Objective information about retirement, financial planning and investments

 

Social Security and Working – What You Need to Know

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In today’s world of early or semi-retirement, many people wonder when they should begin taking their Social Security benefits. The combination of Social Security and working can complicate matters a bit. You can begin taking your benefit as early as age 62, but that is not always the best choice for many retirees. If you are working either at a job where you are employed or some sort of self-employment, you need to analyze the pros and cons based on your situation.

Full retirement age

 Your full retirement age or FRA is the age at which you become eligible for a full, unreduced retirement benefit. FRA is an important piece in understanding the potential implications of working on your Social Security benefit.

Your FRA depends on when you born:

  • If you were born from 1943 -1954 your full retirement age is 66
  • If you were born in 1955 your FRA is 66 and two months
  • If you were born in 1956 your FRA is 66 and four months
  • If you were born in 1957 your FRA is 66 and six months
  • If you were born in 1958 your FRA is 66 and eight months
  • If you were born in 1959 your FRA is 66 and ten months
  • If you were born in 1960 or later your FRA is 67

Source: Social Security

Social Security and working

If you are working, collecting a Social Security benefit and younger than your FRA your benefits will be reduced by $1 for every $2 that your earned income exceeds the annual limit which is $18,240 for 2020. This increases to $18,960 for 2021. Earned income is defined as income from employment or self-employment.

During the year in which you reach your full retirement age the annual limit is increased. For 2020 this increased limit is $48,600. for 2021 this limit is $50,250. The reduction is reduced to $1 for every $3 of earnings over the limit.

This chart shows the monthly reduction of benefits at three levels of earned income for 2021.

                                         Reduction of Benefits – 2021

Age $25,000 earned income $60,000 earned income $75,000 earned income
Younger than FRA $252 per month $1,710 per month reduction $2,335 per month reduction
Year in which you reach FRA No reduction $271 per month reduction $688 per month reduction
FRA or older No reduction No reduction No reduction

Source: Social Security

Temporary loss of benefits

The loss of benefits is temporary versus permanent. Any benefit reduction due to earnings above the threshold will be recovered once you reach your FRA on a gradual basis over a number of years. However, your benefit will be permanently reduced by having taken it prior to your FRA. This means that any future cost-of-living adjustments will be calculated on a lower base amount as well.

A one-time do-over 

Everyone is allowed a one-time do-over to withdraw their benefit within one year of the start date of receiving their initial benefit. This is allowed once during your lifetime. This is called withdrawing your benefit.

One reason you might consider this is going back to work and earning more than you had initially anticipated. This is a way to avoid having your benefit permanently reduced. You would reapply later when you’ve reached your FRA, or your earned income is under the limit. Your benefit would increase due to your age and any cost-of-living increases that might occur during this time.

When you do take advantage of this one-time do-over, you must pay back any benefits received. This includes not only any Social Security benefits that you received, but also:

  • Any benefits paid based upon your earnings record such as spousal or dependent benefits.
  • Any money that may have been withheld from your benefits such as taxes or Medicare premiums.

Social Security and income taxes 

Regardless of your age or the source of your income, Social Security benefits can be taxed based upon your income level. This could certainly be impacted from income earned from employment or self-employment, but it also includes other sources of taxable income such as a pension or investment income.

The amount of the benefit that is subject to taxes is based upon your combined income, which is defined as: adjusted gross income + non-taxable interest income (typically from municipal bonds) + ½ of your Social Security benefit.

The tax levels are:

Tax filing status Combined income % of your benefit that will be taxed
Single $25,000 – $34,000 Up to 50%
Single Over $34,000 Up to 85%
Married filing jointly $32,000 – $44,000 Up to 50%
Married filing jointly Over $44,000 Up to 85%

Source: Social Security

The Bottom Line 

The decision when to take your Social Security benefit depends on many factors. If you are working or self-employed you will want to consider the impact that your earned income will have on your benefit.

You should also understand that your benefits can be subject to taxes at any age over certain levels of combined income, regardless of the source of that income.

