Tuesday, March 22, 2016

A Follow-Up on Confusing Issues

In a recent post, I asked, “What Do You Find Most Confusing About Retirement?” You can read the comments I received and my responses, as well as responses from other retirement planners and researchers, at that link. I also searched those comments for common threads and will consolidate my (our) responses in this post.

Social Security benefits are confusing, as is the process for identifying optimal claiming ages.

Amen. I have studied Social Security benefits extensively and have concluded that it is a topic with which most retirees and planners (including me) need help. Becoming an expert requires a lot of work and understanding the rules is only the first step. You then must apply the rules optimally for a given retiree's unique financial situation, life expectancy and tolerance toward longevity risk.

My favorite Social Security guru is Mike Piper at ObliviousInvestor.com. He has updated his book, Social Security Made Simple, to include recent changes regarding file-and-suspend and I recommend it. I am also quite fond of Laurence Kotlikoff's MaximizeMySocialSecurity software to identify optimal claiming strategies.

Trying to become a Social Security benefits expert on your own will be quite frustrating.

I have trouble finding a good retirement planner.

Join the club. I haven't found a lot of retirement planners I would trust with my money and the top planners and retirement researchers with whom I have discussed this challenge completely agree. But there are good ones out there, as I suggested in the previous post.

It isn't terribly difficult to become a Chartered Financial Analyst (CFA) or Certified Financial Planner (CFP), so those credentials alone don't guarantee you've found a good planner. I put a bit more stock in Retirement Management Analysts (RMAs) because I know their training process and I have met several of them, but it's still no guarantee. I would suggest you use such designations as a baseline starting point in your search. I really only trust financial planners I know, like Dana Anspach and Mike Lonier (see their comments on my previous post) or those referred by someone I trust.

I also suggest that you review a prospect's qualifications. You can usually tell when a CPA, insurance salesman, tax preparer or stock broker has added retirement planning to the quiver. Finding a planner with insurance or investment expertise, for example, can be a good thing unless it's merely a path to generate more insurance or stock sales.

Don't limit yourself to retirement planners who are located near you. Because there are relatively few good ones, you may have to search other cities or even states. Planning via telephone and internet is perfectly viable.

Lastly, and perhaps most importantly, I recommend a fee-only planner who has no monetary  incentive to sell you products. If the planner will manage your money or provide investment advice, confirm in writing that he or she assumes fiduciary responsibility for your account. And don’t give your adviser custody of your funds! (See A New Ponzi Scheme Every Week.)

To reiterate, most of us agree that good retirement planners are hard to find, but they're out there.

“Figuring out the most tax-efficient way to distribute from IRAs, Roth IRAs, and taxable accounts at the right time is just a few too many variables for me and Excel.”

Many planners recommend that you distribute from the taxable account first, then the traditional IRA, then the Roth last, but there will be situations that dictate otherwise. It may sometimes be optimal to withdraw from two or more types of accounts in the same year and the optimal withdrawal plan may change with time. The decision between Roth and Traditional IRA withdrawals will be affected by your opinion of future tax rates, which are impossible to predict. The outcome is also tied to your Social Security claiming strategy.

The problem is so complicated that at least one company, Retiree Inc., has been formed primarily to solve this problem for retirees. The company offers to develop an optimal withdrawal plan for a fee of $500.

I like Kotlikoff's E$Planner for this. It allows you to switch the order of withdrawal and measure the results by the consumption generated. It’s less expensive (currently $149) and is a more general purpose retirement planning tool. (I have used both Kotlikoff products, but I am unfamiliar with the Retiree Inc. product. I should also note that many find E$Planner confusing to use.)

It may not work well to decide on a withdrawal plan at the beginning of retirement and stick with it come hell or high water. Your situation may change as retirement progresses, suggesting an annual review and tweaks to your strategy may be warranted.

Another reason to dynamically manage this process is that tax laws change over time. Changes are nearly impossible to predict because they are political and they can have a significant impact on your plan. Stretch IRA's, for example, appear to be in present danger. A withdrawal plan you choose today might not make sense if tax laws change.

Retirement plan distribution choices also affect creditor protection of assets. Retirement plan assets are generally better protected than assets outside a plan. When you are spending retirement plan assets you are probably decreasing you pool of protected assets. (See Is My Retirement Plan Protected?)

