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Social Security


Coming ‘Of Age’ – ‘Retirement Age’ That Is…As more and more of our ‘baby boomers’ come of age and near the time for applying for social security benefits, I thought it might be appropriate to review a little bit about our social security benefit program as it applies to everyone.

It is extremely important to understand what our social security options are before we make a potentially irrevocable decision about taking and receiving our benefits as the dollar amounts received over our lifetimes could be meaningfully more!

Taxes – Funding Benefit and Receiving Benefit
Social security benefits are funded by contributions made through payroll taxes that are half paid by the employer and half paid by the employee with self-employeds effectively paying both halves. When we receive social security benefits they are income tax free unless you ‘make too much money’.

So managing income recognition and managing the character or type of income (cash flow) received when we are drawing social security benefits can be extremely important in maximizing what we keep of this otherwise income tax free benefit!

Social Security Benefits Started Before Full Retirement Age (FRA)
If you start your social security benefits before FRA you will receive a reduced benefit of about 75% at age 62, about 80% at age 63, about 87% at age 64 and age 65 about 93%. Another complication of drawing social security before the year in which you turn FRA is that if you keep working you will have to give back some of your social security earnings.

In 2013 that $1 of ‘giveback’ for every $2 of earned income starts when you make more than $15,120. In the year you reach FRA the ‘giveback’ becomes $1 for every $3 of earnings above $40,080 (2013 amount).

Social Security Benefits Started At Full Retirement Age (FRA)
Social security benefits are calculated based on a minimum of 40 credits (quarters of covered work) to be eligible for benefits. Depending on your birth date, your age of retirement, FRA, will vary between 65 and 67 years of age (if you were born after 1960).

The Social Security Benefits Administration has a calculator for you to run some what-ifs about choosing a retirement date. They also have other calculators that can run estimated benefits, offset effects (see discussion below), etc., etc. Besides the when to take retirement question, there are other strategies to consider in maximizing the social security benefits to be received.

One such strategy is called ‘file-and-suspend’ which may allow a qualifying recipient to suspend payments while the spouse files for spousal benefits.

Another strategy comes available to us when we have been married to another for at least 10 years. In those cases, you may qualify for benefits based upon the former spouses earnings. If you wait until your FRA, you can file on your former spouses earnings for a spousal benefit and delay taking your retirement until age 70. This strategy will not work if you apply for the spousal benefit before FRA!

Social Security Benefits Started At Age 70 (Post-FRA)
By waiting until age 70 to draw upon our social security benefits a person born after 1943 would have their FRA benefit increase 8% per year by waiting until age 70! Very compelling, indeed!

Social Security Benefits Post the Windsor Supreme Court Decision
As a result of the US Supreme Court decision on same sex marriages the Social Security administration is no longer prohibited from recognizing same-sex marriages for purposes of determining benefit claims filed after June 26, 2013. The decision and its social security benefits impact are being discussed by the Administration and exact details on same-sex marriage benefits will be forthcoming.

Medicare Starts At Age 65
Social security is one matter, Medicare is another! If you do not sign up for Medicare at age 65, your Medicare coverage may be delayed and cost more!

‘Other Pension’ Offsets to Social Security Benefits Received
Two issues that could impact your benefit received are the following.

  • Government Pension Offset. If you receive a pension from a federal, state or local government based on work where you did not pay Social Security taxes, your Social Security spouse’s or widow’s or widower’s benefits may be reduced.
  • Windfall Elimination Provision. The Windfall Elimination Provision primarily affects you if you earned a pension in any job where you did not pay Social Security taxes and you also worked in other jobs long enough to qualify for a Social Security retirement or disability benefit. A modified formula is used to calculate your benefit amount, resulting in a lower Social Security benefit than you otherwise would receive.

Survivors Benefits and Benefits for Children
Benefits can be made available to others based on our benefit should we die or become disabled. Two of those are survivor benefits (spouse) and benefits for children.