Approaching retirement and want another opinion on where you stand? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring regarding the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

Photo by Sharon McCutcheon on Unsplash

Small Business Retirement Plans – SEP-IRA vs. Solo 401(k)

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One of the best tax deductions for a small business owner is funding a retirement plan. Beyond any tax deduction you are saving for your own retirement.  As a fellow small businessperson, I know how hard you work.  You deserve a comfortable retirement. If you don’t plan for your own retirement who will? Two popular small business retirement plans are the SEP-IRA and Solo 401(k).

Small Business Retirement Plans – SEP-IRA vs. Solo 401(k)

SEP-IRA vs. Solo 401(k)

SEP-IRA Solo 401(k)
Who can contribute? Employer contributions only. Employer contributions and employee deferrals.
Employer contribution limits The maximum for 2020 is $57,000, this has been increased to $58,000 for 2021. Contributions are deductible as a business expense and are not required every year. For 2020, the employer plus employee combined contribution limit is a maximum of 25% of compensation up to the maximums are $57,000 and $63,500, respectively. These have been increased to $58,000 and $64,500 for 2021. Employer contributions are deductible as a business expense and are not required every year.
Employee contribution limits A SEP-IRA only allows employer contributions. Employees can contribute to an IRA (Traditional or Roth, based upon their individual circumstances). $19,500 for 2020 and 2021. An additional $6,500 catch-up contribution is available for participants 50 and over. In no case can this exceed 100% of their compensation.
Eligibility Typically, employees must be allowed to participate if they are over age 21, earn at least $600 annually, and have worked for the same employer in at least three of the past five years. No age or income restrictions. Business owners, partners and spouses working in the business. Common-law employees are not eligible.

Note the Solo 401(k) is also referred to as an Individual 401(k).

  • While a SEP-IRA can be used with employees in reality this can become an expensive proposition as you will need to contribute the same percentage for your employees as you defer for yourself. I generally consider this a plan for the self-employed.
  • Both plans allow for contributions up your tax filing date, including extensions for the prior tax year. Consult with your tax professional to determine when your employee contributions must be made. The Solo 401(k) plan must be established by the end of the calendar year.
  • The SEP-IRA contribution is calculated as a percentage of compensation. If your compensation is variable the amount that you can contribute year-to year will vary as well. Even if you have the cash to do so, your contribution will be limited by your income for a given year.
  • By contrast you can defer the lesser of $19,500 ($26,000 if 50 or over) or 100% of your income for 2020 and 2021 into a Solo 401(k) plus the profit sharing contribution. This might be the better alternative for those with plenty of cash and a variable income.
  • Loans are possible from Solo 401(k)s, but not with SEP-IRAs.
  • Roth feature is available for a Solo 401(k) if allowed by your plan document. There is no Roth feature for a SEP-IRA.
  • Both plans require minimal administrative work, though once the balance in your Solo 401(k) account tops $250,000, the level of annual government paperwork increases a bit.
  • Both plans can be opened at custodians such as Charles Schwab, Fidelity, Vanguard, T. Rowe Price, and others. For the Solo 401(k) you will generally use a prototype plan. If you want to contribute to a Roth account, for example, ensure that this is possible through the custodian you choose.
  • Investment options for both plans generally run the full gamut of typical investment options available at your custodian such as mutual funds, individual stocks, ETFs, bonds, closed-end funds, etc. There are some statutory restrictions so check with your custodian.
  • For those wishing to invest in alternative assets inside of their SEP or solo 401(k), a number of self-directed retirement plan custodians offer this option.

Both plans can offer a great way for you to save for retirement and to realize some tax savings in the process. Whether you go this route or with some other option I urge to start saving for your retirement today 

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

Photo credit Flickr

Review Your 401(k) Account

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For many of us, our 401(k) plan is our main retirement savings vehicle. The days of a defined benefit pension plan are a thing of the past for most workers and we are responsible for the amount we save for retirement and how we invest that money.

Managed properly, your 401(k) plan can play a significant role in providing a solid retirement nest egg. Like any investment account, you need to ensure that your investments are properly allocated in line with your goals, time horizon and tolerance for risk.

Photo by Aidan Bartos on Unsplash

You should thoroughly review your 401(k) plan at least annually. Some items to consider while doing this review include:

Have your goals or objectives changed?

