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Topic: Retirement Planning

Simplicity vs. Flexibility In Your Portfolio

By Scott Roark, MBA, PhD | December 18, 2020

There is much to be said for the practice of simplifying and de-cluttering in life.  It seems like I keep seeing consultants and tools that will help you clean out and organize your garage, your food pantry, or your closet.  It seems that the hoarding gene (apparently it resides in a region on Chromosome 14) is relatively widespread among us.

It turns out that this tendency to accumulate clutter can be fairly common in the financial arena as well.  If you change jobs, move around or respond to financial services marketing, chances are that you have more accounts than are really necessary for a smoothly functioning life.  While there may be some arguments to having more than a couple of accounts for a particular category, it may sometimes be easier to keep track of financial matters when you are not dealing with endless statements at the end of each month. This logic also transfers to the actual investments that make up your multiple accounts. The financial services industry has attempted to provide simplicity with an investment vehicle called a Target Date Fund.

Target Date Funds have been marketed is as a simplifying tool for retirement savings.  They can be appealing because, in one fund, you can get a well-diversified holding that can achieve a targeted asset allocation (or at least get very close to one). The theory behind Target Date Funds is rather than having a portfolio with a dozen or more varying asset classes, one simple fund may do it all. As a quick overview of Target Date funds, they have dates contained in their name that roughly correspond to a “targeted retirement date”, often occurring in 5-year increments. Funds with a target date in their name closest to the current year will theoretically have less volatility and more fixed income and cash-like holdings in them while funds with a target date in their name furthest from the current year will be invested in a more growth-oriented manner. For example, a fund sponsor may have funds that range from a 2020 fund that might have 35% in stocks and 65% in fixed income and cash-like holdings while a 2065 fund could be allocated to 90% stocks and just 10% in fixed income and cash-like holdings.

Obviously, a full discussion of Target Date funds is beyond the scope of this simple article.  I will get into more depth on these complex funds in the future, perhaps on one of our EDU podcasts! But in terms of adding simplicity to your portfolio, they may be an attractive tool, especially in the accumulation phase of retirement planning – that period of time when you’re just adding to your portfolio every month and you are not taking any distributions.

However, in retirement when you begin sending your savings and living off them, I would argue the simplicity that Target Date funds offer starts to lose its appeal.  In the distribution phase of retirement planning investment flexibility become more valuable than account holding simplicity.  Unfortunately, that is where a Target Date fund can lose some appeal.  For instance, consider the situation of March 2020 when the Corona Virus scare had the equity markets down 30%+ in a short period of time. However, in the same period, some fixed income and cash-like holdings (not all, but some) held steady or even gained in value.  If you were taking a $20,000 quarterly distribution from your retirement funds in March, it would have been nice to pull from the fixed income or cash-like holdings that were more stable in value and had not dropped rather than selling your stock holdings which had likely dropped in value. This is where the simplicity of a Target Date fund loses out to its inflexibility.  If all your assets are in a Target Date fund, you can’t choose to sell the winners and leave the losers alone. If the Target Date fund’s “losers” dropped enough that they took the entire fund’s value down, even though the fund holds some “winners”, you must still sell the entire fund as one. There is no picking and choosing allowed!  It is the proverbial “Throwing the baby out with the bathwater” conundrum.

When you are close to, or in retirement and you are actively spending from your portfolio, I think it is better to have the flexibility that comes from breaking your actual retirement portfolio into its constituent parts.  At Jim Saulnier & Associates we call this “positioning” and it allows you the flexibility to pick and choose what holdings you sell under what market conditions.

Target Date funds and others in their ilk, do offer simplicity and can be a useful option to busy professionals lacking the time and inclination to monitor and manage an investment portfolio during their accumulation years. But in retirement, when assets must be sold to fund your spending needs, I would suggest you opt away from simplicity and begin “positioning” your portfolio for spending by utilizing separate low-cost passive asset classes in your portfolio for the spending flexibility they afford. After all, babies should not be thrown out with the bathwater!


