The “Nastiest, Hardest Problem” in Retirement

Running out of money in retirement is, according to Nobel Prize winning economist William Sharpe, the “nastiest, hardest problem” in retirement. Professor Sharpe has spent his career thinking about risk. His work on the Capital Asset Pricing Model and systemic risk produced in 1966 the Sharpe ratio, which measures risk-adjusted returns. Now, he’s tackling a much broader subject, extremely important to everyone, about possibly outliving your money in retirement. Similar to the Monte Carlo analysis that DWM uses to provide a probability of success for your financial plan, Dr. Sharpe created a computer program with 100,000 retirement-income scenarios to calculate the probability of not running out of money. He’s published a free 730 page e-book “Retirement Income Scenario Matrices.”

In short, there are three key variables that impact your retirement income; your spending, your investment returns and your eventual age (when your plan “ends.”)

The first variable, spending, is the one you can most control. Your spending before retirement will generally determine how much money you accumulate while working. What you don’t spend becomes savings/investments and these annual additions and their appreciation increase your investment portfolio overtime. Your spending in retirement will determine how much you need to withdraw from your investment pot. As your earnings during the working years increase, you need to save a larger percentage of your income in order to accumulate an investment pot at retirement time that will support the lifestyle you’ve created. Withdrawals from your investment portfolio during retirement typically should not exceed 4% of the total investment pot. It’s an easy calculation. For example, if you determine you will need to withdraw $100,000 from the portfolio in your first year of retirement, you’ll need a portfolio of $2.5 million.

Now let’s look at investment returns. No one can predict the future. Historically, we know there is a relationship between inflation, asset allocation and returns. Hypothetically, let’s assume that a diversified fixed income portfolio over the long term would produce a return of 1% above inflation. The return above inflation is called the “real return.” Equities, because of their higher risk, have earned an “equity risk premium” of roughly 3 to 7% above the inflation rate over the long term. Again, hypothetically, let’s assume that in the long-run equities earn 5% above inflation. Alternatives have a shorter historical track record but are designed to produce returns comparable to fixed income returns over time. Therefore, a portfolio with 50% fixed income holdings and 50% equity holdings might hypothetically produce a 3% real return over time. If long-term inflation is expected to be 2.5%, the nominal return could be expected to be 5.5%. A larger allocation to equities will likely produce a larger real return and a smaller (more defensive) allocation of equities would likely produce a smaller real return.

Lastly, longevity. Certainly, we can look at actuarial tables, such as those used by insurance companies and social security, to calculate life expectancy. These charts show that a male age 60 might be expected to live another 22 years; a female age 60, another 25 years. However, we suggest you not use these actuarial tables. Harvard Professor David Sinclair‘s “Lifespan- Why we Age- and Why We Don’t Have To” shows that the increases in technology and medicine are going to give those individuals who want to live a longer and healthier life the opportunity to do so. It is very possible that many of our clients and friends will live a healthy 100 plus years and younger generations, such as millennials and Gen Z, may live to 110 or longer. Accordingly, we suggest using an eventual age of at least 100 when doing your financial planning.

Dr. Sharpe’s final section in the book is about advice. He indicates that many people will need help. He outlines the “ideal financial advisor” and compares a “good financial advisor” to a “fine family doctor” who has “deep scientific knowledge, can assess client needs, habits and willpower and is able to provide scientific diagnoses and can communicate results to the client in simple terms so that the best treatments can be applied.” We like the analogy, we use it all the time.

Yes, running out of money in retirement would be a nasty, hard problem. It’s doesn’t have to be that way. You need a solid financial plan based on realistic values for investment returns and longevity. You also need to focus on spending and savings.   And, you might need some help from a “good financial advisor” that operates like a “fine family doctor,” a firm like DWM.

https://dwmgmt.com/

Tick, Tock…is it Time for Your Required Minimum Distribution (RMD)?

“Time flies” was a recent quote that I had from a client.  Remember a long time ago…putting money aside in your retirement accounts, perhaps at work in a qualified traditional 401(k) or to an individual retirement account (IRA)?  It’s easy to ‘forget’ about it because, it was after all, meant to be used many years down the road.  It would be nice to keep your retirement funds indefinitely; unfortunately, that can’t happen, as the government wants to eventually collect the tax revenue from years of tax deferred contributions and growth.

In general, once you reach the age of 70 ½, per the IRS, many of those qualified accounts are subject to a Required Minimum Distribution (RMD) and you must begin withdrawing that minimum amount of money by April 1 of the year following the year that you turn 70 1/2.  Of course, there are a few exceptions with regards to qualified accounts, but as a rule, when you reach 70 ½, you must begin taking money from those accounts per IRS guidelines if you hold a traditional 401(k), profit sharing, 403(b) or other defined contribution plan, traditional IRA, Simple IRA, SEP IRA or Inherited IRA.  (Roth IRA withdrawals are deferred until the death of the owner and his or her spouse).   Inherited IRAs are more complicated and handled with a few options available to the beneficiary, either by taking lifetime distributions or over a 5 year period.  The importance here, is to be aware that a distribution is needed.  Another word of caution…In some cases, your defined contribution plan may or may not allow you to wait until the year you retire before taking the first distribution, so a review of the terms of the plan is necessary.  In contrast, if you are more than a 5% owner of the business sponsoring the plan, you are not exempt from delaying the first distribution; you must take the withdrawal beginning at age 70 1/2, regardless if you are still working.