Take time to review your retirement goals and objectives. Calculate how much you’ll need at retirement as well as how much you need to save annually to meet that goal. Review the investments offered by the plan and be sure that your asset allocation and the investments selected dovetail with your retirement goals and fit with your overall investment strategy including assets held outside of the plan.

Are you contributing as much as you can to the plan?

Look for ways to increase your contribution rate. One strategy is to allocate any salary increases to your 401(k) plan immediately, before you get used to the money and find ways to spend it. At a minimum, make sure you are contributing enough to take full advantage of any matching contributions made by your employer. For 2020 the maximum contribution to a 401(k) plan is $19,500 plus an additional $6,500 catch-up contribution for individuals who are age 50 and older at any point during the year. These limits are unchanged for 2021.

Are the assets in your 401(k) plan properly allocated?

Some of the more common mistakes made when investing 401(k) assets include allocating too much to conservative investments, not diversifying among several investment vehicles, and investing too much in an employer’s stock. Saving for retirement typically encompasses a long time frame, so make investment choices that reflect your time horizon and risk tolerance. Many plans offer Target Date Funds or other pre-allocated choices. One of these may be a good choice for you, however, you need to ensure that you understand how these funds work, the level of risk inherent in the investment approach and the expenses.

Review your asset allocation as part of your overall asset allocation

Often 401(k) plan participants do not take other investments outside of their 401(k) plan, such as IRAs, a spouse’s 401(k) plan, or holdings in taxable accounts into consideration when allocating their 401(k) account.

Your 401(k) investments should be allocated as part of your overall financial plan. Failing to take these other investment assets into account may result in an overall asset allocation that is not in line with your financial goals.

Review the performance of individual investments, comparing the performance to appropriate benchmarks. You shouldn’t just select your investments once and then ignore them. Review your allocation at least annually to make sure it is correct. If not, adjust your holdings to get your allocation back in line. Selling investments within your 401(k) plan does not generate tax liabilities, so you can make these changes without any tax ramifications.

Do your investments need to be rebalanced?

Use this review to determine if your account needs to be rebalanced back to your desired allocation. Many plans offer a feature that allows for periodic automatic rebalancing back to your target allocation. You might consider setting the auto rebalance feature to trigger every six or twelve months.

Are you satisfied with the features of your 401(k) plan?

If there are aspects of your plan you’re not happy with, such as too few or poor investment choices, take this opportunity to let your employer know. Obviously do this in a constructive and tactful fashion. Given the recent volume of successful 401(k) lawsuits employers are more conscious of their fiduciary duties and yours may be receptive to your suggestions.

The Bottom Line

Your 401(k) plan is a significant employee benefit and is likely your major retirement savings vehicle. It is important that you monitor your account and be proactive in managing it as part of your overall financial and retirement planning efforts.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring in two areas: the financial transition to retirement or small business financial coaching.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

4 Benefits of Portfolio Rebalancing

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The past couple of years have been a roller coaster ride in the stock market. The S&P 500 lost 4.38% in 2018 mostly from a poor fourth quarter performance. The market recovered nicely in 2019 with the index posting a 31.49% total return for the year. This trend seemed to be continuing into 2020, with the index hitting a record high in late February.

Then the markets felt the impact of COVID-19. By late March the index had plummeted over 33% from its all-time high reached only a month prior. Since then, however, the stock market has recovered nicely with the S&P 500 closing at an all-time high yesterday.

The recovery in the markets has been an uneven one. Growth stocks have led the way, while value has largely lagged. Apple’s shares are up over 70% year-to-date, Amazon is up almost 78% and Microsoft is up over 36%.

With all of these gyrations among various asset classes over the past couple of years, you may be taking on more or less risk than is appropriate for your situation. If you haven’t done so recently, this is a good time to consider rebalancing your investments. Here are four benefits of portfolio rebalancing.

4 Benefits of Portfolio Rebalancing

Balancing risk and reward

Asset allocation is about balancing risk and reward. Invariably some asset classes will perform better than others. This can cause your portfolio to be skewed towards an allocation that takes too much risk or too little risk based on your financial objectives.

