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10/8/2018
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Putting Together the Pieces of Your Financial PuzzleThomas Ford Library Investment Discussion Group – October 9, 2018
Kirk A. Kreikemeier, CFP®, CFA, FSA4365 Lawn Avenue, Suite 5Western Springs, IL 60558
708‐246‐[email protected]
• Bombarded with confusing topics but difficult to put in context
• Implications of decisions seem overwhelming and not sure where to start
• We will start with a picture capturing the broad financial cycle of life
• Then will sharpen the focus on key areas and identify three action steps for each
• Like a puzzle, will start with square edges (base understanding) before filling in pieces
• No easy button ‐ leave tonight with checklist to do on own or with a professional
Complete Financial Picture ‐ Fitting Pieces Together
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Agenda
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4365 Lawn Avenue, Suite 5 Western Springs, IL 60558 | 708 246‐2366 | pvwealthmgt.com
Income• Employment• Other (non‐investment)• Company Stock Options
Checking Account
Monthly Bills
Mortgage/Student Loans ‐
(good debt ‐appreciating
assets)
Outstanding Balances ‐credit cards(bad debt ‐depreciating
assets)
Social Security / Medicare
401K / Pensions
IRA Account(Traditional and Roth)
Health Savings Account
529 Accounts
Taxable Accounts(including reserve funds)
Set Aside for Your Future
6.2% SS + 1.45% Medicare1
Future Goals
Taxes
Life Insurance / Annuities
Estate Planning(Wills, POAs, Trusts)
NOTES: 1. Employer also contribute 7.65%; extra 0.9% for income > $200k / $250K 2. Invest gains only taxed upon withdrawal
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Financial Plan Big Picture
1. Know what you have
2. Set goals and estimate costs
3. How do you react to market risk? How soon need the money? => Asset allocation
4. What accounts to open to back these goals and basics of investing
5. Understand key tax brackets and concepts
6. Save for retirement expenses – where to begin!
7. Save for portion of college you are paying – they grow quickly
8. Focus on basic features of insurance and annuities
9. Understand Social Security and Medicare
10. You retired! Where does my paycheck come from? Don’t forget taxes! How long last?
11. Pull it all together, stress test and monitor – especially near retirement
12. Leave your legacy by design, not default
Summary of key areas
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Checklist
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1. Prepare a net worth report• List things you have (assets) and debts owed (liabilities); difference is net worth• Assets – taxable, tax deferred, personal• Liabilities – rate, funding an appreciating or depreciating asset
2. Understand paycheck *
• Start with gross pay and note FICA deductions• Then see amounts to savings, benefits, federal and state taxes
3. Prepare ‘savings generator’ – i.e. a budget
• On paper, spreadsheet or tools available• Start with gross pay, list savings (pay self first), expenses, taxes• Begin tracking actual; make sure going where want; “have to measure to manage”
* Blog Post: “Wrap the Gift of Financial Wisdom for the College Graduate”
What have? Money coming in? Where does it go?