Find a good retirement planner with tax expertise, or one who is willing to get help from a tax expert. If you insist on doing it yourself, try E$Planner. Optimizing your withdrawal strategy can provide significant improvements, but it is, in my opinion, a second-order problem. Getting it mostly right or a little wrong won’t make or break your plan. Spending from taxable accounts, then traditional IRAs, then Roth IRAs may get you most of the way there. The more important piece of the strategy is to adapt your plan as changes dictate.

The potential for early retirement.

I wrote a few posts on this previously beginning with The Risk of Retiring (or Being Retired) Early. Retiring early is far riskier than most people assume. We say the most important factor in the cost of retirement is how long you live, but what we really mean is "how long you live in retirement." Retiring early means increasing the largest risk factor in the cost of retirement.

Retirees who ask, “Do I have enough savings to retire?” are often frustrated when they can get a yes or no answer. The issue is far more complicated. A better question would be, “Do I have enough savings to retire and maintain my desired standard of living with an acceptable risk of not going broke before I die?”

Two of the critical pieces of that question can be answered by you alone. What is your desired standard of living? What do you consider an acceptable risk of going broke before you die?

Retiring earlier is significantly riskier than retiring later, so the correct answer to the question, "Can I retire early?" is "Maybe – we'll need to run the numbers – but it would probably be a lot safer not to."

A simple way to look at this problem is to add your expected annual Social Security benefits to the annual payout you could receive by purchasing a life annuity. According to Wade Pfau’s Retirement Researcher Dashboard, a 65-year old couple could currently receive a 3.85% pay-out, or about $3,850 a year for every $100,000 they have saved.

For example, a couple who has saved $250,000 and expects $30,000 a year in Social Security benefits could generate $39,625 of annual income.

Do you feel like the total you calculate would be adequate retirement income? Are you willing to accept the risk that this amount of income will cover future expenses including significant expense surprises? If so, you can probably retire.

Continuity of investment and household expense management if I die or become disabled and where to find emotional, decision making, and day-to-day support in very old age, when we're less sharp and mobile.

These are concerns I share, even though I am blessed with bright and reliable children who could help and a wife with an MBA. These issues are a bit outside my area of expertise, however.

Huffington Post recently provided a list of “10 Bloggers Who Make Aging A Whole Lot Easier.” Ted Carr and his wife were applauded in that article for providing excellent podcasts on a broad range of retirement issues.

When I asked Ted about the continuity issue, he told me that his “May podcast is with Professor Sharona Hoffman who has written Aging With a Plan. Her book contains a lot of information about different types of support to help with all sorts of issues. She too does not have children and shares similar concerns.” I downloaded the book to my Kindle but haven’t read it, yet. I suggest you take a look at the other nine recommendations, as well.

I thank my readers who posted their concerns. I will keep an eye out for additional concerns at that post and invite anyone to ask any retirement finance question at any time following any of my posts.

Saturday, March 12, 2016

What Do You Find Most Confusing About Retirement Planning?

In response to my recent post, Retirement Savings and Annual Spending, a reader made the following comment.
"For older workers, I would say that the level of knowledge is generally a state of confusion unless they are working with a good RIA type of planner. The barrage of conflicting information from the financial industry has generally made it difficult for people to become well-informed, even if they put a modest amount of effort in."
We can start with a clarification of the term "RIA", an abbreviation of registered investment adviser. I think Investopedia says it well. 
"In general, only larger advisors that have at least $25 million in assets under management or that provide advice to investment company clients are permitted to register with the SEC, while smaller advisors are required to register with state securities authorities. Registration of an investment advisor is not meant to denote any form of recommendation or endorsement by the SEC or state securities regulators. It simply means that the investment advisor has fulfilled all the requirements for registration as an investment advisor."
RIA is not a certification, like CFA or CFP, but simply a required registration with the Securities Exchange Commission for large firms or the state for smaller firms. RIA does not speak to the skills or training of the adviser, it only denotes that the adviser has legally registered to provide advice, analysis or recommendations regarding securities for pay.

What do you find most confusing about retirement planning?
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It is also possible that the reader meant to type "RIIA", an abbreviation for Retirement Income Industry Association. RIIA does offer a certification called a Retirement Management Analyst (RMA) Designation that involves "rigorous educational and ethics training curriculum."

I responded to this reader by saying that I try to resolve some of that confusion with my blog, but it occurred to me that I may not have a clear idea of what confuses people most about retirement finance. So, here's your chance to let me know.

