Category Archives: Personal Finance

100 Words On: When Financial Perfection Is the Enemy of Good

When it comes to matters of personal finance, trying to find the optimal solution can be counterproductive simply because many decisions don’t require extensive research. One of the best examples of this is when comparison shopping for a certain product or service. Typically, a modest survey of three to five samples is all that’s necessary before enough information is available to make an enlightened decision.

The bottom line: Whether you’re choosing a new refrigerator or a 24 hour plumber, trying to make the perfect choice usually results in wasted time and energy. Sometimes “good enough” really is okay.

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100 Words On: Why Frugality Has Its Limits

The main benefit of frugality and saving is they’re good habits that lay a strong personal finance foundation. That being said, the frugal lifestyle definitely has its limits. Although scrimping and cutting corners can result in significant savings, at some point, it simply becomes impractical to cut anymore. Meanwhile, those trying to save their way to prosperity will sadly discover that it’s a painfully slow process.

The bottom line: Frugality has its merits to be sure, but for those looking to build wealth or get out of debt as fast as possible, increasing income is a much better strategy.

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Retire on 70% of Your Income? It Might Be Tough

You may have seen this rule of retirement planning in numerous articles: “Save enough to live on 70% of your income.” A significant number of financial planners and respected retirement experts use this benchmark, too, but is it accurate? After you retire, can you really live on 70% of what you’re making now?

If you’ve lived as an adult for at least 20 years, you’ve seen drastic changes in how Americans save for retirement. A shift from a well-funded pension to a 401(k) model that requires more work and investment by the employee is just one of the major changes underway. (See What’s the Difference Between a 401(k) and a Pension Plan?) What will it look like in another 20 years? The trend certainly isn’t for employers to fund more of an employee’s retirement.

Here are some things to consider as you start doing the math of your retirement.

Don’t Count on Social Security Alone

The Social Security Old-Age and Survivors Insurance (OASI) Trust Fund will keep increasing until the beginning of 2020. But by 2035 (in 20 years) it is projected to be depleted – though still able to pay 79% of benefits based on “pay as you go” income from employment taxes. A variety of fixes have been proposed (see Will Baby Boomers Bankrupt Social Security?).

Even if you do get some kind of Social Security payment at retirement, it may well go less far you imagine. The average monthly benefit for a retired worker in January, 2017 was $1,248.67. Start paying attention to those estimated projections you sometimes receive from the Social Security Administration.

Statistics show that the average working household has next to no money saved for retirement. The median retirement savings for working age households is only $3,000 and for households close to entering retirement, it’s $12,000. Americans are collectively between $7 and $14 trillion behind in retirement savings.

Look at How You Live Now

One study found that three out of four Americans are living paycheck to paycheck. Even one out of three people in households earning $75,000 per year report living paycheck to paycheck at least some of the time.

As you do the math, realize that you’re probably already living on around 70% of your official income – income and payroll taxes take a hefty bite out of your paycheck. The average U.S. worker has a 31.5% tax burden, according to the Tax Foundation, a Washington, D.C.-based research organization.

The question is, what will the financial picture look like when you retire? You can expect that you will spend more on some things and less on others.

Medical Expenses

For most people, the cost of healthcare rises as they get older. So could the cost of insurance. Traditional Medicare won’t cover enough of your health costs; you will need to pay for either a Medigap policy, plus Part D drug coverage – or choose a Medicare Advantage Plan. These could cost more than employer-based healthcare, if you currently have a plan at work. The ongoing repeal of the Affordable Care Act may also cause health related costs to increase. In addition, you will likely get sick more as you get older. It makes sense to budget for increased healthcare costs and hope you won’t end up needing all you’ve slotted for them. A Fidelity study found that couples retiring at age 65 will need about $220,000 (in 2014 dollars) to cover their medical expenses.

To learn more about these issues, read Medicare 101: Do You Need All 4 Parts? and How to Pick the Best Medicare Part D Plan for You.

Taxes

Those could well go down. Depending on your state, pension and Social Security income may or may not be taxed at the state level.

