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401(k)

Taxing Times

By | 2021, Money Matters, Newsletter | No Comments

It is that time of the year! Tax season is upon us. As you gather your tax documents together, you may be wondering how you are taxed on investments. This is a good time to review how taxes apply to different account types.

Tax-deferred

Most everyone has some type of tax-deferred account, generally thought of as a retirement account(s). Money is invested in these accounts before taxes are paid. It grows over the years and is taxed when you take it out of the account through withdrawals and distributions. These accounts include Individual Retirement Account (IRA), 401(k), 403(b), SIMPLE IRA, SEP IRA, etc. It can also include non-qualified tax-deferred annuities where the initial investment has been taxed, but the tax on the growth is deferred until you take a withdrawal from the account.

Money taken from tax-deferred accounts is taxed as ordinary income. That means it is taxed at your marginal-income tax rate.

Restrictions apply to these accounts. For instance, the amount of money you can invest each year is limited based on the account type and your age. If you take money out before you are age 59 ½, you will pay an early withdrawal penalty of 10%. Furthermore, you must begin taking money out of these accounts by age 72. This is known as a Required Minimum Distribution (RMD), and you will be subject to a penalty if you miss the deadline.

Taxable

Taxable investment accounts can be accessed at any time without restriction. They are often used to reach a specific goal or increase savings that will be used to supplement income during retirement. The initial investment has already been taxed, and you will only pay tax on the growth.

The tax rate is determined by the length of time you hold the investment. If you hold a specific investment within a taxable account for more than one year and one day, you will be taxed at lower capital gains rates. If you sell an investment in less than one year, taxes are calculated at your ordinary income-tax rate. Dividends received are generally taxed as ordinary income as well.

You can manage taxes within the account by offsetting gains and losses. This strategy can be helpful in reducing taxes.

You are free to add as much money as you want to a taxable account, and there are no requirements to take money out of this type of account regardless of your age.

Tax-free

Growing money without taxes is a wonderful way to plan for retirement. This can be done in a Roth IRA or Roth 401(k). Money is invested in the account after taxes have been paid. Any growth earned over the years is tax-free. It does not get better than that!

There are differences between the two types of Roth accounts. The amount of money you can contribute is limited by the type of account and your age. A Roth IRA has no required distribution date. You can leave the money in the account until you are ready to use it or pass it to your heirs tax-free. Unfortunately, the Roth 401(k) is subject to Required Minimum Distributions at age 72. This can be avoided by rolling the Roth 401(k) to a Roth IRA before the year you will turn 72.

For details on marginal tax rates, capital gains rates, and contribution limits, visit us at SmedleyFinancial.com and browse the updated 2021 tax information. You can also call us at 800-748-4788. Happy tax season!

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Supersized Retirement Savings

By | 2020, Money Moxie, Newsletter | No Comments

If you want to supersize your retirement savings for early retirement or help you make up for lost time, consider a mega backdoor Roth. It can allow you to stash up to another $37,500 into retirement savings, which will grow tax-free. In an environment where taxes may go up because of government debt, this can be a very worthwhile proposition. It is especially beneficial for earners that make too much to contribute to a regular Roth or have too much in IRA assets to do a regular backdoor Roth. Of course, there are hurdles and restrictions.

The first hurdle is maxing out your 401(k) or Roth 401(k) contributions. In 2020, the limit is $19,500, or $26,000 if over age 50. If you aren’t contributing enough to hit these thresholds, then a mega backdoor Roth doesn’t apply. If you are hitting these thresholds, then your normal contributions should probably be pre-tax, and the backdoor Roth can serve as your after-tax savings. (It may not make sense to put all of your contributions into the Roth bucket if you are taxed at 37% federally.)

If you earn less than $124,000 or $196,000 filing jointly, then you are still eligible to contribute to your normal Roth IRA. Make that contribution first, which can be $6,000 or $7,000 if over age 50. If you earn more than the limits, then a mega backdoor Roth is your only retirement savings option.