  • Survivor Benefits. Your widow or widower may be able to receive full benefits at full retirement age. Your widow or widower can receive benefits at any age if she or he takes care of your child who is receiving Social Security benefits and younger than age 16 or disabled.
  • Benefits for Children. Children of disabled, retired or deceased parents may be entitled to a benefit. Your child can get benefits if he or she is your biological child, adopted child or dependent stepchild. (In some cases, your child also could be eligible for benefits on his or her grandparents’ earnings.)

To get benefits, a child must have:

  • A parent(s) who is disabled or retired and entitled to Social Security benefits; or
  • A parent who died after having worked long enough in a job where he or she paid Social Security taxes.
  • The child also must be:
    • Unmarried;
    • Younger than age 18;
    • 18-19 years old and a full-time student (no higher than grade 12); or
    • 18 or older and disabled. (The disability must have started before age 22.)

Concluding Thoughts.
Social security benefits have been providing a ‘safety net’ to our citizens since the program came into existence.

Pre-retirement benefit programs like ‘Benefits for Children’ and ‘Surviving Spouses’ provide support to those qualifying families who have lost a breadwinner.

Retirement benefit program options are diverse and not readily understood by many. For some households social security retirement benefits comprise as much as 85% of household income so ensuring that one receives as much as is legally possible of the benefits that they have earned the right to, is so important! Consult with your advisor before you make any decisions. You may well be bound to them for your lifetime!

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


21 Comments

Keeping What You Make – Managing Taxes Owed on Income Received


The Debt Crisis Isn't Over YetTax Rates Overview

Under our current tax code, The Tax Act of 1986, as amended to date, the income that we earn for income tax purposes can be subject to either ‘no taxation’, ‘regular income taxation’, or an ‘alternative rate of taxation’ known as capital gains rates.

For some taxpayers the regular income taxation rate will be defaulted to a ‘parallel’ tax system known as the Alternative Minimum Tax (AMT) and an alternative tax rate on that income which is a flat tax rate of 26 or 28%.

For individuals who are not subject to AMT, their income would be subject to one of the following tax rates – 10%, 15%, 25%, 28%, 33%, 35% and 39.6% ($400,000 single or head of household or $450,000 if married filing jointly). Well technically one who is subject to the 33% tax rate, for example, is subject to each of the 10, 15, 25, and 28% tax rates because we have a progressive tax system that taxes us at various levels as we fill up those lower income tax rate buckets with income. If we took each bucket’s tax and related income number, we could calculate a weighted average tax paid from all of those buckets of income and we would call it the taxpayer’s ‘effective tax rate’. The lower one can get that effective tax rate for a given level of income, the better one will have done to ‘manage’ their tax liability on income.

For taxpayers making over $200,000, as single or head of household, and $250,000, as married filing jointly there will be an additional 3.8% tax on investment income which could be either (1) regular income, called ordinary income, like interest earned, (2) qualified dividend income, like income on your NYSE traded stock, or (3) capital, like capital gains. This new 3.8% tax will alter how we manage our income resources for those at these income levels.

Capital gains and qualified dividend taxes could be 0%, 15%, 20% (taxpayers making over $400,000 single or head of household and $450,000 married filing joint), 25% (real property depreciation unrecaptured gain) or 28% if a collectible is sold at a gain.

Social Security income is tax free if we do not earn too much income so for those who are receiving social security benefits managing income and the taxability upon it is crucial. Too much income annually is defined by the IRS as $25,000 for single, head of household, qualifying widow or widower with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year; $32,000 for married couples filing jointly; and $0 for married persons filing separately who lived together at any time during the year. For every dollar of income earned over those thresholds a dollar of otherwise tax free social security benefits becomes taxable. For a taxpayer in the 35% tax bracket, for example, the loss to taxes from social security benefits becoming entirely taxable would be 32 cents on a dollar – (85% maximum of benefits that could be taxed) times (35% the marginal tax bracket). The least amount of benefits that could become subject to taxation if you go over the threshold is 50%.