The formula for determining the amount that must be taken is calculated using several factors.  Basically, your age and account value determine the amount you must withdraw.  As such, the December 31 prior year value of the account must be known and, second, the IRS Tables in Publication 590-B, which provides a life expectancy factor for either single life expectancy or joint life and last survivor expectancy, needs to be referenced.  The Uniform Lifetime expectancy table would be referenced for unmarried owners and the Joint Life and Last Survivor expectancy table would be used for owners who have spouses that are more than 10 years younger and are sole beneficiaries.  It comes down to a simple equation: The account value as of December 31 of the prior year is divided by your life expectancy.  For most individuals, the first RMD amount will be roughly 4% of the account value and will increase in percentage each year.

It all begins with the first distribution, which will be triggered in the year in which an individual owning a qualified account turns 70 ½.  For example, John Doe, who has an IRA, and has a birthdate of May 1, 1949, will turn 70 ½ this year in 2019 on November 1.  A distribution will need to be made then after November 1, because he will have needed to attain the age of 70 ½ first.  Therefore, the distribution can be taken after November 1 (for 2019), and up until April 1 of the following year in 2020.

Once the first distribution is withdrawn, subsequent annual RMDs need to be taken for life, and are due by December 31.  In this case, John Doe will need to next take his 2020 distribution, using the same formula that determined his first distribution.  This will become a regular obligation of John’s each year.

So, we’ve talked about who, what, why and when, now let’s talk about the where.  Once the distribution amount is calculated, an individual can then choose where he or she would like that money to go.  Depending on circumstances, if the money is not needed for living expenses, it is advised to keep the money invested within one of your other non-qualified accounts such as a trust, individual or joint account, i.e. you can elect to make an internal journal to one of your other investment accounts.  Alternatively, if you have another thought for the money, you can have it moved to a personal bank account or mailed to your home.  Keep in mind that these distributions are taxed as ordinary income, thus, depending on your income situation, you may wish to have federal or state taxes withheld from the distribution.  At DWM, we can help our clients determine if, and what amount, to be withheld.  One exception is the qualified charitable distribution or QCD, which is briefly discussed next.

Another idea that may be a possibility for some individuals is for the distribution amount to be considered a qualified charitable distribution (QCD).  Instead of the money going into one of your accounts, a direct transfer of funds would be payable to a qualified charity.  There are certain requirements to determine whether you can make a QCD.  For starters, the charity must be a 501 (c)(3) and eligible to receive tax-deductible contributions, and, in order for a QCD to count towards your current year’s RMD, the funds must come out of your IRA by the December 31 deadline.  The real beauty about this strategy is that the QCD amount is not taxed as ordinary income.  You would simplyprovide the QCD acknowledgement receipt(s) along with your 1099R(s) to your accountant for the correct reporting on your tax return.

It may be pretty scary to know how quickly time flies, but with DWM by your side, we can take the scare out of the situation!

Your Choice- $1 Million or $5,000 per Month for Life?

Most of our readers will likely have to make that type of decision someday.  From our perspective, it’s a pretty easy answer.  As Cuba Gooding, Jr. famously told Tom Cruise in “Jerry Maguire”:  “Show me the money!!”

Yet, an article in the WSJ on Monday tried to make the decision sound really tough, with losers on both sides.  It would have you believe that many will suffer from either an “illusion of poverty” or an “illusion of wealth” and are likely going to experience a disappointing retirement.  Really?

Researcher Daniel Goodwin at Microsoft Research asked people how adequate they would feel if they have $1 million at the time they retired.  He used a seven-point system with one being “totally inadequate” and seven being “totally adequate.”  Then, he asked them to rate instead an income each month in retirement of $5,000.

In theory, the choices are similar based on pricing of annuities. If a 65 year old paid $1 million for a “single premium immediate annuity” they could receive payments of $5,000 each month for their life.  Actuarially, a 65 year-old is expected to live 18-20 years.  So, 19 years of monthly payments of $5,000 would be $1,140,000 and represent a 1.4% annual return on the investment.

Yet, believe it or not, many people, feel that $5,000 per month is more adequate than the $1 million lump sum.  Mr. Goldstein says that this group suffers from the “illusion of poverty.”  Apparently, these folks are “inclined to think about wealth in terms of monthly income” and don’t want the “burden” of a lump sum which could run out someday.  Hence, they dial down their expenses, eliminate any wants or wishes and make do on their $5,000 per month.

