Stop Retiring Early, People!


When I was 30, I set a goal of being able to retire at age 50. I’m still on track for that goal, but with my 44th birthday coming up next month, I now wonder what the hell was I thinking. I don’t want to retire. I get bored on a three-day weekend. I need to have mental activity, variety, and the sense of purpose and fulfillment that comes with work. So, no, I won’t be retiring at 50 even if I can.

Self Employed? Discover the SEP-IRA.


The SEP-IRA is a terrific accumulation tool for workers who are self-employed, have a family business, or who have earnings as a 1099 Independent Contractor. SEP stands for Simplified Employee Pension, but the account functions similar to a Traditional IRA. Money is contributed on a pre-tax basis, and then withdrawals in retirement are taxable. Distributions taken before age 59 1/2 may be subject to a 10% penalty.

What Do Low Interest Rates Mean For Your Retirement?


A 2013 study from Prudential considered whether a hypothetical 65-year old female retiree would have enough retirement income to last her lifetime. In their scenario, they calculated a 21% possibility of failure, given market volatility and longevity risk. When they added in a third factor of “an extended period of low interest rates”, the failure rate rose to 54%.

Qualified Charitable Distributions From Your IRA


For several years, taxpayers have had an opportunity to make Qualified Charitable Distributions, or QCDs, from their IRA. This was originally offered for just one year and then subsequently was renewed each December, an uncertainty which made it difficult and frustrating for planners like myself to advise clients. Luckily, this year Congress made the QCD permanent. Here is what it is, who it may benefit, and how to use it.

A QCD is a better way to give money to charity by allowing IRA owners to fulfill their Required Minimum Distribution with a charitable donation. To do a QCD, you must be over age 70 1/2 at the time of the distribution, and have the distribution made payable directly to the charity.

If you are over 70 1/2, you must take out a Required Minimum Distribution from your IRA each year, and this distribution is reported as taxable income. When you make a qualified charitable contribution, you can deduct that amount from your taxes, through an itemized deduction. The QCD takes those two steps – an IRA distribution and a charitable contribution – and combines them into one transaction which can fulfill your RMD requirement while not adding to your Adjusted Gross Income (AGI) for the year.

The maximum amount of a QCD is $100,000 per person. A married couple can do $100,000 each, but cannot combine or share these amounts. For most IRA owners, they will likely keep their QCD under the amount of their RMD. However, it is possible to donate more than your RMD, up to the $100,000 limit. So if your goal is to leave your IRA to charity, you can now transfer $100,000 to that charity, tax-free, every year.

The confusing thing about the QCD is that for some taxpayers, there may be no additional tax benefit. That is to say, taking their RMD and then making a deductible charitable contribution may lower their taxes by exactly the same amount as doing a QCD. Who will benefit from a QCD, then? Here are five situations where doing a QCD would produce lower taxes than taking your RMD and making a separate charitable contribution:

1) To deduct a charitable contribution, you have to itemize your deductions. If you take the standard deduction (or would take the standard deduction without charitable giving), you would benefit from doing a QCD instead. That’s because under the QCD, the transaction is never reported on your AGI. Then you can take your standard deduction ($6,300 single, or $12,600 married, for 2016) and not have to itemize.

2) If you have a high income and your itemized deductions are reduced or phased out under the Pease Restrictions, you would benefit from doing a QCD. The Pease Restriction reduces your deductions by 3% for every $1 of income over $259,400 single, or $311,300 married (2016), up to a maximum reduction of 80% of your itemized deductions.

3) If you are subject to the Alternative Minimum Tax (AMT). The AMT frequently hits those who have high itemized deductions. With the QCD, we move the charitable contributions from being an itemized deduction to a direct reduction of your AGI.

4) If you are subject to the 3.8% Medicare Surtax on investment income. While IRA distributions are not part of Net Investment Income, they are part of your AGI, which can push other income above the $200,000 threshold ($250,000, married) subject to this tax.

5) If your premiums for Medicare Parts B and D are increased due to your income, a QCD can reduce your AGI.