If there are issues about retirement finance at any life stage that you find particularly confusing or conflicting, please let me know with a comment below. I'll do my best to respond to them all.

I'll summarize the results in my next post, Following Up on Confusing Issues.

Some readers have had difficulty posting comments recently, possibly a problem with the IE 11 browser. Here are a couple of options. First, try a different browser. When one reader switched from IE 11 to Chrome, he was able to post with no problem. Second, email your comment here and I will post it anonymously for you. Add whatever name or user id you wish in the text of the email, or omit it to remain anonymous. I'll only post the body of the email. These problems tend to get fixed with a little time.

Friday, March 11, 2016

Is My Retirement Plan Protected?

In Why Retirees Go Broke, I explained that the risk of outliving your savings portfolio and the risk of insolvency are two very different risks. In Retirement Plan or Investment Plan?, I mentioned that a retirement plan should consider protection of your assets from creditors in the event of the worst-case outcome, i.e., bankruptcy becomes a consideration, and that most retirement plans are protected, at least to some extent.

To follow up, I thought it might be helpful to create an overview of asset protections for retirement accounts. It is, to say the least, a complicated subject, as legal issues tend to be, so I teamed up with Kim Steffan, an attorney from nearby Hillsborough, NC who writes the monthly “Ask the Lawyer” legal column for the News of Orange County.

We’re going to provide an overview but you really should discuss your specific situation with an estate attorney. Protection from creditors should be part of your retirement plan but if your planner is not also an estate attorney, insist that he or she consult one.

In broad strokes, different retirement plans are protected in different ways by the Employee Retirement Income Security Act of 1974 (ERISA, a federal law), the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA, also a federal law), and by your state laws.

ERISA is a federal law that “sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans.” An employer, for example, might voluntarily set up an ERISA qualified retirement plan for its employees such as a 401(k), 403(b) or a defined benefit (DB) plan. ERISA protects individuals in these plans from creditors. Most employer plans are ERISA-qualified, but you should be able to confirm this with your plan administrator.

BAPCPA is a federal law passed in 2005 largely to limit debtor protections during bankruptcy, but that actually added protections for individual retirement plans not covered by ERISA, like traditional and Roth IRAs.

Debtors are allowed to exempt (protect) some amount of property in bankruptcy. BAPCPA defines exempt amounts at the federal level but allows states to “opt out” and define their own exemptions. Many states have chosen to opt out of the federal exemption scheme, so the laws of your state are likely to play a major role in protection of your individual retirement accounts.

Most retirement plans are protected from creditors to some extent, but protection varies by state and creditor.
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Protection of our retirement plans may vary depending on whether or not we declare bankruptcy. Some creditor protections apply only during bankruptcy while others protect our IRAs from creditors without our having to file for bankruptcy. ERISA protects our employer plan benefits in both scenarios. BAPCPA protects individual plans only during bankruptcy. Creditor protection of individual retirement plans without declaring bankruptcy is dependent upon state law and varies widely.

Michael Kitces wrote an excellent piece soon after The Bankruptcy Abuse Protection and Consumer Protection Act (BAPCPA) changed the landscape in 2005. Kitces pointed out that “a client might actually need to file for bankruptcy to protect an IRA from creditors. On the other hand, if a client's other assets or income might be treated unfavorably during bankruptcy in the client's domicile, this might not necessarily be a desirable course of action.” In other words, your IRA might not be protected unless you declare bankruptcy and bankruptcy might have undesirable consequences for other assets.

Protections for non-ERISA plans like IRAs also need to be sorted depending upon whether they were created by a rollover. Rollovers from a qualified employer plan to an IRA inherit the unlimited protections of their former ERISA plan. SEP and Simple IRA plans are treated like employer plans, but if they are rolled over to an IRA they are then treated as individual plans and may have less protection from creditors.

According to the National Institute of Pension Administrators (download PDF),
There are both federal and state exemptions that might apply to a debtor. States are permitted to opt out of federal exemptions and define their own. These state exemptions vary widely. The Bankruptcy Code allows debtors to claim certain property as exempt, using either exemptions allowed under state law, or exemptions provided in the Bankruptcy Code. While this choice is available in a few states, the majority of states mandate that debtors use only the exemptions provided under state law.
When I searched for bankruptcy exemptions in my home state, North Carolina, I learned from NOLO that “North Carolina debtors must use state exemptions.” Also, IRAs and Roth IRAs have an unlimited exemption under NC state law. You need to check your state laws to see when state and federal law applies. Here’s a summary chart from The Tax Adviser of exemptions by state (download PDF), but it doesn’t provide everything you need to know.

