Avoid Haunting Your Heirs With Unnecessary Taxes

jack o lanternNaming beneficiaries for IRA and 401(k) accounts is critical: It keeps these assets from becoming part of your estate and potentially raising your heirs’ tax exposure.

But if you don’t plan carefully beyond this move, your heirs could still be haunted by Uncle Sam in the form of big tax bills when they take cash from these accounts.

Many people don’t see this peril because they’re focusing on estate tax exposure. Estates worth less than $5.43 million aren’t subject to federal estate tax, or state estate tax in some states. So people figure that if IRA and 401(k) assets become part of their estate, taxes aren’t a problem as long as the estate’s worth is still below that threshold.

But these folks may not be considering the income tax hit their heirs might take. If you and your heirs don’t take the right precautions, these transfers can result in painful income tax and penalties.

Those inheriting a 401(k) account should look at the plan document or summary plan description to find out what rules apply to their situation. It’s a good idea to ask a tax professional for help, as it can be complicated.

Rules may differ depending on whether the person who died was one’s spouse, and whether he or she was already receiving periodic payments from the account. Some 401(k) plans mandate posthumous lump-sum cash-outs within a defined time period, and such distributions can trigger a tax event.

This is because the money withdrawn from 401(k) plans and IRAs is always taxable. Money goes into these accounts pre-tax and isn’t subject to federal income tax until it’s withdrawn. Remembering this eternally, the ghost of Uncle Sam looks for opportunities to tax these assets as income.

Here’s what you can do to thwart that ghost.

Update your beneficiary information

If you haven’t named beneficiaries for your 401(k) or IRA accounts with the financial institutions that hold them, do so as soon as possible. Otherwise, these assets could become part of your estate and potentially subject to probate fees, state estate tax and, if your estate is large enough, federal estate tax. If you’ve had life changes that affect whom you want to name — such as divorce, the death of a spouse or remarriage — contact the financial institutions holding these accounts and update your beneficiary forms.

Remember that spouses are special heirs

Spouses get preferential tax treatment from the IRS when inheriting retirement-plan assets. (Now that the U.S. Supreme Court has upheld same-sex marriage, these spouses can legally designate their partners as beneficiaries in all 50 states.)

Unlike other heirs, spouses can assume an inherited IRA as their own; they can roll it into their own accounts.

Be aware of advantages for younger spouses

If you die at age 59½ or older, the IRS threshold for avoiding the 10% penalty on withdrawals, your (younger) spouse can avoid this penalty, provided your spouse retains your account as an inherited IRA. But if he or she transfers these assets to his or her own IRA account, this penalty will apply to all withdrawals from that account until your spouse reaches the threshold age.

All withdrawals are subject to income tax — at any age. It’s the penalties that can be avoided. Required distributions will be imposed, and for a spouse’s IRA these apply after he or she reaches 70½.

A spouse who doesn’t need to take withdrawals right away from an inherited account may opt to simply roll over the account to his or her own, to take them later. Even if a spouse makes a decision in favor of an inherited IRA, he or she can later convert the account and roll it over into his or her own.

Pay attention to deadlines

After your death, various moves by heirs regarding these accounts must meet strict IRS deadlines. When transferring assets, heirs need to act within defined windows of time or face disqualification or unnecessary taxes.

Have family discussions

Discuss the transference of retirement accounts with your family now to avoid extra turmoil following your death — for example, unprepared heirs might contact a financial professional who moves assets prematurely in ways that trigger tax hits. Your heirs should get qualified advice in advance and follow up with those same advisors when the time comes. All of this preparation should result in a clear plan listing the necessary steps to take upon your death. Heirs should name their own heirs for the new accounts.

These are just a few considerations for keeping Uncle Sam from haunting posthumous transfers of your tax-deferred accounts. To learn more, contact a qualified financial professional.

*This information is not intended to be substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

The Do’s and Don’ts of Keeping Assets Separate in Marriage

By Kathleen Nemetz, MBA, CFP®, CDFA®
Originally published on Nerdwallet.com, 2015

When passion is in its prime, it’s hard to see how finances could turn marital life into a fiasco.

But passion can wane and differences over money can put enormous pressure on a marriage.

Whether you live in a community property state like California, or another state, you might choose to keep some assets separate in marriage. To do so, consider consulting with a family law attorney before marriage to create a prenuptial agreement, or if you’re already married, something called a post-nuptial agreement. The need for the latter may arise if you acquire separate property during your marriage. This can come from an inheritance or a personal injury legal settlement, for example. You might wish to protect the separate asset even while possibly using the income from it for your life as a couple.