You can make a QCD from a SEP or SIMPLE IRA, provided you are no longer making contributions to the account. You can also make a QCD from a Roth IRA, but since this money could be withdrawn tax-free, it would be preferable to make the QCD from a Traditional IRA. 401(k), 403(b), and other employer sponsored plans are not eligible for the QCD. If you want to do the QCD, you would need to rollover the account to an IRA first.

Charitable giving is close to our heart here at Good Life Wealth Management. We believe that true wealth is having the ability to fearlessly help others and to use our blessings to make the world a better place. If that’s your goal too, we can help you do this in the most efficient manner possible.

2016 Contribution Limits and Medicare Information


Inflation was almost non-existent in 2015 due to falling commodity prices. This means that for 2016, most of the IRS contribution limits to retirement accounts are unchanged. Zero inflation creates some unique problems for Social Security and Medicare beneficiaries, which we will explain.

If you are automatically contributing the maximum to your retirement plan, good for you! You need not make any changes for 2016. If your contributions are less than the amounts below, consider increasing your deposits in the new year.

2016 Contribution Limits
Roth and/or Traditional IRA: $5,500 ($6,500 if age 50 or over)
401(k), 403(b), 457: $18,000 ($24,000 if age 50 or over)
SIMPLE IRA: $12,500 ($15,500 if age 50 or over)
SEP IRA: 25% of eligible compensation, up to $53,000
Gift tax annual exclusion: $14,000 per person

Tax brackets and income phaseouts increase slightly for 2016, but there are no material changes. People are still getting used to the new Medicare surtaxes, which include a 3.8% tax on net investment income (unearned income), and a 0.9% tax on wages (earned income). The surtax is applied on income above $200,000 (single), or $250,000 (married filing jointly).

Capital gains tax remains at 15%, with two exceptions. Taxpayers in the 10% and 15% tax brackets pay 0% capital gains, and taxpayers in the 39.6% bracket pay a higher capital gains rate of 20%. For 2016, you will be in the 0% capital gains rate if your taxable income is below $37,650 (single) or $75,330 (married).

For Social Security recipients, the Cost of Living Adjustment (COLA) for 2016 is 0%. We previously had a 0% COLA in 2010 and 2011, and it creates an interesting situation for Medicare participants. Medicare Part A is offered free to beneficiaries over age 65. Medicare Part B requires a monthly premium.

Part B premiums should be going up in 2016, but about 75% of Part B participants will see no change, thanks to Social Security’s “Hold Harmless” provisions. The “Hold Harmless” rule stipulates that if Medicare Part B costs increase faster than Social Security COLAs, beneficiaries will not have their SS benefits decline from the previous year. And since there is no COLA for 2016, any Medicare Part B premium increase would cause SS benefits to negative.

For the past three years, Part B premiums have remained at $104.90 per month. You are eligible for no increase under the “Hold Harmless” rule, if you are having your Part B payments deducted from your Social Security benefit AND you are not subject to increased Medicare premiums under the Income Related Monthly Adjustment Amount (IRMAA).

For most Part B recipients, Medicare premiums are fixed. For higher income participants, IRMAA increases your premium, as follows for 2016:

MAGI $85,000 (single), $170,000 (married): $170.50
MAGI $107,000 (single), $214,000 (married): $243.60
MAGI $160,000 (single), $320,000 (married): $316.70
MAGI $214,000 (single), $428,000 (married): $389.80

If you fall into one of these income categories, above $85,000 (single) or $170,000 (married), you are ineligible for the “Hold Harmless” rule and will have to pay the premiums above, even if this causes your Social Security benefit to decline from 2015.

If you are delaying your Social Security benefits and pay your Part B premiums directly, you are also ineligible for the “Hold Harmless” rule. Finally, if you did not participate in Social Security, for example, teachers in Texas, you would also not be eligible for the “Hold Harmless” rule.

What Should You Expect from Social Security?

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The big surprise this week was that the new budget approved by Congress and signed by President Obama on Monday abolishes two popular Social Security strategies for married couples. The two strategies that are going away are:

1) File and Suspend. A spouse could file his or her application but immediately suspend receiving any benefits. This would enable the other spouse to be eligible for a spousal benefit, while the first spouse could continue to delay benefits to receive deferred retirement credits until age 70.