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#1 – What Have, In, Out
Net Worth, Paycheck and Budget Examples
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#1 – What Have, In, Out
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1. Identify items wanted in the future not covered by current job income• Emergency fund for unexpected; 3‐6 months’ expenses; keep liquid and safe• Retirement living, health costs and college are common• Travel that ends after x years; wedding costs; fun money• Changing homes? State of residence may impact travel and taxes
2. Estimate cost in today’s dollars with assumed inflation
• Use current expenses as a guide and apply inflation• Health costs and college have higher inflation; fixed mortgage has none• Consider reduction in living expenses at advanced ages
3. Prioritize into needs, wants, wishes
• Able to focus if funds are tight• Determine portion of ‘needs’ covered by ‘annuity‐like’ income if wish
Set your goals and estimate costs
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#2 – Set Goals and Estimate Costs
Set your goals and estimate costs
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#2 – Set Goals and Estimate Costs
Identify expense amounts with appropriate inflation
Graphical summary of above expense needs
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1. Complete risk questionnaire• Questions help determine how you react to market volatility• Range from general questions (custodian) to robust research‐based (Finametrica)
2. Choose portfolio consistent with risk tolerance and time horizon• Key consideration is tolerance for loss and volatility of portfolio• Consider how soon need money – emergency fund, college savings, retirement
3. Establish portfolios with various asset classes and different weights• Historically used 60/40 stocks/bonds; now – add international, refine stocks/bonds, alternatives• Different portfolios have same asset classes but % in asset class varies• Some ‘easy‐button’ funds – target‐date (retirement) and age‐based (529s)
How handle market risk? How soon need money
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#3 – Gut and time => Allocation
How handle market risk? How soon need money
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#3 – Gut and time => Allocation
Growth of $100 9/25/98–9/24/18 Source: Morningstar, PVWM Research
Asset Class Benchmarks
Total Ret 1Yr
Total Ret
10Yr
Std Dev 1Yr
Std Dev 10Yr
DJ US TSM Large Cap TR USD 17.95 11.99 8.94 14.41DJ US TSM Small Cap TR USD 14.48 12.69 9.32 19.38MSCI EAFE NR USD 2.74 5.38 9.12 17.44MSCI EM NR USD -0.81 5.40 13.29 21.25BBgBarc US Trsy Bellwethers 5 Yr -2.05 2.65 2.22 3.77BBgBarc US Trsy Bellwethers 30Y -3.75 5.01 8.67 15.51BBgBarc US Corp Bond TR USD -1.19 6.35 2.78 5.44BBgBarc US Corporate High Yield T 3.05 9.46 2.00 10.05BBgBarc Short Treasury 1-3 Mon T 1.53 0.31 0.11 0.14
Source: Morningstar Office ‐ 9/30/18; PVWM Research
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1. Who holds the money and executes trades?• Custodian is firm where open an account ‐ brokerage, 401k, bank, insurance company• Investment range: Brokerage ‐ full; 401k ‐ limited; bank – savings, CDs; ins co ‐ annuities
2. Types of investment securities• Individual companies issue stocks and bonds• Mutual funds and exchange‐traded‐funds (ETFs) have basket of stocks or bonds for diversification• More refined strategies ranging from options, factor‐based funds, commodities, currency
3. Type of underlying risk of investment• Know what type of stock or bond is inside a mutual fund or ETF owned• Should map to asset classes used for asset allocation• Morningstar Instant X‐Ray – not detailed but good start; careful with bonds; verify all holdings used
http://portfolio.morningstar.com/RtPort/Free/InstantXRayDEntry.aspx
What accounts to open; basics of investing
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#4 – Where Invest? In What?
What accounts to open; securities to invest
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#4 – Where Invest? In What?
Output of Morningstar X‐Ray Funds, ETFs, Individual StocksSource: Blackrock
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1. Tax brackets and marginal rates• Progressive tax rate and how next dollar of income is taxed• Federal varies by single vs. joint filing; states range from 0% to flat % to progressive• Know what marginal bracket in now vs. what expect during retirement
2. Ordinary income vs. capital gains/qualified dividends *
• Wage income is ‘ordinary’; capital gains / qualified at lower rate• Some investment income is qualified, rest is non‐qualified => ordinary• Capital gains tax depends on time held; if < 365 days then short‐term => ordinary
3. Tax qualified accounts ‐ deductible, deferred, taxed when withdrawn?• Taxing the seed or harvest? Limitations on withdrawals? Apply to federal and state?• What tax bracket when deducted vs. withdrawn? Ordinary income or qualified?
* Extra 3.8% Medicare taxes on investment income > $200k (single), $250k (joint)
Understand key tax brackets and concepts
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#5 – Tax Tidbits: Fed and State
Understand key tax brackets and concepts
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#5 – Tax Tidbits: Fed and State
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1. How much to save? As much as can. Max tax‐qualified limits is good start.• Analyze if assets plus annual savings covers goals (see later)• Priority – emergency fund, high rate debt, 401k match, HSA, better of 401k/IRA, 529 college savings
2. Use tax‐qualified 401k / IRA accounts – Traditional vs. Roth *
• 401k (company match!); Individual IRAs; Spousal IRAs (different deduct level)• Pay tax now (Roth) or withdrawal (Traditional); what tax bracket at each point?• Don’t forget about spousal IRAs; also maybe contribute to non‐deductible IRA• Can convert Traditional to Roth but must pay taxes at current ordinary rates
3. Medical costs, use Health Savings Accounts (HSAs) and Flexible Spending Accounts
• If have high‐deductible medical plan, use HSA; CAN’T USE WITH MEDICARE• HSAs encourage smart medical utilization; “triple‐tax play” if use for medical• FSAs are deductible and ‘use‐or‐lose’, but nice deductible savings; vision and dental only if also HSA
* Blog Post: Tax the seed or the harvest…or neither?