Mr. Goldstein then suggests that I and most people may suffer from the “illusion of wealth.”  He thinks that those selecting the lump sum, through a false sense of security, may spend too much and run out of money. In fact, the larger the lump sum, the more likely the “extra millions will lose their meaning.”  Really?  Do we all suffer from illusions, as Mr. Goldstein suggests?  Are we all on the road to an unsuccessful retirement regardless of our choices?  It certainly doesn’t have to be that way.

Perhaps I should contact Mr. Goldstein and invite him (and his wife) to go through the DWM Boot Camp.  First, we’d sit down and help them with their goal setting. We’d help them identify their needs, wants and wishes.  We’d look at their assets, health care costs, income taxes, expected inflation and investment returns, and insurance and estate matters.  Ultimately, we’d help them design a financial plan.

If Mr. Goldstein was under an “illusion of poverty,” we’d show him that his $5,000 per month program is a poor choice.  To begin with, his $5,000 per month would lose its purchasing power each month due to inflation.  With 3% inflation, after 15 years of retirement, his $5,000 would only buy $3,200 worth of goods in today’s dollars.  Second, if he did a “personal annuity” by simply taking the lump sum, investing it, earning 6%, e.g., and withdrawing the $5,000 per month, his family would still have the $1 million in principal when he passed away.  No need for an illusion of poverty here.

On the other hand, if Mr. Goldstein was under an “illusion of wealth”, the plan would help him identify his needs, wants and wishes and would have helped evaluate whether those potential expenses were affordable based upon his assets, expected investment returns and the other metrics.  We would have created numerous scenarios to ultimately result in a plan that was successful.  The plan would be stress tested for items that could negatively impact that plan and monitored and modified over time.  In short, the plan would not suffer from an illusion of poverty nor of wealth.

We’re glad contributors Shlomo Benartzi and Hal Hershfield ran the article Monday focusing on Mr. Goldstein’s findings. Retirement/financial independence planning is extremely important.   However, we don’t agree that it has to be a dire situation with poor choices, lots of suffering and disappointments.   It’s simple: take the lump sum and put together your realistic plan with a fee-only adviser like DWM and then have us help you monitor it for the changes that will undoubtedly occur in the future. You’ve worked hard for your money, the time will come to enjoy it. As Ginny’s blog http://www.dwmgmt.com/blogs/82-2017-02-07-23-30-00.html pointed out a few weeks ago, retirement/financial independence should be a time for “jubilation” not illusions or disappointments.  Proper planning with the right team can make that happen.

Feliz Jubilación!

We loved recently learning the word for retirement in Spanish …Jubilación!  It has a much more festive ring to it than “retirement” or even “financial independence”, as we say in the U.S.  In France, they use the word for retreat or “retraite” to define this time of life.  We don’t think many of us want to retreat, exactly, or hide away from anything!  And in England or Italy, they use a derivative of pension to describe a ‘retiree’ – ‘pensioner’ or ‘pensionato’, while in Spanish, you are a ‘jubilado’!  While they all mean the same general thing, we think this transition in life should be celebratory and warmly anticipated without any anxiety or trepidation.  As wealth managers at DWM, our goal is to make this transition so easy that you are indeed… jubilant!

So how can this transition truly be smooth and worry-free?  We do think that there are some things that you can do for yourself and then some things where your financial advocate, like DWM, can be very helpful.  Let’s start with some of the administrative items that come up at “a certain age”.  In fact, at DWM, we keep track of the important dates and significant milestones in our clients’ lives so we can remind them of the things that they will soon want to do.  For example, at age 50, you can start increasing your IRA or 401(k) contributions each year.  At 55, we like to discuss the pros and cons of long term care for you and your family and around age 60 or 62, we like to discuss Social Security strategies and help you with plans to start thinking about Medicare sign-ups.  We are always available to help analyze the proper benefits, help you schedule sign-ups or meet with professionals to assist you.  We also help with tax strategies and account transitions as you leave your job and need to understand your employer retirement benefits packages.  And when you hit 70 and it is almost time to start taking your required minimum distributions from your IRA’s, we are also here to guide you and manage this.  There are a few things that need to be done, but we like to educate our clients on the process and then help to guide them through it.

It is also important to make sure that your resources are protected and wisely invested to maximize your success in achieving your goals.  Assessing your resources and making a realistic plan will allow you to make the best choices for your future.  As wealth managers, we are always mindful of taxes, asset allocations, estate planning and risk management, as we look for ways to make the most of what you have.  We want to help you realize your goals with a comprehensive financial plan and a roadmap to success.  Money certainly isn’t everything, but having your finances in order and the details understood can make this transition much more worry-free and enjoyable.  Looking at all of your goals and assets with honest and realistic expectations will allow your plan to reach its highest potential.