But before you begin, there are a few legal definitions you should know:

Marital property

Marital property definitions can vary by state. That said, husbands and wives are always responsible for the expenses of the family and for the education of their children, including stepchildren. Laws generally define marital property according to sources of income, and set a fiduciary standard of care for each of the spouses when managing assets that fall into the marital or shared category.

Interestingly, married couples typically file jointly under the federal tax code, but may each be liable for the taxes levied on separate assets or activities. For instance, one spouse may have business income coming from a pass-through business entity, such as an S-Corporation. A prenuptial agreement may have defined the business as a separate asset, but the business income may be marital property and the taxes associated with it a marital debt obligation to the U.S. government.

Separate property

Separate property can be anything you owned before marriage or included in a prenuptial agreement that was explicitly defined and agreed to by your spouse. Separate property can also include gifts and inheritances if kept separate and not commingled with community assets.

Common mix-ups

Couples often commingle separate and marital property and create potential problems for themselves later. Sometimes one’s spouse incurs debt during the marriage, with the consent of a spouse, but the spouse wishes to be reimbursed in the event of divorce. So try to be as clear and intentional as possible.

Here are some key do’s and don’ts for keeping assets separate in marriage, and for building a successful financial life as a couple.

Do:

  • Pay attention to the titling of financial accounts. A separate account should be kept in the name of the spouse or in the name of a trust for a spouse, not as a joint account.
  • Deposit dividends and interest from a separate investment account into a separate checking account.
  • Consider carefully whose name goes on the deed of a house. Without a prenuptial agreement, mortgage and property tax payments made by both spouses using separate incomes can create a marital asset of the house, even if one partner initially purchased it.
  • Create a shared household budget. Decide how you and your spouse will share these expenses and manage your finances as if they were all in one pool, for purposes of discussions about budgets, use of credit and tax liability.
  • Establish shared long-term goals and the appropriate financial milestones to achieve them.
  • Consider reciprocity. If you ask your spouse to relocate to accommodate your next job promotion, consider doing the same for him or her later on. You can also put any promises in writing. Otherwise you might find in the event of a divorce, you are asked to reimburse lost wages or earning power if your spouse suffered a salary cut from the relocation.

Don’t:

  • Don’t deposit funds from separate property sources into joint accounts, unless you intend to convert the money to marital property.
  • Don’t ignore the appreciation factor in the value of homes or in assets held over the course of a long marriage — especially if your spouse is helping improve a home or trade an investment account to which she or he doesn’t have title. The increase in value may be a jointly claimed asset.
  • Don’t reduce family life to an ongoing debate about the numbers. Discuss your life goals and how to finance them openly, and talk about what priorities you may share for the children. Remember to be transparent in discussing what investment of time or money is necessary to realize these goals.

A final word

It’s always important to seek professional advice before discussions become heated. Learn how to choose a financial advisor who suits your needs. Your life as a couple should create bonds on many levels, including one of trust about money.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.  All investment related performance references are historical; there is no guarantee of future investment results. All indices are unmanaged and unavailable for direct investment. This information is not meant to substitute for individualized tax or legal advice specific to your situation. I suggest that you discuss your personal situation as needed with the appropriate tax and legal experts appropriate for your situation prior to taking action.

Originally published on Nerdwallet.com, 2015.

Avoid Haunting Your Heirs With Unnecessary Taxes

Kathleen Nemetz, MBA, CFP®

NerdWallet
PUBLISHED OCT 29, 2015

Naming beneficiaries for IRA and 401(k) accounts is critical: It keeps these assets from becoming part of your estate and potentially raising your heirs’ tax exposure.

But if you don’t plan carefully beyond this move, your heirs could still be haunted by Uncle Sam in the form of big tax bills when they take cash from these accounts.

Many people don’t see this peril because they’re focusing on estate tax exposure. Estates worth less than $5.43 million aren’t subject to federal estate tax, or state estate tax in some states. So people figure that if IRA and 401(k) assets become part of their estate, taxes aren’t a problem as long as the estate’s worth is still below that threshold.

But these folks may not be considering the income tax hit their heirs might take. If you and your heirs don’t take the right precautions, these transfers can result in painful income tax and penalties.

Those inheriting a 401(k) account should look at the plan document or summary plan description to find out what rules apply to their situation. It’s a good idea to ask a tax professional for help, as it can be complicated.

Rules may differ depending on whether the person who died was one’s spouse, and whether he or she was already receiving periodic payments from the account. Some 401(k) plans mandate posthumous lump-sum cash-outs within a defined time period, and such distributions can trigger a tax event.

