Retirement Planning

Retirement Planning

Five Tax Saving Strategies for the Affluent

By Echo Huang, CFA, CFP®, CPA

When I worked as a tax CPA for KPMG in the late 90s, I served many corporate executives and wealthy families as their senior tax specialist and prepared many individual income tax returns, trust returns, and gift tax returns.  Now I use that knowledge and expertise to help my affluent and high-income clients plan ahead to keep more money in their pockets by using some smart tax savings strategies.  

Looking at this Historical Tax Rate Chart 1913 - 2019, the current top income rate is relatively low.   Similar to the importance of diversification in investing, I think the thought of tax diversification is relevant as we help people plan for their financial future.  I want to share five tax savings strategies here with some examples:

  1. Diversify Your Taxable Income.  Investors should consider owning investments in all three tax buckets: tax-deferred (such as 401(k), IRA), tax-free (Roth IRA, HSA) and taxable (individual, joint, revocable living trust).  The tax treatments are different in each of the three buckets before withdrawal: you can sell investments with gains or losses inside the tax-deferred bucket and tax-free bucket without reporting them to IRS; you must watch for short-term or long-term capital gains, interest income or dividend income each year inside the taxable bucket.  

When it’s time to withdraw, you’ll pay the ordinary tax rate (normally higher than long-term capital gain rate) on the distributions from the tax-deferred bucket.  You won’t need to pay any taxes on distributions from your Roth IRA after age 59.5 or having met the five-year rule after converting some IRA money to Roth IRA.  You use after-tax dollars to fund a Roth IRA, but any distributions including earnings after age 59.5 will be tax-free.  IRS determines the income limit each year for making contributions to a Roth IRA.

Since you cannot predict your future income tax rates, owning investments in all three tax buckets allows you to have the maximum tax planning flexibility during retirement in order to reduce taxes.  For example, if our government’s deficit continues to be large, and during your retirement the tax rates may go up for people earning over $200,000 annual taxable income, you may be able to withdraw some money from your Roth IRA instead of IRA to keep your taxable income below $200,000, therefore paying taxes at a lower rate.  When tax rates go down because of the change of the president or congress, then you can switch to withdrawing from your IRA and taxable account.

Must-Know Facts About Health Savings Account

By Echo Huang, CFA, CFP®, CPA

A Health Savings Account (HSA) can be a powerful tool to help you save and invest, now, to pay for your qualified medical expenses (QMEs) during retirement.  The HSA has become popular as more and more employers move to high deductible health plans (HDHP) in order to reduce insurance premiums.  Employees must choose the HDHPs instead of traditional health insurance plans if they want to use their HSAs to fill the gap.  I have used HSAs personally for about 10 years and I want to share these essential facts with you:

  1. The HSA provides triple tax benefits.  Contributions are made with pre-tax dollars (free of federal, state and FICA taxes) through payroll if your employer offers it.  If you purchase an HDHP on your own in the insurance market, you can set up your own HSA online and make contributions before the tax return filing deadline.  You can choose to invest the balance and the growth is tax-deferred.  Distributions are income-tax free if you use them to pay for qualified medical expenses (QME).  "Typical" retiree expenses on health care are often as high as $500/month (or $1,000/month for a married couple), much of which are HSA-eligible QMEs, including Medicare premiums and out-of-pocket medical costs (although Medigap coverage doesn't count). 
  2. How much can I contribute per year?  For a self-only HDHP, you can contribute up to $3,400 in 2018 ($3,500 in 2019).  For a family HDHP, you can contribute up to $6,900 in 2018 ($7,000 in 2019).  If you are age 55 and older, you can contribute additional $1,000.  
  3. The HSA balance does not expire, unlike the Flexible Spending Account (FSA).  You don't have to spend the balance within the calendar year.  You can keep the receipts of QMEs and get reimbursed from your HSAs many years from now as long as the expenses have not been reported as medical expenses on tax returns and increased your total itemized deductions.  If your income is not low, it is difficult to get tax benefits through reporting medical expenses on Schedule A because total QMEs for the calendar year must exceed 7.5% of adjusted gross income (AGI) to generate tax benefits.  Beginning in January 1, 2019, the 7.5% of AGI will increase to 10% of AGI.  If your AGI is $100,000, you must incur greater than $10,000 QMEs in one year to be worth it to report them on Schedule A.  Therefore, if you don't get tax benefits from your tax returns, then you can save the receipts and file them in a folder called "To Be Reimbursed from My HSA" - you decide the timing of distributions in the future.

Withdrawal Strategies During Retirement

By Echo Huang, CFA, CFP®, CPA

You may have heard of the 4% rule for withdrawals during retirement as you approach your retirement. I would like to clarify this rule in this blog post and offer some thoughts on how to withdraw from your nest egg to make the money last for at least your lifetime.

What is the 4% rule?

