to its completeness or accuracy. The author is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information.
Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services, Member SIPC. 6 Corporate Drive, Shelton, CT  06484

Tel: 203-513-6000. 

CRN202006-232146

Changes Gonna Come: Primer on Tax Changes

Investments, retirement plans, taxes and estate and gift taxes make a confusing stew in the more stable of times.  These times, as you know, aren’t stable.  The pandemic, a party-changing election, and resulting massive government spending provide the catalyst for investable change.  The proposals are coming out almost weekly, with mind boggling numbers and strategies to raise the revenues to pay for them.  With this, a slew of nearly inscrutable jargon flow from the lips of television commentators and keypads of pontificators of the written word. A day doesn’t pass when I don’t field a great question from a confused person on how a proposed tax code change will affect them.  

The answer, of course, is no one knows until legislation is passed, singed into law, and implemented by the IRS.  Still, the factors at play are long term-features of the U.S. tax code. Consider this a handy primer to help you make sense of our new unfolding reality.

Ordinary Income, Capital Gains and the Cost of Dying 

Last week, a client arrived in my office and promptly asked how much the proposed changes is capital gains taxes would cost him and his wife.  I examined the accounts, looked him in the eye, and replied confidently, “nothing.”  

How could I be so confident? 

His accounts are all retirement accounts, taxed at ordinary income rates when money in withdrawn.  

This brings me to my first point of clarification.  Your investments and the proceeds that will hopefully flow from them can be thought of as either capital assets or ordinary income assets.  

 Capital assets are things such as your house or investments purchased with after-tax money for which there is a “cost basis.” When you sell, the cost basis comes back without tax.  The incremental gain is taxed as a “capital gain,” either short or long term depending on how long the investment was held.

Retirement plans, whether pre-tax, Roth, or non-qualified annuities, are ordinary income assets.  Here the untaxed portion is taxed as ordinary income when withdrawn.  

In the case of pre-tax retirement plans, this means all of it. In the case of Roth assets, this should mean none of it. And for income assets with a basis, such as after-tax IRAs or non-qualified annuities, this means the portion of payments that is counted as earnings. 

Since this gentleman’s accounts were all IRAs, changes in capital gains tax rates and cost basis structures have no effect.  What he and his wife need to focus on is ordinary income tax rates and the terms on which the accounts must be emptied while alive through RMDs and after death for the beneficiaries. 

The Cost of Stepping Up

Proposed changes to the treatment of “cost basis” at death is the source of most confusion I’m confronting. Longtime rules follow a logical and easy to administer path. Your cost basis is what you paid for an investment plus any future monies invested. 

 In a stock account, this is typically reinvested dividends and additional purchases.  In real estate, it’s material improvements.  Under current rules, if a person gives a capital asset away, the cost basis follows the asset and the recipient will pay taxes on the gains when sold.  If a person dies and passes the asset only when they are no longer able to use it, it receives a step-up or step-down in basis to the value on the date of death. 

Happy Surprises

One of the biggest—and best received-- surprises I deliver to clients is the answer to the question of how much tax they will owe on an inheritance of stock or a house.  I look at them squarely in the eye and deliver the news: “Nothing.” 

“If you sell it,” I quickly add, “very little.”

I can say this because I know that the basis of the asset has reset to recent market prices at the date of death.  A stock purchased by your grandparents for $1 and inherited by you when it was selling at $200 a share, has a new basis of $200.  The ability for $199 a share in gain to be taxed is gone, at least for the moment. 

The President has proposed a change in these rules for some people, reportedly those with more than $1 million in income. Again, the particulars will change, so it’s the principle that’s important here.  The desire is to tax capital gains of more than $1.25 million at a person’s death, regardless of whether the asset is sold or retained by a beneficiary.  

This elimination of the step-up in basis is a major change to the current tax and planning structure. It’s worth keeping an eye on as any change may require an adjustment to your personal financial planning. 