2) Restricted Application. Also called the “claim now, claim more later” strategy, this would allow a spouse to restrict their application to just their spousal benefit at age 66, while continuing to defer and grow their own benefit until age 70.

Both of these strategies were ways for married couples to access a smaller spousal benefit, while still deferring their primary benefits until age 70 for maximum growth. And now, these strategies will be gone in 6 months from today. It was estimated that these strategies could provide as much as $50,000 in additional benefits for married couples. Needless to say, people close to retirement who were planning on implementing these strategies feel disappointed and upset.

Some Baby Boomers have done a lousy job of saving for retirement and are going to be heavily reliant on Social Security. According to Fidelity Investments, the average 401(k) balance as of June 30 was $91,100 and their average IRA balance is $96,300. If an investor had both an average IRA and 401(k), they’d still have only $187,400. But those figures don’t tell the true depth of the problem facing our nation, because those “average balances” don’t count the 34% of all employees who have zero saved for retirement. For many retirees, savings or investments are not going to be a significant source of retirement income.

Looking at current beneficiaries, the Social Security Administration notes that 53% of married couples and 74% of single individuals receive at least 50% of their income from Social Security. For 47% of single beneficiaries, Social Security is at least 90% of their retirement income! As of June 2015, the average monthly benefit is only $1,335, so that should give you some idea of how little income many retirees have today.

Our country simply cannot afford to let Social Security fail, and yet the current approach is unsustainable. People think that Social Security is a pension or savings program, but it is not. It is an entitlement program where current taxes go to current beneficiaries. Back in the years when the ratio of contributors to retirees was 5 to 1, there was a surplus of taxes which was saved in the Social Security Trust Fund. Currently, there are only 2.8 workers per beneficiary and since 2010 Social Security benefits paid out have exceeded annual revenue into the program. By 2035, there will be only 2.1 workers per beneficiary, and this demographic change is the primary reason the system cannot work in its current form.

Today’s estimate is that the Trust Fund will be depleted by 2034. The Disability Trust Fund will be depleted next year, in 2016, at which time funds will have to shifted within Social Security to pay for Disability benefits not covered by payroll taxes.

The 2015 Trustees Report calculates that to fix Social Security for the next 75 years, the actuarial deficit is 2.68% of taxable payroll. This represents an unfunded obligation with a present value of $10.7 Trillion. Every year, the Trustee’s Report tells Congress the size of the shortfall, so Congress can take steps to either reduce benefits or raise taxes to correct the problem.

Unfortunately, changing Social Security has become a “hot potato” which no politician wants to touch. For those who have been brave enough to propose a solution, they are attacked with one-liner sound bites, accusing them of “trying to take away your Social Security benefits.” It is so disappointing that our elected officials cannot come together on a solution to ensure the solvency of our primary source of national retirement income.

It was surprising that the two Social Security claiming strategies were abolished so quickly and with such little opposition or discussion. This will save Social Security a small amount, but it’s doubtful this will make any material improvement in the program’s long-term viability.

For workers close to retirement, it seems unlikely that there will be any significant changes to the Social Security system as we know it today. The best thing you can do is to delay benefits from age 62 to age 70, which will result in a 76% increase in benefits. If you live a long time (to your late 80’s or longer), you will end up receiving greater lifetime benefits for having waited, and the guaranteed income from Social Security will decrease the “longevity risk” that you will deplete your portfolio over time.

For younger workers, I think it is highly probable that we will see the Full Retirement Age increase or a change in how the Cost of Living Adjustments are calculated. For high earners, I believe that you will see the current income cap of $118,500 increase significantly or be removed altogether. Another proposal is to apply a Social Security tax to unearned income, such as dividends and capital gains, to prevent business owners from shifting income away from wages in order to avoid taxes.

I think the strongest approach for investors will be to save aggressively so that your nest egg can be the primary source of your retirement income. Then you can consider any Social Security benefits as a bonus.

