investing for long-term goals (retirement-college)

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Investing for Long-Term Financial Goals (Retirement and College) Dr. Barbara O’Neill, CFP® Rutgers Cooperative Extension [email protected]

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Investing for Long-Term Financial Goals (Retirement and College)

Dr. Barbara O’Neill, CFP®

Rutgers Cooperative Extension

[email protected]

Your Questions?

What Are Your Retirement Dreams?

Investing can get you there!

Retirement – “Time in life when most of one’s income changes from earned income to Social Security, employer-based benefits, withdrawals from private saving plans, and perhaps income from part-time employment.”

Key Retirement Planning Factors Current age and projected retirement age?

How long will you live?

What will be your source(s) of income?

How much income do you need each year?

How much money have you already saved?

How comfortable are you taking investment risks?

The Ball Park Estimate Six easy steps; can do online or download paper worksheet Can do online at www.choosetosave.org Flexible annual retirement income and life expectancy figures Assumes a 3% constant real rate of return

Retirement Living Expenses Some expenses may go down or stop:

401(k) retirement fund contributions

Work expenses - less for gas, lunches out

Clothing expenses - fewer and more casual

Housing expenses - house payment may stop if your house is paid off

Federal income taxes will probably be lower

Other expenses may go up: Life and health insurance unless your employer continues coverage

Medical expenses increase with age

Expenses for leisure activities

Gifts and contributions

Inflation will increase the amount needed to cover expenses over the course of retirement

The Benefit of Starting EarlyTake advantage of the time value of money

Start at age 25: Invest $50 a week At 6% APR For 40 years

Start at age 50: Invest $200 a week At 6% APR For 15 years

N = 480 months

FV = $431,490

N = 180 months

FV = $252,043

Retirement Savings Plans Tax-deferred plans postpone taxes until

withdrawal (on both contribution and earnings)

Often require investor initiative to enroll

Investors make investment selections

Restrictions: contribution amount and age limit for penalty-free withdrawals

Required minimum distribution rules (exception: Roth IRAs)

Building a Retirement Investment Portfolio

Determine % of money in each broad asset class (e.g., 60% equity, 40% fixed income)

Break down into more specific categories

Equity: 10% real estate, 50% stocks

Fixed-Income: 30% bonds, 10% cash

Identify specific mutual funds or securities

Key investment strategies

Dollar-cost averaging

Occasional portfolio rebalancing

Be Sure to Diversify Among Industry Sectors

Building/forestry

Financial services

Consumer growth (e.g., soft drinks)

Consumer staples (e.g., food)

Consumer cyclicals (e.g., cars)

Technology

Capital goods (e.g., machinery)

Energy (e.g., oil)

Materials (e.g., paper)

Transportation

Utilities

Health care

Conglomerates

Sources of Retirement Income Social Security

Personal Retirement Savings (e.g., Roth and Traditional IRAs and taxable and tax-free investments )

Employer Pension Plans

Defined Contribution

Defined Benefit

Annuities

Other?

Individual Retirement Accounts

A personal retirement savings plan

Available to people under age 70 with earned

income from a job or self-employment

Available from a variety of vendors

Not an investment but a place to put investments:

Examples: mutual funds, stocks, bonds, CDs

Traditional IRAs $5,500 max contribution in 2015 (+ $1,000 catch-up if 50+)

Can’t contribute once you turn 70 ½ (at end of tax year), even if still working

Contribution may be tax-deductible (depending on adjusted gross income and access to an employer plan)

Earnings accumulate tax-deferred until withdrawal

May begin penalty-free withdrawals at age 59 ½

Must begin withdrawals at age 70 ½

Withdrawals are taxed as ordinary income

Resource: http://www.irs.gov/taxtopics/tc451.html

Taxable vs. Tax-Deferred Growth

27,600

31,300

48,300

58,600

75,800

98,800

112,200 157,900

160,300

244,700

$0

$50,000

$100,000

$150,000

$200,000

$250,000

10yrs 15yrs 20yrs 25yrs 30yrs

Taxable Returns (at 28%)

