USA TODAY International Edition
Going rogue in retirement
Smash these usual rules of personal finance,
In the absence of a personalized financial plan, you might think it OK to rely on conventional wisdom when planning for and living in retirement. But you would be wrong, experts say.
In fact, conventional financial wisdom can be dangerous to your wealth. Here are some pearls of wisdom worth reconsidering.
DON’T TAKE ANY MORE INVESTMENT RISK THAN YOU’RE COMFORTABLE WITH.
The financial services industry likes questionnaires to determine an investor’s risk tolerance. But these questionnaires don’t always help investors reach their goals.
“It doesn’t matter what ( an investor) prefers, but rather what is the minimum investment risk necessary to provide the highest probability of success,” says Jim Christian, a financial adviser in Lakeville, Minn. “‘ Success’ being defined by not running out of money before running out of years.”
Bottom line: If you invest conservatively because that’s what you prefer instead of how you should invest, you run the risk of going broke or living below your desired standard of living.
YOU’LL BE IN A LOWER TAX BRACKET WHEN YOU RETIRE.
You might be. But likely not, says Frank St. Onge, a certified financial planner with Total Financial Planning, in Brighton, Mich. And that’s especially so if you own IRAs.
Consider: You have to take required minimum distributions from your IRA once you reach age 70 ½ . And those RMDs can wreak havoc on best- laid retirement plans. “The RMD amount will, for many people, cause an almost equal amount of Social Security benefits to become taxable,” says St. Onge.
Remember: If you file a joint return, and you and your spouse have a combined income that is between $ 32,000 and $ 44,000, you may have to pay income tax on up to 50% of your benefits; and if your combined income is more than $ 44,000, up to 85% of your benefits may be taxable.
St. Onge’s advice: Consider converting some or all of your IRA to a Roth IRA before you start taking Social Security.
PAY MORE ON YOUR MORTGAGE EACH MONTH TO REDUCE A 30- YEAR MORTGAGE TO A 20- YEAR MORTGAGE.
The better thing to do: Save the extra payment amount each month and invest it. “If you did that, the amount of savings would far exceed the value of your mortgage balance at the end of the 20- year period, at which time you could elect to pay off the mortgage and still have plenty left over,” says St. Onge.
His advice: Invest the money in a Roth IRA and you will be even further ahead as the growth and distributions would be taxfree. Plus, you’ll still be able to deduct your mortgage interest each year.
USE 529 EDUCATION ACCOUNTS FOR YOUR CHILDREN’S EDUCATION.
St. Onge thinks there’s a better option. Use a Roth IRA to fund your retirement and, if needed when your child is ready for college, draw out the contribution amounts to pay the education bills. You can withdraw the amounts you’ve contributed to a Roth IRA tax- free.
Why does this strategy make sense? You can use a 529 plan only to pay for college costs. But that’s not the case with a Roth IRA. “You know you will be retiring in the future; you do not know if you will need education money to pay for schooling in 18 or so years down the road,” St. Onge says.
FULLY FUND YOUR 401(K).
Experts will often tell you to contribute as much as possible, up to the maximum allowed, in your 401( k). But not Don James, a certified public accountant with Kiplinger & Co. in Strongsville, Ohio.
James recommends that workers, and especially Millennials new to the workforce, contribute to their 401( k) as much as needed to receive their full employer’s match and then contribute anything additional into a Roth IRA.
One reason why: It gives you account diversification. By having different types of retirement accounts, one from which distributions are taxed as ordinary income ( your 401( k) and IRA) and one from which distributions are tax- free ( Roth IRA), you’ll have the opportunity to withdraw money in the most tax- efficient manner possible later on.
CONTRIBUTE TO A TRADITIONAL IRA.
Millennials might also consider not contributing to a traditional IRA. Instead, they should contribute to a non- deductible IRA and immediately convert it to a Roth IRA, says James. If they have a traditional IRA, they can’t convert to a Roth IRA without tax consequences.
When might Millennials consider doing this? When they can no longer contribute to a Roth IRA. And that could happen, says James, as their careers advance and salaries rise. For 2015, if your filing status is married filing jointly and your modified adjusted gross income ( MAGI) is less than $ 183,000, you can contribute up to the limit — $ 5,500, or $ 6,500 if you’re 50 or older. If your MAGI is $ 183,000 to less than $ 193,000, then you can contribute a reduced amount. And if your MAGI is $ 193,000 or more, you can’t contribute to a Roth IRA.
100 MINUS YOUR AGE.
One bit of conventional wisdom would have you invest the difference between 100 and your age in stocks. In other words, if you’re 20, you’d invest 80% of your portfolio in stocks. And if you’re 80, you’d invest 20% in stocks.
But that “is probably the worst rule of thumb that is regularly quoted,” says H. Jude Boudreaux, a certified financial planner and founder of Upperline Financial Planning in New Orleans. “This ( rule of thumb) often has relatively conservative young people over- invested in stocks that will scare them out of down markets and has them taking unnecessary risk,” he says. And for older investors, he says, it’s not really useful either, because most 60year- old clients I’ve seen probably need more than 40% of their portfolio in stocks, especially in this low- yield environment.”
Conventional wisdom can steer investors wrong, so sometimes you have to go rogue