The rule states that if you begin by withdrawing 4% of your nest egg's value during your first year of retirement, and then adjust subsequent withdrawals for inflation, you'll avoid running out of money for 30 years. If you retire with $2 million, the first year's withdrawal is $80,000 and if the inflation is 2% the second year, you adjust the second year's withdrawal by 2%, that is $81,600. It's simple to use and has been considered as the standard rule for withdrawals for many years. In my opinion, this rule is far from perfect for several reasons:

  1. This rule assumes that your investment mix is 60% stocks and 40% bonds. If you're conservative and allocate 75% to bonds, your portfolio may not grow enough to last your lifetime. If you are more aggressive and have 80% in stocks, your portfolio value may decline sharply during stock market crashes and won't have enough time to recover. Your investment mix should be designed based on all your factors: risk preference, loss capacity, time horizon and market conditions.
  2. The time frame of 30 years of retirement may not be long enough for some people and may be too long for others. If you retire early at age 50, your portfolio may have to last more than 30 years. If you retire late at age 70, you may limit your lifestyle spending too much by sticking to the 4% rule if you don't expect to live past age 85 based on your health conditions and family history. There is no do-over in retirement - running out of money even a year before you die is a failure and you simply cannot go back to work at age 89.
  3. Investment return expectations are outdated. When the rule was introduced in the early 1990s by William Bengen, then a financial planner in California, the historical data used at the time included periods that bonds had a high rate of return. Based on the current and projected interest environment, it is unreasonable to assume bond returns of 5% to 6% for next decade. The current federal funds rate is 2.25%. The federal funds rate's year-end estimate for year 2020 is 3.38%, based on the September 2018 FOMC meeting.

Should I Change My Asset Allocation When I'm About to Retire?

By Echo Huang, CFA, CFP, CPA

It takes years to accumulate and grow your nest egg with disciplined saving and investing to an amount where you finally feel comfortable hanging up your spurs and starting the next phase of your life, Retirement.  Now you are about to start ticking off the items on your bucket list; perhaps traveling with family to amazing destinations, pursuing your passion in music or the arts or volunteering with some non-profit organizations. Your portfolio, on the other hand, must continue to work hard for you in order to last at least your lifetime, and that can be 30 years or more.  

In this post, I would like to share what I think you should consider to review your portfolio and make adjustments as needed.

Although it's hard to go very wrong with a simple 50% stock/50% bond mix, there aren't any one-size-fits-all asset allocations for retirement portfolios. An individual's age, retirement income such as social security and pension income, withdrawal rate, and risk profile, among other factors, can all dictate higher or lower equity or bond weightings.  

  1. Allocation to Equity (stocks).  Assume that you have an average appetite for risk, you can take your age, subtract from 110 to determine how much of your portfolio should remain in stocks.  For example, if you are age 65, then allocate 45% to equity and 55% to bonds and cash. If you have longevity gene in your family history and your personal life expectancy is over age 90, consider using 120 instead of 110 to calculate your equity allocation.  As a general rule, you don't want to have too much money tied up in cash, and while you most definitely need an emerging fund going into retirement, that money should be in its own separate account.

Why Invest in Bonds?

By Echo Huang, CFA, CFP®, CPA

In the year 2017, the US Bonds’ return was just 3.54%, much lower than stock market returns. Globally, stock market returns were great in 2017: US Stocks (measured by S&P 500 Index) 21.83%, International Stocks (measured by MSCI EAFE Index) 25.03% and Emerging Market Stocks (measured by MSCI Emerging Markets) 37.28%. Bonds, they say, are a pretty boring asset class. The stock market is far more exciting. That’s where the biggest returns are found and it’s also the segment that the financial media tends to focus on.

Bonds have been out of favor for several years, with low interest rates not seen for several decades resulting in tiny yields. Why should you invest in bonds at all?

Have You Considered This Mega Roth Strategy?

By Echo Huang, CPA, CFP®, CFA

Last month, one of my new clients and I called the administrator of her old 401(k) plan to rollover the balance to her IRA account at TD Ameritrade.  To her surprise, she had $36,000 in after-tax contributions (not the same as a Roth) with earnings of $70,000 from the after-tax contributions she made many years ago in addition to $700,000 pre-tax contributions and earnings.  She was able to request two checks - one for the $36,000 to a new Roth IRA account (a Roth conversion that is tax-free because there is no taxation on otherwise after-tax funds!) and one for the $770,000 to a traditional IRA account (which does not incur an income tax assessment by virtue of being a rollover).  The end result – now she has $770,000 of all pre-tax funds in an IRA, $36,000 in a Roth IRA, and her tax cost this year is zero!

One great benefit is that the balance in her Roth IRA account will now grow tax free!  It was a pleasant surprise for both her and for me, but I thought to myself “If she had rolled-over the $36,000 to her Roth IRA earlier in 2014 or 2015, the earnings from this after-tax contribution in the past two to three years (i.e. $7,000) would have been tax-free instead of being in an IRA that will be taxable upon distribution.”  And this made me want to tell you, that if you have made any after-tax contributions to your 401(k) from before the Roth 401(k) became available, you should consider reviewing the plan provisions on in-service withdrawals if you still work for this company.  If you have already left or retired from this company, it’s still easy, you can do what my client did.  But leaving an after-tax balance in the plan does not help you grow tax-free because the earnings from the after-tax contributions are taxable if you take distributions from the plan to spend in the future.

To Rollover or Not Rollover Your 401(k) - It Depends

One of the biggest decisions many of our clients face is what to do with their 401(k) plan when they leave their employer. There is no clear cut answer as to whether you should roll over your 401(k) plan to an IRA, another employer’s 401(k) plan, or simply to leave it where it is, because it involves several different factors, including long term investment costs and the availability of investment options within the plans. Both can impact the long term performance of your retirement plan. However, the most critical factor that can have a big impact, both short and long term, are the tax implications of a rollover.  Understanding these implications is essential before making any decision regarding your 401(k) plan.

Here are some of the more common tax complications that arise from a rollover:

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