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