The next big hurdle is your 401(k) plan. Only 43% of companies allow for after-tax contributions. In addition, the company 401(k) plan needs to allow for in-service distributions into the Roth. If the plan checks both of these boxes, then the contributions go into the after-tax portion, and the plan administrator can convert those assets into a Roth.

If the plan doesn’t allow for in-service distributions, then you can still put money in after-tax, but the earnings will only be tax-deferred. Usually at age 59½ or at retirement, you can place the after-tax portion into a Roth IRA, and the tax-deferred portion can go into a traditional IRA. This somewhat defeats the purpose as the goal is to get as much as possible into a Roth as soon as possible to allow for tax-free growth.

If you have jumped over these hurdles, then you are ready to stash money away. In 2020, you can put a maximum of $57,000 into a retirement plan, including your contributions and the company’s match. So, if you put in $19,500, and the company matches $5,500, then you can put in up to $32,000 more in the mega backdoor Roth. Talk about supersizing your retirement savings!

The major benefit of a mega backdoor Roth over a regular backdoor Roth conversion is not having to deal with the pro-rata rule. In a normal backdoor Roth, whatever you convert is proportionate across all of your IRAs. So, if you have any sizable amount in pre-tax IRA (i.e., traditional IRA), then you have to convert and pay taxes on the proportional amount converted from the IRA. Depending on the size of your IRA, and if you are under age 59½, this can really hurt. Since the mega backdoor Roth takes place in a 401(k), that pro-rata rule doesn’t apply.

While there are hurdles and restrictions, the mega backdoor Roth can be a great way to supersize your retirement savings. If you have any questions on how this can help you reach your goals, please contact our Private Wealth Managers.

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What is in a name?

By | 2020, Money Matters, Newsletter | No Comments

When it comes to designating a beneficiary – everything!

It is hard to remember how many times we have named a beneficiary on a document or account. I would say it is even harder to remember who we named. The phrase “out of sight, out of mind” rings true.

The reality is the person or entity named as the beneficiary can trump your plans. Even after spending time and money creating a will and trust, you may have missed an important step. If the beneficiary is not named correctly or updated to meet changes in your plans, your desires will not be met.

Last month our Just for Women webinar focused on Wills and Trusts and featured Kent Brown of Strong & Hanni Law Firm. He shared several threats that can wreck an estate plan. One of those threats was naming beneficiaries. If you missed the webinar, you can view it on our website under Just for Women.

Here are some things to keep in mind when naming a beneficiary.

Naming one child as the beneficiary – We have experienced situations where a single child was named as a beneficiary. The intent was that the named child would split the money among the other children of the deceased. Unfortunately, the child often feels strongly that the money was intended for them alone and therefore does not distribute any money to their siblings. Do not assume a child will feel inclined to distribute the money as you wanted. If you intend that all your children will receive a portion of the account, name them all as a beneficiary and specify their portion. If your child splits the money as intended, they may have a problem with taxation. If the account was a qualified account, the full tax burden falls on the named child. This could push them into a higher tax bracket, reducing the amount distributed to siblings.

Naming a spouse and a child as primary beneficiaries – This often happens in error or because you believe your spouse will need help handling the money at your demise. Naming a spouse as the primary beneficiary gives them full access to the account. Including a child as an additional primary beneficiary does not make them a joint owner in the asset. Instead, it transfers the portion or share listed directly to them as an owner. They are under no obligation to share the money with the surviving parent. This can lead to serious financial consequences for the surviving spouse.

Naming a special needs child or adult Receiving money as a beneficiary can impede a special needs individual from receiving benefits from assistance programs. A special needs trust can help ensure the individual gets the money intended for them and names someone to handle the money on their behalf, creating a layer of protection.

Not naming a contingent beneficiary – Unfortunately, your primary beneficiary may predecease you, or you may die in a common accident. If there is not a contingent beneficiary listed, the assets will have to go through probate. In essence, you have decided the asset will be handled according to your will, if you have one, or that the courts will decide how your assets will be divided. This can cost the executor of your estate a great deal of time and expense.