During robust periods in the stock market equities will outperform asset classes such as fixed income. Perhaps your target allocation was 65% stocks and 35% bonds and cash. A stock market rally might leave your portfolio at 75% stocks and 25% fixed income and cash. This is great if the market continues to rise but you would likely see a more pronounced decline in your portfolio should the market experience a sharp correction.

Portfolio rebalancing enforces a level of discipline

Rebalancing imposes a level of discipline in terms of selling a portion of your winners and putting that money back into asset classes that have underperformed.

This may seem counterintuitive but market leadership rotates over time. During the first decade of this century emerging markets equities were often among the top performing asset classes. Fast forward to today and their performance has been much more muted.

Rebalancing can help save investors from their own worst instincts. It is often tempting to let top performing holdings and asset classes run when the markets seem to keep going up. Investors heavy in large caps, especially those with heavy tech holdings, found out the risk of this approach when the Dot Com bubble burst in early 2000.

Ideally investors should have a written investment policy that outlines their target asset allocation with upper and lower percentage ranges. Violating these ranges should trigger a review for potential portfolio rebalancing.

A good reason to review your portfolio

When considering portfolio rebalancing investors should also incorporate a full review of their portfolio that includes a review of their individual holdings and the continued validity of their investment strategy. Some questions you should ask yourself:

  • Have individual stock holdings hit my growth target for that stock?
  • How do my mutual funds and ETFs stack up compared to their peers?
    • Relative performance?
    • Expense ratios?
    • Style consistency?
  • Have my mutual funds or ETFs experienced significant inflows or outflows of dollars?
  • Have there been any recent changes in the key personnel managing the fund?

These are some of the factors that financial advisors consider as they review client portfolios.

This type of review should be done at least annually and I generally suggest that investors review their allocation no more often than quarterly.

Helps you stay on track with your financial plan 

Investing success is not a goal unto itself but rather a tool to help ensure that you meet your financial goals and objectives. Regular readers of The Chicago Financial Planner know that I am a big proponent of having a financial plan in place.

A properly constructed financial plan will contain a target asset allocation and an investment strategy tied to your goals, your timeframe for the money and your risk tolerance. Periodic portfolio rebalancing is vital to maintaining an appropriate asset allocation that is in line with your financial plan.

The Bottom Line 

Regular portfolio rebalancing helps reduce downside investment risk and ensures that your investments are allocated in line with your financial plan. It also can help investors impose an important level of discipline on themselves.

How has the volatility in the stock market impacted your investments and your financial plan? Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if its right for you. Financial coaching focuses on providing education and mentoring for the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

7 Tips to Become a 401(k) Millionaire

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According to Fidelity in an update released in February of this year, the average balance of 401(k) plan participants stood at $112,300, up 7 percent from the balance at the end of the prior quarter. This data is from plans using the Fidelity platform. This came on the heels of significant gains in the stock market in 2019. It will be interesting to see how these numbers change in the wake of the market volatility from the fallout of COVID-19.

Fidelity indicates that about 441,000 401(k) participants and IRA account holders had a balance of $1 million or more, What is their secret? Here are 7 tips to become a 401(k) millionaire or to at least maximize the value of your 401(k) account.

Be consistent and persistent 

Investing in your 401(k) plan is more of a marathon than a sprint. Maintain and increase your salary deferrals in good markets and bad.

Contribute enough 

In an ideal world every 401(k) investor would max out their annual salary deferrals to their plan which are currently $19,500 and $26,000 for those who are 50 or over.

If you are just turning 50 this year or if you are older be sure to take advantage of the $6,500 catch-up contribution that is available to you. Even if your plan limits the amount that you can contribute because of testing or other issues, this catch-up amount is not impacted. It is also not automatic so be sure to let your plan administrator know that you want to contribute at that level. 

According to a Fidelity study several years ago, the average contribution rate for those with a $1 million balance was 16 percent of salary. The 16 percent contribution rate translated to a bit over $21,000 for the millionaire group.

As I’ve said in past 401(k) posts on this site, it is important to contribute as much as you can. If you can only afford to defer 3 percent this year, that’s a start. Next year try to hit 4 percent or more. As a general rule it is a good goal to contribute at least enough to earn the full match if your employer offers one.

