Increased Retirement Plan Contribution Limits

For the first time since 2009, the IRS has raised the contribution cap on 401(k), 403(b), most 457 plans, and the government's Thrift Savings Plan in its cost-of-living-adjustment for 2012. Important changes include:

• 401(k) and 403(b) elective deferrals were increased to $17,000, up from $16,500 last year; the catch-up elective deferral limit remained at $5,500
• Defined Benefit plan benefit limits moved higher to $200,000, up from $195,000 last year
• Annual contribution plan limits rose to $50,000, up from $49,000 last year
• Annual compensation limits were raised to $250,000, up from $245,000 last year
• The threshold for highly compensated employees moved higher to $115,000, up from $110,000 last year
• The taxable wage base for social security rose to $110,100, up from $108,600 last year
• The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (AGI) between $58,000 and $68,000, up from $56,000 and $66,000 in 2011; for married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $92,000 to $112,000, up from $90,000 to $110,000; for an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $173,000 and $183,000, up from $169,000 and $179,000
• The AGI phase-out range for taxpayers making contributions to a Roth IRA is $173,000 to $183,000 for married couples filing jointly, up from $169,000 to $179,000 in 2011; for singles and heads of household, the income phase-out range is $110,000 to $125,000, up from $107,000 to $122,000; for a married individual filing a separate return who is covered by a retirement plan at work, the phase-out range remains $0 to $10,000
• The AGI limit for the saver’s credit (also known as the retirement savings contributions credit) for low-and moderate-income workers is $57,500 for married couples filing jointly, up from $56,500 in 2011; $43,125 for heads of household, up from $42,375; and $28,750 for married individuals filing separately and for singles, up from $28,250

Managing Your Retirement - Part IV

Prioritize Asset Withdrawals

As you require income, Peterson Wealth Advisory will guide you in choosing the order in which to sell assets.

When you start taking federally mandated RMDs from your traditional IRAs and employer-sponsored retirement accounts (with the possible exception of Roth 401(k)s), you’ll want to use these funds for your spending needs before you tap any other accounts. But until then, we will base recommendations on two important considerations:

• Maintain allocation targets and diversification; possibly use the withdrawal as an opportunity to bring allocations back into balance.

• Keep your assets growing at the highest degree possible and at a comfortable risk level.

These goals may appear to be conflicting at times, however, as a rule of thumb rebalancing is generally considered to be more important. Each retiree’s situation is unique, so there are exceptions.

Sell to Keep Your Investment Mix on Target

We may suggest you start withdrawing funds from the portion of your portfolio that has become over concentrated in one type of investment. For example, if the stock market has grown rapidly and your target mix of 60% stocks and 40% bonds has become a lopsided 65% stocks and 35% bonds, we may suggest selling stocks in order to adjust your investment mix, reduce the portfolio’s risk level, and produce income.

Sell to Maximize Asset Growth

The next best thing to not paying taxes is paying as little as possible for as long as possible. Consequently, we may recommend withdrawing your assets in this order:

• Taxable assets.

• Tax-deferred assets in traditional IRAs and employer-sponsored plans.

• Tax-free assets in Roth IRAs.

Here’s the reasoning: In taxable accounts, you’re paying tax each year on the dividends interest, and capital gains that your assets produce. You also may pay taxes on the withdrawals themselves if your assets have appreciated in value. In tax-deferred accounts, you pay tax only when assets are withdrawn, even on gains. In Roth IRAs, you pay no taxes provided certain conditions are met, including holding the account for at least five years and being 59 ½. You can even pass the assets on tax-free to your heirs.

If you’re participating in the new Roth 401(k), you can avoid taking RMDs by rolling your money in the Roth 401(k) over into a Roth IRA. Otherwise, you’ll be required to start making withdrawals from the Roth 401(k) in the year after you reach age 701/2.

Fine-Tune Your Withdrawals

Withdrawals can be fine-tuned further, either to gain as much tax efficiency as possible or to help you meet specific financial goals. Some examples of withdrawal tactics include:

• Sell taxable assets that have lost money.

• Sell taxable assets you’ve held longer than a year.

• Sell tax-deferred assets when conditions are right.

Peterson Wealth Advisory will check your investment mix after you sell assets and will rebalance your portfolio if necessary. However, if your primary goal is to maximize the amount you leave to your heirs, a different approach may be advised. In this case, you may want to continue to hold taxable assets that have risen significantly in value.

What about the equity in your home?