Not naming your trust – A common mistake after establishing a trust is neglecting to name the trust as the beneficiary or assuming the attorney has taken care of the change. You are the only one who can sign the document naming beneficiaries on your accounts.

Not updating beneficiary designations – There are so many accounts that require a beneficiary designation that is it easy to overlook an account when you have a significant life change. This could be marriage, divorce, death of a spouse, the birth of a child or newly adopted child, or the death of a named beneficiary. We have uncovered too many instances where the divorce took place years prior. However, the ex-spouse was still listed as the primary beneficiary on the retirement account at the employer. This type of error can cause unintended heartache and financial trouble for a surviving spouse.

Make it a priority to review the beneficiaries on your accounts now. Then each year, take a few minutes to review the current beneficiaries and make changes if needed.

Here are some of the accounts to consider when reviewing your beneficiaries:

  • Retirement accounts: IRAs, Roth IRAs, 401(k), 403(b), 457, SIMPLE IRA, SEP IRA
  • Employer’s pension plan
  • Annuities
  • Life Insurance: Individual policies and group policies

Understanding when to name an individual and when to name a trust can be challenging. If you have questions or need assistance, please contact the SFS Wealth Management Team at 800-748-4788.

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What To Do With Your 401(k), If…

By | 2020, Money Moxie | No Comments

1: You are still employed by the sponsor company

Keep investing! The 401(k) implements an effective purchasing strategy called dollar- cost averaging. This strategy involves making regular and continuous fixed-dollar investments. But it is more than just a payroll deduction plan. Dollar-cost averaging removes the risk of trying to time the market.

By using dollar-cost averaging in a long-term investment account, the average cost per share ends up being less than the average price per share. This is because you buy less shares when prices are high and more shares when prices are low. In other words, volatility can work in your favor. So keep investing.

2. You are no longer working for the sponsor company but are employed elsewhere

You have some options.

(1) You can take a partial or full distribution. In most cases, this is a taxable event and may carry additional tax penalties. In rare situations, is this a good idea. Speak with a professional advisor before choosing this option.

(2) You can leave your 401(k) with your previous company. You can no longer contribute to it, but it will continue to perform based on the investments you have selected.

(3) If your new employer offers a 401(k) and you are eligible for it, you can roll your old 401(k) into your new 401(k) plan. This is a tax-free rollover, and you will need to select new investments based on what the new plan offers.

(4) You can roll the old 401(k) into an IRA. In most cases, this is what we recommend. An IRA gives the account owner more control, more investment options, and better planning opportunities than a 401(k). Like a 401(k), an IRA is a retirement account with annual maximum contribution limits and early withdrawal penalties. A rollover is not considered a contribution, and therefore any amount can be rolled.

3. You are no longer working for the sponsor company and are not employed

You have the same options as above, with the obvious exception of rolling to your new 401(k). If you are retired, however, the rollover option to the IRA may be even more appealing. When it comes time to take distributions from your retirement accounts, the IRA has some significant advantages. Some of these include better risk management strategies, tax-saving distribution strategies, and avoiding mandatory distributions from Roth accounts.

4. You need financial help due to COVID-19

The CARES Act allows some individuals to take early withdrawals from retirement accounts in 2020 without the early withdrawal penalty. If you have been diagnosed with COVID-19, have a spouse or dependent diagnosed with COVID-19, or have experienced a layoff, furlough, reduction in hours, have been unable to work, or lack childcare because of COVID-19, you may qualify. Withdrawals may impact your tax liability, so speak with a financial advisor before taking an early distribution.

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Investing Is Not Like Buying A Refrigerator

By | 2020, Executive Message, Money Moxie, Newsletter | No Comments

Some people think that investing has been simplified so much that it is like buying a refrigerator: You spend a few hours researching the options and then select a product that will last for 10 years. While there have been significant improvements to simplify investments, there is still a world of knowledge that is needed to select the right investments for your personal goals and time horizon. Buying the wrong refrigerator won’t wreck your retirement, but buying the wrong investment might.