The Secret Way to Contribute $35,000 to a Roth IRA

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Roth IRAs are incredibly popular and for good reason: the ability to invest into an account for tax-free growth is a remarkable benefit. Unlike a Traditional IRA or Rollover IRA, there are no Required Minimum Distributions, and you can even leave a Roth IRA to your heirs without their owing any income tax. For retirement income planning, $100,000 in a Roth IRA is worth $100,000, whereas $100,000 in a Traditional IRA may only net $60,000 to $75,000 after you pay federal and state income taxes.

The only problem with the Roth IRA is that many investors make too much to be able to contribute and even those who can contribute are limited to only $5,500 this year. If you’re a regular reader of my blog, you may recall a number of posts about the “Back-Door Roth IRA”, which is funded by making a non-deductible Traditional IRA contribution and immediately making a Roth Conversion.

But there is another way to make much bigger Roth contributions that is brand new for 2015. Here it is: many 401(k) plans offer participants the ability to make after-tax contributions. Typically, you wouldn’t want to do this. You’d be better off making a tax-deductible contribution.

When you separate from service (retire, quit, or leave) and request a rollover, many 401(k) plans have the ability to send you two checks. One check will consist of your pre-tax contributions and all earnings, and the second check will consist of your after-tax contributions.

What can you do with these two checks? This was a gray area following a 2009 IRS rule. If the distributions were from an IRA, you would have to treat all distributions as pro-rata from all sources; i.e. each check would have the same percentage of pre-tax and after-tax money in it.

Remarkably, the IRS ruled in 2014 that when a 401(k) plan makes a full distribution, it can send two checks and each check will retain its unique character as a pre-tax or after-tax contribution. No pro-rata treatment is required. This will allow you to rollover the pre-tax money into a Traditional IRA and the after-tax money into a Roth IRA. This rule applies only when you make a full distribution with a trustee to trustee transfer.

Since this is a new rule for 2015, it is likely that your HR department, 401(k) provider, and CPA will have no idea what you are talking about, if you ask. Refer them to IRS Notice 2014-54. Or better yet, refer them to me and I can explain it in plain English!

Even though the salary deferral limit on a 401(k) is only $18,000, the total limit for 2015 is actually $53,000 or 100% of income. So you should first contribute $18,000 to your regular, pre-tax 401(k). Assuming there is no company match or catch-up, you could then contribute another $35,000 to the after-tax 401(k) to reach the $53,000 limit.

Let’s say you do this for five years and then retire or change jobs. At that point, you would have made $175,000 in after-tax contributions which could be converted into a Roth IRA, and since your cost basis was $175,000, there would be no tax due.

The earnings on the after-tax 401(k) contributions would be included with your other taxable sources of funds and rolled into a Traditional IRA. Only your original after-tax contributions will be rolled into the Roth account. Please note that this two-part rollover only works when you separate from service and request a FULL rollover. You may not elect this special treatment under a partial withdrawal or an in-service distribution.

Lastly, before attempting this strategy, make sure your 401(k) plan allows for after-tax contributions and will send separate checks for pre-tax and after-tax money. While this strategy is perfectly legal and now explicitly authorized by the IRS Notice, 401(k) plans are not required to allow after-tax contributions or to split distribution checks by sources. It’s up to each company and its plan administrator to determine what is allowed. The IRS Notice stipulates that this process is also acceptable for 403(b) and 457 plans, in addition to 401(k) plans.

Not sure if this works with your 401(k)? Call me and I will review your plan documents, enrollment and distribution forms, and call your plan administrators to verify. I think this would be a great approach for someone who is a handful of years away from retirement who wanted to stuff as much as possible into retirement accounts. Additionally, anyone who has the means to contribute more than $18,000 to their 401(k) each year might also want to consider if making these after-tax contributions would be a smart way to fund a significant Roth IRA.

Choosing a Small Business Retirement Plan


If you own your own business, or are self-employed, there are a myriad of options for establishing a retirement plan for yourself and your employees. If you want to attract and retain high quality employees, you need to be able to offer wages and benefits that are competitive within your industry. There are many employees who will prefer a job that includes the stability of a robust benefits program over a job that just offers a higher salary.

I am surprised how often owners of small businesses balk at establishing a retirement plan. Yes, it may entail some additional costs and extra administrative work. Some business owners aren’t planning to retire, so they aren’t focused on creating a retirement nest egg. Of course, if you think your employees feel the same way – that they want to work for you until they die, you may be overestimating the attractiveness of your workplace!