This is because the money withdrawn from 401(k) plans and IRAs is always taxable. Money goes into these accounts pre-tax and isn’t subject to federal income tax until it’s withdrawn. Remembering this eternally, the ghost of Uncle Sam looks for opportunities to tax these assets as income.

Here’s what you can do to thwart that ghost.

Update your beneficiary information

If you haven’t named beneficiaries for your 401(k) or IRA accounts with the financial institutions that hold them, do so as soon as possible. Otherwise, these assets could become part of your estate and potentially subject to probate fees, state estate tax and, if your estate is large enough, federal estate tax. If you’ve had life changes that affect whom you want to name — such as divorce, the death of a spouse or remarriage — contact the financial institutions holding these accounts and update your beneficiary forms.

Remember that spouses are special heirs

Spouses get preferential tax treatment from the IRS when inheriting retirement-plan assets. (Now that the U.S. Supreme Court has upheld same-sex marriage, these spouses can legally designate their partners as beneficiaries in all 50 states.)

Unlike other heirs, spouses can assume an inherited IRA as their own; they can roll it into their own accounts.

Be aware of advantages for younger spouses

If you die at age 59½ or older, the IRS threshold for avoiding the 10% penalty on withdrawals, your (younger) spouse can avoid this penalty, provided your spouse retains your account as an inherited IRA. But if he or she transfers these assets to his or her own IRA account, this penalty will apply to all withdrawals from that account until your spouse reaches the threshold age.

All withdrawals are subject to income tax — at any age. It’s the penalties that can be avoided. Required distributions will be imposed, and for a spouse’s IRA these apply after he or she reaches 70½.

A spouse who doesn’t need to take withdrawals right away from an inherited account may opt to simply roll over the account to his or her own, to take them later. Even if a spouse makes a decision in favor of an inherited IRA, he or she can later convert the account and roll it over into his or her own.

Pay attention to deadlines

After your death, various moves by heirs regarding these accounts must meet strict IRS deadlines. When transferring assets, heirs need to act within defined windows of time or face disqualification or unnecessary taxes.

Have family discussions

Discuss the transference of retirement accounts with your family now to avoid extra turmoil following your death — for example, unprepared heirs might contact a financial professional who moves assets prematurely in ways that trigger tax hits. Your heirs should get qualified advice in advance and follow up with those same advisors when the time comes. All of this preparation should result in a clear plan listing the necessary steps to take upon your death. Heirs should name their own heirs for the new accounts.

These are just a few considerations for keeping Uncle Sam from haunting posthumous transfers of your tax-deferred accounts. To learn more, contact a qualified financial professional.

This information is not intended to be a substitute for specific, individualized legal and tax advice. We suggest you discuss your specific situation with a qualified tax or legal advisor.

Possibly boring, but who cares? These stocks sure beat zero yields.

The Fed’s latest decision in September 2015 to again stand pat on whether to raise interest rates has at least some investors happy. Holders of utilities stocks are seeing their shares rise as expectations reset for continued low cost capital to this sector.

Anyone searching for income in this market has of course been frustrated by the low yields offered by government bonds, money market funds, and savings and time deposits. Yields for these securities remain close to zero percent on investment. Conservative investors dislike the risks generally posed by stocks and by long term bonds, which can be subject to volatility like we experienced in August.

Just staying in cash may be tempting, but is often unrealistic unless the investor opts in to draw down his or her balance over a period of years. There is a way, however, for conservative investors to put their money back to work. 

Anyone who has lost patience with zero returns for yield may find an attractive alternative in shares of selected U.S. public utilities. Companies providing natural gas, electricity, and water to residential and commercial customers are supplying life’s necessities. Utility companies can exhibit more consistent revenues and profits than do companies exposed to the wider swings of today’s economic cycles. Most consumers will pay their utility bills before they use funds for other bill payments.  Utilities can benefit as the population grows, as rate increases are imposed, and as service areas expand.

At present, dividends in the public utility market range from three to over five percent per year! The dividends, although never guaranteed, are usually consistent. In choosing among these stocks, investors should favor those companies that pay steady dividends or that increase dividends over time.  In this way, long-term investors buy a hedge against future inflation.

