Front Street Wealth Management

Fee Only, Proactive Wealth Managment

Finding Your Safe Spending Rate

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More goes into planning for and sustaining a retirement than meets the eye. On the surface lies plenty of generic advice from the financial planning industry. Yet, beneath the surface are a slew of assumptions about a largely unknown future. To understand how to manage your sustainable retirement clearly takes more than simple rules-of-thumb.

It should come as little surprise that your retirement decision may be dominated as much by feelings of insecurity as it is by feelings of excitement. Thankfully, the balance between these two emotional poles can be tilted in your favor with pre-retirement planning.

For example, one critical first step for a soon-to-be retiree is to develop a deeper understanding of your post-retirement budget. During your working years, budgeting is all-too-often dismissed. However, when your income becomes more-fixed and less-active in nature, spending choices take on a new sense of importance.

During meetings with soon-to-be-retired clients, my early fact-finding focuses on gaining a better understanding of the true cost of their lifestyle. Without that understanding, retirement planning – and the day-to-day services that follow from that planning – can feel like stumbling in the dark.

With your lifestyle’s financial obligation defined, the traditional survey of your assets and debts and the review of your various sources of income begin to take on the deeper purpose of building financial sustainability.

Of course, the financial obligation that springs from your choice of retirement lifestyle must be met by sustainable income. For most retirees, at the base rests Social Security and, for a shrinking number, pension income. Together, these are just two legs of the proverbial three-legged financial stool.

The final leg of a sustainable retirement is built from income earned from your personal savings. While some might be generated from real estate or even business interests, it often must be earned from traditional sources, such as IRAs or after-tax savings and investments.

It is here, within this portion of private savings, where you may have a lack of confidence of how much you can safely spend from private savings each year.

This central question about your safe spending rate, known in the industry as the sustainable withdrawal rate, is where financial planners toss around overly-simplistic rules-of-thumb. In reality, the assumptions that underpin rules, like the “4% Rule”, are complex and debatable. For good reason, this subject dominates the thoughts of many financial planners. Honestly, it rarely strays far from my mind when managing my clients’ investment portfolios.

As we enter the new year, it would be wise for you, a current or soon-to-be retiree, to establish your own personalized safe spending rate. Only then will a confident retirement – and, yes, a worthwhile New Year’s resolution – be sustained.

Jason P. Tank, CFA of Front Street Wealth Management will hold a free educational workshop on “Finding Your Safe Spending Rate” on Jan 13th at 6:30pm in the McGuire Room at the Traverse Area District Library. Call (231) 947-3775 with questions.

Interest Rates to Rise Slightly

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The Fed did it! After nine years since the last rate hike, and following seven years of near zero interest rates, the Fed and Janet Yellen last Wednesday finally raised short-term rates by a whopping one quarter of one percent. The financial markets, which had been displaying concern and worry during the decision’s build-up, largely sloughed it off.

Listening to Yellen during her follow-on press conference, what strikes me is the Fed’s propensity to represent the consensus view. As economic cheerleaders, this is quite natural for the Fed, of course. What else could they say and how else could they feel other than believe the near-term future will resemble the recent past? The past trend is always the future trend to consensus thinkers. This is precisely why the majority of investors fail to anticipate a change in the trend.

For example, as the calendar turns, many will read market prognostications for the year ahead. Already I have noticed news stories that indicate stock market returns will be in the range of 5% to 10%. For as long as I can remember, I’ve seen this range of returns anticipated time and time again. Not coincidentally, that range fits the long-term historical return of stocks in the US.

Published along with the news release of the Fed’s decision last Wednesday, Fed governors made public their own individual projections of economic growth, inflation expectations and unemployment over the next few years along with their long-range expectations of these same measures. What’s striking about this report is their consistent lowering of economic growth and inflation relative to their prior projections. The Fed has consistently been too optimistic.

Like many economists and investors, the Fed has looked for inflation to rise back to its long range target of 2% per year. Today, that measure sits closer to 1%. The consistent undershoot of inflation is not a phenomenon of the US alone. Many of the largest economies in the world are also experiencing what’s known as disinflation – a decrease in the rate of inflation. This was true prior to the drop in oil prices and does raise questions about possible structural issues for the global economy that may lead to continued subdued inflation rates.

It’s fair to say that the largest concern of all central bankers is for disinflation to morph into deflation – that is, an outright drop in prices. This is what Japan struggles with today following their own financial crisis many decades ago. Global central bankers, through zero interest rates and asset purchases, responded to this prospect with an unparalleled monetary experiment.

The question is, did the experiment work? With the Fed finally raising interest rates off the floor, the largest impact may be in the confidence “signaling” impact for investors. In other words, if the Fed feels it’s safe to finally raise rates after seven years in credit crisis-recovery mode, they must feel the trend is their friend. Outside of asset price appreciation and a now-larger pile of low-cost debt, a definitive answer to the question remains unanswered.

Social Security New Rules – Part II

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In this second segment of in my series on the new rule changes within Social Security, I will delve into other aspects worthy of deeper analysis.

Where my previous column highlighted the late April 2016 deadline faced by a 66 year-old couple planning on using Social Security’s “file-and-suspend/restricted application” trick to maximize their benefit, this week focuses on how the new law affects two younger demographic groups; those age 62 to age 65.5 and those younger than age 62.

Over the next four years, Congress is winnowing down the filing options that Social Security now offers. As time passes, the available choices for retirees will become fewer and fewer. The upside of this narrowing of choices is the beauty of simplicity for future retirees. The downside, as you might have guessed, is your Social Security benefits over your lifetime will likely be less than those received by the prior generation.