More and more retired homeowners are considering reverse mortgage loans, which let you tap the value of your house without selling it. Here’s how they work: A lender grants you a loan against the equity in your home, which is repaid when your house is sold—usually after your death.

A reverse mortgage loan offers several advantages: You don’t have to repay the loan while you live in your house; you can’t be evicted; and you owe no income tax on the loan. Reverse mortgage lenders, however, charge steep up-front fees—as much as 10% of the loan value or more. The loan must be repaid before the property can passed on to another individual.

Managing Your Retirement - Part III

How much can I live on this year?

Continuing with the third installment of the “How to Manage Your Retirement” series we consider the amount of money you can take out each year. This key step helps guard against overspending and increases the longevity of your assets. Click here for Part I and here for Part II in the series.

PLAN YOUR ASSET WITHDRAWALS

To prevent exhausting your savings it is important to calculate your monthly/annual withdrawal amount. There are two generally recommended withdrawal methods both requiring you to sell a portion of assets to produce retirement income. Your assets include the interest, dividends, and capital gains you’ve reinvested, along with your principal.

It may make sense to sell assets once or twice a year and place the funds in a money market account that has check writing privileges. For convenience, you could also deposit ongoing income payments, such as Social Security and pension, in this account.

Choosing Your Withdrawal Method

There are two basic methods for turning your assets into income, and each has advantages and disadvantages. As you consider the two methods, keep in mind that the income produced by Method 1 isn’t tied to market conditions and the annual income produced will be predictable. However, the income produced by Method 2 is directly tied to the performance of financial markets every year and will fluctuate.

Method 1: Dollar-Adjusted Withdrawals

Using this method, you withdraw 3% to 4% of your portfolio the first year. Each subsequent year the dollar amount of your withdrawal increases by the previous year’s inflation rate. The initial withdrawal will be based on what you’ll need in order to cover the differences between your income and expenses.

With this method, withdrawals are relatively predictable and generally keep pace with inflation. However, if the market should undergo a prolonged downturn during the first few years of retirement, your assets could be substantially depleted. That’s because as your portfolio value shrinks, you’ll be spending a larger percentage of your portfolio than you had originally intended. In this situation, it may be wise to recalculate your withdrawals so that you do not continue to overspend.

Here’s a three-year example of the dollar-adjusted method for a retiree, Sarah, who has a $500,000 portfolio and decides on a 3% withdrawal rate:

•First year. Sarah withdraws $15,000: 3% of the portfolio balance.

•Second year. Sarah withdraws $15,600: the previous year’s amount ($15,000) increased by an amount to take into account a 4% inflation rate ($600).

•Third year. Sarah withdraws $16,380: the prior year’s inflation-adjusted withdrawal ($15,600) bumped up by a 5% inflation rate ($780).

Method 2: Percentage Withdrawals

Using this method, you withdraw the same percentage annually from your portfolio.

Annual withdrawals aren’t increased for inflation; instead, this method counts on long-term portfolio growth to take care of adjusting for inflation. Recent studies and analysis indicates that an annual withdrawal rate between 4% and 5% is reasonable. The recommended percentage will be based on the amount you’ll need to cover the difference between your income and expenses.

Here’s how a retiree, Liberty, would use the percentage-withdrawal method over a three-year period. Liberty starts out with a $500,000 portfolio and chooses a 5% annual withdrawal rate:

•First year. Liberty withdraws $25,000: 5% of her portfolio balance.

•Second year. The portfolio has grown to $530,000: Liberty withdraws $26,500 (5%).

•Third year. The portfolio has declined to $450,000: Liberty withdraws $22,500 (5% but 15% less than in the second year).

Liberty has to discipline herself to spend less during periods when her portfolio balance drops. For example, if after the third year shown in the example, the portfolio declines again, say by 10%, her income would drop to $19,238—about 23% lower than the first year’s withdrawal.

Method 2 is easier to use and can mean your assets will last longer. But your income stream will fluctuate—significantly at times. This means during periods when your income drops you’ll have to discipline yourself to spend less. On the other hand, during years when the market is performing well, you’ll have the enviable task of deciding whether to withdraw the amount that exceeds your spending needs or leave it in the portfolio to potentially grow for future needs.

Managing Your Retirement - Part II

Organize, Share, Simplify

Your plans for retirement involve more than just financial calculations. You also need to make sure that those you care about understand your plans and have access to important information.

Here are a few steps to consider:

• Periodically update your beneficiary designations. These will supersede instructions in your will.