Many utilities are currently reinventing themselves, in face of growing competition from homeowners investment into solar panels. For this reason, careful research can identify those companies that are actively seeking new business models for offering value to their customers.
A company that delivers an indispensible product, enjoys government mandated price increases, and is favored with near compulsory billings should merit an investor’s attention. As a financial planner, I often work with my clients to diversify their income holdings to include utilities will for greater current income, opportunities for increasing income, and some appreciation.
People interested in this sector might review the white papers recently published by the major accounting firms with utilities practices. These include KPMG, Deloitte and PWC. The insights provided by these strategists are excellent. They have helped me discover some of the better opportunities for growth among utility stocks.
*Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Steady the Course With Preferred Stocks for Yield

During market unrest, preferred stocks can offer smoother returns.

Starved for income, on deposits at the bank? Looking for ways to get bigger income payments from your fixed income holdings? Then you might consider preferred stocks , before you starve for lack of income.  But don’t jump into these quirky securities before you understand their pros and cons.
Information about preferred securities is not as readily available as is information about a company’s common stock. For that reason it pays to do a little more research, to understand how they are similar to bonds, and how they differ. 

Typically issued by banks, real estate investment trusts, and utilities, preferred stocks usually pay a fixed rate of dividends.  That makes them similar to bonds, which usually pay a set dollar amount of interest.  Payments are usually quarterly, better than for bonds, which typically pay just twice a year.  Issuers of preferred securities give preference over holders of common stock when paying out the dividends. The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.

Before any company issuing them reduces dividends, it must first ax those paid on common stock.  Any such decision of course can affect the company’s credit rating. Consequently most companies issuing these securities rarely reduce the dividend paid on preferred classes of their shares.

Preferred holders also get preference over common holders in the event a company liquidates or goes bankrupt.  Of course bondholders get first dibs on the firm’s assets, in this scenario; preferred shareholders would be paid from assets left over.

So, if these stocks are harder to understand, why consider them? There are several reasons why investors should give these a closer look.  One: preferred stocks generally yield more than a company’s common stock and sometimes yield more than the firm’s bonds.  In addition, dividends from some preferred stocks are qualified, meaning that they are taxed at a top federal tax rate of 23.8%*.  Non-qualified dividends are taxed at a maximum federal rate of 43.4%*.    For this reason, it’s best to use non-qualified preferreds inside of tax-deferred accounts, such as IRAs.

Two: in the context of current market volatility, preferred stocks can be less risky.  That is, they oscillate less in value day to day than do common stocks.  Of course, bonds – that is, actual bonds, not the mutual fund or ETF forms- can move around even less as they are not as actively traded by retail investors.  Therefore, they usually don’t exhibit the wild swings that the equities market may on a particularly volatile day.

This said, when compared to common stocks, preferred stocks offer less opportunity for appreciation.  Like bonds, they tend to trade within a narrow range near their par or face values and are purchased primarily for income, not growth.

However, rising interest rates can reprice preferred stocks downward below their par values, raising the current yields for new buyers. Existing shareholders would be holding discounted valuations until redemption. For this reason, inflation and rising interest rates are risk factors.  Because preferreds pay fixed dividends, higher rates could force down preferred share prices.

Unlike bonds, preferred shares do not have a fixed maturity date, but most may be redeemed by their issuers.  Before buying a preferred, find out when it can be called and at what price. You could lose principal if the stock is redeemed at a call price below your purchase price.
Have questions? Time for a checkup. Review the level of fixed income in your portfolio and whether you are adequately diversified for yield and return.
*Includes Medicare Investment Income Tax of 3.8%
*Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

What to Ask Your Spouse About His or Her 401K Plan

Couples should coordinate asset allocation across all of their retirement holdings, including those in employer plans. 

Moving from the “I” vs. “we” mentality in planning for life’s goals.

Planning for life’s finances can be challenging enough for one, but when doing so for two people, it’s even more important to take the time to do it – and to do it right.

972a67b5-ab0d-4127-bb66-1307cd7c62b3If you are a partner in a couple that rarely if ever discusses finances, it may be time to schedule a conversation. If you are married, you are already subject to joint taxes. It makes sense to discuss the individual decisions you are making that contribute to the rate of taxation that you both share.

Even more important will be a discussion about how to sustain your life bond into retirement. And how to do so by allocating all assets, including all holdings in employer retirement plans.

As a financial planner, I work with couples who are trying to move from “I” to “we” mentalities when planning for life’s goals. In community property states, there is already a reality defined by law about what constitutes shared or marital property. Retirement plans fall into the shared category. But somehow, many people overlook this when making decisions about how to make choices about their workplace retirement plans.

Better communication by partners about goals and how to fund them can strengthen commitments that they have already made to each other. This discussion can also reduce anxiety about where salaries may be going and whether joint savings will be enough to finance retirement.