Tax Rates

At present, there are two sets of tax rate tables applied in America. The first is that for ordinary income, which includes earned income, pensions, the taxable portion of social security, and interest income. 

These rates tax income starting at zero for the portion in standard deduction. 10, 12, 22, 24, 32, 35 and 37 percent.  

The feds apply a lower set of rates to long-term capital gains and dividends.  These rates are zero, for those in the 10 and 12 percent brackets, 15 percent for those up into the 35 percent bracket and 20 for people whose income takes them to the top rate. 

In addition to this, the health care reform in the Obama years tacked on additional 3.8 percent for individuals who earn more than $200,000 and couples who top $250,000. 

At present, the top earner’s income will be taxed at 37 percent.  Capital gains and dividends at 23.8 percent.  

The Biden administration proposes two adjustments.  First, increase the top income tax rate to 39.6 percent, where it was when Trump arrived in office. 

Second, apply the ordinary income rate—plus the Net Investment Income Tax surtax—to capital gains for Americans earning more than $1 million. 

This nearly doubles the current top federal capital gains tax rate from 23.8 percent to 43.4 percent.  Throw in state taxes and for some taxpayers the top rate breaches 50 percent. 

At present, the proposed increases are reserved for top earners.  You’ll want to keep an eye on this and apply it to your personal situation.  

Death and Taxes

Both are inevitable and if President Biden gets his way they will be combined more often.  Here we are talking about the U.S. Federal Government’s gift and estate tax structure.  At present, a person can give $15,000 to anyone she wants annually.  In addition, she can give $11.7 million over a lifetime or at death.  For married couples, the numbers are doubled, and the tax is only due after the second to die. Amounts over this are taxed at rates that top out at 40 percent.  

This affects a mere 4,100 households a year. 

The President has not formally proposed changing these limits. Killing stepped up in basis, however, would create an effective death tax at far lower levels of wealth than the current estate tax thresholds. 

Consider Mary, who inherits a house and stock portfolio from her father valued at $2,500,000. At present, if she sells it shortly after inheriting it, she will owe little to no tax. If she keeps it to use and perhaps sell later, she’d only pay tax on growth over $2.5 million when she ultimately sold the assets. 

The proposal would kill the long-standing provision and replace it with a $1 million exemption per individual plus $250,000 for a primary residence.  It will also likely assess the tax at death, regardless of whether the assets are sold. Thus, in this example, Mary’s father’s estate would owe tax on the $1,250,000 gain.  Like a gameshow winner of a car, she vehicle may get sold just to pay the tax on the winnings. 

Stay Tuned

Keep in mind what we all learned Saturday mornings from School House Rock.  A proposal is not a bill and a bill is not a law until passed by both houses of Congress and signed by the President. I’ve outlined a few of the proposed changes.  There are of course many more proposed on the table.  It’s early in the process.  Please contact us with any questions on how the unfolding changes will apply to your situation.  Unfortunately, there is not likely to be much that’s simple with the big changes to the income tax code that is coming our way. 

Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. He can be reached at mlynch@barnumfg.com or 203-513-6032. His writings and videos can be enjoyed at www.michaelwlynch.com. 

Securities and investment advisory services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only, does not purport to complete or cover every situation, and should not be construed as legal, tax or accounting advise. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. CRN202305-282833

Summer’s Gone: Open Enrollment Has Arrived

As hard as it’s to believe and accept, Summer 2021 is on its way out. I hope each of you made the most of it.  Hello football, falling leaves and, for those working for large institutions, open enrollment for benefit elections.  It’s this once-a-year opportunity on which I will now focus. 

Employees of large institutions, government, corporations, and non-profits such as hospital chains, typically enjoy a period in the fall of each year in which they can adjust their benefit elections, health care, life and disability insurance coverage, and often ancillary benefits such as pre-paid legal plans. The window if often tight—ten days for example—so it’s prudent to be prepared for the offering when it comes.  These benefits are a key component of most people’s financial plans and it’s important to optimize them. 