The other question to ask yourself is what is your passion?  How would you like to spend your time, now that it is yours to spend?  Will you continue working?  Will you travel? Will you move to a new home?  Some people find that they can now spend their time doing exactly what they have always wanted to be doing, but just aren’t sure what that may be!  There are many things to investigate and you can now take some time to explore your options – whether it is continuing to work, volunteer, travel or take up a hobby that might have always interested you.  The goal here is to look at it as a wonderful opportunity where you embrace the change and get excited to find a happy “new normal”.  It may take some time and some patience to make this adjustment smoothly.  Staying healthy, active and engaged with others are all great tips to helping with the emotional transition.  You may have to adjust to your new identity and staying busy and connected with others can definitely support you through this process.

This should be a wonderful time in your life and we are here to help in any way we can as you move forward into “retirement”.  Just remember, you have earned the ability to celebrate – this is your lifetime achievement award!   As your financial advisor, we look forward to helping you look at this time with joyous and resounding JUBILATION!

“The Future Depends on What You Do Today”- Mahatma Gandhi

100-candlesNo one has a crystal ball.  If we did, we might ask three important questions:

-How long will I live?

-Will I have enough money if I live to age 100?

-How will I spend the time I have on this earth?

As wealth managers dedicated to increasing families’ wealth and legacies, we consider these questions and the related answers as extremely important.

We Americans are living longer.  From 1980 to 2020, the number of Americans 90 years of age and older tripled to 1.9 million. And, by 2050, it is expected there will be 8 million 90 and over.  This is a new paradigm.  Historically, people retired in their 50s and early 60s and lived their last few years retired in comfort during the “golden years”.   These days, someone retiring in their early 60s could live 30 or 40 more years.  If so, will they have enough money and what will they do for that time period (perhaps 1/3 or more of their lifetime on earth)?

Life Expectancy. There are some good tools to help you estimate when your “plan will end.”  Here are three: https://www.livingto100.com/, https://www.bluezones.com/ (click on tools), and https://www.myabaris.com/tools/life-expectancy-calculator-how-long-will-i-live/, (Note: each site will require you entering your email address) These tools can take 5-10 minutes.  All look at personal health, family history and socioeconomic status.

Will My Nest Egg Hold Out?  Next, it’s time to calculate your expected “financial independence” date.  See our blog of April 21, 2015 http://www.dwmgmt.com/plan-for-financial-independence-not-retirement/  This is the date at which you have enough assets for the rest of your life without needing to work for money.  Recently this “independence” date has been extended for many due to three principal factors; increased expected longevity, lower expected returns, and reductions in and uncertainty about pensions and social security. The financial independence calculation requires a review and monitoring of key current and expected metrics: assets, additions to assets, longevity, retirement income, inflation, investment returns, tax rates, and spending goals.  Of course, all results must be stress tested and regularly monitored and revised as appropriate.

Meaning, Identity and Purpose in Remaining Years.  Planning for the “golden years” goes well beyond money.   Happiness, of course, is more than that.  We discussed it in our September 9th blog http://www.dwmgmt.com/how-would-you-rate-your-life/.  We ask our clients not only about their financial priorities, but also about their visions for their family, career, health, dreams, legacy, education and charity.

These days, more and more seniors are taking inventory on who they are, their accumulated skills and experience and want to stay engaged in the broader society and economy, continuing to be useful, active and “keep going”.  Here are some recent inspiring examples in the news:

  • Gerry Marzorati, former editor of the New York Times and author of the new book “Late to the Ball” has immersed himself in tennis since taking it up in his mid-50s. Mr. Marzorati recognizes that “Sixty is not the new 40. Fifty isn’t either.  Your lung capacity in late middle-age is in steady decline as are your fast-twitch muscle fibers that provide power and speed. Your sight, senses and balances are getting worse.”  Yet, undaunted, Mr. Marzorati concluded that for him, his “golden years” would be spent on “finding something new, something difficult- to immerse yourself in and improve at.”  He threw himself into his new passion, hiring a coach, practicing for hours and hours and even entering competitions in his new love.  No trophies yet, but fulfillment.
  • Alan Page, the leader of Vikings’ Purple People Eaters, is about to start his third career at age 70.  After his Hall of Fame NFL career, Mr. Page finished law school and became a Justice in the Minnesota State Supreme Court for 24 years until recent mandatory retirement.  Now he and his wife will commit their full-time efforts to their Page Foundation, focused on educating young children, through money and mentoring.
  • At 100, Ida Keeling is still running for her life. She has the fastest time for American women aged 95-99 in the 60-meter “dash” at 29.86 seconds.  She is 4’6” and weighs 83 pounds.  She said she was fast as a girl, though back then there were few opportunities for girls.  What makes her faster now is that “everyone has slowed down.”  She became a single parent of four when her husband died at age 42.  Ms. Keeling’s daughter, Shelley, herself a track coach, got Ida back into running when Mom was 67.  Her one hour of daily running gives Ms. Keeling a sense of serenity: “Time marches on, but I keep going.”