Additional Disclosure:

Diversification and asset allocation strategies do not assure profit or protect against loss. Past performance is no guarantee of future results. Investing involves risk. Depending on the types of investments, there may be varying degrees of risk. Investors should be prepared to bear loss, including loss of principal.

Asset Allocation and Asset Positioning

By Scott Roark, MBA, PhD | November 23, 2020

Asset Allocation

One of the most important decisions investors make is the “asset allocation” decision.  This is the decision about the broad categories of investments that will be held in a portfolio.  In the broadest sense, these categories would be things like stocks and bonds.  But many times, investors also consider other categories of assets like cash, commodities and real estate and maybe even more esoteric categories like private equity, blockchain currencies (e.g. bitcoin) and vintage cars.  In this article, we’re going to stick with a mix of asset types (also called “asset classes”) that addresses the needs of the vast majority of investors – stocks, bonds and cash.  And in terms of how investors participate in these asset classes, I’m going to assume that broad based ETFs are used for stocks and bonds and a money market fund is the stand-in for cash.

There are a few important characteristics of asset classes that matter to investors, including average return, risk, liquidity and correlation. Each asset class will usually have slightly different expressions of these characteristics and several are listed below.

  • Average return reflects the expected total return of an asset is going forward. This return is made up of income and capital gains (price increases) that benefit the owner.  Over the past 100 years or so, stocks have had the highest average return, followed distantly by bonds with cash bringing up the rear.  According to the 2020 edition of the SBBI Yearbook, the average annual compound return for the various classes is:

Large-cap stocks                                 10.2%

Long-term corporate bonds                  6.1%

U.S. Treasury Bills (cash proxy)          3.3%

Inflation                                                2.9%

  • Risk reflects the uncertainty associated with returns and is frequently measured by the standard deviation of returns. The more ups and downs there are in the returns for an asset class, the higher the standard deviation will be.  From 1926-2019, stocks have been the riskiest asset class, followed by bonds and then by cash. Based on the 2020 SBBI Yearbook, the standard deviation of returns for the asset classes is:

Large-Cap stocks                                 19.8%

Long-term corporate bonds                  9.8%

U.S. Treasury Bills (cash proxy)          3.1%

Inflation                                                4.0%

  • Liquidity is really about the ease of converting an asset to cash without losing too much value in the conversion. The asset classes we are considering are very liquid.  Of more concern here is really the interaction between risk and liquidity.  It is easy to sell a stock ETF, but you don’t really want to do that when the market has tanked by 25%.  A better time to sell investments is when they have had a nice increase.
  • Correlation is the last important characteristic of asset classes that we will consider. Correlation touches on the diversification benefits of an investment – does having this asset reduce the overall risk of your portfolio?  This could also be thought of as a measure of how one asset zigs when another asset zags.

According to the 2020 SBBI Yearbook, the correlations between stocks, bonds and cash are all below 0.17 – which means they have generally contributed to diversification and reduced risk when held together in a portfolio.


Asset Positioning

The notion of asset positioning ties investing decisions related to asset allocation to spending decisions based on timing.  Many times, this is thought about as matching the timing of a known liability (spending need) to the characteristics of an asset.   Here are a few principles of matching that are commonly used in the accumulation phase of life (up to retirement):

Saving for retirement – there is a long horizon (anywhere from 20-40 years of future participation in the labor force), so a heavy dose of stocks is usually called for.  The need for a high average return to provide a sizable nest-egg and the fact that there is plenty of time to recover from a downturn means stock are an appropriate choice.

Saving for college education – this might be up to 18 years away if you start setting aside money at birth in a 529 account (use a stock-heavy allocation) all the way up to saving some money for next year when junior or juniorette starts college (use money market).

Saving for a house – if you are planning on buying a house in the next couple of years, the biggest need from an investment is stability.  If the money you’ve set aside for a down payment takes a 25% haircut from a market downturn, then perhaps the purchase decision has to be put off for quite some time.  Generally, for these needs that are imminent, setting aside money in low-risk money market accounts is best.