Healthy Choices

Health coverage is traditionally the dominant benefit elected in open enrollment.  The coverages and costs of the plans offered are compared in side-by-side tables.  In recent years, high deductible plans with health savings accounts have increasingly appeared on the scene.  These can be confusing, as they present a higher potential initial out of pocket, but also contain a total stop loss on payments, potentially a cash employer contribution to a Health Savings Account, and then the ability for a person to accumulate money completely tax free for use for health care in the current or future years.  As a financial planner, I value these flexible tools and have written about them.  You can find my article here. https://www.michaelwlynch.com/tax-me-never-yeah-baby

It does require some analysis to know if such a plan will fit a person.  We are happy to help you with this. Contact Sarah at my office to schedule a call. 203-513-6058 or sarah.rizk@barnumfg.com

Who doesn’t like tax free money? 

One way to spend $1 for every $1 you earn is to funnel it through a flexible spending account for health care. This is typically use it or lose it, so you need to figure out how much you are likely to spend on deductibles, co-pays and other medical services. The IRS offers a splendid publication https://www.irs.gov/publications/p502 that details all that can be purchased under the umbrella of health care.  Typically, you will elect either a Health Savings Account or Flexible Spending Account.  The former accompanies a high deductible plan and the money will remain in plan from year to year.  The latter sits aside a more traditional health care plan and the money is use it or lose it.  

Another way to save on taxes—but certainly not money—is to have children who need day care.  If you are a Dependent Spending Account, which allows up to $5,000 in contributions in 2021, will let you spend this tax free.  It can also apply for a disabled spouse who needs attention or even dependent parents.  At a 35 percent marginal tax rate, moving $5,000 this way saves you $2,700 in income, Social Security and Medicare Taxes.  

Don’t Die for Free

We are increasingly getting more of our life insurance through our employer.  This has some fantastic benefits, less hassle to obtain initially and easy payment terms, as the funds come from our paychecks. It also has some downsides, as I see it often leading to complacency that can put your family at risk if you’re under covered or leave your job and your coverage behind and your pocketbook in peril if you pay too much in premium as you age. 

Prepare yourself prior to that ten-day period when you must elect coverage.  First, determine how much life insurance you need with a detailed analysis of what happens to the people you love if you die tomorrow. Again, we are happy to help you with this.  Contact Sarah at my office to schedule a call. 203-513-6058 or sarah.rizk@barnumfg.com.  

Second determine how much of this can be acquired through your group plan and, most important, under what terms and at what cost.  Group plans typically increase premiums every five years as we age. It’s starts cheap at the beginning of our careers and often ends up expensive. 

At one company for which I have rates, a 25-year old non-smoker will pay $31.50 a month for $500,000 in coverage while a 55-year old will pay $145 a month. 

Third, determine the range of premiums you would pay if you went into the private marketplace and secured a policy.  This can be done many ways, including online or by contacting an independent insurance agent who has access to quotations from multiple companies.  

Once you have figured out the likely private costs—it’s always a guess until the companies get a medical on you—you can compare the overall value of covering all or a portion of your protection need though group or private or a combination thereof.  Be sure to calculate the group premiums for the duration of the expected term. A private plan may start out more expensive but provide big savings over the last decade of coverage. 

Key action item:  If it appears private insurance is a better value for you, you need to apply early enough that you are approved by the end of the open-enrollment period.  A cornerstone concept is protection planning is don’t give up any insurance until you have the replacement contract fully executed. 

Protect the Money Machine

Disability Income Insurance is increasing becoming an option to elect at open enrollment. With disability, as with life, you should also conduct a thorough needs analysis to determine how much after-tax income your family needs if you can’t work.  Insurance is always an expense, so you want to make sure you obtain the proper amount.  Here too we can help. Contact Sarah at my office to schedule a call. 203-513-6058 or sarah.rizk@barnumfg.com.