Tax-Deferred Returns

Garman/Forgue, PERSONAL FINANCE, Fifth Edition, Tax-Sheltered Returns are Greater than Taxable Returns (Illustration: 8% Annual Return and $2,000 Annual Contribution)

Roth IRAs Contributions made with after-tax income

Contributions are not tax-deductible and may be withdrawn without penalty

Maximum income limits for contributing

After account is open five years, earnings are tax-free if you are at least age 59 ½

Can convert a Regular IRA to a Roth IRA

Must pay taxes for year of conversion

Spousal IRAs Contributions for a non-working spouse if

filing a joint return

Same contribution limits as working spouse’s Roth or Traditional IRA:

Maximum of $11,000 if both under age 50

Maximum of $13,000 if both age 50 or older

IRA Terminology Rollover- Transferring your IRA account

from one IRA custodian to another

Best to do a direct rollover by custodians

Typically between like IRAs (e.g., 2 Roth IRAs)

Beneficiary- Person(s) named to receive accumulated IRA assets when you die

Name contingent beneficiary(ies) also

Employer Retirement Plans: Defined Benefit Pensions Employer pays a certain amount per month when

workers retire using a formula based on:

Pre-retirement salary

Number of years of service

Employers make investment decisions; assume risk of having enough money

Workers’ benefit amount stays the same regardless of how the investments perform

Employer Retirement Plans: Defined Contribution

“Salary-reduction” plan: workers elect to reduce their salary (up to maximum amount allowed)

Plan contributions and earnings are tax-deferred

Some employers provide matched savings

Workers select specific investments

“You have what you saved for as long as it lasts”

Types of Employer Plans 401(k)s- Corporate employees

403(b)s- School, university, and non-profit organization employees

Section 457 Plans- State, county, and municipal government employees

Thrift Savings Plan (TSP)- federal government employees and service members

Benefits of Employer Retirement Savings Plans

Tax Advantages- Funded with pre-tax dollars Example: $40,000 gross income; $3,000 contribution;

$37,000 federal taxable income

Automation- Deposits deducted from pay A common form of dollar-cost averaging

Matching Contributions-% of workers’ pay Most common in 401(k) plans; some 403(b) plans

Portability- Can take money when leaving a job

Drawbacks of Employer Retirement Savings Plans

Employer plan may have limited menu of investment options Work-around: Balance out with taxable accounts

Workers may have to wait to participate Work-around: Save somewhere else (e.g., credit union) to

get used to payroll deduction

High administrative costs Work-around: Lobby employer for low-cost options

Vesting Amount of time workers have to work to be

entitled to employer retirement plan contributions

Two formulas:

Gradual vesting: 6 years

Cliff vesting: 5 years

Always consider vesting period before making a job change

Self-Employed and Small Business Retirement Plans

Keogh plans

SEP or SEP-IRASimplified Employee Pension

SIMPLE-IRASavings Incentive Match Plan for Employees

Simplified Employee Pension (SEP or SEP-IRA) Simplest retirement plan for self-employed persons

An IRA funded by small business owner for self and employees (all workers must be treated the same)

Employer can make annual contributions up to $53,000 (in 2015)

Contributions are tax-deductible

Same withdrawal and penalty rules as IRAs

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IRA and Qualified Employer Retirement Plan Withdrawals CAN make withdrawals without penalty after

age 59 ½ (any amount)

MUST begin taking Required Minimum Distributions (RMDs) at age 70 ½

Some people need money immediately

Others want to keep money invested as long as possible (until 70 ½) to continue deferring income taxes

to stretch out their retirement assets

Required Beginning Date (RBD) Minimum payments from regular IRAs must begin

by April 1 of year after the year when account owner reaches 70 ½

Example: 4/1/16 if you turn 70 ½ in 2015

Minimum payments from qualified plans must start by the LATER of:

The year participant turns 70½ OR

The year employee actually retires (current employer’s plan ONLY)

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More About RMD Rules

After the first year, RMDs must be made by December 31 of every year

Example: 2015 RMD by 12/31/15; based on current age divisor and account balance on 12/31/14