Go ahead.  Take the test!  See how long you will be at life’s party.   Then, by yourself, or with help from a wealth manager like DWM, develop, monitor and maintain a financial, personal and family plan for the future that meets your priorities and visions. The future depends on what you do today.  Go for it!

MGP 4 – The Next Generation of Financial Planning

MGP logo onlyThe financial industry is seeing some interesting changes spurred by the recently-enacted DOL fiduciary rule (see our recent blog at http://www.dwmgmt.com/fiduciary-standard-closing-in-on-reps-and-brokers/ ). At DWM, we welcome these changes as it now requires financial advisors to adhere to a rule that we have been following from the beginning…which is to make investment and planning recommendations with the client’s best interests in mind.  We always put the client first and always remain committed to this philosophy.

 

Last week, MoneyGuidePro, our chosen software provider, came out with a new version of their financial planning tool called MGP 4.  It is the next generation of financial planning software and the updates are specifically intended to help the financial advisor stay in line with the new rules.  The changes have made the software more “conversational” so advisor and client can spend more time discussing goals and retirement requirements, something we have always focused on.  We have spent some time reviewing the new features and there is a small learning curve with it.  We do think in the long run, it’s a nice update.  If you have recently logged on and were surprised or frustrated with it, you are not alone.  We want to describe some of the basics to you and, of course, we are always available for questions.

 

The biggest change is in the presentation and some of the familiar indexes are set up in new locations.  The updated format takes you to a My Plans landing page where you will have access to your financial plan.  Once the plan is selected, you will be on the page with personal information, similar to the previous version.  If you look at the top of this page, there is a progression line with three circles on it. The circle on the left is marked “About You” and is green at this stage. Once you click on the circle, the dropdown has all the items from the previous version grouped in four categories- Personal, Goals, Money and Risk and Allocation.  Click on each of these for details. ‘Personal’ shows personal information and has a new area for expectations and concerns.  ‘Goals’ has a retirement schedule and a place to include your goals, including one for health care, a newly-established feature to help us understand and track the costs that health care may have on your financial plan.  When you click on ‘Money’, you will see the familiar drop-down categories from the old version – including investments, retirement income and net worth.  Finally the ‘Risk and Allocation’ section will help us evaluate your risk tolerance and allocation strategy so we can see if they are in line with your goals.  You can always skip a category by returning to the “progression line” at the top and selecting your choice.   Everything is here, it just may take an extra step to get there.

 

*Tech Tip:  If you want to have an abbreviated look at your plan, you can select the ‘My Snapshot’ tab on the first page to have quick access to some of the most popular features like net worth, goals and results.

 

Once you finish ‘Risk & Allocation’, you are ready to move to the ‘Results’ circle.  You’ve seen these headings before. We suggest you click on ‘recommended scenario’.  Once on that page, look at the left side and you’ll see blue rectangles with personalized strategy tabs based on your goals.  One new, exciting feature is the Social Security tab which allows you to calculate your best strategy drawing benefits, if you haven’t already begun.  You can also choose the “What if Worksheet”. Here is where we modify certain predictors for the future like rates of return, inflation or living longer.  You can look under the recommended scenario or under the ‘What if worksheet’ Monte Carlo simulation graphs and you will see the blue rectangle “explore”.  Click on explore and then scroll down to “combined details.”    You’re now into the results page and graph, which all of our clients have seen before and shows the annual and linear progression of the value of your future portfolio.  This chart starts with the current value of your investment portfolio and shows how the additions, earnings, taxes and spending or goals might impact it going forward.  You can follow it to the wonderfully euphemized “end of your plan”!  We always find that amusing…

 

There are many other features hidden in this financial planning software and we invite you to “play” with this program any time. There is something for everyone in here.  In the play zone, you can add any number of crazy or exciting goals to see if you can make them come true.  Or if you want to prepare for the worst, you can stress test for challenges in the “what are you afraid of” feature. There are strategy tools, a budget feature and you can print your net worth report anytime. The ‘Finish’ tab includes the reports area which is not as intuitive as before, so if you have questions, please call us.  We are always glad to help…or run them for you!  And don’t worry, when you are finished playing with your plan, we always keep the original copy that is our constant.  DWM wants you to understand and participate in your financial planning and be as educated and knowledgeable as possible.  After all, that is our fiduciary responsibility and we always put our clients first!

How the New Changes to Social Security May Affect You

How-Social-Security-Works-cartoonPresident Barack Obama signed the Bipartisan Budget Act of 2015 into law on November 2, 2015. The budget provides relief for sequester cuts and allows for increased investments to support economic growth and build a strong middle-class for the next two years. To offset the cost of additional discretionary spending, the budget had to make cuts or changes to certain programs, including the Social Security program. The adjustments to Social Security will eliminate the file and suspend and restricted application strategies that helped some couples increase their lifetime Social Security benefits.