Plans vary widely, but one thing they all have in common is they won’t replace 100 percent of your income.  Given that most people live on all their income—when essential savings in included—I typically recommend taking as much as possible.  Your needs analysis will determine if this is true for you. Exceptions to this include people who don’t need their income to support themselves and sometimes workers past age 65 for whom the group coverage would only pay out of few months or years. 

The second election that is increasingly common is whether to have the benefit paid by your employer or have you pay it or pay tax on the premium.  Counterintuitively, you usually should pay it or have the employer’s payment count as taxable income to you.  

Here’s why.  If you pay the premium or have it included in taxable compensation, which is small, the benefit which is large is income tax free.  If your company does not pass the premium through to you as taxable compensation, the benefit is taxable.  

Finally, if your group plan is insufficient to meet your needs—or unusually expensive—you should look to the private marketplace to secure an individually owned policy.  

Bells and Whistles

You company may offer other valuable benefits, in addition to these core offerings.  Common free offerings include Employee Assistant Plans that provide professional help in tough times.  A potentially valuable offering I’ve myself used in the past is group legal plans—I think of them as HMOs for lawyers—that provide you will access to pre-paid legal services based on a low payroll contribution.  Common uses for this include real estate transactions, wills and estate planning and even traffic violations.  Be sure to read the offering booklet your employer provides carefully.  You never know when you may need to rely on some of the services.  They are part of your overall compensation package.

Don’t Delay

Life’s busy and open enrollment comes and goes quicky. The default is typically your last year’s elections.  These may serve your needs.  They may not.  Do yourself and your family a favor and take the time to thoroughly analyze your employer’s offerings and compare them to private alternatives.  It may just make a big financial difference someday.  As always, we are here to help. 

Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT, a member of Ed Slott’s Elite IRA Advisor Group and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. You can find more articles and videos at michaelwlynch.com. He can be reached at mlynch@barnumfg.com or 203-513-6032.

Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only, does not purport to complete or cover every situation, and should not be construed as legal, tax or accounting advise. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.

Old Formulas Collide with a New Reality

Group exercises are fun, especially when they bring diverse people together into a shared experience. That’s why I always encourage the adult students that populate my financial planning classes to fill in the blanks to this admonition.  

The formula to financial success our elders taught is simple. Get a good job and ________ it.  Spend less than you ____________.  Put the money in a safe ___________. When you retire, live off the ______________.  Never touch the __________.

Nearly everyone in the room can blurt out the blanks—and most do.  Keep. Earn.  Place.  Interest.  Principle.  

“How is that working for your today?” I ask, as I chuckle and then watch smiles turn to grimaces. The problem, my students note, is that there is no longer any interest. This is certainly true in a world where banks spend money to advertise “high interest” savings accounts paying 1.15 percent.  

But I think this misses the point, as there’s nothing any of us can do to increase the interest on “safe” assets.  The real problem, I assert to a room full of unbelievers, is that we are defining safety all wrong. Our grandparents’ safety is our risk. 

If “safe” means principle can never decline, guaranteed by our fellow taxpayers, then we place ourselves at the mercy of the banking industry and purveyors of government bonds and products backed by them.  But how safe are assets that increase at 1 percent when the government is committed to increasing inflation at a minimum of 2 percent?  At best, these vehicles lose money safely, which is akin to other great oxymorons such as jumbo shrimp. 

 What we need, I assert, is to redefine safety in our minds to mean we have inflation adjusted income when we need it. So today, a dollar needs to be a dollar.  But in ten years, assuming 2 percent inflation, that dollar must be $1.20.  And this is just if you want to tread water.  To make any progress, it must be greater. 

It’s not that we don’t need some money in principled-guaranteed assets.  We do. It’s just that the money we need in 5, 10, 15 and 20 years needs to be in assets that will grow both principle and income.  This, I intone, must be your “new safety.”  In other words, the only assets that will be safe for us in the future are Investments that, at the very least, have a fighting chance of delivering future income and asset returns that match, if not surpass, inflation.  If not, like a swimmer treading water in a river heading to sea, you will soon find yourself adrift in the middle of a financial ocean where today’s dollar buy’s $.50 of yesterday’s goods.  