If your “combined income” is more than $25,000 as an individual, or more than $32,000 filing a joint return, you will begin having to pay federal taxes on a portion of your Social Security retirement benefits. At higher levels you will owe tax on up to 85% of your benefits. (Avoid the Social Security Tax Trap has details.) On the other hand, you won’t be paying payroll taxes if you’re no longer employed.

Will You Really Spend Less?

Medical costs aside, the conventional wisdom is that you will spend less once you retire, but that may not be true. Look at your life today. Do you spend more money when you’re working or when you have free time? For nearly everybody, the answer is the latter.

Your bucket list likely includes a number of high-dollar activities. You may need to budget more, especially for the first years of retirement. Check out The 4 Phases of Retirement and How to Budget for Them.

On the other hand, if you manage to pay off your mortgage by retirement – or chose to downsize – some of your living costs will decrease. Another option is to relocate abroad, at least for the first part of your retirement, as a growing number of Americans are doing.

Factor in Market Volatility

Remember the financial crisis of 2008? Remember what happened to retirees’ investment accounts? Remember the people who couldn’t retire when they wanted to – and still can’t? The financial crisis taught everybody that relying on the world’s investment markets is necessary, but far from a sealed deal. Many of those accounts have since recovered if the account holders were able to sit out the storm. But timing is everything and older people have less time to earn back losses.

Don’t cut it close. Save more than you think you’ll need so you can weather the ups and downs of the market. See Retirement Savings: How Much Is Enough? and Retirement Planning: How Much Will I Need? for more.

The Bottom Line

As with anything, the more people you ask, the more opinions you’ll receive. Instead of listening to the voices, try this experiment: If you’re currently living paycheck to paycheck, try living on 30% less for the next six months.

If, on the other hand, you have money left over each month, figure out how much more you would need to save (if anything) to bring your living expenses down to 70% of what you spend now – minus any costs associated with children.

Crunch the numbers and use that information to start figuring out what your target income needs to be in retirement. Add up what assets you have now and check with Social Security to get an estimate of your retirement income. Then talk with a financial planner about how you can start working to accumulate what you need in time for when you need it.

Will Baby Boomers Bankrupt Social Security?

Baby Boomers are that huge demographic that came of age in the 1960s and 1970s. Totaling 76 million, Baby Boomers were born between 1946 and 1964. This vast cohort began to reach age 62 in 2008. By 2031, the youngest Boomers will have passed full retirement age of 67. There’s a lot of talk about whether the Baby Boomer generation will bankrupt Social Security. Before you panic, let’s look at the facts.

The Facts

According to The National Academy of Social Insurance, Social Security costs are projected to remain relatively steady due to the increase in the full retirement age and other Social Security cuts put in place in the 1980s. During the 1970s, 1980s and 1990s the government made substantive changes to the Social Security system. This large program remains on the governmental radar, which is well aware of the Social Security reserves.

Currently, there is a large Social Security surplus. The Social Security Administration stated in Social Security Trust Fund Cash Flows and Reserves (Social Security Bulletin, Vol. 75, no. 1, 2015) the following: “In 1980, the OASDI trust fund reserves were low and declining. Congress enacted changes in 1983 that enabled reserves to begin to accumulate. In the 2014 edition of the Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, reserves are projected to peak around 2020 and to be depleted around 2033 if no changes are made to the tax or benefit provisions before then.”

Once those reserves are depleted in approximately 2033, an estimated 77% of the expected Social Security benefits will continue to be paid from the government’s tax revenue. These projections have remained constant since 1987 and are believed by experts to be quite reliable. Yet, we’re still looking at a declining Social Security fund beginning in just four years. So what is the possibility that Baby Boomers will bankrupt the Social Security system? (For more, see: How Baby Boomers Will Change the Way Others Retire.)