The new Social Security laws will take effect May 1, 2016. For those individuals currently using the file and suspend or restricted application strategies, they will not be affected by the rule changes. In addition, those individuals that turn age 66 before April 30, 2016 may elect to use the file and suspend strategy, if completed before May 1, 2016. The restricted application strategy will be available for those individuals that turned age 62 by December 31, 2015.

The file and suspend strategy allowed for one spouse, who reached their full retirement age, to file for and immediately suspend his or her benefits. By doing so, the second spouse would be allowed to start receiving a spousal benefit. The suspended benefits of the first spouse would then accrue delayed retirement credits at 8% a year. Under the new rules, if an individual decides to suspend his or her benefits, all benefits payable on his or her earnings record to other individuals will be suspended as well.

The restricted application strategy was often used in conjunction with the file and suspend strategy. By filing a restricted application, a person could apply for just a spousal benefit while his or her benefits accrued delayed retirement credits. Under the new rules, filing for a spousal benefit will trigger a person’s own retirement benefit. The Social Security Administration will pay only the greater of the spousal benefit or a person’s own benefit.

These two strategies were actually unintended loopholes that extended from the “voluntary suspension” concept introduced by the Senior Citizen Freedom to Work Act of 2000. The idea was originally intended to allow seniors that had mistakenly applied to receive their benefits early, stop their payments and earn delayed retirement credits. This allowed for these seniors to continue working, or even rejoin the workforce, without the risk of reducing or eliminating their social security benefit. The Social Security Administration will reduce a person’s annual benefit, if under the full retirement age, by $1 for every $2 made over a certain dollar threshold ($15,720 for 2016). Earned income includes W-2 wages and net earnings if self-employed. It does not include pensions, annuities, investment income, interest, or government or military retirement benefits.

It’s important to note that even if you missed out on using one of these strategies, you still may receive your maximum benefit. According to an analysis done by Social Security Choices, a software company that helps individuals optimize Social Security strategies, only about 18% of the cases analyzed showed it was beneficial to use the file and suspend and restricted application strategies. In addition, if these strategies were implemented, it could take as many as 12 years until a cumulative benefit was received.

With Social Security benefits playing a large part in calculating financial independence, DWM has researched the new adjustments to better understand how our clients will be affected. Although the new laws will limit the amount of planning available, we will continue to analyze each client’s Social Security situations in an effort to maximize their benefits, as there are still options and strategies available.

Furthermore, any quantitative analysis is complicated by the risk that there will be future changes to Social Security, which could include “means testing”.   Individuals, whose retirement incomes exceed established thresholds, could have their future benefits reduced or eliminated. We anticipate that maximizing Social Security strategies will continue to be a moving target. We look forward to working with each of our clients as they approach “retirement age”.

Is the 4% Withdrawal “Rule” Reliable?

DiceRules of thumb can be great, except when they don’t work. Take the 4% withdrawal rate rule, for example.

This rule, developed twenty years ago, is used to forecast how much people can spend annually in retirement without running out of money. Let’s say a couple has $1,000,000 and has just retired. The rule says if they spend $40,000 (4%) from the portfolio and increase this annual withdrawal by the inflation rate, their $1 million nest egg should last for the rest of their lives.

Historically, an average annual return on a balanced allocation strategy portfolio was roughly 7% from 1970 until 2014, while annual inflation was 4%. Hence, a real return of 3%. The conditions during those four decades are different from today. The decades of the ’80s and ’90s produced average equity returns close to 20% per year. The bond bull market produced returns of almost 9% per year for the last three decades. During this time, the “rule” could have worked fairly well for some people. Today, however, there are a number of problems with this rule.

First, inflation forecasted returns and longevity have changed greatly. Inflation has been negative over the last twelve months and has averaged less than 1% per year over the last three years. Forecasted returns, of course, vary widely and no one can predict the future. A conservative estimate might be a 2% real return (3% nominal less 1% inflation, or 5% nominal less 3% inflation). Longevity is increasing. Hence, for many people, their calculations should be based on an eventual age of 100.

In an article from this past Sunday’s NYT, Professor Wade Pfau at the American College of Financial Services put it this way: “Because interest rates are so low now, while stock markets are also very highly valued, we are in unchartered waters in terms of the conditions at the start of retirement and knowing whether the 4 percent rule can work in those cases.”

Second, the 4% rule never took into account non-linear spending patterns of retirees, other goals, other retirement resources, asset allocation, taxes and stress testing the plan.

There’s a much better way to do this, though it takes more thought and time and a disciplined process. For those who value their financial future, it’s worth the effort. Here are some of the elements that you need consider:

Start with your goals. At what age do you want to achieve financial independence (freedom to retire)? What will be your likely spending patterns during retirement? What will your housing be? What will be your likely health care costs? Are there any other needs, wants or wishes you have for the future?

