When Can I Retire?

Posted on February 23rd, 2011 in Financial Abundance, Newsletter Articles, Retirement Planning by wayne

A common question of the baby boomer generation is “when I can retire?”  At Financial Abundance, LLC, we have a detailed, proprietary approach to help our client’s answer this question.  However, there is an easy to perform, 9 Step calculation that may help you answer this question.  Here is how it works.

Step 1: Separate expenses into either essential or discretionary expenses.  Essential expenses include food, clothing, housing, property and casualty insurance, taxes and medical expenses.  Essential expenses should also include all “required” expenses, including telephones, cable, internet, pet care, hair care, etc.  All other expenses, including expenses (such as travel) that you would like to increase in retirement, are classified as discretionary expenses.

Step 2: Identify available lifetime income streams.  This annual income will include pensions and Social Security (starting as early as age 62) as well as any lifetime annuity or trust income.  If these income streams are not inflation adjusted (as is Social Security), use only 2/3 of the annual amount to adjustment for future inflation.

Step 3: Subtract the amount in Step 2 from annual essential expenses.  This provides the essential income gap.

Step 4: Identify annual income expected from sources other than the lifetime income streams.  This would include income expected from taxable and tax deferred investment accounts, income from rental properties, post retirement employment income and all other income sources available during retirement.

Step 5: Subtract the amount in Step 4 from annual discretionary expenses.  This provides the discretionary income gap.

Step 6: Add the values found in Step 3 and Step 5 to determine your Total Income Gap.  If the sum is negative, you should have more than adequate resources to retire and meet your income requirements.  Most people will find that this number is positive.

Step 7: Sum all of your investible retirement assets including taxable accounts, tax deferred accounts, Roth accounts and the net sales value of any properties or other assets that might be sold in retirement.  If you included income from rental properties in Step 4, do not include those properties in Step 7.

Step 8: Divide the amount calculated in Step 7 by the Total Income Gap (Step 6) to determine the number of years that investment resources will last after retirement.

Step 9: Add your planned retirement age to the number found in Step 8.  If this sum is over 90, retirement in the planned year may be possible

Let’s look at an example of how this would work:

The Smith’s are both age 60 and plan on retiring at their full Social Security retirement age of 66. After examining their current expenses, the Smith’s have determined that their “essential” expenses are $50,000 per year and their “discretionary” expenses are $30,000 per year.  This figure includes an additional $10K per year that they will spend on travel after they retire. Total retirement expenses are $80,000 per year.

Based on current Social Security statements, their combined monthly Social Security income at age 66 will be $3,225 or $38,700 annually.  Mr. Smith will receive a non inflation adjusted $500/mo pension from a previous employer.  The annual inflation adjusted pension amount is  12*$500*2/3 = $4,000, for a total lifetime income of $42,700.  Subtracting this amount from the essential expenses of $50,000 leaves a $7,300 essential income gap.

The Smiths have approximately $600,000 in taxable and tax deferred retirement accounts, yielding 2.5%% annually.  These investments provide an annual income of $15,000.  Since their discretionary expenses are $30,000, their discretionary income gap is $15,000.  The Total Income Gap is $22,300.

By dividing $600,000 by $22,300, the Smiths find that their savings should last 26.9 years after they retire at age 66.  Since they will be 93 at that time, their current savings will likely be sufficient.

While this is a rudimentary approach to determining retirement preparedness, it is an easy method of estimating one’s ability to retire at a given age.  Next month, we will consider some approaches to help close the income gaps and reduce the age at which you can retire.

Increase Investment Returns – Guaranteed

Posted on February 23rd, 2011 in Investments, Newsletter Articles, Taxes by wayne

There is guaranteed way to increase investment returns without adding any investment risk or even changing your current investments.   Most investors have taxable investment accounts as well as tax deferred retirement accounts and even tax-free (Roth) accounts.  To increase investment income, determine which investment assets should be held in which types of accounts.  With this approach, you can maximize after-tax income by minimizing investment taxes.

Now that Congress has approved an extension of the investment income tax rates, it is important to examine investment holdings.  If possible, have only tax efficient investments in taxable accounts.  Let’s examine what types of investments are tax-efficient.

Through at least 2012, “qualified” stock dividends and long term capital gains are taxed at a maximum rate of 15%.  Most stock’s dividends are “qualified”, as long as the stock is held for more than 60 days. Stocks held for at least one year and a day will have their appreciation (capital gains) taxed at the maximum rate of 15%, making them very tax efficient.  Indexed stock funds, including most Exchange Traded Funds (ETFs), are also considered tax efficient, if held over one year.  Unfortunately, actively managed mutual funds require some research before determining their tax efficiency.

Each year, mutual funds must distribute all realized capital gains and dividends.  Mutual funds with high turnover rates will likely produce short term capital gains.  Regardless of how long a mutual fund is held, income taxes must be paid each year on all realized capital gains and dividends.  High turnover rate funds may have a significant amount of short term gains, taxed at ordinary income rates. This type of mutual fund is not  tax-efficient.

Stock based ETFs generally avoid year end taxable distributions, as do many stock index based mutual funds.  As long as the fund is held for over one year, actively managed mutual funds with low turnover rates and index based ETFs and mutual funds will typically be tax-efficient.

Whenever possible, place tax-inefficient investments in your tax-deferred or tax free (Roth) retirement accounts.  Tax-inefficient investments are investments in which most, if not all of their income is taxed at ordinary income tax rates.  Interest payments on bonds and bond funds, as well as “nonqualified” dividends are taxed at ordinary income rates.

Investments that generate short term capital gains are also tax inefficient, since short term capital gains are taxed at ordinary income rates.  If you plan to trade stocks on a short term basis or wish to invest in high turnover rate mutual funds put these investments in your tax deferred account.

Real Estate Investment Trusts (REITs) or REIT funds pay nonqualified dividends.  Bonds and bond based funds pay taxable interest income.  Since these payments are taxed at ordinary income rates, these investments are considered “tax-inefficient” and should be kept in your tax deferred accounts, when possible

With ETFs, owning gold or silver is now as easy as buying a stock.  However, with precious metal ETFs such as GLD (SPDR Gold Shares) or SLV (iShares Silver Trust), the shareholder is treated as if they own the actual gold or silver that backs the ETF.  The IRS considers precious metals to be collectibles.  Collectibles have a long term capital gain tax rate of either 25% or 28%, depending upon the taxpayer’s marginal income tax rate.  Precious metal ETFs are therefore tax-inefficient investments to be kept in tax deferred or tax free accounts.

Commodity ETFs such as DBC (PowerShares DB Commodity Index) often invest in futures contracts.  At the end of each year, the capital gains from a fund’s futures contracts holdings are taxed at 60% long term rates and 40% at short term rates.  This income is reported on the annual K-1 form.  When possible, minimize both your taxes and tax reporting hassles by holding these investments in a tax-deferred account.

Step 3 of the Seven Steps toward Financial Abundance is “minimize your taxes.”  By paying close attention to the types of accounts in which investments are held, you can minimize your taxes while maximizing your after-tax investment return.