Protection from creditors without declaring bankruptcy is a matter of state law. According to Kim Steffan’s website, for example,
The good news [for North Carolinians] is that retirement accounts which you fund while you are working are generally safe from most creditors. N.C. General Statute section 1C-1601 covers what assets creditors can seize and sell to satisfy judgments – a topic which is entirely separate from filing bankruptcy, by the way. Under that statute, money in your 401(k), traditional IRA, Roth IRA, and/or 403(b) is protected . . . NC law doesn’t put a dollar limit on protection of retirement assets for those who do not file bankruptcy. Your contributions to your employer’s pension plan (like the N.C. State Retirement System) are also safe, but for a different reason – because they are held by the pension plan and are not assets in your name.
Again, the key point is to check state law for your IRA protections from creditors both during and outside bankruptcy.

One relatively new development is that the Supreme Court ruled in 2014 that An Inherited IRA Is Not A “Retirement” Account For Bankruptcy Protection (another excellent summary by Kitces). The theory is that if you inherit your father’s retirement account, though it was a retirement account for him, it’s just a normal inheritance for you. Yet another development is the concern that “stretch IRA’s” are endangered, as described in this interview with IRA expert, Ed Slott.

My best shot at simplifying this morass is the following table.

Retirement Account Protection from Creditors

During Bankruptcy Outside Bankruptcy
Account Type Federal Protections North Carolina Protections [2] Federal Protections North Carolina Protections [2]
Qualified ERISA Plans
401(k), 403(b), Defined Benefit Plans, Profit Sharing Plans, Deferred Compensation Plans Generally Unlimited [4,5] Generally Unlimited [4,5] Generally Unlimited [4,5] Generally Unlimited [4,5]
IRA Plans Protected by BAPCPA
IRA (ERISA Plan Rollover) Unlimited [4] Unlimited per NC Law Generally Unlimited [4] Unlimited per NC Law
Traditional IRA $1,245,475 [1] Unlimited per NC Law None Unlimited per NC Law
Roth IRA $1,245,475 [1] Unlimited per NC Law None Unlimited per NC Law
Simple IRA Generally Unlimited [4] Unlimited per NC Law None Unlimited per NC Law
Simple IRA Rollover $1,245,475 [1] Unlimited per NC Law None Unlimited per NC Law
SEP IRA Generally Unlimited [4] Unlimited per NC Law None Unlimited per NC Law
SEP IRA Rollover $1,245,475 [1] Unlimited per NC Law None Unlimited per NC Law
Keough Generally Unlimited [4] Unlimited per NC Law None Unlimited per NC Law
Protection of Other Retirement Assets
Contribution to Employer Pension Plan Unlimited [3] Unlimited [3] Unlimited [3] Unlimited [3]
Distributions from Plans (incl. RMDs) None None None None
Inherited Plan None None None None

[1] This amount under BAPCPA ($1M) is adjusted every three years for inflation and was $1,245,475 as of 2013.   
[2] Protections vary widely by state.                   
[3] Contributions are safe because they are held by the pension plan and are not assets in your name.       
[4] There are some circumstances when a creditor can still get to your ERISA benefits. That includes seizure by: your ex-spouse under a Qualified Domestic Relations Order (QDRO), to the extent of your spouse's interest in those benefits as a marital asset or as part of a child support attachment.
[5] State law superseded by ERISA protections.

As you can imagine from the table above, it may be simpler to consider which retirement plans might be at risk, as opposed to identifying which are protected. Consider the following:

  • Retirement accounts that you have inherited are not protected from creditors.
  • Individual retirement accounts are protected under BAPCPA only to an aggregate amount of $1,245,475 (total balance of all your individual retirement accounts), but state law may provide more protection. For example, in NC, protection is unlimited by state law.
  • SEP and Simple IRA accounts receive unlimited protection under BACCPA, but IRA’s from rolled-over SEP and Simple IRA accounts are protected under BAPCPA to an aggregate amount of $1,245,475. They may, however, have greater protection under your state law.
  • Your retirement plan is not protected from claims from government creditors, or judgments needed for paying alimony or child support.
  • Distributions from retirement plans, including Required Minimum Distributions, are not protected.
  • Individual retirement plans are not protected outside of bankruptcy by federal law, but may be protected by your state law. Exception: IRA’s created from rollovers from ERISA plans are federally protected.
  • Government and church retirement plans are not protected from creditors.
These issues are quite complicated, which is the point of this post. However, as I pointed out in recent posts, about half a percent of Americans over the age of 65 declare bankruptcy at some point, usually early in retirement. It’s important to consider protecting your retirement accounts from creditors.