Retirement resources. The calculation needs to include not only the investment portfolio, but also other income sources, such as social security, pension, rental income or part-time work. The calculation also needs to review all assets, not simply the investment portfolio, and determine the amount, if any, of proceeds from the sale of those assets that could be used in the future to fund goals.

Asset allocation. Varying allocations will likely produce varying results of returns and volatility. The plan should be calculated using the appropriate allocation strategy. Returns should be calculated in two ways- historical and forecasted.

Taxes. Income taxes can have a huge impact on a plan. Allocation of investments into appropriate (taxable, qualified, Roth) accounts can make a real difference. Tax-efficiency throughout the plan is imperative.

Stress Testing. The calculations need to be done using a “stochastic” process such as Monte Carlo simulation rather than a linear one. A Monte Carlo simulation is a tool for estimating probability distributions of potential results by allowing for random variations over time. The world does not operate in a straight line and linear projections can be greatly upset (and therefore of little value) when outliers come into play. In addition, stress testing involves looking at the potential impact of negative factors in the future, including living longer, social security cuts, lower than expected investment returns, and/or large health care costs.

In short, the old 4% withdrawal rule is not a good way to predict whether or not you will fulfill the goals you have for you and your family. However, there is a process that can provide reasonable assurance and one you should expect from your wealth manager, like DWM, as part of their package of services for you. It can be a little complicated but should be customized for your particular situation. It will take some time and effort. It requires discipline and monitoring. However, if you value your financial future, it’s well worth the effort.

Plan For Financial Independence, Not Retirement

drseussWhen the Social Security program was started in 1935, the average life expectancy was 61 years old. Today, life expectancy is around 80, with more and more people living into their 90s and beyond. Yet, much of society continues to expect people to stop working in their early to mid 60s and retire, because giving up work is “simply what most people do.”

Yet, times are changing. People are working longer. And it’s not about economic distress. The WSJ recently reported that this trend is being driven by many highly educated workers in professional-services jobs who are sticking around by choice, doing something they love to do. Dr. Jan Abushakrah, 69, typically works 60 hour weeks as chairwoman of the gerontology department at Portland (OR) Community College. Retirement isn’t on her agenda. She says “As long as I am healthy and happy every morning when I wake up and have something exciting on my plate to look forward to, it is easy to say I could keep doing this forever.” Personally, I feel the same way. Helping people is a great way to spend your time.

Money isn’t the main factor that people keep working in later years. 67% do it because they want to stay active and involved. 51% enjoy working. 50% want to keep health insurance and other benefits. 47% need money to make ends meet. 38% want money to buy extras. 15% try a new career.

We have our clients target their “financial independence” date rather than their retirement date for planning. This is the date at which you have enough assets for the rest of your life without needing to work for money. The beauty is that once you reach this point, you keep working only if you want to. For those that have a vocation- a higher calling, rather than a job, and are making an impact, continuing to work is a likely possibility.

As someone approaches financial independence and can afford to stop working, they need to ask themselves a series of hard questions starting with “What would I do if I didn’t have to go to work today?” Certainly, there are physical activities, grandchildren, travel, education, charities and lots of other options. What combination produces a “series of successful days” that becomes a successful life? With financial independence, there are thousands of choices. You can make your own “cocktail” of choices every day.

Of course, it is important for spouses to work on these planning issues together. As financial independence approaches, both spouses should create an individual vision of what each wants to achieve in the next phase of life and then compare notes. Sometimes you have a situation where one person in the couple loves their job and the other only likes theirs. That’s a big difference. Communication, compromise and negotiation is key.

At the same time, older Americans are exercising more, which keeps them young. A recent study showed that how we age physically is, to a large degree, up to us. A recent study of recreational cyclists aged 55-79 by King’s College in London showed that on almost all measures, their physical functioning remained fairly stable across decades and was much closer to that of young adults than of people their own age. As a group, even the oldest cyclists had younger people’s levels of balance, reflexes, metabolic health and memory ability. However, the study showed that endurance and strength does decrease to some extent over time. All in all, though, aging is simply different for active people. On a personal note, for those of you who know I annually run the 10k Cooper River Bridge run here in Charleston, I am happy to report that due to some extra training and use of a coach, I was able to run my best time in 7 years last month. Not sure if I can turn back the hands of time, but maybe at least slow them down a little.

With Americans living longer, we suggest you focus on financial independence rather than retirement. At that point, you’re in control. You can determine what every day’s activities will be- hopefully, all things you want to do. You hold the keys to your future. As Dr. Seuss would say: “Oh, the Places You’ll Go.”

So Many Numbers: Which Ones Are Important?

stock-photo-old-typeset-166120136Our world is full of numbers. They’re everywhere. Our calendars just moved from 2014 to 2015. We get bombarded continually with numbers representing time, temperature, and, yes, stock market reports. NPR’s Eric Westervelt last week called numbers “the scaffolding that our economy, our technology and huge parts of our life are built on.”