Can take RMDs any time during year

Multiple payouts are fine as long as the minimum amount is withdrawn

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Example of a RMD Calculation Person turns 70 in first half of year

Appropriate divisor is 27.4

Assume $100,000 in IRA at previous year-end

$100,000/27.4 = $3,650 (RMD amount)

Can always withdraw > RMD

IRS penalty of 50% of shortfall if < RMD

Can withdraw RMD from as few or as many IRA accounts as you wish. Suggestion: Consolidate IRA accounts for easier record-keeping

Annuities Insurance company product sold by financial advisors

Purchased on your own with after-tax dollars

Money compounds tax-deferred

Pay tax on earnings at regular tax rate at withdrawal

Often have high expenses compared to mutual funds and other securities (especially variable annuities)

Types of Annuities Immediate

Purchased with lump sum of money (e.g., life insurance) Fixed income for life starting one month after purchase

Deferred Single premium purchase; buy now and collect later Deposits over time (e.g., during working years)

Fixed - Earns an interest rate established for a set time Like a tax-deferred CD

Variable - Earnings dependent on performance of subaccounts Like tax-deferred mutual funds

Investing for College: 4 Options Section 529 Plans

Coverdell Education Savings Accounts

Formerly called “Education IRAs”

$2,000 annual deposit limit; income limits

Uniform Gifts to Minors Accounts

Acronym: UGMAs

U.S. Savings Bonds

No federal tax for college expenses; annual income limits apply

Education is often key to future earning ability and lifestyle

Section 529 Plans Named for section of IRS tax code

Sponsored by state government

Many states: managed by investment companies

Plan features and investment options vary from state to state

Many have “glide paths” and automatically get more conservative as child ages

Good info source: http://www.collegesavings.org

Investing in Your 20s Don’t have to sacrifice a lot: even modest regular

deposits will have high impact

Time is on your side (compound interest)

Pay off high-interest debt quickly and low rate loans over time

Begin an IRA and/or employer retirement plan

Start out with an index fund or life-cycle fund and branch out (focus on growth)

Investing in Your 30s and 40s Accumulate an adequate emergency fund

Match investments to goals; as a goal gets closer, shift to stable, fixed-income investments

Fund a college savings plan for children after you fund your retirement savings plan(s)

Keep most of your retirement savings invested in stock, stock mutual funds, and/or stock ETFs (exchange-traded funds)

Investing in Your 50s Try to contribute the maximum allowed to employer

retirement savings plan

Use IRAs, taxable accounts and/or annuities to invest even more

With 10 years to retire, keep growth allocation

Consider postponing retirement if short on cash:

Accumulate more in investment accounts

Earn higher Social Security and/or pension benefit

Postpone tapping assets

Investing in Your 60s & Beyond Could have 20-30 years in retirement so keep a

portion of portfolio invested for growth Select income-oriented investments

dividend-paying stock or preferred stock investment grade corporate or municipal bonds U.S. Treasury securities

Develop a plan to create a retirement “paycheck” Plan for RMD withdrawals after age 70 ½ Consider an immediate annuity with lump sums

Action Steps Start or increase retirement savings, even 1% more of pay

Earn the maximum match available from your employer

Estimate retirement living expenses

Estimate potential length of retirement

Determine your current net worth

Use personal data to do a retirement savings need calculation (e.g., The Ballpark Estimate)

Use the “Rule of 3” to compare investments

Other Prudent Strategies Aim to pay off mortgage before you retire

Make sure you get all the income you are entitled to (e.g., former employer’s pension)

Consider converting illiquid assets into cash or income, if needed (e.g., collectibles, land, reverse mortgage)

Consider working later and/or during retirement

Dip into your nest egg cautiously (4% withdrawal rule)

Questions and Comments?Barbara O'Neill, Ph.D., CFP®, CRPC

Extension Specialist in Financial Resource Management and Distinguished ProfessorRutgers University

Phone: 848-932-9126

E-mail: [email protected]

Internet: http://njaes.rutgers.edu/money/

Twitter: http://twitter.com/moneytalk1