Take appropriate risks 

As with any sort of investment account be sure that you are investing in accordance with your financial plan, your age and your risk tolerance. I can’t tell you how many times I’ve seen lists of plan participants and see participants in their 20s with all or a large percentage of their account in the plan’s money market or stable value option.

Your account can’t grow if you don’t take some risk.  

Don’t assume Target Date Funds are the answer 

Target Date Funds are big business for the mutual fund companies offering them. They also represent a “safe harbor” from liability for your employer. I’m not saying they are a bad option but I’m also not saying they are the best option for you. Everyone’s situation is different, be sure you make the best investing decisions for your situation.

I like TDFs for younger investors say those in their 20s who may not have other investments outside of the plan. The TDF offers an instant diversified portfolio for them.

Once you’ve been working for a while you should have some outside investments. By the time you are in your 30s or 40s you should consider a portfolio more tailored to your situation.

Additionally Target Date Funds all have a glide path into retirement. They are all a bit different: you need to understand if the glide path offered by the TDF family in your plan is right for you. 

Invest during a long bull market 

This is a bit sarcastic but the bull market for stocks that started in March of 2009 and recently ended with the market decline in the wake of the COVID-19 pandemic, is in part why we’ve seen a surge in 401(k) millionaires and in 401(k) balances in general. The equity allocations of 401(k) portfolios have driven the values higher.

The flip side are those who swore off stocks at the depths of the 2008-2009 market downturn and have missed one of the better opportunities in history to increase their 401(k) balance and their overall retirement nest egg.

Don’t fumble the ball before crossing the goal line 

We’ve all seen those “hotdogs” running for a sure touchdown only to spike the ball in celebration before crossing the goal line.

The 401(k) equivalent of this is to just let your account run in a bull market like this one and not rebalance it back to your target allocation. If your target is 60 percent in stocks and it’s grown to 80 percent in equities due to the run up of the past few years you might well be a 401(k) millionaire.

It is just as likely that you may become a former 401(k) millionaire if you don’t rebalance. The stock market has a funny way of punishing investors who are too aggressive or who don’t manage their investments.

Pay attention to those old 401(k) accounts 

Whether becoming a 401(k) millionaire in your current 401(k) account or combined across several accounts, the points mentioned above still apply. In addition it is important to be proactive with your 401(k) account when you leave a job. Whether you roll the account over to an IRA, leave it in the old plan or roll it to a new employer’s plan, make a decision. Leaving an old 401(k) account unattended is wasting this money and can hinder your retirement savings efforts.

The Bottom Line 

Whether you actually amass $1 million in your 401(k) or not, the goal is to maximize the amount accumulated there for retirement. The steps outlined above can help you to do this. Are you ready to start down the path of becoming a 401(k) millionaire?

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

Required Minimum Distributions in 2020 – What You Need to Know

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This was already a year of change for those impacted by required minimum distributions (RMDs). The SECURE Act signed into law at the end of 2019 includes some significant changes in RMDs starting in 2020. The CARES Act (passed in the wake of the coronavirus pandemic) included additional changes that apply only to 2020. Below is a discussion of some major changes for required minimum distributions in 2020 and what you need to know.

The CARES Act and RMDs

The CARES Act is a stimulus package geared in large part to providing relief for businesses, but it did contain some portions directed at individuals. One such piece is the waiver of RMDs for 2020.

This waiver includes 2020 RMDs for those who reached age 70 ½ prior to January 1, 2020 and were required to take them, this includes those who reached age 70 ½ in 2019 and who would have been required to take their first RMD on April 1 of 2020.

The waiver also applies to those who otherwise would have needed to commence their RMDs this year due to reaching the age of 72 as mandated by the rules in the SECURE Act. This effectively delays the commencement of their RMD a few years beyond their expectations prior to the SECURE Act.

The waiver applies to RMDs from IRAs, 401(k)s, 403(b)s and other types of retirement plans. Additionally, the waiver applies to those who would otherwise be required to take their RMD as the beneficiary of an inherited IRA.