Inside of a 401(k), the participant is the money manager. Because of this, the options had to be simplified. This has given rise to retirement-ready investments that have target dates based on when a participant will retire. We applaud this because most investors don’t know the nuances of investing in large-cap companies vs. small-cap companies, etc. The closer you get to retirement, and the more assets you have, the more important investment selection becomes.

Investment selection is less like picking out a fridge and more like being the forecaster for a home improvement store. That forecaster must determine beforehand how much is needed of each product, for each department, at the right time of year. If the quantity or timing is significantly off, then it puts the store in jeopardy of decreasing revenue and potential bankruptcy. Because of this complexity, a forecaster needs to have advanced training, education, and experience.

With investments, not only do you have to understand the individual investment, but you also must understand how it is impacted by the different market sectors, business cycle movements, politics, and the world economic environment.

At SFS, we are lucky to have a chief investment strategist, James Derrick, who has his MBA, CFA, and two decades of money management experience. He managed investments through the downturns of 2000-2003 and 2007-2009 when the S&P 500 lost 55% and 57%, respectively.* In fact, other financial advisors hire James and SFS to manage their clients’ money.

Don’t risk your retirement nest egg. You aren’t buying a refrigerator. Choose a money manager with the foresight, knowledge, and experience to help protect you against the downturns while allowing your assets to grow in the good times.

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Are You Retired and Have a 401(k)? Read This!

By | 2019, Money Moxie, Newsletter | No Comments

As financial advisors, our job is to help clients create wealth. Most people expect us to accomplish this through market investments. Although that does play an important role, advice regarding financial decisions outside of the market can often amount to significant savings and wealth creation. The topic covered here is one that has amounted to significant savings for many of our clients. If you are currently retired or are approaching retirement and have a 401(k), this article is for you.

When talking about financial planning, there are two main phases of life: the accumulation phase (pre-retirement) and the distribution phase (post-retirement). The 401(k) is a fantastic savings vehicle for those in the accumulation phase. If you are currently working, a 401(k) is great! Employers often contribute to this type of account by way of a company match or profit-sharing because the 401(k) annual contribution limit is higher than that of other retirement accounts. Plus, paycheck deductions make saving easy.

If you are already retired, a 401(k) has some weaknesses that you should be aware of. The cost associated with these may be a lot more than you realize.

• When you take a distribution from a 401(k), you do not have the ability to choose which assets you sell. A distribution will require selling from all investments equally. This is a huge disadvantage as you may be forced to sell from the wrong investment at the wrong time. Proper distribution planning requires one to analyze the individual investments and sell those that make sense based on current market conditions and performance expectations. Unfortunately, the 401(k) does not give you this ability.

• If you have Roth 401(k) contributions, you will be forced to take a distribution at age 70.5. This can have large negative consequences to both future tax-free earnings and your ability to pass on wealth tax free. Roth IRA accounts will not force a distribution regardless of age.

• If you are over age 70.5 and donate to 501(c)(3) organizations, you cannot take advantage of a great tax-savings strategy called a Qualified Charitable Distribution (QCD). The tax savings from QCD’s can be thousands of dollars every year. Examples of qualified organizations are churches, universities, humane societies, hospitals, etc.

In many cases, we recommend that clients roll their 401(k)’s into IRA’s at retirement. An IRA is a much better retirement distribution vehicle given its flexibility and its greater selection of investment options. It also does not suffer from the weaknesses mentioned above. 401(k) rollovers are tax-free and easy.

We work hard to ensure our clients make good financial decisions. Often, small changes have a large impact. We have seen investors greatly benefit from a 401(k) rollover. If you have a 401(k) that you can’t contribute to due to separation of service or retirement, we highly recommend you meet with us to discuss if a rollover is in your best interest.

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After 35 Years, the 401(k) Dominates Retirement Savings

By | 2017, Money Moxie | No Comments

The people who helped start the 401(k) revolution in 1981 lament what has become of it. At the time, the hope was just to help supplement a traditional pension program. The reality is that 401(k)s have replaced pension plans as the main retirement savings vehicle.