To begin, if you won’t reach age 62 by the end of this year, you will not be allowed to restrict your filing to just your spousal benefits. If you fall into this younger group, Social Security will simply pay you the greater of your own earned benefit or the benefit you’re entitled to receive as the spouse of another then-collecting worker.

With these simplified rules, for the youngest among you, Congress just took away your ability to begin collecting your spousal benefit – which can begin at age 66 – while also simultaneously deferring the benefit you may have earned yourself. That “restricted application” trick is over for you.

This ability to collect only your spousal benefits – and watch your own benefits based on your work record grow year after year after year – is now only available to those who are at least age 62 by the end of 2015.

For this slightly older group – let’s call them the middle demographic – you will still have the right to collect your spousal benefit at your full retirement age, to continue to let your own benefit grow 8% per year until age 70 and then, finally, to switch over to your bigger benefit. But, there’s a catch to remember with this strategy.

Unlike the older retirees profiled last week, for this middle demographic to be allowed to restrict their filing to only their spousal benefit, their spouse must also be collecting their own benefit.

With deadlines approaching and with the key role Social Security plays in retirement income planning, understanding the rules has gained importance.

Social Security New Rules – Part I

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There is yet another financial planning deadline looming on the horizon. Congress was nice this time as this newest deadline occurs when the snow melts by April 30, 2016. Nonetheless, time seems to move at an accelerated pace and May will be here before you know it. For that very reason, planning around the latest rule changes regarding Social Security is something to act upon well before then.

To begin, Social Security presents complexities that are not fully recognized by most people. Many retirees consider Social Security a benefit that is simply started at a particular age. Most commonly, surprisingly, people apply at the earliest eligible age of 62. In fact, almost half file for benefits at the earliest moment possible and, as a result, accept a permanent 30% reduction in benefits for life.

On the other hand, some people plan extensively to maximize their Social Security benefits. The latest law changes – hot off the presses – significantly affect their well-laid plans. These people should bone up now on the changes as Congress has set a clock that’s ticking down.

For background, the most classic Social Security maximization strategy is one used by dual-income couples. The strategy goes something like this, assuming a same-age couple.

The higher earning spouse – let’s say it’s the husband, in this case – files for benefits at age 66 and then immediately suspends his Social Security benefit. This move is called, file-and-suspend. During his benefit suspension period, his eventual benefit will grow 8% larger for each year he waits to collect – until he hits age 70.

Now, because he formally filed for benefits, his wife is entitled to receive her spousal benefit equal to 50% of his benefit amount, even if he’s chosen to not collect his benefit. All spouses are entitled to receive this 50% benefit. In this example, she is not filing to receive the benefit she’s earned through her own lifetime of work. Instead, she’s only choosing to receive her likely smaller spousal benefit. This move is called, filing a restricted application.

The trick is, while she’s collecting her smaller spousal benefit, her own eventually larger benefit – the benefit that’s based on her work record – will continue to grow 8% per year, until she too reaches age 70. For dual-earning couples, this strategy works to maximize their Social Security benefits.

And, here’s the punchline, this strategy – for those who haven’t already put it in place – will end on April 30, 2016, unless they act by then.

Of course, the myriad of Social Security claiming strategies are nearly endless and deserve individualized analysis. In future columns, I will address additional situations affected by the recent law changes. Change is clearly a rule and Social Security’s new rules are no exception.

Jason P. Tank, CFA will hold a free public educational workshop on this topic on December 9th at 6:30pm at the Thirlby Room at the Traverse Area District Library.

No Holiday From Financial Tasks

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As part of my series on end-of-year financial tasks, there are a few deadlines that many people need to pay attention to as they do annual planning with their investment advisors and other consultants.

I’ll highlight one in particular that is of extreme importance for many senior investors. I’ve discussed this in past columns, but it bears repeating given the onerous penalties you face if you do not comply with the law.

Once you reach age 70 1/2 and forevermore, you face what is referred to as a “required minimum distribution” from your IRA accounts. Like too many things, this one goes by an acronym of RMD. Essentially this is your annual requirement to withdraw a certain minimum dollar amount from all of your tax deferred accounts.

The logic behind this is the government wants to finally collect its take on the money you’ve put away and invested free of taxes. Their required minimum distribution rule assures the tax is paid.

If you don’t comply – whether or not your neglect is completely benign – the penalties are extraordinarily harsh. They can total 50% of the expected annual distribution. Please don’t forget. With penalties like these, a double-check is just a smart policy.

Typically, after your first required minimum distribution has been processed by your account custodian or brokerage firm, the subsequent distributions from your tax-deferred accounts will become automatic. This lessens the burden placed on you to remember each year.

However, your first distribution must be set up manually either with your advisors help or by you if you are a do-it-yourself investor. It’s often this first year where an oversight can occur.

While it should be simpler than this, there are a few nuances with required minimum distributions that are worth discussing further.

The first involves people who may have inherited an IRA from a non-spouse loved one. In this case, the required minimum distribution rule can be much more burdensome. With Inherited IRAs, the custodians or brokerage firms often do not set up an automatic process in subsequent years as they do for non-inherited IRA account holders. Therefore, Inherited IRAs require some extra care.

In my experience, the prospect of forgetting to take an annual distribution occurs with situations of Inherited IRAs. To minimize the risk, my advice is to speak to an advisor the moment you inherit an IRA.

In addition, in the year in which you turn 70 1/2, there are special rules regarding the required timing of the first annual distribution. To discuss the benefits of this special first-year rule, it may require a personalized conversation with your investment advisor and your tax consultant to help craft the most tax efficient strategy.

As is often the case in life, the busiest times of the year, such as the holidays, often inconveniently correspond with some of the most important times of the year to review your financial situation. There’s simply no way around it, no matter how much you and your advisers would love to have the ability to turn back time!