This discussion can be even more important for same sex couples. The June decision by the US Supreme Court to uphold the right to same sex marriage throughout the United States has led many people to reevaluate their retirement plans – and other retirement related choices.

Here are seven ideas for coordinating 401K or equivalent plans, with those of your spouse.

-Discuss your relative savings goals, the timeline for achieving them, your taxation rate, and whether your annual deferral rates will allow you to retire by the age you desire. In your review, consider any difference in your ages, other savings you may have, your relative tolerances for risk, types of investments you have available to you in employer plans, and how you might allocate among them to balance risk and reward.

18-Various online calculators are available that can estimate the rate of savings and return necessary to arrive at a given dollar figure over a specified period of time. These are approximate calculations that should be vetted by a financial planner and or tax professional on a periodic basis.

-Look deeper into your plans to determine how to optimize among the funds provided. Some plans offer lower fees on funds and lower overall expenses allocated by participant. Examine how the individual funds are rated. You can even chart relative performance using no-cost tools on such websites as http://finance.yahoo.com.

-Determine how to weight the strategic asset classes offered in your plans, which include equities, fixed income, and cash. Using a website such as www.morningstar.com can help you choose an approximate mix to reduce risk of overexposure in any one category. If your plan is a 403b, you may also have the option to invest in a tax deferred insurance contract, also known as an annuity.

-Judge whether some assets you would like to hold would be better held in a taxable account. These might include tax exempt municipal bonds and stocks that pay no dividends – but that offer substantial opportunity for appreciation. If available to you, you could also holding such stocks in a Roth IRA, which can allow you to forego taxation upon the sale of these holdings provided you satisfy the other requirements imposed by the IRS.

-Once you have decided what assets to hold in what mix, be sure to rebalance this mix quarterly. Equities usually outpace bonds, so to hold true to fixed income weight you will need to sell off a little equity each quarter. You would then reinvest the proceeds into fixed income.

-Review all fund choices at least once a year and don’t be afraid to jettison funds that are off target or that are underperforming their category. If your two plans offer vastly different menus of fund selections, compare the funds available in both plans. Choose the best funds from either plan and allocate as if you were managing a single portfolio.

-Update beneficiary information as needed. Be sure to indicate your spouse as a primary beneficiary; and to choose a contingent beneficiary as appropriate. If you elect to name a trust as a beneficiary, be clear on the tax impact of this decision. Any trust document used should offer some language about pass through rollovers so that heirs aren’t forced into a tax event. Better yet name the heirs as contingent beneficiaries, so that tax glitches don’t force lump sum payouts at higher tax rates.

If you find yourself struggling to get on the same page as your partner in this conversation, a financial planner can help.   The subject of money is often touchy. We help our clients with the negotiation necessary to arrive at consensus.

*Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

Transitioning From Growth to Income for Retirement

If you’re age 50 or older and are like most investors, you’re investing largely in mutual funds through an employer-sponsored retirement plan. If you have a brokerage account, you’re probably choosing funds rather than individual stocks.

Investors who have a little more knowledge will often assess the balance of their holdings and the ratings of the funds they own. They may subscribe to newsletters or visit financial sites that provide guidance and recommend stocks and funds.

So much of that guidance, however, is focused on growth — the potential for price appreciation as investments increase in value. The only way to turn investment growth into cash is to sell the investment. As investors get closer to retirement, though, they want to know more about how much income their portfolios are earning — that is, how much cash their holdings are actually generating. Growth may be high, but income may be quite low.

So what is an investor to do? Ride the hills and valleys of the market and hope for the best from a growth standpoint? Or take steps to lock in more certainty about income?

Making the transition from growth-focused investing to income is often challenging. Investors comfortable with stock funds may have a hard time adjusting to the notion that a mix of securities might better achieve their income goals.

To choose the strategy that’s best for you, it’s important to understand some income-related financial terms and definitions.

Yield

To explain yield, I often use the analogy of a house rental. Say you rent a house to a tenant. The rent you collect, minus your expenses, is your yield — that is, the income from the property. The rent by itself is not the value of the property. The property value can rise or fall independent of the rent you receive. You realize a gain or loss on the property only when you sell the house. In the interim, you can take deductions against income on your taxes.

Stocks pay dividends, bonds pay interest, and these payments are made on specific dates, often several times a year. Divide the annual amount of payments by the value of the stock or bond to determine the effective rate at which it pays income. That is yield.