Nor is bankruptcy the only concern. You may wish to protect assets from creditors and judgments without declaring bankruptcy. These protections are separate from those in bankruptcy.

What should a retiree do?
  • Use the information in this post to better understand your asset protections and then discuss them with a qualified attorney and your financial planner.
  • Several sources suggest that you create a separate account to receive your Social Security benefits payments to avoid commingling the funds and maintain their exemption. Similarly, several also suggest you create a separate IRA account to roll over an ERISA plan.
  • Find out if your state has opted out of the federal exemption scheme. (Google, for example, “Kentucky Bankruptcy Exemptions NOLO.”) If your state has opted out, determine what protections your state provides for individual retirement accounts. Use this form to record the information.
  • Develop a list of your retirement accounts, the type of plan (401(k), IRA, Roth IRA, etc.), and the balance of each for your accounts and your spouse's. Use the same form above to record the information.
  • Discuss these accounts with a qualified estate attorney. Prepare yourself by studying your state’s bankruptcy laws regarding IRAs and other non-ERISA plans.
  • Ask your attorney if those unprotected plans might be protected in some way.
  • Don’t roll over your SEP and Simple IRA’s without determining the possible loss of protection from creditors in your state.
  • Modify your retirement plan accordingly.

Check your state's retirement plan creditor protections and discuss them with a qualified attorney and your financial planner. About a half percent of Americans declare bankruptcy after reaching age 65. In the unlikely event it happens to you, or you are subject to a judgment, you’ll be happy that you did what you could to protect your assets.

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Monday, March 7, 2016

Retirement Savings and Annual Spending

The Motley Fool (TMF) recently published a column entitled, “The Average American Household Approaching Retirement Has This Much Saved Up.” It’s pretty discouraging.

TMF took data from a GAO report that includes the current financial status of households between the ages of 55 and 64. (A link to the report is provided in the TMF column.) They found that 41% of the households in the study had been unable to save for retirement directly though many of those have homes with paid-off mortgages and about a third have pensions.

TMF provided the following graph in that column, showing the distribution of retirement savings within that 55-64 age group. Keep in mind that some of the group have nearly reached retirement age while the youngest have another decade or more to save.

Ignoring the 41% of households with no savings and considering only the 59% with some savings, the Motley Fool produced the following chart showing median savings of just over $106,000.

Wade Pfau’s Retirement Researcher website includes a dashboard that shows the current payout of annuities, TIPs bonds, systematic withdrawals, and other distribution methods. It currently shows the payout for a 65-year old couple from a life annuity adjusted for CPI-U (inflation) with 100% survivor benefits to be about 3.85%. Wade's current estimate for the payout of a “4% Rule” spending regime is about 2.92% (the “4% Rule” is currently a little less than a “3% Rule”).

Annual income implied by median retirement savings is only $4,085 from an annuity and $3,098 with 4% Rule.
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It's interesting to look at the savings in the Motley Fool chart in terms of the income that those amounts imply for a life annuity and for “4% Rule” spending. As the following chart shows, the median annual income implied by the TMF chart is only $4,085 for households that buy an annuity and $3,098 for households that go with the “4% Rule”. That’s not a lot of income. Of course, some of these families have pensions, some could borrow against the equity in their homes, perhaps through a reverse mortgage, and most will have Social Security benefits.

Realistically, families that have saved less than the median savings would probably be better off using the savings for emergencies rather than annuitizing them.

As for retirement savings, while saved amounts seem small for most households, the amount of annual income that could possibly be generated is even more discouraging for more than half of 55-64-year-old retirees today.

To get a quick estimate of your possible annual spending, divide the amount you hope to have saved by your retirement date by 34 if you plan to spend systematically from an investment portfolio, or by 26 if you plan to purchase an annuity.

If your calculated spending is disappointing, Wade Pfau has recently written extensively about reverse mortgages (download PDF) and their potential to bail out under-savers. He adds that "there is great value for clients to open a reverse mortgage line of credit at the earliest possible age."