Herbert Whitehouse, a Human Resources executive for Johnson & Johnson, was one of the first to recommend his executives use a 401(k) as a tax-free way to defer compensation. “We weren’t social visionaries,” he says. They were looking for ways to cut expenses and retain top workers. However, because many companies have jumped on the bandwagon, pensions are becoming a thing of the past.

Traditional pension plans do have their weaknesses: bankruptcies could weaken or wipe out the plan, and it is difficult for employees to transfer the plan to a new company.

Enter the 401(k) with the promise that an employee could have enough savings for retirement. Teresa Ghilarducci, who directed the Schwartz Center for Economic Policy Analysis offered assurances to Union Boards and even to Congress that 3 percent savings would be enough. She now admits the first calculations were a little “too rosy.”

There were other issues policy makers didn’t take into account, such as workers yanking the money out of the 401(k) or choosing investments unsuitable for their ages.

Only 61 percent of eligible workers are currently saving. A whopping 52 percent of households are at risk of running low on money during retirement.4 These are scary numbers. It is no wonder people fear running out of money more than they fear death.5

The nation’s policy makers and some states have made proposals or started initiatives to help change the behaviors of savers and companies. One proposal would mandate retirement savings and the system would be run by the Social Security Administration. However, we are a ways off from having a solution to a societal problem that could be compounded by the Social Security trust fund running dry by 2034.6

The onus is on each one of us to save for retirement and implore our parents, children, friends, and even neighbors to help patch the holes in a sinking ship by saving for retirement.

The bright spots are the people that have benefited from the 401(k). For example, Robert Reynolds could retire comfortably at age 64 after saving for 3 decades. He says the formula is very simple, “If you save at 10 percent plus a year and participate in your plan, you will have more than 100 percent of your annual income for retirement.”7

Like it or not, we live in a world where 401(k) accounts have nearly eliminated pensions. Your financial future is your responsibility. So, make a personal commitment to save for your future.

 

1. The Champions of the 401(k) Lament the Revolution They Started, Wall Street Journal, Jan 2, 2017
2. The Champions of the 401(k) Lament the Revolution They Started, Wall Street Journal, Jan 2, 2017
3. The Champions of the 401(k) Lament the Revolution They Started, Wall Street Journal, Jan 2, 2017
4. The Champions of the 401(k) Lament the Revolution They Started, Wall Street Journal, Jan 2, 2017
5. http://www.marketwatch.com/story/older-people-fear-this-more-than-death-2016-07-18
6. http://money.cnn.com/2016/06/22/pf/social-security-medicare/
7. The Champions of the 401(k) Lament the Revolution They Started, Wall Street Journal, Jan 2, 2017

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Women Should Save 2 Percent More Than Men

By | 2016, Money Moxie, Newsletter | No Comments

In an age where women have an increased influence in the workforce, it doesn’t seem right that women have to save more than men for retirement. However, that is what the research from Hewitt Associates suggests.

There are several contributing factors to this need, some inherent and some that can be corrected. An inherent factor for women is a longer lifespan—living an average of three years longer than men after retirement. The extra 2 percent is needed for the additional insurance cost for a longer life. The lower average yearly salary for women ($57,000) compared to a man’s ($84,000) indicates that a woman should save a higher percentage to match the dollar amount men save. Some correctable factors include: waiting longer to start saving for retirement, investing more conservatively, and not taking advantage of the company match in a 401(k).

Women are able to close the retirement gap by taking a few simple steps.

• Invest early and increase contribution rates. One goal should be to contribute 10-20 percent of gross income into a retirement account. This doesn’t have to be done at once; contributions can be marginally increased each year.

• Ask for advice. Many women feel insecure about managing finances. A wealth management professional can help determine personal risk tolerance and how aggressively to invest money.

• Leave a 401(k) invested. If suspending work due to family reasons, don’t cash out a 401(k)—this avoids taxes and hefty penalties. A 401(k) can be rolled-over into an IRA or professionally managed account.

• Put off retirement for a few years. This may be painful but could mean a great deal down the road. Don’t sacrifice the future for the present.