Dividends

Dividends are paid by common and preferred stocks, usually on a quarterly or semiannual basis. Preferred stocks are a type of fixed-income instrument, with a guaranteed dividend. Common stocks are the more typical equity issues; their dividends aren’t guaranteed, although they have greater potential for growth.

Interest

Interest accrues and is paid on debt instruments such as certificates of deposit and bonds. The bond owner receives interest, usually twice a year, in the form of a “coupon” payment. (Bond funds usually distribute interest monthly.) Investors get their principal back when they redeem the CD or bond.

Capital gain distributions

Capital gains are the fruits of growth — money made by selling an investment for more than you paid for it. Mutual funds declare and distribute capital gains from the sale of investments within the fund. These distributions are typically not guaranteed.

Other income sources

Annuities produce regular, guaranteed payments that are usually a mix of income and a return of capital. Depending on the annuity, there may be a guarantee of lifetime income.

Covered calls are an additional source of revenue for people who own a portfolio of common stocks. Engaging in a call strategy requires an in-depth conversation with your financial advisor to review your risk tolerance and the tax implications for realized gains.

What income sources are right for you?

Well-diversified investors may be using a mixture of all these strategies to produce the annual income they need from their accounts. The actual allocation of weight among strategies may depend on the risk tolerance of the investor, as well as the amount available to invest. All of these decisions are made in the context of an investor’s need for liquidity — the ability to convert investments to cash. Investors who are already retired are normally advised to keep a percentage of assets in cash to have available for emergency needs. This lets them avoid “fire sale” events should markets turn down.

Planning ahead

A discussion with a financial planner can help you identify the income sources that make the most sense for your retirement. Tax issues should also be considered, as larger withdrawals from IRA and 401(k)-type accounts can affect your tax rates. Having tax-free Roth IRAs can help as well.

*This information is not intended to be a substitute for specific individualized tax and legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

*Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

 

Financial lingo to know for retirement planning

Knowing what retirement strategy to follow can be tricky, especially with all of the finance jargon that is used. NerdWallet’s Kathleen Nemetz breaks down it so you can figure out how to plan for your retirement. 

Martin Smith-Rodden/The Virginian-Pilot/AP/File
Retired couple Penny and Ty Brown stand on the balcony of their apartment in Virginia Beach, Va. To choose the best retirement strategy, it’s important to understand some income-related financial terms and definitions.

First published May 28, 2015, Nerdwallet.com
Reprinted by Christian Science Monitor

  • By Kathleen Nemetz If you’re age 50 or older and are like most investors, you’re investing largely in mutual funds through an employer-sponsored retirement plan. If you have a brokerage account, you’re probably choosing funds rather than individual stocks.

Investors who have a little more knowledge will often assess the balance of their holdings and the ratings of the funds they own. They may subscribe to newsletters or visit financial sites that provide guidance and recommend stocks and funds.

So much of that guidance, however, is focused on growth — the potential for price appreciation as investments increase in value. The only way to turn investment growth into cash is to sell the investment. As investors get closer to retirement, though, they want to know more about how much income their portfolios are earning — that is, how much cash their holdings are actually generating. Growth may be high, but income may be quite low.

So what is an investor to do? Ride the hills and valleys of the market and hope for the best from a growth standpoint? Or take steps to lock in more certainty about income?

Making the transition from growth-focused investing to income is often challenging. Investors comfortable with stock funds may have a hard time adjusting to the notion that a mix of securities might better achieve their income goals.

To choose the strategy that’s best for you, it’s important to understand some income-related financial terms and definitions.

Yield

To explain yield, I often use the analogy of a house rental. Say you rent a house to a tenant. The rent you collect, minus your expenses, is your yield — that is, the income from the property. The rent by itself is not the value of the property. The property value can rise or fall independent of the rent you receive. You realize a gain or loss on the property only when you sell the house. In the interim, you can take deductions against income on your taxes.

Stocks pay dividends, bonds pay interest, and these payments are made on specific dates, often several times a year. Divide the annual amount of payments by the value of the stock or bond to determine the effective rate at which it pays income. That is yield. Of course, the payment of dividends or interest is not guaranteed. Companies may reduce or eliminate the payment of dividends at any time. Interest payments are less likely to be skipped, depending on the credit rating of the company.

Dividends

Dividends are paid by common and preferred stocks, usually on a quarterly or semiannual basis. Preferred stocks are a type of fixed-income instrument, with a guaranteed dividend. Common stocks are the more typical equity issues; their dividends aren’t guaranteed, although they have greater potential for growth.