Potential Solutions

There’s clearly cause for concern, after all 2033 is less than two decades away. Yet, this is not a “surprise” issue. Since February 1st, 2016, there have been 16 proposals reported by the Social Security Administration currently in various stages of review by the U.S. government — many of which suggests to increase the normal retirement age. The full retirement age for Social Security benefits is already scheduled to rise during the coming years from age 65 to age 67 for those born in 1960 and later. This makes sense given life spans have drastically expanded since Social Security was initiated. Another proposal recommends raising the normal retirement age to 69. This initiative advocates that starting in 2022, the age would rise by three months each year until it reached age 69 in 2030. Another proposal is entitled longevity indexing. Since American’s life spans continue to grow, it seems reasonable that Social Security payments should adjust. The indexing would continue benefits for a longer time period and offset this extended lifespan duration with smaller monthly benefits as life spans grow. There are a variety of versions of this type of adjustment. Some years ago, entitled longevity indexing was proposed as a solution. Since American’s life spans continue to grow, it seems reasonable that Social Security payments should adjust. The indexing would continue benefits for a longer time period and offset this extended lifespan duration with smaller monthly benefits as life spans grow. There are a variety of versions of this type of adjustment.

The Bottom Line

The looming Social Security shortfall is front and center in both the public and legislators’ collective agendas. As one of the most prized social programs, there is no reason to believe that the Baby Boomer generation will bankrupt Social Security. History confirms that the program was amended with regularity during the recent past. Social Security’s solvency and benefits ar currently under review.

Your Chance of a Tax Audit Is the Lowest in Years

Even the thought of a tax audit can cause panic and anxiety. The correspondence audit, the mildest form of the Internal Revenue Service (IRS) procedure, is one in which a few tax records are questioned by the IRS and a request is made for documents to be mailed in. More in-depth audits require you to meet in person with an IRS auditor, either at a government office or your own. These more-serious audits might cover multiple years and/or sections of your tax returns. Random audits are just like they sound – arbitrary – and could cover any section of your return; however, they generally focus on areas that might require you to pay more tax. (For more, see How Do IRS Audits Work?)

What Are Your Chances of a Tax Audit?

A recent CNBC.com article states that your chance of being audited by the IRS is at the lowest level in recent years. The number of Americans audited last year continued a six-year decline, with only around 1,000,000 individuals selected.

Between 2015 and 2016 the number of people audited dropped by 16%. In other words, only 0.7% of individuals were audited last year. Furthermore, it’s been 12 years since so few people were audited, and over that time U.S. population has expanded by approximately 30 million people.

Why the Decline in IRS Audits?

As you might expect, budget, personnel and funding cuts are behind the drop in the frequency of IRS audits. In 2010 the IRS budget was $12.2 billion; in 2016 funding had dropped to $11.2 billion, a full $1 billion less. Currently, 80,000 people work at the IRS, a decrease of 17,000 employees since 2010. This includes 7,000 fewer enforcement agents.

Consumers’ low chance of being audited has already resulted in lower tax revenues from auditing fines Last year, Commissioner John Kiskinen reported that audit declines had cost the government at least $2 billion in revenue that would otherwise have been collected between 2010 and 2015.

Who Is at the Greatest Risk of Being Audited?

As you might expect, the higher your income, the greater your chance of being audited. If you have more money, the government assumes that it will have a better likelihood of finding an error in its favor. (For more, see Surviving the IRS Audit.)

In 2016 IRS representatives audited 5.8% of the returns of those who reported more than $1 million in income. For individuals with more than $200,000 in income, only 1.7% were audited. Although the percentages were higher for these groups than for lower-income earners, they were reduced from previous years.

If you’re in a high-income group, it’s wise to keep meticulous records. That way, if you are among the small percentage summoned for an audit, you’ll be prepared to respond. Additionally, for any type of audit other than a correspondence check, it’s wise to call in your accountant – or consider hiring one.

What About Corporate Audits?

Corporate audits are at their lowest levels in a decade, down by 17% last year, when only 0.49% of corporations were investigated. Congressional Republicans began cutting IRS funding in 2010. Given the Trump administration’s “low regulation” environment, don’t expect a reversal. Tack on the fact that President Trump regularly cites tax audits as a reason for withholding his returns from the public, and you can pretty much assume that he won’t be enthusiastic about giving the IRS additional resources.

The Bottom Line

The chance of an audit, for you or your company, is lower than it’s been in years, but that doesn’t mean you should skirt the law or stop keeping tax records. What it does suggest is that can worry less about the possibility of being audited. Your risk is minimal in 2017. (For advice on making it even more minimal, see Avoid an Audit: 6 ‘Red Flags’ You Should Know.)