Establishing a company retirement plan doesn’t need to be complicated or have unknown, limitless expenses. There are quite a few benefits to starting a plan, including:

  • Being able to move company profits into a creditor-protected account for the owner and his or her family as a tax deductible business expense.
  • Creating assets that are separate from your company. Diversifying your net worth so your wealth is not 100% linked to the value of your company. What would your spouse be able to do with your company, if you were hit by a bus tomorrow?
  • Providing valuable benefits so you can hire and keep top quality employees. Offering your employees a program to encourage their own retirement saving.

Luckily, there are a number of retirement plan options for employers, each with its own unique benefits. Here is a quick overview of six retirement plans to consider and a profile of the ideal candidate for each.

1) 401(k). The 401(k) is the gold standard of retirement plans, and while it would seem to be the obvious choice, 401(k) plans can be expensive, complicated, and often a poor fit for a smaller company. Many 401(k) providers are happy to work with your company if you have $500,000 or $1 million in plan assets, but fewer are willing to work with start-up plans or companies with fewer than 50 full-time employees.

Sometimes employers decide to offer a 401(k) but are not willing to provide a matching contribution. You may think you’re adding a benefit, but this often backfires. You will have very low participation without a match, so the administrative cost per employee and the fixed costs for the amount of assets in the plan ends up being higher. And since 401(k)’s have “top heavy” testing, the higher paid employees who do want to participate are often told that they have contributed too much to the plan and that they have to remove some or all of their contributions. No one wins in this situation.

The solution to avoiding the top heavy testing is to establish a “safe harbor” plan, but this will require that the company provides a matching contribution.

Best candidate for a 401(k): a company who is willing to provide a matching contribution for employees and will have at least 10 or 20 participants in the plan (actual participants, not just eligible employees). Without the company willingness to offer a match, I’m not sure the plan will satisfy the needs of the owner or the employees. 401(k)’s tend to have a better participation rate in companies with higher paid, white collar employees.

2) SIMPLE IRA. The Savings Incentive Match PLan for Employees (SIMPLE) was created to enable employers with fewer than 100 employees to be able to offer a “401(k)-like” plan, without complicated rules or high administrative costs. Employees choose to participate and have money withheld from their paycheck. They may contribute up to $12,500 for 2015; if over age 50, they may contribute an additional $3,000. The company will match employee contributions up to 3% of their salary.

If you have payroll of $200,000 a year, and ALL employees participate, you’d match $6,000 of their contributions. The company match is a tax deductible business expense. Both employee and employer contributions vest immediately and are held in each employee’s name where the employee chooses how to invest their account. If a participant makes a withdrawal in the first two years, the penalty is 25%. If the withdrawal is after two years, but before age 59 1/2, the penalty is 10%. For the business owner, there is no top heavy testing, so you may contribute the maximum (plus the match) to your own account, regardless of whether your employees choose to participate or not.

Best candidate for a SIMPLE IRA: any company with 2-100 employees that is willing to match 3% of employee contributions and wants a plan that is easy to administer and low cost. More owners should be looking at the SIMPLE rather than trying to make a 401(k) fit. It’s a great option. There are two reasons why you might choose a 401(k) instead. The first would be if you plan to have more than 100 employees. Second, if you think many of your employees will want to contribute more than $12,500 in a SIMPLE, they could contribute $18,000 to a 401(k). If neither of those reasons apply, a SIMPLE is a great alternative to a 401(k).

3) SEP-IRA. The Simplified Employee Pension (SEP) is an employer-funded plan. The employee does not contribute any money to a SEP; employer contributions are elective and can vary from year to year. However, the company must provide the same percent contribution to all eligible employees, from zero to 25% of salary. The maximum contribution for 2015 is $53,000 (at $265,000 of net income). Contributions are a tax deductible business expense.