Interest

Interest accrues and is paid on debt instruments such as certificates of deposit and bonds. The bond owner receives interest, usually twice a year, in the form of a “coupon” payment. (Bond funds usually distribute interest monthly.) Investors get their principal back when they redeem the CD or bond.

Capital gain distributions

Capital gains are the fruits of growth — money made by selling an investment for more than you paid for it. Mutual funds declare and distribute capital gains from the sale of investments within the fund. These distributions are typically not guaranteed.

Other income sources

Annuities produce regular, guaranteed payments that are usually a mix of income and a return of capital. Depending on the annuity, there may be a guarantee of lifetime income.

Covered calls are an additional source of revenue for people who own a portfolio of common stocks. Engaging in a call strategy requires an in-depth conversation with your financial advisor to review your risk tolerance and the tax implications for realized gains. Options strategies potentially involve risk to create income. Have a professional explain this to you, or visit the disclosures found at the Options Industry Council website, 

What income sources are right for you?

Well-diversified investors may be using a mixture of all these strategies to produce the annual income they need from their accounts. The actual allocation of weight among strategies may depend on the risk tolerance of the investor, as well as the amount available to invest. All of these decisions are made in the context of an investor’s need for liquidity — the ability to convert investments to cash. Investors who are already retired are normally advised to keep a percentage of assets in cash to have available for emergency needs. This lets them avoid “fire sale” events should markets turn down.

Planning ahead

A discussion with a financial planner can help you identify the income sources that make the most sense for your retirement. Tax issues should also be considered, as larger withdrawals from IRA and 401(k)-type accounts can affect your tax rates. Having tax-free Roth IRAs can help as well.

This information is not intended to substitute for specific individualized tax or legal advice. We suggest you discuss your specific situation with a qualified tax or legal advisor.

Transitioning From Growth to Income for Retirement

KATHLEEN NEMETZ, MBA, CFP®, CDFA®

May 28, 2015
originally published on Nerdwallet.com

If you’re age 50 or older and are like most investors, you’re investing largely in mutual funds through an employer-sponsored retirement plan. If you have a brokerage account, you’re probably choosing funds rather than individual stocks.

Investors who have a little more knowledge will often assess the balance of their holdings and the ratings of the funds they own. They may subscribe to newsletters or visit financial sites that provide guidance and recommend stocks and funds.

So much of that guidance, however, is focused on growth — the potential for price appreciation as investments increase in value. The only way to turn investment growth into cash is to sell the investment. As investors get closer to retirement, though, they want to know more about how much income their portfolios are earning — that is, how much cash their holdings are actually generating. Growth may be high, but income may be quite low.

So what is an investor to do? Ride the hills and valleys of the market and hope for the best from a growth standpoint? Or take steps to lock in more certainty about income?

Making the transition from growth-focused investing to income is often challenging. Investors comfortable with stock funds may have a hard time adjusting to the notion that a mix of securities might better achieve their income goals.

To choose the strategy that’s best for you, it’s important to understand some income-related financial terms and definitions.

Yield

To explain yield, I often use the analogy of a house rental. Say you rent a house to a tenant. The rent you collect, minus your expenses, is your yield — that is, the income from the property. The rent by itself is not the value of the property. The property value can rise or fall independent of the rent you receive. You realize a gain or loss on the property only when you sell the house. In the interim, you can take deductions against income on your taxes.

Stocks pay dividends, bonds pay interest, and these payments are made on specific dates, often several times a year. Divide the annual amount of payments by the value of the stock or bond to determine the effective rate at which it pays income. That is yield.

Dividends

Dividends are paid by common and preferred stocks, usually on a quarterly or semiannual basis. Preferred stocks are a type of fixed-income instrument, with a guaranteed dividend. Common stocks are the more typical equity issues; their dividends aren’t guaranteed, although they have greater potential for growth.

Interest

Interest accrues and is paid on debt instruments such as certificates of deposit and bonds. The bond owner receives interest, usually twice a year, in the form of a “coupon” payment. (Bond funds usually distribute interest monthly.) Investors get their principal back when they redeem the CD or bond.

Capital gain distributions

Capital gains are the fruits of growth — money made by selling an investment for more than you paid for it. Mutual funds declare and distribute capital gains from the sale of investments within the fund. These distributions are typically not guaranteed.

Other income sources

Annuities produce regular, guaranteed payments that are usually a mix of income and a return of capital. Depending on the annuity, there may be a guarantee of lifetime income.

Covered calls are an additional source of revenue for people who own a portfolio of common stocks. Engaging in a call strategy requires an in-depth conversation with your financial advisor to review your risk tolerance and the tax implications for realized gains.

