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When It’s Time to Stop Saving for Retirement

Re-posted from Investopedia

You’ve done all the right things – financially speaking, at least – to get ready for retirement. You started saving early to take advantage of the power of compounding, maxed out your 401(k) and individual retirement account (IRA) contributions every year, made smart investments, squirreled away money into additional savings, paid down debt and figured out how to maximize your Social Security benefits.

Now what? When do you stop saving – and start enjoying the fruits of your labor?

A Nice Problem to Have (But a Problem All the Same)

Many people who have saved consistently for retirement have trouble making the transition from saver to spender when the time comes. Careful saving – for decades, after all – can be a hard habit to break. “Most good savers are terrible spenders,” says Joe Anderson, CFP, president of Pure Financial Advisors, Inc. in San Diego.

It’s a challenge most Americans will never face: More than half (55%) are at risk of being unable to cover essential living expenses – housing, healthcare, food and the like – during retirement, according to a recent study from Fidelity Investments.

Even though it’s an enviable predicament, being too thrifty during retirement can be its own kind of problem. “I see that many people in retirement have more anxiety about running out of money than they had working very stressful jobs,” says Anderson. “They begin to live that ‘just in case something happens’ retirement.”

Ultimately, that kind of fear can be the difference between having a dream retirement and a dreary one. For starters, penny-pinching can be hard on your health, especially if it means skimping on healthy food, not staying physically and mentally active, and putting off healthcare. (For more, see 7 Signs You’re Spending Too Little in Retirement.)

Being stuck in saving mode can also cause you to miss out on valuable experiences, from visiting friends and family to learning a new skill to traveling. All these activities have been linked to healthy aging, providing physical, cognitive and social benefits. (For more, see Retirement Travel: Good and Good for You.)

One reason people have trouble with the transition is fear: in particular, the fear that they will outlive their savings or have medical expenses that leave them destitute. One thing to keep in mind that spending naturally declines during retirement in several ways. You won’t be paying Social Security and Medicare taxes anymore, for example, or contributing to a retirement plan. Plus, many of your work-related expenses – commuting, clothing and frequent lunches out, to name three – will cost less or disappear.

To calm people’s nerves, Anderson does a demo for them: “running a cash-flow projection based on a very safe withdrawal rate of 1% to  2% of their investable assets. Through the projection they can determine how much money they will have, factoring in their spending, inflation, taxes, etc. This will show them that it’s OK to spend the money.”

Another reason some retirees resist spending is that they have a particular dollar figure in mind that they want to leave their kids or some other beneficiary. That’s admirable – to a point. It doesn’t make sense to live off peanut butter and jelly during retirement just to make things easier for your heirs. (For more, see Designating a Minor as an IRA Beneficiary.)

“Retirees should always prioritize their needs over their children’s,” says Mark Hebner, founder and president of Index Fund Advisors in Irvine, Calif.  “Although it is always the desire for parents to take care of their children, it should never come at the expense of their own needs while in retirement. Many parents don’t want to become a burden on their children in retirement and ensuring their own financial success will make sure they maintain their independence.”

When to Start Spending

Since there’s no magical age that dictates when it’s time to switch from saver to spender (some people can retire at 40 while most have to wait until their 60s or even 70+), you have to consider your own financial situation and lifestyle. A general rule of thumb says it’s safe to stop saving and start spending once you are debt-free and your retirement income from Social Security, pension, retirement accounts, etc. can cover your expenses and inflation.

Of course, this approach only works if you don’t go overboard with your spending; creating a budget can help you stay on track. (For more, see The Complete Guide to Planning a Yearly Budget.)

Line in the Sand

Even if you find it hard to spend your nest egg, you’ll have to start cashing out a portion of your retirement savings each year once you turn 70-1/2  years old. That’s when the IRS requires you to take required minimum distributions, or RMDs, from your IRA, SIMPLE IRASEP IRA or retirement plan accounts (Roth IRAs don’t apply) – or risk paying tax penalties. And these aren’t trivial penalties: If you don’t take your RMD, you will owe the IRS a penalty equal to 50% of what you should have withdrawn. So, for example, if you should have taken out $5,000 and didn’t, you’ll owe $2,500 in penalties.