3.8% Investment Tax Effect

Interest Income from a bond taxable at 35% or interest free? What is better? The formula for determining net yield after tax would be (yield) minus [(yield) times (tax)]. So to determine the tax equivalent of a municipal (tax free) bond to a corporate bond we would divide the tax free yield by (one) minus (marginal tax rate). For example, before the 3.8% extra tax a taxpayer in the 35% tax bracket would have been indifferent between a corporate bond that paid 5% and a tax free bond that paid 3.25%. Now, after the 3.8% additional tax is imposed, the same taxpayer earning the taxable 5% would be indifferent if the tax free rate was only 3.07%. Alternatively stated, to earn the equivalent of a 3.25% tax free, now the taxpayer would be looking for a taxable bond earning 5.29%.

Strategy Considerations

For Investment Income: Interest, Qualified Dividends and Capital Gains

The first thought is to re-allocate your CD type money into a dividend paying stock. For a single person in the 28% tax bracket ($87,850 to $183,250) that would save .13 cents on every dollar of earnings (.28 – .15). For a single person in the 15% tax bracket ($8,925 to $36,250) that would save .15 (.15 – 0) cents on every dollar. But is that penny wise and pound foolish? It might be because unlike your CD investment where your principal is secure, and most likely FDIC protected, the stock price associated with your investment paying that dividend may decline. A 1% negative move in a $20 dividend paying stock, 20 cents, would wipe out the tax gain you were trying to achieve by seeking out dividend income over ordinary income. So consider both your personal ability to tolerate risks of loss and determine the appropriateness to your financial circumstances of putting your principal to that risk.

To ensure that your capital gains get the favorable 0, 15%, or 20% (plus 3.8%, if applicable) tax treatment the investment must be held for more than one year. Knowing that the market does not go straight up, it might not be appropriate to seek capital gains by investing in the stock market if the money you are investing might be needed in the short to intermediate term – 3 to 5 years. Again, risk tolerance and diversification should always be taken into consideration.

For those subject to the 3.8% tax muni bonds can avoid that tax so they have become somewhat more attractive (as illustrated above a tax free rate of 3.25 is now equivalent to 5.29% rather than 5% without that tax being imposed. There are a significant number of strategies with regard to the 3.8% tax so consult with your advisor if you are subject to the tax.

For Social Security Taxability

When one is receiving social benefits it is even more important to manage the timing and character of income (ordinary, tax free, capital) so that one minimizes the impact of taxation on those benefits. Municipal bond income is tax free but it is considered taxable for purposes of determining whether or not, and how much of, your social security benefits could become taxable. To the extent the muni bond can provide more income than the taxable bond considering all of these factors it may (always run the numbers) be a tax optimizing investment choice when one is drawing social security benefits. Alternatively, an investment that provides cash flow without large taxable components to the cash flow might be a very good strategy to manage social security benefit’s taxability. An immediate annuity purchased with after tax dollars will have an exclusion ratio to the payments received that will then provide cash flow without taxation.

Concluding Thoughts and Observations

Wealth accumulation and wealth management require vigilance in both tax and portfolio risk management from the investment perspective. Tax rates have a huge impact on our net returns so strategizing for optimizing our tax impact with consideration of our own risk tolerance, and need to take risk, if any, for investment returns is an ongoing responsibility. Choices of tax-free, tax deferred, ordinary or capital gains income are very important in achieving optimal results with our resources earned over our lifetime. I hope you are maximizing and keeping all that you have worked so hard to earn.

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


26 Comments

Not Your Father’s Retirement Plan


Personal-DebtA recent article in Time featured a study by the Deloitte Center for Financial Services suggesting many American pre-retirees are throwing in the towel when it comes to saving or planning for retirement. Insufficient savings combined with the market downturn five years ago, a housing bubble, extended low interest rate environment and a Federal government seemingly bent on making it difficult to plan for the long term has created a perfect storm for many. This will be a significant problem facing Boomers over the next few decades.

But, this blog is not meant for those near retirement. This is for the Millennials entering the workforce and the Gen Y folks already there. It’s a brief wakeup call about your future financial goals and retirement plans. The short version – you’re on your own. Your retirement plan is not and cannot be that of your parents.

For most, pensions are a thing of the past. 401(k)s and similar plans are great places to start saving, but have their limitations. Social security is likely headed for substantial reform that will leave future benefits unclear. Medicare will face significant changes over the long run. Many of the sources past generations have relied on to help care for them in their later years are more vulnerable than ever before.