Women have several challenges that make retirement preparation more difficult. Recognizing these issues and making small changes in their saving and investing habits can have a significant impact.

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Americans Are Taking Control of Their Money

By | 2016, Money Moxie, Newsletter | No Comments

Do you remember what America was like in 2006? If we could give the year a financial theme, I would label it, “Borrow and Spend!” Buying a home was easy; no verification of employment and no down payment were necessary. An interest-only loan could be obtained without any reasonable expectation of one’s ability to repay the loan.

As a matter of fact, you could borrow up to one-hundred percent of a home’s value, skip a month’s payment, and even cash out any value that had come from the rising price of the home. Leverage was the hot financial fad! Many Americans borrowed as much as they could and bought whatever they wanted!

money

What a difference ten years can make. Contrast 2006 with 2016; today people are taking control of their financial situations, putting themselves in the driver’s seat, and keeping their own hands on the steering wheel. Financial responsibility is much more prevalent.

Disposable income —the money we have left to spend after taxes have been paid—has increased at an average rate of just less than one percent per year over the past ten years. So income is up a little. This makes the fact that personal saving is up very impressive. We have seen the personal savings rate increase from 3 percent at the end of 2005 to 5.5 percent at the end of 2015.

This significant improvement demonstrates a shift for Americans towards greater financial strength. Here are some of the positive outcomes.Americans saving

Reduction in personal debt
Still smarting from the financial pinch of the last recession, cash flow is now king. For many of us the perception of acceptable levels of debt has changed significantly. Debt is financial fragility, which is why Americans again recognize the value of getting out of debt as quickly as possible. Many have taken advantage of low-interest rates and refinanced to shorter-term loans. Paying off short-term loans such as car loans and signature loans is now a priority, and the use of credit card debt has reduced significantly.

Spending less
Knowing what we should do and putting it into practice can be challenging. This is especially true when it comes to living within your means. However, it is possible and it is powerful. No other financial habit is more important!

We have had the opportunity to meet with many people that have adopted the philosophy of a simpler lifestyle. This allows them to enjoy what they have without the pressure to get more “stuff” and then live with the financial burden. Managing spending also impacts our future lifestyle. If we spend everything today…what will we live on in retirement?

Increased accessible savings
After experiencing financial instability, many people have gained a witness of the need for liquidity. Access to emergency money to cover needs for 3 to 6 months has been widely recommended for decades, but it has gained new favor in the last 10 years. The wisdom of this applies beyond those still working. Retirees are also paying attention to liquid savings to make sure they can cover the unexpected emergencies that will surely come.

Focus on planning for the future
A shift has taken place in young people as well. They are saving for their futures at the beginning of their careers. Company-sponsored retirement plans such as 401(k) or 403(b), as well as individual IRA or Roth IRA, are now common to this young generation and they are off to a strong start.

Financial Health

Those who see retirement on the horizon have a new goal. They want to maintain a comfortable lifestyle throughout their retirement years. With fewer pension plans providing retirement income, the burden to provide income during retirement has been shifted to them. Many have hit the ceiling on contributing to their retirement plans and are using additional savings to help them reach their goals.

It is clear that over time all things can change; the market, our spending and savings habits, even our perception of what’s important financially. We have learned many valuable lessons and have made significant strides to improve our financial situations. The next ten years will undoubtedly bring more changes; some will be good and some will be bad. Remember to prepare when times are good and don’t fall prey to the next financial fad. Keep in mind that you are in the driver’s seat.

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Open Enrollment

By | 2015, Money Moxie | No Comments

For most employees fall is the season to enroll in many of the benefits offered by their company. It is a good time to review your options and make sure you are taking advantage of the benefits available to you. Here are the most common open enrollment benefits:

• Participation in 401(k), 403(b), or other company-sponsored retirement plans

• Health insurance plan selection

• Planned spending account contributions (Cafeteria plan)

• Beginning or increasing group life and disability income benefits

Don’t let this opportunity pass you by. If you miss the open enrollment period, you may not be eligible to enroll or make changes for another year.

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