If you are looking for a profit-sharing type of plan that allows the employer flexibility of how much to contribute each year, the SEP may be a good fit. In practice, the vast majority of SEP plans are established by sole proprietors or other self-employed individuals who do not have any employees, other than possibly a spouse. Since your contribution amount to a SEP depends on your profits, it is impossible to know the exact amount you can contribute until you do your taxes. Most SEP contributions occur in April, but the unique thing about a SEP is that it is the only IRA which you can fund after the April 15 deadline. If you file an extension, you can contribute to a SEP all the way up to October 15 on your individual return, or September 15 on a corporate return.

Best candidate for a SEP: a business owner with no additional employees. Note that any 1099 independent contractors you hire are not eligible for your company SEP, only W-2 employees.

4) Individual 401(k). Also called a “Solo 401(k)” or “Self-Employed 401(k)” sometimes, this is just a regular 401(k)/Profit Sharing plan where a custodian has created a set of boilerplate plan documents to facilitate easy administration. Even though the Individual 401(k) is for a single individual (and spouse) who is self-employed, there are technically two contributions being made: as the employee, you can make a salary deferral contribution (up to $18,000), and then as the employer, you can make a profit sharing contribution, up to 25% of net income. The plan has the same total contribution limit as a SEP, but because of the 2-part structure of the contributions, people with under $265,000 in net income can often contribute more the the Individual 401(k) than they can to a SEP.

The Individual 401(k) is what I have used for myself for my work as a financial advisor. I am also then able to make a SEP contribution based on my (small) earnings as a free-lance musician. Note that once your Individual 401(k) assets exceed $250,000, you will be required to submit a form 5500 to the IRS each year. If you are interested in an Individual 401(k), we can establish one for you with our custodian, TD Ameritrade.

Best candidate for an Individual 401(k): Self-employed person, with no employees (and no plans for employees), who wants their own 401(k) and plans to contribute more than they can to an IRA.

5) Traditional IRA. The Traditional IRA is not an employer-sponsored retirement plan. However, if you are single and do not have an employer-sponsored plan, you can contribute up to $5,500 to a Traditional IRA as a tax-deductible contribution, regardless of how much you make. Or, if you are married and your spouse is also not eligible for an employer-sponsored plan, then you can each contribute $5,500 into a Traditional IRA, with no income restrictions. I point this out, because if you don’t have any employees and only plan to contribute $5,500 (or $11,000 jointly) each year, then you don’t need to start a 401(k) or any of these other plans. Just do the Traditional IRA.

Best candidate for the Traditional IRA: a business owner not looking to offer an employee benefit, who will contribute under $5,500 per year.

6) Defined Benefit Plan (Pension Plan). 401(k) plans are “Defined Contribution” plans, where the employee makes the majority of the contributions and determines how to invest their account. At the other end of the spectrum is the Defined Benefit Plan, or Pension Plan, where the employer makes all the contributions, manages the investment portfolio, and guarantees the participants a retirement pension. Undoubtedly, there are fewer and fewer large employers offering DB plans today because of their cost and complexity. However, for a specific set of situations, a DB Plan can be a brilliant way to make very large contributions on behalf of owners and highly-paid employees of small companies. The Plan will aim to provide a set benefit, for example, 50% of the final salary, with 30 years of service, at age 65. Each year, the plan’s actuary will calculate how much the company needs to contribute to the plan’s account to be on track to offer this benefit for all eligible employees. Obviously, the amount contributed for employees who are older will be higher, as will be the amount contributed for higher income employees.

The plan does not need to pay pension benefits for an indefinite period. Assuming the owner is the oldest employee, he or she can simply shut down the plan when he or she retires and then distribute the plan assets into IRAs for vested participants. In a situation where the owner is much older (say 61, versus employees in their 30’s and 40’s), and the owner makes $300,000 versus employees who make $50,000, the vast majority of the assets will be distributed to the owner upon dissolution of the plan. The DB Plan can be in addition to a DC Plan, like a 401(k), and is a great way to maximize contributions for an owner with very high earnings who is planning to retire in a couple of years.

Best candidate for a DB Plan: high earners who are older, who will retire and shut down their business, and who have a couple of much younger employees. Many small law firms and medical practices fit this profile exactly. If you have been lamenting that the $53,000 limit in a Profit Sharing Plan is too low for you, consider adding a DB Plan.