Sound frightening? It is. But it’s no excuse to throw in the towel. Inaction is not an option. There are simple, but not always easy ways to put meaningful plans and processes in place to enjoy today while keeping a mindful eye on tomorrow. You just have to be willing to commit to a plan and stay true to your own values.

The bottom line? Knowledge is the key. Not about which stock to pick or what your magic number is for retirement. Instead, you need a firm grasp on what you really value in life, what you want to do for your children or others close to you, and a realistic view of what resources you have and how much you’re willing to balance those resources between goals for today and those for tomorrow. You need to revisit these questions on a regular basis to make sure you’re on track and be clear in how you communicate expectations to all those impacted by your financial decisions.

I’m no pessimist. Quite the opposite as I think the future ahead is very, very bright. I also believe that we can meet our goals, provided there’s a plan in place, we stay true to that plan, protect against the unexpected to a responsible degree and really have a grasp on what’s important to us as early as humanly possible.

The most dangerous things we put off are those that are important, but not urgent. The best time to start mapping out your plan for today, tomorrow and well down the road is now. It may not feel urgent, but it may be the most important thing you do any time soon. The you that is 20, 30 and 40 years down the road is counting on you.

Chip Workman, CFP®, MBA
Lead Advisor
The Asset Advisory Group
Cincinnati, OH


49 Comments

Keeping What You Make – Managing Taxes Owed On Income Received


What I Learned From the Tax SeasonTax Rates Overview

Under our current tax code, The Tax Act of 1986, as amended to date, the income that we earn for income tax purposes can be subject to either ‘no taxation’, ‘regular income taxation’, or an ‘alternative rate of taxation’ know as capital gains rates.

For some taxpayers the regular income taxation rate will be defaulted to a ‘parallel’ tax system known as the Alternative Minimum Tax (AMT) and an alternative tax rate on that income which is a flat tax rate of 26 or 28%.

For individuals who are not subject to AMT, their income would be subject to one of the following tax rates – 10%, 15%, 25%, 28%, 33%, 35% and 39.6% ($400,000 single or head of household or $450,000 if married filing jointly). Well technically one who is subject to the 33% tax rate, for example, is subject to each of the 10, 15, 25, and 28% tax rates because we have a progressive tax system that taxes us at various levels as we fill up those lower income tax rate buckets with income. If we took each bucket’s tax and income number, we could calculate a weighted average tax paid from all of those buckets of income and we would call it the taxpayer’s ‘effective tax rate’. The lower one can get that effective tax rate for a given level of income, the better one will have done to ‘manage’ their tax liability on income.

For taxpayers making over $200,000, as single or head of household, and $250,000, as married filing jointly there will be an additional 3.8% tax on investment income which could be either regular income, called ordinary income, like interest earned, or capital, like capital gains. This new tax will alter how we manage our income resources.

Capital gains taxes could be 0%, 15%, 20% (taxpayers making over $400,000 single or head of household and $450,000 married filing joint), 25% (real property depreciation unrecaptured gain) or 28% if a collectible is sold at a gain.

Social Security income is tax free if we do not earn too much income so for those who are receiving social security benefits managing income and the taxability upon it is crucial. Too much income annually is defined by the IRS as $25,000 for single, head of household, qualifying widow or widower with a dependent child or married individuals filing separately who did not live with their spouse at any time during the year; $32,000 for married couples filing jointly; and $0 for married persons filing separately who lived together at any time during the year. For every dollar of income earned over those thresholds a dollar of otherwise tax free social security benefits becomes taxable. For a taxpayer in the 35% tax bracket, for example, the loss to taxes from social security benefits becoming entirely taxable would be 32 cents on a dollar – (85% maximum of benefits that could be taxed) times (35% the marginal tax bracket). The least amount of benefits that could become subject to taxation if you go over the threshold is 50%.