If you’re not a big spender, RMDs are no reason to freak out. “Although RMDs are required to be distributed, they are not required to be spent,” Charlotte A. Dougherty, CFP, of Dougherty & Associates in Cincinnati, points out. “In other words, they must come out of the retirement account and go through the ‘tax fence,’ as we say, and then can be directed to an after-tax account which then can be spent or invested as goals dictate.”

As Thomas J. Cymer, DFP, CRPC, of Opulen Financial Group in Arlington, Va., notes: If individuals “are fortunate enough to not need the funds they can reinvest them using a regular brokerage account. Or they may want to start using this forced withdrawal as an opportunity to make annual gifts to grandkids, kids or even favorite charities (which can help reduce the taxable income). For those who will be subject to estate taxes these annual gifts can help to reduce their taxable estates below the estate tax threshold.”

Since RMD rules are complicated, especially if you have more than one account, it’s a good idea to check with your tax professional to make sure your RMD calculations and distributions meet current requirements.

The Bottom Line

You may be perfectly happy living on less during retirement and leaving more to your kids. Still, allowing yourself to enjoy some of the simple pleasures – whether it’s traveling, funding a new hobby or making a habit of dining out – can make for a more fulfilling retirement.

And don’t wait too long to start: Early retirement is when you’re likely to be most active, as The 4 Phases of Retirement and How to Budget for Them makes clear.

Read more: When It’s Time to Stop Saving for Retirement | Investopedia https://www.investopedia.com/articles/personal-finance/021816/when-its-time-stop-saving-retirement.asp#ixzz52ZWCAOIj
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Every Millennial Should Fund A Roth IRA

Reposted from Forbes.com

Personal finance is more personal than it is finance.

Much—too much—has been said and written about the relative superiority of Roth IRAs versus Traditional IRAs. The debate over which is better too often involves the technical numerical merits. In truth, the Roth wins in almost every situation because of its massive behavioral advantage: a dollar in a Roth IRA is (almost) always worth more than a dollar in a Traditional IRA. This is true regardless of one’s age, but the Roth IRA is even more advantageous for Millennials.

I must first disclaim that you can disregard any discussion of Roth or Traditional IRA if you’re not taking full advantage of a corporate match in your employer’s 401(k)—free money is still better than tax-free money. But after you’ve “maxed out” the match in your corporate retirement account, here are the top three reasons Millennials should consider putting their next dollar of savings in a Roth IRA:

1) Life is liquid, but most retirement savings isn’t.

Yes, of course, in a perfect, linear world, every dollar we put in a retirement account would forevermore remain earmarked for our financial futures. But hyperbolic discounting—and the penalties and tax punishments associated with early withdrawal from most retirement savings vehicles—can scare us away from saving today for the distant future. The further the future, the more we fear.

The Roth IRA, however, allows you to remove whatever contributions you’ve made—your principal—without any taxes or penalties at any time for any reason. Therefore, even though I’d prefer you to generally employ a set-it-and-forget-it rule with your Roth and not touch it, if the privilege of liquidity in a Roth helps you save for retirement, I’m all for it.

2) There are too many competing priorities.

Millennials are dropped into the middle of a financial should-fest. You should pay down school loans, save up for a home down-payment, drive a cheap ride, purchase the proper level of insurance, enhance your credit and save three months’ worth of cash in emergency reserves. All while having a life? No chance.

Most personal finance instruction tells you what your priorities should be, and if you’re looking for that kind of direction, I’m happy to help in that regard as well. But it’s also not a mortal money sin to employ some Solomonic wisdom and compromise between, say, two worthy savings initiatives—like short-term emergency reserves and long-term retirement savings. Therefore, while I can’t go so far as to suggest that you bag the idea of building up cash savings in lieu of a Roth, I’m comfortable with you splitting your forces and dipping into your Roth IRA in the case of a true emergency. The challenge we all face is to define “true emergency” without self-deception.  (And no, splurging on concert tickets or a last minute vacation with friends don’t qualify.)

3) Roth contributions cost you less today than they will in the future.

Despite my sincerest attempt, I couldn’t avoid the more technical topic of taxes—and nor should I, in this case. That’s because it only stands to reason that you’re making less money—and therefore paying less in taxes—at the front end of your career than you will be in the future.