At Good Life Wealth Management, retirement planning is our forte. We can help you determine the best plan for your needs and make it easy for you and your employees to get started. Drop me a line and let’s schedule a time to talk about how we can work together.

Guaranteed Income Increases Retirement Satisfaction

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Several years ago, for a client meeting, I prepared a couple of Monte Carlo simulations to show a soon to be retired executive possible outcomes of taking his pension as a guaranteed monthly payment, versus taking a lump sum, investing the proceeds, and taking withdrawals. When I showed that the taking the pension increased the probability of success by a couple of percent, my boss promptly cut me off, and warned the client that if they didn’t take the lump sum they would have no control of those assets and would not be able to leave any of those funds to their heirs. That’s true, but my responsibility was to present the facts as clearly as possible for the client to make an informed choice, without injecting my own biases.

The fact is that retirees who are able to fund a larger portion of their expenses from guaranteed sources of income are less dependent on portfolio returns for a successful outcome. New research is finding that retirees with higher levels of guaranteed income are also reporting greater retirement satisfaction and less anxiety about their finances. Sources of guaranteed income include employer pensions, Social Security, and annuities. This is contrasted with withdrawals from 401(k) accounts, IRAs, and investment portfolios.

For the last two decades, the financial planning profession has been advocating 4% withdrawals from investment portfolios as the best solution for retirement income. Unfortunately, with lower interest rates on bonds and higher equity valuations, even a conservative 4% withdrawal today, increased annually for inflation, might not last for a 30+ year retirement. (See my white paper, 5 Reasons Why Your Retirement Withdrawals are Too High, for details.)

Professor Michael Finke from Texas Tech, writing about a Successful Retirement, found that, “The amount of satisfaction retirees get from each dollar of Social Security and pension income is exactly the same — and is higher than the amount of satisfaction gained from a dollar earned from other sources of income. Retirees who rely solely on a defined contribution plan to fund retirement are significantly less satisfied with retirement.”

Emotionally, there are a couple of reasons why guaranteed income is preferred. It mimics having a paycheck, so retirees are comfortable spending the money knowing that the same amount will be deposited next month. On the other hand, investors who have saved for 30 or 40 years find it very difficult to turn off that saving habit and start taking withdrawals from the accounts they have never touched.  Although taxes on a $40,000 withdrawal from an IRA are the same as from $40,000 income received from a pension, as soon as you give an individual control over making the withdrawals, they want to do everything possible to avoid the tax bill.

The biggest fear that accompanies portfolio withdrawals is that a retiree will outlive their money. No one knows how the market will perform or how long they will live. So it’s not surprising that retirees who depend on withdrawals from investments feel more anxiety than those who have more guaranteed sources of income. The 2014 Towers Watson Retiree Survey looked at retirees’ sources of monthly income and found that 37% of retirees who had no pension or annuity income “often worry” about their finances, compared to only 24% of retirees who received 50% or more of their monthly income from a pension or annuity.

While I’ve pointed out the negative outcomes that can occur with portfolio withdrawals, in fairness, I should point out that in a Monte Carlo analysis, investing a pension lump sum for future withdrawals increases the dispersion of outcomes, both negative and positive. If the market performs poorly, a 4% withdrawal plan might deplete the portfolio, especially when you increase withdrawals for inflation each year. However, if the market performs on average, it will likely work, and if the initial years perform better than average, the portfolio may even grow significantly during retirement. So it’s not that taking the lump sum guarantees failure, only that it makes for a greater range of possible outcomes compared to choosing the pension’s monthly payout.

What do you need to think about before retirement? Here are several steps we take in preparing your retirement income plan:

1) Carefully examine the pension versus lump sum decision, using actual analysis, not your gut feeling, heuristic short-cuts, or back of the envelope calculations. If you aren’t going to invest at least 50% of the proceeds into equities, don’t take the lump sum. Give today’s low interest rates, the possibility of retirement success is very low if you plan to invest 100% in cash, CDs, or other “safe” investments.

2) Consider your own longevity. If you are healthy and have family members who lived for a long time, having guaranteed sources of income can help reduce some of the longevity risk that you face.