Those who wish to make charitable contributions using the qualified charitable distribution (QCD) feature of their normal RMDs from an IRA can still do so. The amount donated to charity will still be exempt from federal taxes up to the donation limits. A benefit of doing this in 2020 is that it can serve to reduce their IRA balance and potentially lower the amount of future RMDs.

For those who have already taken their RMDs for 2020, the IRS recently issued new guidance on undoing these RMDs. For those who took their RMDs from January 1 through June 30, 2020, they can be repaid into a qualifying retirement account through August 31, 2020.

This means that any RMD taken in the first half of 2020 can be repaid into a qualifying retirement account. This will generally include an IRA, a 401(k), a 403(b) and another qualifying account. It doesn’t necessarily need to be repaid into the same account, though in the case of an IRA distribution going into an employer-sponsored retirement plan you will want to be sure that the plan will accept this money.

The one rollover per 12-month period limitation on IRAs will not apply to these rollovers. Note this relief does not apply to any distribution amounts that were taken in excess of what would have been your RMD amount for 2020.

Unlike the original rules on undoing RMDs, this now applies to beneficiaries who took an RMD from an inherited IRA. The funds taken from the inherited IRA must be redeposited back into the account from which they were taken in this case.

As with the original rules, RMDs that apply to a defined benefit pension plan cannot be undone, nor is there any CARES Act waiver for these RMDs.

For those who wish to or need to make withdrawals from their retirement accounts they can of course continue to do so. There were other changes to retirement accounts enacted under the CARES Act, including relaxed rules on 401(k) loans and on withdrawals from retirement accounts to help those impacted by COVID-19.

RMDs and the SECURE Act 

This was already a year of change for required minimum distributions. The SECURE Act raised the age to commence RMDs, called the required beginning date (RBD), from IRAs, 401(k)s and other retirement accounts from 70 ½ to 72 for those who turned 70 ½ on or after January 1, 2020. For those who would normally have commenced taking their RMDs in 2020 upon reaching age 70 ½, this pushed the requirement back by two years.

QCDs

The SECURE Act did not change the age for qualified charitable distributions from age 70 ½, so even though they do not have to take their RMDs until age 72, those who wish do so can still make a charitable contribution via a distribution from their traditional IRA account up to the $100,000 limit and the distribution will not be subject to federal income taxes.

Inherited IRAs 

One of the biggest changes for IRAs in the SECURE Act pertains to inherited IRAs. Non-spousal beneficiaries of inherited IRAs prior to January 1, 2020 could stretch these accounts using RMDs based on their life expectancy. To the extent the beneficiary was younger than the original account owner this could allow them to stretch the RMDs out for many years while the value of the IRA grew tax-deferred.

Under the SECURE Act, most non-spousal beneficiaries of an IRA will now be required to withdraw all funds from the account within a ten-year period. This means that in many cases a higher percentage of the account will go towards taxes than in the past. For example, if a parent passes their IRA to an adult child, that child will need to take a full distribution from the account within ten years and pay the income taxes that will be due. If this child is in their 40s or 50s and in their peak earning years, the amount of any distributions will be added onto their earned income and potentially be taxed at a much higher rate than they would have been in the past.

Beneficiaries, known as eligible designated beneficiaries, will still be able to take distributions from an inherited IRA using RMDs. These beneficiaries include:

  • Surviving spouses
  • A minor child of the deceased IRA account owner
  • A beneficiary who is no more than ten years younger than the deceased IRA account owner
  • A beneficiary who is deemed to be chronically ill

This provision is expected to result in changes to the estate planning of many IRA account owners in the coming years.

The Bottom Line 

Between the planned changes under the SECURE Act and the unplanned changes under the CARES Act, those normally faced with taking RMDs have a number of changes to be aware for 2020 and beyond. It’s a good idea to consult with your financial or tax advisor to ensure that you understand how these rules apply to your situation.

How has the volatility in the stock market impacted your investments and your financial plan? Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if its right for you. Financial coaching focuses on providing education and mentoring for the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

Photo by Sharon McCutcheon on Unsplash

8 Portfolio Rebalancing Tips

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In light of the recent stock market volatility, it’s important to review your asset allocation and consider rebalancing your portfolio if needed. This post looks at some ways to implement a portfolio rebalancing strategy. Here are 8 portfolio rebalancing tips that you can use to help in this process.