Therefore, in addition to beginning tax-free compounding sooner, Roth IRA contributions—which are not tax-deductible—will likely “cost you” less as a career newbie than they will as a seasoned executive. At SpaceX. On the first Mars colony. Furthermore, you can also make too much to contribute to a Roth IRA, progressively phasing out of eligibility at income of $118,000 for an individual and $186,000 for a household.

Like Coachella tickets, the opportunity to invest in a Roth IRA may not be around forever. Tax laws and retirement regulations are constantly evolving, and who knows what the future may hold. This increases their value for everyone, but especially for those who could benefit from them the most—Millennials.

I’m a speaker, author of “Simple Money” and director of personal finance for Buckingham and the BAM Alliance. Connect with me on Twitter, Google+, and click HERE to receive my weekly email.

Glasses on Retirement Summary

Choosing Between Roth and Traditional IRA’s

Among the most important decisions investors make is their choice of location for assets within the various alternatives available for retirement (tax-advantaged) accounts. Allocating between a traditional IRA (a pretax, tax-deferred account) and a Roth IRA (a post-tax, tax-free account) can have a pronounced impact on retirement outcomes, given the $14 trillion in tax-advantaged retirement account assets at the end of 2015.

David Brown, Scott Cederburg and Michael O’Doherty contribute to the literature on retirement asset location with their June 2016 paper, “Tax Uncertainty and Retirement Savings Diversification.”

The modeling approach they adopt accounted for investor age, current income and taxable income from outside sources in retirement, as well as the highly progressive income tax regime now in place. The authors point out that “the marginal rate for a single taxpayer with inflation-adjusted income of $100,000, for example, has changed 39 times since the introduction of income taxes in 1913 and has ranged from 1% to 43%.” This creates considerable uncertainty.

Because risk-averse investors (and most investors are risk averse; it’s generally only a matter of degree) dislike uncertainty, this should create a preference for Roth accounts, as they “lock in” the current rate, eliminating the uncertainty associated with future changes.

On the other hand, a traditional account, which offers retirement savers the benefit of deducting current contributions, allows investors to “manage their current taxable income around tax-bracket cutoffs, which is valuable under a progressive structure.”

Another benefit of traditional accounts, the authors write, is that “the progressive tax rates faced in retirement provide a natural hedge against investment performance. Investors with poor investment results and little wealth in retirement will pay a relatively low marginal tax rate, whereas larger tax burdens are borne by investors who become wealthy as a result of good investment performance.” This creates tension between the traditional and Roth options.

Who Should Use The Roth Structure?

The authors state: “Roth accounts are primarily useful for low-income investors who can lock in a low marginal rate by paying taxes in the current period.” They add that because “future tax rates are more uncertain over longer retirement horizons” and their analysis of historical tax changes suggests “that the rates associated with higher incomes are more variable,” eliminating “exposure to tax risk is particularly attractive for younger investors with relatively high incomes and correspondingly high savings.”

The authors continue: “Despite high current marginal tax rates, and contrary to conventional financial advice, these investors benefit the most from the tax-strategy diversification offered by Roth accounts.”

Brown, Cederburg and O’Doherty concluded: “Whereas conventional wisdom largely supports choosing between traditional and Roth accounts by comparing current tax rates to expected future tax rates, the hedging benefits of traditional accounts and the usefulness of Roth accounts in managing tax-schedule uncertainty are important considerations in the optimal savings decision.” They note that, for wealthy investors, their analysis shows “tax-strategy diversification is particularly attractive, despite their high current marginal tax rates.”

The authors also examined their findings’ economic implications: “Our results are of practical importance to employers and regulators who determine the retirement savings options available to employees. In particular, broadening access to Roth versions of workplace accounts would provide investors with important tools for managing their exposures to tax risk. Given that these accounts are available under current regulations, encouraging the widespread adoption of, and education about, employer-sponsored Roth plans could substantially improve investors’ welfare.”

What the authors found provides investors with the proper framework to make informed decisions regarding the asset location of their retirement savings and the diversification of tax risk.

This commentary originally appeared July 27 on ETF.com

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

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