3) Social Security increases payments for inflation, whereas most pension and annuities do not, so we want to start with the highest possible amount. We will look at your Social Security options and consider whether delaying benefits may improve retirement outcomes.

4) If your guaranteed income consists only of Social Security, and is less than 25% of your monthly needs, you are highly dependent on portfolio returns. Consider using some portion of your portfolio to purchase an annuity. If you are several years out from retirement, we may consider a deferred annuity to provide a future benefit and remove that income stream from future market risks. If you are in retirement, we can consider an immediate annuity. For example, a 65-year old male could receive $543 a month for life, by purchasing an immediate annuity today with a $100,000 premium.

Annuities have gotten a bad rap in recent years, due in large part to unscrupulous sales agents who have sold unsuitable products to ill-informed consumers. However, like other tools, an annuity can be an appropriate solution in certain circumstances. While many financial planning professionals still refuse to look at annuities, there has been a significant amount of academic research from Wade Pfau, Michael Finke, and Moshe Milevsky finding that having guaranteed income may improve outcomes and satisfaction for retirees. This growing body of work has become too substantial to ignore. I believe my clients will be best served when we consider all their options and solutions with an open mind.

Our First Year, in Review


It’s our one-year anniversary at Good Life Wealth Management and we want to thank all of our clients, readers, and friends for your support this year. We’re only getting started with the great things we want to do, so please keep following for future news!

We’re donating 10% of our profits for 2015 to Operation Kindness and there’s nothing we would love more than being able to write them a large check at the end of the year. If you’re looking for a financial advisor, want to make a change in your current approach (or lack thereof), or just want a second opinion, please don’t hesitate to give us a call.

Over the past year, I’ve posted 53 articles to share important financial planning concepts which can help you achieve your goals. Chances are good that if you have a common financial question, I may have written about it already. Here are the articles we’ve posted over the past year; if you see one of interest, please click on the link. Thank you for reading!


Introducing Good Life Wealth Management

Three Studies for Smart Investors

6 Steps to Save on Investment Taxes

Who’s Going to Pay for Your Retirement, Freelancer?

Why Alan Didn’t Rollover His 401(k)

8 Questions Grandparents Ask About 529 Plans

How to Maximize Your Social Security

A Young Family’s Guide to Life Insurance

Catching Up For Retirement

Student Loan Strategies: Maximizing Net Worth

Health Savings Accounts

Socially Responsible Investing

Retirement Withdrawal Rates

Machiavelli and Happiness in an Age of Materialism

5 Tax Mistakes New Retirees Must Avoid

The AFM Pension Plan: What Every Musician Needs to Know

5 Techniques for Goal Achievement

The Geography of Retirement

Bringing Financial Planning to All

Community Property and Marriage

Adversity or Opportunity?

Retirement Cash Flow: 3 Mistakes to Avoid

5 Tax Savings Strategies for RMDs

5 Ways to Save Money When Adopting a Pet

How Some Investors Saved 50% More

An Attitude of Gratitude

5 Retirement Strategies for 2015

Are Your Retirement Expectations Realistic?

Year-End Tax Loss Harvesting

What Not to Do With Your 401(k) in 2015

The Dangers Facing Fixed Income in 2015

Are Equities Overvalued?

A Business Owner’s Guide to Social Security

Should You Invest in Real Estate?

How to Become a Millionaire in 10 Years

Indexing Wins Again in 2014

Get Off the Sidelines: 3 Ways to Put Cash to Work

Proposed Federal Budget Takes Aim at Investors

4 Strategies to Reduce the Medicare Surtax

Retiring Soon? How to Handle Market Corrections

Three Things Millennials Can Teach Us About Money

Deferral Rates Trump Fund Performance

How Much Can You Withdraw in Retirement?

Growth Versus Value: An Inflection Point?

Our Investment Process

Which IRA is Right for You?

Rethink Your Car Expenses

Will the IRS Inherit Your IRA?

Fixed Income: Four Ways to Invest

Setting Your Financial Goals

Giving: What’s Your Plan?

Are We Heading For a Bear Market?

Should You Hedge Your Foreign Currency Exposure?


Have a question or a topic you’d like to learn more about? Send your questions to