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Set a target asset allocation 

Your asset allocation should be an outgrowth of a target asset allocation from your financial plan and/or a written investment policy. This is the target asset allocation that should be used when rebalancing your portfolio. 

Establish a time frame to rebalance 

Ideally you are reviewing your portfolio and your investments on a regular basis. As part of this process you should incorporate a review of your asset allocation at a set interval. This might be semi-annually for example. I generally suggest no more frequently than quarterly. An exception would be after a precipitous move up or down in the markets.

Take a total portfolio view 

When rebalancing your portfolio take a total portfolio view. This includes taxable accounts as well as retirement accounts like an IRA or your 401(k). This approach allows you to be strategic and tax-efficient when rebalancing and ensures that you are not taking too little or too much risk on an overall basis.

Incorporate new money 

If you have new money to invest take a look at your asset allocation first and use these funds to shore up portions of your asset allocation that may be below their target allocation. A twist on this is to direct new 401(k) contributions to one or two funds in order to get your overall asset allocation back in balance. In this case you will need to take any use of your plan’s auto rebalancing feature into account as well. 

Use auto pilot 

For those with an employer sponsored retirement plan such as a 401(k), 403(b) or similar defined contribution plan many plans offer an auto-rebalancing feature. This allows you to select a time interval at which your account will be rebalanced back to the allocation that you select.

This serves two purposes. First it saves you from having to remember to do it. Second it takes the emotion and potential hesitation out of the decision to pare back on your winners and redistribute these funds to other holdings in your account.

I generally suggest using a six-month time frame and no more frequently than quarterly and no less than annually. Remember you can opt out or change the interval at any time you wish and you can rebalance your account between the set intervals if needed.

Make charitable contributions with appreciated assets 

If you are charitably inclined consider gifting shares of appreciated holdings in taxable accounts such as individual stocks, mutual funds and ETFs to charity as part of the rebalancing process. This allows you to forgo paying taxes on the capital gains and may provide a charitable tax deduction on the market value of the securities donated.

Most major custodians can help facilitate this and many charities are set-up to accept donations on this type. Make sure that you have held the security for at least a year and a day in order to get the maximum benefit if you able to itemize deductions. This is often associated with year-end planning but this is something that you can do at any point during the year.

Incorporate tax-loss harvesting

This is another tactic that is often associated with year-end planning but one that can be implemented throughout the year. Tax-loss harvesting involves selling holdings with an unrealized loss in order to realize that loss for tax purposes.

You might periodically look at holdings with an unrealized loss and sell some of them off as part of the rebalancing process. Note I only suggest taking a tax loss if makes sense from an investment standpoint, it is not a good idea to “let the tax tail wag the investment dog.”

Be sure that you are aware of and abide by the wash sale rules that pertain to realizing and deducting tax losses.

Don’t think you are smarter than the market 

It’s tough to sell winners and then invest that money back into portions of your portfolio that haven’t done as well. However, portfolio rebalancing is part of a disciplined investment process.  It can be tempting to let your winners run, but too much of this can skew your allocation too far in the direction of stocks and increase your downside risk.

If you think you can outsmart the market, trust me you can’t. How devastating can the impact of being wrong be? Just ask those who bought into the mantra “…it’s different this time…” before the Dot Com bubble burst or just before the stock market debacle of the last recession.

The Bottom Line 

Portfolio rebalancing is a key strategy to control the risk of your investment portfolio. It is important that you review your portfolio for potential rebalancing opportunities at set intervals and that you have the discipline to follow through and execute if needed. These 8 portfolio rebalancing tips can help.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

401(k) Fee Disclosure and the American Funds

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With the release and subsequent repeal of the Department of Labor’s fiduciary rules for financial advisors dealing with client retirement accounts, much of the focus in recent years has been on the impact on advisors who provide advice to clients for their IRA accounts. Long before these rules were unveiled and then repealed, financial advisors serving 401(k) plan sponsors have had a fiduciary responsibility to act in the best interests of the plan’s participants under the DOL’s ERISA rules.