It’s one of life’s great tradeoffs.  Investments that guarantee principle allow income to fluctuate.  Investments that allow principle to fluctuate, offer much more stable incomes and incomes that often increase over time.  

 Consider that the average interest rates on 6 month CDs collapsed 82 percent from 4.75 percent in 2007 to .85 percent today. This is catastrophic for people relying on safe money for income. By contrast he dividend paid on $100,00 of the S&P 500 owned in the SPY ETF increased from $1,900 in 2007 to $3,205 in 2016.  The dividend dropped 20 percent in 2009. This was far less than the 43 percent drop in principle from March 2008 through February 2009.   Both principle and dividends were surpassing 2007 levels by 2012. 

Most people, as our grandparent’s financial success formula instructs, live off the income, not the principle. Therefore, for most of us, safe assets are not what we intuitively believe, government-backed bank CDs and bonds. These suffer wide fluctuation of income and near-certain depreciation of principle. Safe asses can only be dividend paying stocks, ownership in America’s and the world’s great companies, owned in a diversified portfolio of individual securities, closed end funds, exchange traded funds, insurance company sub accounts, or mutual funds.  This, combined with income producing real estate, is our only chance of not going backwards over a 30-year retirement or a 90-year life. It means that we have to accept the fluctuation of principle, which at times will mean scary drops of 20, 30 and even 50 percent.  But isn’t that preferable to a guaranteed loss of 25 percent, or even worse, over 30 years? 

This article was prepared by Mike Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT and is not intended as legal, tax, accounting or financial advice. Michael is a registered representative of and offers securities, investment advisory and financial planning services through MML Investors Services, LLC.  Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. He can be reached at mlynch@barnumfg.com or (203) 513-6032.

The opinions provided above are not necessarily those of MML Investors Services, LLC. The opinions provided are for general information purposes only. 

CRN202206-266878

The Great Pension Heist

Retirees, fasten your seatbelts. Prices are marching upward, with the Consumer Price Index rising at an annualized rate of 8 percent from April through June 2021, with no end in sight. 

Federal Reserve Chairman Jerome Powell, the keeper of the money temple, maintains that these price jolts in everything from Oreos to snowbird rental houses are transitory, pointing to supply chain issues and conditions of general Covid weirdness. Yet adherents to the monetarist school of economists, whose approach broke the great inflation of the 1970s, beg to differ. “Inflation is always and everywhere a monetary phenomenon,” taught the late, great Nobel Laureate Milton Friedman. It’s too much money chasing too few goods.

Chief among the old-school monetarists is First Trust chief economist Brian Wesbury, who notes that the trillions of dollars in stimulus checks and other Covid government support boosted the money supply by 30 percent in just 15 months; at the same time, mandated shutdowns squashed output. The result was swollen bank accounts and empty shelves. Astonishingly, Americans emerged from an alleged recession with $2 trillion more in their bank accounts than when it started. With an effective vaccine in our arms, that money is heading straight into circulation as we do the same.

This should be of concern to the millions of Americans who are either collecting, or basing their retirement happiness on collecting, a corporate pension.  

No Raises, Ever!

From a recipient’s perspective, a pension is simple. Upon retirement, he or she will get a monthly check, on the same day, for the same amount, until the recipient, and the spouse if a joint payout is elected, need the services of an undertaker. With few exceptions, it’s a fixed payment for life.  (This distinguished it from Social Security, which protects its purchasing power with a potential annual cost of living adjustment.)

Although these financial beasts are getting rarer, a 2016 survey of actual retirees with at least $50,000 of investments found that eight in ten received some monthly income from a pension. Fourteen million more Americans expect to do so in the future. In my practice, many clients rely on pensions for a substantial portion of their income.