3.8% Investment Tax Effect

Interest Income from a bond taxable at 35% or interest free? What is better? The formula for determining net yield after tax would be (yield) times (tax). So to determine the tax equivalent of a municipal (tax free) bond to a corporate bond we would divide the tax free yield by (one) minus (marginal tax rate). For example, before the 3.8% extra tax a taxpayer in the 35% tax bracket would have been indifferent between a corporate bond that paid 5% and a tax free bond that paid 3.25%. Now, after the 3.8% tax, the same taxpayer would be indifferent if the tax free rate was only 3.07%. Alternatively stated, to earn equivalent of a 3.25% tax free now, the taxpayer would be looking for a taxable bond earning 5.29%.

Social Security Income Taxability Management

When one is receiving social benefits it is even more important to manage the timing and character of income (ordinary, tax free, capital) so that one minimizes the impact of taxation on those benefits. Municipal bond income is tax free but it is considered taxable for purposes of determining whether or not, and how much of, your social security benefits could become taxable. To the extent the muni bond can provide more income than the taxable bond considering all of these factors it may (always run the numbers) be a tax optimizing investment choice when one is drawing social security benefits. Alternatively, an investment that provides cash flow without large taxable components to the cash flow might be a very good strategy to manage social security benefit’s taxability. An immediate annuity purchased with after tax dollars will have an exclusion ratio to the payments received that will then provide cash flow without taxation.

Concluding Thoughts and Observations

Wealth accumulation and wealth management require vigilance in both tax and risk management from an investment perspective. Tax rates have a huge impact on our net returns so strategizing for optimizing our tax impact with our own risk tolerance, and need to take risk, if any, for investment returns is an ongoing responsibility. Choices of tax-free, tax deferred, ordinary or capital gains income are very important in achieving optimal results with our resources earned over our lifetime. I hope you are maximizing and keeping all that you have worked so hard to earn.

David Bergmann, CFP®, EA, CLU, ChFC
Managing Principal
The David Bergmann Group
Marina Del Ray, CA


8 Comments

Protect Yourself Against Identity Theft


Young Adults Should Learn to Manage Money Without Credit CardsIdentity theft is an increasingly worrisome topic for many. With more than a million people affected by identity theft each year, the below are some steps and strategies you can implement to ensure you and your family are protected:

Check Your Credit Annually. Visit a website such as www.annualcreditreport.com for a free copy of your credit report and verify all information is accurate. For an extra layer of protection, consider enrolling in a credit monitoring service which can monitor all 3 credit reporting agencies in real time and alert you of any unusual activity.

Review Credit and Debit Card Statements Monthly. Take time to ensure all transactions are legitimate. If you see a questionable charge, contact your bank or credit card company immediately.

Keep Your Personal Information Secure. Don’t share personal information such as your full name, date of birth, SSN, address or phone number over the internet unless it’s a site you’ve initiated contact with and you’re certain it’s secure. Refrain from posting personal details such as your birthday or address on social media sites.

Limit What You Carry. Don not carry your social security card and limit the number of credit cards you have on hand.

Purchase a Micro-Cut Shredder. This machine ensures that your documents cannot be pieced back together. Use it to turn old financial statements, bills, credit card offers and any other secure or personal information into paper confetti.

Opt Out. You can opt out of prescreened offers for credit cards, insurance and more by calling 1-888-567-8688 or visiting www.optoutprescreen.com.

Keep Your Snail Mail Safe. Instead of leaving your outgoing mail in your mailbox, drop it off at a secure USPS center. In addition, if you know you’ll be out of town for a few days, request a vacation hold on your mail.

Keep Your Passwords Safe, Secure and Unique. Make sure your passwords are strong and get creative with them. Use a combination of letters, numbers and symbols and update them every few months. Think you’re already unique? Check out this list for 2012’s most common passwords: http://www.cbsnews.com/8301-205_162-57539366/the-25-most-common-passwords-of-2012.

Bulk Up on Security. Safeguard your computer with firewall, antivirus and spyware protection and update them often. This will protect your computer and files against intrusions.

Be Cautious of What You Click. If you receive an e-mail from a stranger or even a friend with links and attachments, know that opening them could expose your computer and files to a virus. Ask yourself if any part of the e-mail looks suspicious before clicking on links or files.

The above are just a few smart steps to ensure your identity is protected. Remain vigilant about how you share your personal information and who you share it with. Do your research and take necessary precautions to ensure your identity remains with you and you only.