• Make sure important documents and records are easy for your family to locate. These should include your will; trust documents; insurance policies; a detailed listing of your assets, including account numbers and dollar amounts; and a durable power of attorney.

• Involve your family. Because your financial decisions affect your spouse and other family members, you should prepare them to assume responsibility if necessary. Discuss your plans with them and make sure they are familiar—and comfortable—with your decisions.

• Simplify your finances. It may be beneficial to consolidate your assets with a single company. This can lower your expenses and make it easier to track your financial situation and calculate your Required Minimum Distributions (RMD) each year. It can also reduce your paperwork at tax time. In addition, it can ease the transition should a family member have to take charge of your finances.

ADJUST YOUR PORTFOLIO

Before you begin drawing income from your investment portfolio, it is prudent to adjust your investment mix so it is more appropriate for your current circumstances.

Here are some common misconceptions regarding retirement portfolios:

Myth #1: Stocks are too risky for retirees.

Not necessarily. If you were comfortable with a certain proportion of stocks in your portfolio before you retired, chances are that you’ll be comfortable with that same proportion for some time during your retirement. Although we may recommend reducing the proportion of stocks as you move further into retirement, you may still want to maintain the growth potential that stocks can provide.

Myth #2: Bonds are the best investment for retirees because they produce income.

The interest that bonds generate can be an important source of income (possibly tax-free), and bonds can provide the balance and diversity critical to all portfolios. But you may also need stocks in the mix. Although past performance doesn’t guarantee future returns, retiree portfolios usually need the kind of inflation-beating growth that stocks have historically delivered.

All investing is subject to risk. Bond investments are subject to interest rate, credit, and inflation risk.

Myth #3: For safety, stick with short-term reserves.

Short-term reserves, including money market funds, bank certificates of deposit, and U.S. Treasury bills, do offer stability and relative safety. As a result, they can be a great source of liquidity or a place to store cash temporarily. But historically, short-term reserves have barely kept ahead of inflation and typically yield far less than other types of investments. Most retirees should not keep a significant portion of their assets in these kinds of accounts.

Maintain Some Liquidity

When you have unexpected expenses, a small liquid account—usually a money market account—can help you avoid having to sell portfolio assets at an inopportune time. Depending on your circumstances a cash cushion equivalent to one year of living expenses can help ease your mind and allow you keep your other assets invested for future retirement needs.

Plan For Inflation

It is very important to consider the impact of inflation on your financial plan. Too many times this silent stealer of money and purchasing power is overlooked or ignored. Even at a moderate 3% annual inflation rate, you’ll need income of about $270,000 in 20 years to buy what $150,000 buys today.

A Balanced, Diversified Portfolio is Important

Inflation is only one factor we will consider in evaluating your investment mix. One type of investment alone—stocks, bonds, or cash—is not likely to maximize a portfolio’s success. A mix of investments can provide the balance of growth, income, and stability that allows a portfolio to better withstand the fluctuations in financial markets.

We will aim to create a balanced and diversified investment mix and control risk as much as possible, rather than concentrate solely on producing the highest portfolio returns. But keep in mind that diversification does not ensure a profit or protect against a loss in a declining market.

Managing Your Retirement - Part I

Planning now will make a difference later. Whether retirement is on the horizon or you’re already retired, now is the time to work closely with Peterson Wealth Advisory to develop a plan for financing the years ahead.

You've worked hard, you've saved, and you've planned but it can be overwhelming trying to figure out how to make your money last 25 or 35 years. That’s why it’s important to create a financial plan designed to achieve that objective.

Parts of your plan will be familiar because the same principles you used to build your wealth—balanced, diversified, low-cost, long-term investing—also dictate how you should invest during retirement.

You will also face some new decisions that will call for guidance and advice from a financial expert: What kind of investment mix will suit your risk tolerance while still allowing your assets to keep up with inflation? How much can you safely withdraw from your portfolio each year? How do you minimize the impact of taxes on your wealth?

Careful advance planning and ongoing consultation can help you answer these questions and enjoy the kind of retirement that you've always considered desirable. As part of a four part series I will be discussing how to manage your retirement. This month’s issue will help examine present circumstances and adjusting your investments.

EVALUATE YOUR CURRENT SITUATION

For many people, retirement can last a long time. According to the U.S. Department of Health the current life expectancy for men in the United States is 75 years and 80 for women. But these averages understate an important fact: As cited in one of my previous newsletters, life expectancy increases as you grow older.

• A 65-year old man has a 41% chance of living to age 85 and 20% chance of living to age 90.
• A 65-year old woman has a 53% chance of living to age 85 and a 32% chance of living to age 90.