For this blog, I thought it would be interesting to look at the origin of our numbers and then highlight five key numbers that are of real importance to your financial future.

Mr. Westervelt was interviewing Amir Aczel who has written a new book “Finding Zero: A Mathematician’s Odyssey to Uncover the Origins of Numbers.” Mr. Aczel believes the invention or discovery of numbers “is the greatest intellectual invention of the human mind.” We use Hindu-Arabic numerals. Before that, there were many other systems including the Mayans, the Babylonians, and, yes, the Romans. The big problem with the Roman number system is that it had no zero. The numbers didn’t cycle and hence multiplication or division was almost impossible. Five (V) times ten (X) is 50 or L in the Roman system. Each value was unique in the Roman system whereas in our system, numbers can cycle. Two with a zero after it is 20. And, zero is very important. Without it, numbers couldn’t cycle. It’s the reason that 9 numbers plus a zero allow us to write any number we want. Pretty amazing.

stock-photo-old-typeset-166120136Our world is full of numbers. They’re everywhere. Our calendars just moved from 2014 to 2015. We get bombarded continually with numbers representing time, temperature, and, yes, stock market reports. NPR’s Eric Westervelt last week called numbers “the scaffolding that our economy, our technology and huge parts of our life are built on.”

For this blog, I thought it would be interesting to look at the origin of our numbers and then highlight five key numbers that are of real importance to your financial future.

Mr. Westervelt was interviewing Amir Aczel who has written a new book “Finding Zero: A Mathematician’s Odyssey to Uncover the Origins of Numbers.” Mr. Aczel believes the invention or discovery of numbers “is the greatest intellectual invention of the human mind.” We use Hindu-Arabic numerals. Before that, there were many other systems including the Mayans, the Babylonians, and, yes, the Romans. The big problem with the Roman number system is that it had no zero. The numbers didn’t cycle and hence multiplication or division was almost impossible. Five (V) times ten (X) is 50 or L in the Roman system. Each value was unique in the Roman system whereas in our system, numbers can cycle. Two with a zero after it is 20. And, zero is very important. Without it, numbers couldn’t cycle. It’s the reason that 9 numbers plus a zero allow us to write any number we want. Pretty amazing.

Now, knowing a little more about our number system and with numbers seemingly everywhere, where do we focus our attention? Here are five key numbers that have a big impact on your ability to meet your financial goals:

Percentage of your paycheck that goes to savings/investments. This may be the most important decision in your life. By saving early, you can have a portion of earnings grow in a compound fashion for decades. Furthermore, by “paying yourself” off the top, you limit the amount available for everyday living expenses during your working years. This discipline helps you in two major ways to obtaining early financial independence- first, by creating the fund for “retirement” and second, by reducing the expenses you will likely have during “retirement.” BTW- there is no magic percentage. Everyone’s circumstances are different. Consider an amount of 10-20% of your gross pay.

Your Annual Living Expenses. Monitor your expenses for last year and group them in three categories- needs, wants and wishes. Review the data from a long-term perspective. Spending a considerable amount now on wants and wishes will obviously reduce the amount available in future years. It’s all about choices and accountability. For the most part, you alone can determine and control your level of expenses.

The Asset Allocation of Your Portfolio. This is one of your most important investment decisions. Based upon your risk profile you need to determine how best to split up your investment funds between stocks, bonds and alternatives (which can include real estate). Studies show that 90% of your investment returns are the result of your asset allocation.

The Net Returns on Your Portfolio. Research shows that fees really matter. A $1,000,000 portfolio that earns 5% net per year will grow to $4.3 million in 30 years. The same portfolio that earns 4% net per year will grow to $3.2MM. The difference is $1.1 million- a 26% reduction. Over long periods, loads, commissions, high operating expenses and management fees can be a significant drag on wealth creation. Low cost passive investments are best for stocks and bonds. Make sure you understand and monitor all fees charged to your portfolio. Make sure you are getting real value for all the fees. And certainly, know what your net returns have been, are expected to be and how they compare to the appropriate benchmarks.

Your Effective (average) and Marginal Tax Rate. Tax costs on earnings, investment returns and other income can be huge, particularly as a result of the increases caused by the Affordable Care Act. You and your advisors should know your tax rates and use them as a key factor in decision making and investment strategy. Furthermore, proactive planning designed to minimize taxes is a must for you and your advisors.

Over the last 45 years, I have worked with clients of all ages, income levels and circumstances. A common thread among those who have achieved or are achieving their financial goals is that they all knew of and monitored these five key numbers regularly, making adjustments as appropriate. And, of course, they use objective, proactive, value driven advisors like DWM to help them as well.

Why not make it a New Year’s Resolution to know and monitor these five key numbers for your financial future? It could change your life.