Mary Beth Storjohann, CFP®, CDFA
Senior Financial Planner
HoyleCohen
San Diego, CA


3 Comments

Falling Off the Cliff


I am reminded of Douglas Adams’ quote “It’s not the fall that kills you; it’s the sudden stop at the end.” The U.S. Government, as a way to help the economy out of the financial crisis, implemented financial measures designed to boost the economy through lower taxes, employee payroll tax reductions and unemployment compensation among others. While the U.S. economy was saved, the recovery has been tepid at best. The pressing issue facing the U.S. is that most of the measures that have provided financial life support are all due to expire at the end of 2012.

Ben Bernanke, Chairman of the Federal Reserve, dubbed the expiring stimulus measures a “fiscal cliff.” Chairman Bernanke urged Congress to put government debt on a long-term sustainable path, but should not do so at the expense of short-term growth. There is fear that Congress will be engaged in grid lock due to the upcoming elections and that the financial measures will expire at year-end. Should the U.S. economy fall over the fiscal cliff, the pain won’t be felt until the economy comes to a sudden stop.

The programs set to expire are the Bush Tax Cuts from 2001, 2003 and the more recent 2009, 2010 stimulus measures that created the Employee Payroll Tax Reduction and Emergency Unemployment Compensation programs. The estimate by Ned Davis Research on fiscal drag ranges from $72 billion to $388 billion in lost output. Should the loss be toward the higher end of the range, the sudden stop may come sooner than many of the pundits are predicting.

Congress may decide to “punt” like they did last year and extend the financial measures. The risk of this tactic is that while it may spare short-term growth, the long-term debt burden may become unbearable. The Congressional Budget Office projects that the ratio of government debt to Gross Domestic Product would increase to 93%. A larger debt burden may slow the economy by requiring the government to spend more on interest payments on the debt instead of spending on Social Security, Medicare, defense and other important areas. Over half of the interest payments could be going overseas as foreign investors currently hold more than half the U.S. debt.

The U.S. Government will also face increased funding pressures from the near depletion of the Social Security and Medicare Trust Funds. The 2012 Trustees report showed the Social Security Trust fund will be depleted in 2033, three years sooner than last year’s estimate. After 2033, the Trust will only be able to support 75% of benefits promised. Medicare is projected to face the same fate in 2024 with revenues sufficient to cover only 87% of costs.

Social Security and Medicare outlays currently account for a combined 34.5% of government spending, the largest combined spending of any other government program. These entitlements are going to become more burdensome as the Congressional Budget Office estimates that Social Security and Medicare will account for 43% of all U.S. government expenditures in just ten short years.

The burden of these programs will also be felt as entitlements become a larger percentage of the United State’s Gross Domestic Product (GDP). In 1970, Social Security and Medicare were approximately 3.9% of GDP where today it is nearly 9% of GDP. In 2022 the Social Security Administration estimates that the two programs will be nearly 10% of GDP and upwards of 12% in 2033. While these appear to be small incremental gains in terms of percentages, perspective must be kept on the sheer dollar size of the U.S. GDP.

Gross domestic product (GDP) refers to the market value of all officially recognized final goods and services produced within a country in a given period. The U.S. Nominal Gross Domestic Product as of March 31, 2012 was nearly $15.5 trillion dollars. Over a 20-year period, the rise in Social Security and Medicare spending as a percent of GDP will equate to approximately $465 billion dollars. The ability for the United State to avoid a “Greek Tragedy” is to keep our debts and entitlements to a manageable percentage of GDP. As the percentages continue their unabated rise, our Nation’s capacity to shoulder these burdens becomes more and more strained.

There is a definite “fiscal cliff” ahead. The challenge is we don’t know if it is 12 months or 12 years in front of us. The job of the Federal Reserve and our elected officials is to minimize the height of the fall from the top of the cliff. We can sustain a slow down, not a sudden stop.