Money for Simply Breathing. What Could Go Wrong? 

It’s easy to grasp the dangers of a fixed income in a world of rising prices. How much those prices rise, in fact, determines the value of a pension.

Let’s run some numbers. Consider Ed and Bev, a 65-year-old, just retired couple. Bev has cashed her first monthly pension check for $5,000 from the utility for which she worked for 40 years.  Ed’s had a few health challenges, so Bev elected the single-life option that pays her the most but ends when she does. (To protect Ed, she purchased some surprisingly low-cost life insurance that lasts until she’s 80.)

A consultation with the Social Security website https://www.ssa.gov/cgi-bin/longevity.cgi tells us that Bev is expected, on average, to live 21.6 more years. Averages say nothing about an individual, however. She will of course live longer or shorter, and perhaps by almost two decades either way. Still, we can use this base to calculate some values.

Bev’s first retirement (pension) check is worth $5,000. At 2 percent inflation (depreciation of the value of the dollar), close to the 2.18 percent she would have experienced for the last 20 years, her last payment, if she lives for her expected life span, will be worth roughly $3,300--35 percent less. Consider this the baseline, or perhaps the best for which she can hope.

This 2 percent is the Fed’s target. If it misses the mark and comes in at 2.5 percent owing to transitory effects, her check erodes by more than 40 percent to just over $2,900 a month. Inflation that averages just over 3 percent will cut the value of her last pension check in half.

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Another way to examine this is to consider the value of the pension as a lump sum at retirement. It’s the opposite of Bev’s investments, where the balances are known but the total value will be determined by rates of return and timing and amounts of her withdrawals. With the pension, the payments are known, but the net present value of the pension depends on how long she lives and on how much her cost of living increases.

At the baseline 2 percent, her age 65 value of the pension is $1,045,000 if she makes it to life expectancy. At 3.5 percent, it’s roughly $900,000.

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Transitory Effects

What if transitory severe inflation occurs, providing a short period of price pain and then returning to the normal rate of decay? We have two years of 8 percent inflation as the Fed, Congress and the President do their best to provide everyone with paper, for example. After that, we drop back to a more sustainable price growth. The result is even greater pension theft.

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This scenario is particularly perilous to people close to retirement. They get the up-front depreciation but likely won’t have time for employers to boost their pay for enough years to increase their payments. The Fed whacks these folks in the head and they then get to stumble through the rest of their retirement.

Lessons Learned

What strikes me as a practicing financial planner—and should strike you as a pre-retiree no doubt getting pitched on the value of income annuities for income you can’t outlive—is the relationship of the net present value of the income stream to the actual dollar value of the checks at advanced ages.

Retirees and their advisors are told relentlessly that fixed pensions—be they provided by former employers and called pensions or purchased in the private marketplace and called fixed income annuities--provide lifetime income that protects against poverty in old age. The math shows that these vehicles hold up well for total value. At 2 percent inflation, the total value is 80 percent of nominal dollars withdrawn, dropping to 66 percent at 4 percent inflation.

Yet at advanced ages, pensions and annuities put the income squeeze on anyone relying on them for a mainstay of their consumption. At 2 percent, a dollar in the last check cashed is worth only 65 cents in current-year dollars. At 4 percent, it’s not even worth a famous rapper, 50 cents or two bits, to quote my grandpa.

At this point, the early money is already spent and seniors—unless they have savings and investments--are left with drastically depreciated checks to purchase stuff they want and perhaps need but can no longer afford in their advanced years. Welcome to the world of fixed nominal payments in a time of inflation.

Don’t Fight the Fed

My training in economics as well as 50 years on this planet convince me that the economic and social incentives people face strongly influence their actions. There’s no denying that policymakers, regardless of political and ideological orientation, have a professional interest in inflating prices (debasing the dollar). They also have a personal hedge, since their federal pensions and sometimes their salaries are adjusted for inflation.