There’s a reasonable possibility that your retirement could last 25 to 30 years. That’s why it’s critical to make sure you’re prepared.

Keep an eye on cash flow: Once you’re retired, it’s essential to watch your cash flow and estimate your income and expenses each year. This practice can help us spot potential financial problems and make adjustments that will help keep your retirement plan on track.

Estimate your income and expenses: When you estimate your expenses, it can be helpful to separate them into nondiscretionary and discretionary categories.

• Nondiscretionary: These are basic expenses, such as food, mortgage payments, insurance premiums, taxes, gasoline, and utilities.

• Discretionary: These are optional expenses, such as travel, hobbies, gifts, and charitable contributions.

When considering your sources of income, include such things as Social Security benefits, pensions, veterans’ benefits, royalties, real estate contracts, rents from investment properties, dividends, and interest.

Depending on your age, you may also need to include the required minimum distributions (RMDs) that you must take from your traditional IRAs and qualified retirement plans such as a 401(k)’s. Federal law mandates that you generally must start making withdrawals from these accounts by April 1 in the year after you turn age 70 1/2. Remember that withdrawals made from a tax-deferred plan before age 59 1/2 may be subject to ordinary income tax, plus a 10% federal penalty tax.

Using your estimated expenses and sources of ongoing income, we can determine approximately how much you will need to withdraw from your investment portfolio each year.

REVIEW YOUR INSURANCE COVERAGE

Large, unexpected expenses can damage the best-laid retirement plans, but adequate insurance coverage can help protect you against many of these expenses. That’s why you’ll want to make sure your coverage is sufficient on all your policies.

Medicare: During your retirement, you also may incur insurance costs specific to retirees. For example, retirees age 65 and older qualify for Medicare health insurance, but must pay a monthly fee for the coverage. And because Medicare doesn’t cover all health care costs, most people purchase Medigap insurance to fill the holes in Medicare coverage.

Many states offer a Medicare managed care plan as an alternative to regular Medicare coverage. While these plans may cover some expenses that Medicare doesn't, they limit participants to certain doctors and hospitals.

Medicare Part D: Prescription drug coverage through Medicare was introduced on January 1, 2006. Known as Medicare Part D, the program gives recipients a choice of drug plans, provided by private companies, which are designed to suit a variety of medical and financial needs. Visit the Medicare website (www.medicare.gov) for details about the plans and tools to help you determine which one suits your needs. Read the fine print – most policies limit many medications to generic prescription medications.

Long-term care: Medicare provides little help if you require long-term assistance with everyday activities. Consequently, many retirees purchase long-term care insurance to try to prevent having their savings devastated, should they require such care. Long-term care insurance can be complicated and expensive but we are here to help evaluate the coverage appropriate for you.

Life insurance: While providing for the needs of a spouse or immediate family, life insurance can also be a valuable estate-planning tool. Depending on your level of wealth and the type of capital, a life insurance policy can be used for buy-sell business agreements, estate taxes, and liquidity needs.

There is also the scenario where you may not require a life insurance policy any more. It depends on factors including the amount of assets you have saved, pension or other income that would cease when you die, or major debts such as a mortgage or loans for children in college.

If you own a cash-value life insurance policy, you have several choices: Cash it out and incur taxes; exchange the cash value of the policy, tax-free, into an annuity; or keep the policy for estate planning purposes.

Annuities: These are insurance products designed to pay income as long as you live. Certain annuities allow you to name a recipient of the income after your death. Many retirees purchase annuities to provide ongoing income that supplements Social Security and pensions.

Some annuities make fixed payments, while others make payments that increase over time. Some generate variable income based on the performance of the underlying mutual funds you select. Keep in mind that variable annuities are subject to market risk.

The trade-off for many annuities is that, upon your death, any remaining principal stays with the company issuing the annuity and is not available to your heirs. The upside is that, if you live long enough, you may exhaust the principal. Annuities can be complicated, expensive, and restrictive. Consider these as a last resort.

REVIEW YOUR LIVING SITUATION

Retirement is also a time to look at your living situation. Begin by asking yourself how well your current home works for you. Things to consider include: size, upkeep, physical limitations and accessibility, property taxes, insurance, etc.

Downsizing to a smaller home allows you to free up cash. In addition, capital gains of up to $250,000 ($500,000 for a married couple) from the sale of your house are free of federal income tax. Your savings may be even greater if you relocate to an area with lower living costs and low (or no) state and local income taxes.