Ed GjertsenEdward Gjertsen II, CFP®
Vice President
Mack Investment Securities, Inc.
Glenview, IL


2 Comments

The New Reality of Retirement


“Retirement” is different now than it was for previous generations. Retirees used to be able to count on a solid pension, full healthcare benefits for them and their families, and relatively subdued inflation. Unfortunately, that is no longer the case. Companies are cutting back significantly on pension benefits, individual health care costs are skyrocketing, and some even fear a return of the 80’s hyper-inflation environment.

As a result, people are retiring much later in life (either by choice or not), and a significant percentage of the work force are working well into their “retirement” in order to maintain their standard of living. As a matter of fact, a recent survey conducted by Employee Benefit Research Institute and Matthew Greenwald & Associates shows that almost 70% of employed Americans expect to continue to work some amount during retirement.

In addition to dealing with the potential issues such as lack of pension, high cost of health care, and inflation, retirees are also living much longer than ever before. A study shows that if you are 65 today and married, there is a 91% chance that either you or your spouse will live to be 80 years old, and there is a 52% chance that one of you will live to see your 90th birthday (source: Society of Actuaries).

With the prolonged life expectancy comes the challenge of finding affordable health care options. Data indicate that only 27% of retirees are fortunate enough to have access to employer medical coverage, while the rest have to count on Medicare or Medicaid. For the 73% who retire without employer medical coverage, a recent study shows that it will cost approximately $200,000 in savings to fund out-of-pocket health care costs during retirement (Source: Employer Benefit Research Institute, Issue Brief No. 351, December 2010).

So how does one plan for the new reality of retirement?

The single most important decision individuals can make about retirement is to take responsibility for funding it themselves. Living costs, health care expenses, social security, pensions, and future employment income are all uncertain. But saving today is one concrete way to prepare for a more predictable retirement.

The question for most retirees is, what percentage of one’s own retirement should he or she be prepared to fund? You may have heard Financial Planners refer to the “3-legged stool” retirement income model. The 3-legged stool is a terminology used to describe the three most common, and somewhat equal, sources of retirement income — social security, employee pension, and personal savings. However, this income model is no longer the reality. For today’s retirees, diversifying their sources of income is as important as diversifying their investments.

According to a recent study, a typical retiree today will have 5 sources of income – social security (42%), pension/annuities (14%), personal savings (20%), work/earnings (20%), and other (rental, family support, etc). As the statistics suggest, retirees now have to fund close to 50% of their own retirement income through a combination of drawing down their personal assets and/or working in retirement.

It goes without saying that the sooner one starts planning for retirement the better. As a matter of fact, delaying your saving plan by as little as 5 years can have a significant impact on the end result. To illustrate the point, let’s take a look at several different scenarios.

As you can see, Susan is able to accumulate a significant nest egg of almost $850,000 by investing a total of only $50,000 between the age of 25 and 35 and let it accumulate. Bill, on the other hand, who delayed his saving plans by 10 years, has to invest significantly more ($150,000 total), and invest over a much longer period of time than Susan (30 years vs. 10 years), and still end up with a much smaller nest egg. Chris, the most diligent saver of the three, started early at age 25 and continued until his retirement age of 65. His consistency allowed him to accumulate a sizable nest egg of about $1.5 million.

Now that we have demonstrated the importance of saving, let’s talk a bit about spending. As most Financial Planners would attest, determining one’s spending needs in retirement is a complex exercise because there are numerous “unknowns”. One often has to make an assumption about not only life expectancy, but also tax rates, inflation, investment return, as well as other unforeseen costs.

As a rule of thumb, assuming a typical market return, a $500,000 portfolio consisting of 60% equities and 40% bonds can historically sustain a withdrawal rate of approximately 4% for well over 30 years, even in the worst historical time periods for investing. However, if a retiree ratchets up the withdrawal rate even by just 2 percent per year, the portfolio can now potentially only last about 21 years. The situation is even more dire if you happen to retire at the beginning of a cyclical bear market (see chart).

As we stated earlier, the only way for modern day retirees to ensure a comfortable retirement is to take responsibility for funding it themselves. With proper planning and sensible investing, it is still possible to enjoy your golden years. Remember, saving today is one concrete way to prepare for a more secure retirement.

Andrew B. Chou, CFP®
Senior Portfolio Manager
Westmount Asset Management, LLC
Los Angeles, CA