Debtors benefit from inflation, as it erodes the value of their liability. Your fixed-rate mortgage, after all, isn’t increased for the cost of living. Over time, your salary likely will be. For federal employees, this is a locked in guarantee since 1961.  

The US government is the world’s largest debtor and it’s going deeper into hawk at mind-boggling rates. It also desperately needs low interest rates to keep the costs of its past and expected purchases affordable. Talk may be cheap, but our government’s promises likely won’t be for us and our progeny.

For evidence of this, you need to look no future than writers for the New York Times and Wall Street Journal who are noting the already mentioned benefits of inflation and low interest rates as the erosion of debt for student loans, mortgages, and the U.S. government.

Attack on Savers

The current policy seems particularly brutal on conservatively invested seniors and pensioners. When we last experienced much higher inflation in the 1970s, at least people could count on real interest from government bonds and banks. CDs peaked at 18 percent in March 1980. As recently as 2008, a person could secure a six-month CD at more than 5 percent interest. The real value was likely eroded by taxes, depending on one’s rate, but at least the interest provided lubrication to make the cash saving transaction slightly less brutal.

Since the financial crisis of 2008, the official US government policy has been to explicitly transfer wealth from savers to borrowers by using every tool at its disposal to keep interest rates low. Today, with Chairman Powell’s Fed committed to minuscule interest rates and increasing prices, there’s nowhere to hide and only one place to run: more volatile assets. This is exactly where many retirees fear to go. 

No Such Thing as Safety

When it comes to finance, nothing is safe in all environments and every investment option will prove risky in some environments. Insured corporate pensions, a government-backed fixed income asset, at first appear to be 100 percent safe. As you can see, they are in fact subject to economic forces. What seems so comforting in early retirement may in fact prove painful in your later years. Like the smooth pleasure of menthol cigarettes in one’s youth, the price paid is debilitation if not complete destruction of life at advanced age.

At the end of the day, there’s nothing a person can directly do about the likely eroded value of a corporate pension. That’s a given, as are economic policies made and influenced by forces over which you likely have no control.  A pensioner’s best course, therefore, is to understand the long-term possibilities of this fixed-income asset and the proportionate value in his or her financial life, and to invest remaining investable assets (consistent with individual tolerance for shorter-term volatility) in businesses and investments that should prosper or at least keep up in an environment of rising prices.

When the government renders safe assets risky, you have little choice but to offset them with riskier assets that, ironically, have just been made safer compared with the alternatives. 

Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT, a member of Ed Slott’s Elite IRA Advisor Group and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. You can find more articles and videos at michaelwlynch.com. He can be reached at mlynch@barnumfg.com or 203-513-6032.

Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only, does not purport to complete or cover every situation, and should not be construed as legal, tax or accounting advise. Clients should confer with their qualified legal, tax and accounting advisors as appropriate.  CRN202408-637020

My Three Sons: Equal Isn’t Always Optimal

The SECURE Act passed and signed into law in the waning days of 2019, upended traditional legacy planning relating for retirement plans. Since these never-taxed assets account for the bulk of most Americans non-real estate wealth, this is a big deal.  For many, it’s a game changer that will result in a major tax hit if you don’t adjust. 

Prior to this new “security,” the straightforward strategy for most Americans was simply to live off their IRAs and other retirement plans, paying taxes as they withdrew the funds.  When a person no longer needed the money—that is, they needed an undertaker—the accounts could pass to the next generation. The key is that beneficiaries had the option withdraw the funds over their life expectancy.  This continued slow use of funds allowed them to grow as well as smooth out the taxes paid. The slang for this strategy was “stretching” the IRA. 

Death of a Tax Strategy

The SECURE ACT killed the stretch IRA for non-spouses, replacing it with a ten year and out rule for people who inherited in 2020 going forward.  There are no longer any required annual withdrawals, but the entire account must be emptied in ten years. If not, the half the account plus taxes will head to DC. 