Saving for retirement expenses
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#6 – Retirement Savings
Saving for retirement expenses
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#6 – Retirement Savings
• Emergency fund> 401k match max> HAS> better of 401k/IRA> 529 college> taxable
• View all retirement accounts on a combined basis vs. target allocation (# 4 slides)
• Consider tax treatment of securities and the account held – “asset location”
• Don’t forget about tax implications discussed earlier (# 5 slides)
401K/403B IRAs HSA Single
HSAFamily
FSA
Annual Limit
$18,500 $5,500 $3,450 $6,900 $2,650
Annual including Catch Up
$24,500>= Age 50
$6,500>= 50
$4,450>= 55
$7,900>= 55
N/A
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1. Decide what portion parent covers and estimate annual costs• Even if parent pays 100%, discuss costs and value as child approaches college• Colleges list tuition, room/board, fees but need to estimate tuition inflation
2. Utilize 529 Savings Plans – has market and tuition inflation risk• No federal deduction for contributions but some states allow (IL does)• Both federal and state tax‐free growth and withdrawal if used for qualified education• Age‐based or build own allocation; be mindful of rapidly decreasing time horizon
3. 529 PrePaid Plans – has state credit risk and conversion factors• Only covers tuition, not room/board• Able to use out of state but conversion factor reduces benefit relative to in‐state school
College savings and rapidly declining time horizon
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#7 – College Savings
College savings and rapidly declining time horizon
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#7 – College Savings
• Assume $35,000/yr, 4 years, start saving age 5 through last year college, 6% returns
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1. What if die too soon? Life insurance• Focus on amount needed first, then if term or cash value policy• How much? Consider savings, SS, survivor expenses; NOT multiple of income• Employer life insurance ok, but better choices if reasonably healthy
2. What if alive but can’t work? Disability insurance• Pays % of salary if can’t work due to illness or injury; employer plans attractive
3. What if live long life? Annuities (not a bad word, be aware of types)• Pay as long as alive; can also continue to survivor; additional use is investment component• Consider for core expenses (along with SS, pension) but give up control of principal
4. Long‐term care – difficult decision• Could buy insurance but expensive, future rates increases, once start need to keep paying• Options ‐ insurance policy (individual or group), hybrid (life or annuity), self‐insure, Medicaid
Basic features of insurance and annuities
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#8 – Insurance, Annuities
Basic Features of insurance and annuities
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#8 – Insurance, Annuities
Term vs. Cash Value Life Insurance Different Annuity Options
higher mortality cost at higher ages Consider portfolio for early years, then longevity annuity IF alive > 85
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1. Social Security – yes will be around but maybe reduced benefit if younger *• Risk free, inflation adjusted, 150% J & 100% S annuity for life• Latest Trustee Report states 25% reduction in year 2034 if no changes made• Benefits count as income; 50% if MAGI > $25k/$34k; 85% if MAGI > $32k/$44k• Don’t forget the disability and survivor benefits features also
2. SS claiming strategies, spousal benefits and increase if delay• If each spouse has earnings history, analyze when optimal to claim; maximize highest earner• Spouse will receive at least 50% of other’s benefit, then 100% if pass away
3. Medicare (recall those payroll taxes!) **• Starts at 65 even if Normal Retirement Age later• Part A (hospitals), Part B (doctors), Part D (drugs), Medicare Supplement (Part A, B copays/ded)• Part B premiums surcharge for higher income – MAGI > $85k / $170k• Medicare DOES NOT cover long‐term‐care for life; only 100 days if preceded by hospital stay
* Blog Post: “7.65% of paycheck goes to Trust Funds. How are they doing?”; “Social Security and Medicare Financial Overview”** Blog Post: “What’s Your 2017 Medicare Premium? It Depends…”
Understand Social Security and Medicare
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#9 – Social Security and Medicare