What income sources are right for you?

Well-diversified investors may be using a mixture of all these strategies to produce the annual income they need from their accounts. The actual allocation of weight among strategies may depend on the risk tolerance of the investor, as well as the amount available to invest. All of these decisions are made in the context of an investor’s need for liquidity — the ability to convert investments to cash. Investors who are already retired are normally advised to keep a percentage of assets in cash to have available for emergency needs. This lets them avoid “fire sale” events should markets turn down.

Planning ahead

A discussion with a financial planner can help you identify the income sources that make the most sense for your retirement. Tax issues should also be considered, as larger withdrawals from IRA and 401(k)-type accounts can affect your tax rates. Having tax-free Roth IRAs can help as well.

This information is not intended to be a substitute for individualized tax or legal advice. Please consult your tax or legal advisor as appropriate regarding your specific situation.

Mars, Venus and the Shared Wallet, Women and Money

Women and men differ fundamentally in their approaches to investing and finances. What studies show.

Why would 27% of women in households earning more than $200K fear ending up broke, homeless and as a bag lady, in their later years?

While advising couples, I have noticed that men and women often have very different approaches to investment decisions and managing risk. Curious to learn more, I researched available studies to learn more about the scope of these differences and why they occur.

The findings were in some cases very surprising. However they almost universally validated my anecdotal evidence that women tend to be more conservative than are men, when making decisions about finances and investments.

These tendencies occur for a number of reasons. The studies have shown that more women than ever are supporting households as a primary breadwinner, and that women are living for longer periods of time. Female headed households are also more likely to include extended family members, including children, and older parents. Decisions about allocating a paycheck may need to support several people.

Married women were also found to be very interested in finances; but less likely to be taking the initiative in a conversation with professionals about household finances or investing. They were found to be very concerned about their financial security. Most surprising to me, personally, was a finding that 27% women in households earning more than $200,000 a year had a deep seated fear of ending up broke, homeless and as a bag lady later in life.*

Among married women, most were far likelier to discuss a purchase of more than $360 with their husbands prior to making it. By comparison, the husbands surveyed were not likely to involve their spouses in a purchase decision unless the amount exceeded $1200!

There are many implications of these studies. One of the first takeaways for me is that it is important for women, if they are not already well informed and assertive, to delve into household finances and to share in decisions about them. Women should choose professionals – whether they are CPAs, tax preparers or financial advisors – with whom they can collaborate, rather than be patronized.

Also, women in significant relationships should understand that their voices should be heard on money topics. It is important for couples to work toward ease in communications about money, an often difficult subject. In community property states, salaries and retirement assets are considered to be marital property. It is logical that both spouses work together on decisions about these assets rather than assigning more control to the one who earns more.

One way women can be made to feel more comfortable about investment decisions and saving for retirement is to engage in planning. The studies found that women who plan had a higher level of confidence about achieving their eventual goals, and more awareness of the resources and milestones necessary to attain them. These women also felt more comfortable with assuming some risk to attain the desired outcome.

Estate planning can also be important, to help women feel reassured that they will have sufficient resources for their later years. The process of creating a will or trust can identify issues for funding legacy goals, as well as the needs of a surviving spouse. Estate planning can also direct the outcome of “instant estates” created, when an untimely death of a parent or both parents triggers life insurance payouts for children. Estate planning may serve as a reality check on levels of current spending, which may not allow for sufficient accumulation toward retirement.

Recently, I spent a morning talking with women about life planning, and estate planning. Even people who don’t self identify as rich realized that if both parents were to die, leaving the insurance payouts of a group life insurance plan for children, that the parents’ estates could suddenly be substantial. Informed choices of when to start Social Security benefits and to coordinate benefits with those of a spouse can provide life-changing results.

If you would like to learn more or to read more about these studies, to assess where you may be with some of these decision points, I can send you some links. You can also consider attending my panel discussion tomorrow in Mill Valley. Link is below. I would also be happy to engage you in an important planning discussion, toward taking more control over your finances, and life goals.

The bottom line is that life circumstances can significantly affect risk tolerance and assumptions regardless of gender. Rather than totally avoid risk, we need to ask ourselves how much we might tolerate to reach a desired goal.

*Allianz Life, 2012

**Research studies by: Allianz Life, 2012; Sullivan Trust Study, BNY Mellon, Jan. 2011; Spectrem Group, Oct. 26, 2011, Experian, 2014; and Family Wealth Advisors Council, 2012.

***Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.