Consider a $1 million IRA transferring to a 50—year old child.  Under the old rules, she’d have to withdraw just over $29,000 in the first year after mom’s death.  Over ten years, given a 6 percent rate of return, she’d withdraw $442,000.  If the beneficiary had a household income of $150,000, she would pay just over $100,000 in taxes over a decade with plenty more to come in the future. 

The account balance at that point would be $1,292,683. By her life expectancy at 84 she would have turned the $1 million of initial value into $3.6 million of withdrawals.  She’d pay $950,000 in taxes.  Seemed like a good deal for everyone, save mom of course who had to die for it. 

The New Reality

Post Secure Act, if she elected to take $100,000 out a year and the gains in year 10, she’d pay $378,000 in taxes.  $278,000 more.  The withdrawals would also move her up the tax brackets, eventually right to the top.  If she waited until year ten, she’d withdraw $1.7 million and pay $590,000 in federal taxes.  A loss of more than a third of the account.  

Although customized inheritance planning was always advisable, the death of the stretch IRA makes it imperative for people who want to maximize money to family. I was struck by this recently when reviewing the substantial IRAs with a client.  He and his wife live in a zero-tax state.  They are practicing the planning of plentitude. They will likely leave substantial IRA inheritance to their three sons.  

Three Sons, Three Strategies

This couple has an above average if not burning desire for their hard-earned money to benefit their boys.  One son is a high earning executive.  One earns an above average income in a two-income household.  The third is a bit of a free spirit and let’s just say income taxes are not a concern at this point.  Each of the boys lives in a state that taxes income. 

To optimize the after-tax value of the IRAs, we developed the following strategy for the $300,000 of funds that he and his wife knew they were not going to need for their own support. 

The First Strategy

For the high earning son’s third, my clients would create an IRA and convert it to a Roth. This would create a taxable event of $24,000 for my clients, as it put them in the 24 percent bracket.  I said send the bill to your son.  He pays the $24,000 out of pocket. This is far lower than his combined tax rate of 44 percent.  He has effectively bought out the IRS’s interest in his inheritance. The $100,000 now compounds for thirty years. You live 20 and then there’s 10 before it must be withdrawn.  $24,000 today generates $575,000 of tax-free money in the future.  

Number Two

Son number two pays substantial taxes but does not have the funds to pay the tax on conversion.  His financial plan shows that he will pay taxes on income throughout his life, so there is a value to tax free future assets.  For him, my clients convert to Roth and pay the taxes out of the conversion.  There is no state tax, and this leaves $76,000 to invest.  Over thirty years, this grows to $436,000 of tax-free money.  This compares well to leaving it taxable, producing more than $100,000 more in after tax money. 

The Third Alternative

Son number three may face 99 struggles, but to misquote Jay-Z, “taxes ain’t one.” Therefore, his IRA should remain pre-tax.  His parents pay higher taxes than he does and likely always will.  Given the progressive nature of the tax code, he should be able to withdraw the funds starting in year 20 with a minimal tax drag. 

The simple concept here is that families that plan and execute intergenerationally can expect more success than those who wing it. Laws are always changing creating the need to adjust. This is a simple example good family communication and tax-arbitrage (taking advantage of different tax rates) to produce big financial results.  Feel free to contact me if you feel this type of strategic planning might benefit your family. 

Michael Lynch CFP is a financial planner with the Barnum Financial Group in Shelton CT and the author of Keep It Simple, Make It Big: Money Management for a Meaningful Life, October 2020. He can be reached at mlynch@barnumfg.com or 203-513-6032.

Securities, investment advisory and financial planning services offered through qualified registered representatives of MML Investors Services, LLC. Member SIPC. 6 Corporate Drive, Shelton, CT 06484, Tel: 203-513-6000. Any discussion of taxes is for general informational purposes only, does not purport to complete or cover every situation, and should not be construed as legal, tax or accounting advise. Clients should confer with their qualified legal, tax and accounting advisors as appropriate. CRN202304-282065