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Starting in 2012, retirement plan sponsors have been required to disclose the costs associated with the investment options offered in 401(k) plans annually.

As an illustration, here’s how the various share classes offered by the American Funds for retirement plans stack up under the portion of the required disclosures that deal with the costs and performance of the plan’s investment options.

American Funds EuroPacific Growth

The one American Funds option that I’ve used most over the years in 401(k) plans is the EuroPacific Growth fund.  This fund is a core large cap foreign stock fund.  It generally has some emerging markets holdings, but most of the fund is comprised of foreign equities from developed countries. The R6 share class is the least expensive of the retirement plan share classes. Let’s look at how the various share classes stack up in the disclosure format:

Share Class Ticker Expense Ratio Expenses per $1,000 invested Trailing 1-year return Trailing 3-year return Trailing 5-year return
R1 RERAX 1.60% $16.00 -8.63% 1.02% 0.98%
R2 RERBX 1.60% $16.00 -8.62% 1.03% 0.99%
R3 RERCX 1.14% $11.40 -8.19% 1.49% 1.45%
R4 REREX 0.84% $8.40 -7.92% 1.79% 1.75%
R5 RERFX 0.54% $5.40 -7.65% 2.10% 2.06%
R6 RERGX 0.49% $4.90 -7.60% 2.15% 2.11%

3-and 5-year returns are annualized.  Source:  Morningstar   Data as of 4/30/2020

While the chart above pertains only to the EuroPacific Growth fund, looking at the six retirement plan share classes for any of the American Funds products would offer similar relative results.   

The underlying portfolios and the management team are identical for each share class. The difference lies in the expense ratio of each share class.  This is driven by the 12b-1 fees associated with the different share classes. This fee is part of the expense ratio and is generally used all or in part to compensate the advisor on the plan.  In this case these advisors would generally be registered reps, brokers, and insurance agents. The 12b-1 fee can also revert to the plan to lower expenses. The 12b-1 fees by share class are:

R1                   1.00%

R2                   0.75%

R3                   0.50%

R4                   0.25%

R5 and R6 have no 12b-1 fees.

Growth of $10,000 invested

The real impact of expense differences can be seen by comparing the growth of $10,000 invested by a hypothetical investor on April 30, 2010 and held through April 30, 2020.

  • The $10,000 invested in the R1 shares would have grown to a value or $14,607.11.
  • The $10,000 invested in the R6 shares would have grown to a value of $15,321.34.

This is a difference of $1,714.23 or 11.7%. The portfolios of the two share classes of the fund are identical, the difference in performance is due to the difference in expenses for the two share classes. If you think of these as two retirement plan participants, one whose plan uses the R1 share class and the other whose plan uses the R6 share class, the first investor would have 11.7% less after ten years due to their plan sponsor’s choice regarding which fund share class to offer.

This analysis assumes a one-time investment of $10,000 and the reinvestment of all distributions. Morningstar’s Advisor Workstation was used to perform this analysis.

Share classes matter

The R1 and R2 shares have traditionally been used in plans where the 12b-1 fees are used to compensate a financial salesperson. This is fine as long as that salesperson is providing a real service for their compensation and is not just being paid to place the business.

If you are a plan participant and you notice that your plan has one or more American Funds choices in the R1 or R2 share classes in my opinion you probably have a lousy plan due to the extremely high expenses charged by these share classes. It is incumbent upon you to ask your employer if the plan can move to lower cost shares or even a different provider. The R3 shares are a bit of an improvement but still quite pricey for a retirement plan in my opinion.

To be clear, I’m generally a fan of the American Funds. Overall however, their funds tend to offer a large number of share classes between their retirement, non-retirement and 529 plan shares. While the overall portfolios are generally the same, it’s critical for investors and retirement plan sponsors to understand the differing expense structures and the impact they have on potential returns.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

NEW SERVICE – Financial Coaching. Check out this new service to see if it’s right for you. Financial coaching focuses on providing education and mentoring on the financial transition to retirement.

FINANCIAL WRITING. Check out my freelance financial writing services including my ghostwriting services for financial advisors.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Check out our resources page for links to some other great sites and some outstanding products that you might find useful.

Photo credit:  Flickr