Understand Social Security and Medicare
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#9 – Social Security and Medicare
• SS statement wealth of information – and assumptions• Online – ssa.gov/myaccount; paper statement mailed for age 60+
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1. Social Security plus pension (if any)• Recall amounts in plan… be aware of taxes – including state• Inflation adjustment for Social Security but usually NOT with pension
2. Withdraw from investment portfolio for any shortfall; convert portion to annuity?• Manage tax recognition when can; forced RMD after age 70.5• Consider annuity after rates rise for non‐discretionary expenses not covered by SS/Pension • Amount from portfolio not just income; use total return concept and sell for capital gains
3. How long should it last? 50% chance of outliving “life expectancy”• Consider health and family history, likely longer than think; age with 30% or 20% chance outlive• Unknown, so have some resources in place to manage this risk (SS, annuity)
4. Tapping home equity if need (unexpected, LTC, other)• Ideally not part of base income plan but have as extra security• Reverse mortgage not first tool to use, but a nice back‐up; improved recently
I’m retired! Where is paycheck? Taxes? How Long?
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#10 – Retiree Paycheck, Taxes
I’m retired! Where is paycheck? Taxes? How Long?
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#10 – Retiree Paycheck, Taxes
2 Months – 1 Year 1 Year and beyond – Long‐term Portfolio
Social Security
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1. Project cash flows to see if cover goals; test “what‐if” scenarios• Review goals with best estimates, different scenarios, stress‐test assumptions• See which variables most sensitive to security and try to manage (rtmt age, inflation, expenses)• Life expectancy => 50% chance longer; optimistic returns; taxes on qualified balances
2. Continue to monitor, especially as event nears• College savings – happens quickly; estimated college costs can change• Retirement plan – changing tax laws, different savings, portfolio returns, expense needs
3. Goals specified can change• Annual needs increase with style of living• May consider moving out of state (weather, taxes) or start own business
4. A free tool, but be careful with inputs (taxes, returns, inflation, how long…)
T. Rowe Price Retirement Calculator ‐ https://www3.troweprice.com/ric/ricweb/public/ric.do
Pull it all together, stress test, monitor
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#11 – Pull Together; Monitor
Pull it all together, stress test, monitor
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#11 – Pull Together; Monitor
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Leave your legacy by design, not default
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#12 – Leave a Legacy
1. Wills, POAs, Trusts, Living Wills• Will – names guardian for children; specifies how assets distributed if not
covered by other documents (beneficiary forms!, trusts, TOD)• POA – financial and medical; name someone to act on your behalf if unable• Trusts – specify how assets distributed; can be revocable or irrevocable• Living Wills – express final wishes; “Being Mortal” by Atul Gawande
2. Trusts – manage distribution, control, taxes• Federal estate exemption is large ($11.18mm/$22.36mm), but don’t forget state (IL $4mm)• Even if exempt from estate tax, trusts able to efficiently manage transfer and control of assets
3. Beneficiary designations• Applies to IRAs, life insurance, pensions, company benefits, TOD/POD; they override a will• Life changes ‐ make sure beneficiary designations keep up
4. Provide summary document for executor and communicate intentions to family• Explanation from patriarch/matriarch while alive better than assumptions after
Contact information and additional resources Appendix
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• Upcoming Talk ‐“Who is FRED? Where to Find Free Web‐based Resources of Economic and Market Data” ‐ Thursday, October 18th 7:00 – 9:00pm North Campus Rm 116
• Sign up for monthly newsletter – see sheet
• See website for blog and other resources: http://www.pvwealthmgt.com/
• Kirk A. Kreikemeier, CFP®, CFA, FSA and Bre Robinson4365 Lawn Avenue, Suite 5Western Springs, IL 60558708‐246‐2366 | [email protected] | [email protected]