In retirement planning, asset positioning is also key.  At Jim Saulnier & Associates, we believe strongly in the need to position assets in such a way that spending decisions are aligned with investment decisions.  We work with our clients to move away from one catch-all portfolio to a portfolio that has been positioned with different mini-portfolios (also known as “sleeves” in our business) to meet different spending objectives.  For instance, we position clients such that they have a principal-protected sleeve for immediate spending needs (anywhere from 1-5 years of spending will be set aside in cash or cash-like holdings so that there is no risk of a market downturn causing a loss of spending power.  The drawback of this safe approach, especially in the past few months, has been the very low interest rates that can be earned on these kinds of investments.

For intermediate spending needs (from 5-10 years or more in the future), we may position clients where there is some modest level of risk, but also the opportunity to have the investments grow in value to keep up with and hopefully exceed inflation.

Because retirement can last anywhere from 10-30 years (or more), it is important to have some investments allocated to more aggressive holdings (i.e. stocks) that can continue to grow over time.

And because some needs don’t necessarily have a definite timetable attached – such as the need for long-term care – there may be sleeves set aside with a mix of immediate liquidity and longer-term growth potential.

Because of all these considerations, asset positioning is a dynamic process that requires on-going maintenance and attention.  We always want to manage investments in such a way that there is plenty of cash available for near-term spending while keeping an eye on longer term goals and needs of our clients.

Five Positives and a Negative about the SECURE Act

By Bob Palechek, CPA | February 7, 2020

The U.S. Government is finally reacting to its concern that Americans are not saving enough for retirement. (About one-quarter of working Americans have no retirement savings.) So, Congress started writing bills and resolutions that would make it easier for certain employers to offer retirement plans to their employees – and for workers to save more money.

The name they gave it was the SECURE Act: the “Setting Every Community Up for Retirement Enhancement” Act of 2019. After months of delays, Congress finally passed the Act in December 2019 by tucking it into an Appropriations bill that had a year-end deadline.

But, not all of the parts of the new law will “enhance” everyone’s retirement, especially someone planning to use a specific strategy that benefits future generations. First, let’s see the five key positive changes, and then the one that may call for some crucial retirement plan adjustments.

Five Key Positive Changes

  • Before the SECURE Act, you had to distribute a minimum amount of your qualified retirement accounts (called RMDs) beginning in the year you turned 70½. (In the first year, the percentage to be distributed is about 3.65% and increases each year.) For higher net worth taxpayers, being forced to add this income to Social Security benefits can create a sudden jump in the taxes due. This Act raises the starting age to 72 for anyone younger than 70½ at the end of 2019.
  • Until this Act passed, you were allowed to contribute to a Roth IRA after age 70½, but not to a tax-advantaged traditional IRA. The Act removes the age limit on traditional IRAs. Yeah! Please keep in mind that you still need “earned” income to contribute. Part-time wages or consulting income (Sch C) works just fine.
  • Thanks to the Act, you now have increased access to lifetime income options (annuities) inside qualified retirement accounts.
  • If student loans somehow figure into your finances and you own a 529 Plan, you can now take a tax-free distribution from the plan to pay toward qualified student loans. The lifetime limit of $10,000 per child means a maximum of $40,000 for four children, for example. You cannot take a deduction for any student loan interest associated with these payments, but that deduction was phased out for many taxpayers in any case. What isn’t clear yet is how the states will handle this and which ones will conform or not.
  • The Kiddie Tax is going back to the old rules, starting in the tax year 2020. Changes in the Tax Cuts and Jobs Act of 2017 had some undesired tax effects as soon as they were implemented in 2018. Some families with minor or college-age dependents found they were hit with high tax rates on their Social Security benefits or taxable scholarships received by the kids. Taxpayers can opt out when filing for 2019, and can also amend their 2018 returns if it makes sense.

A Change with Cause for Concern

This change – the elimination of the lifetime Stretch IRA – was placed in the law to help offset the government’s overall decrease in tax revenues caused by the Act’s various positive changes. (And if it is good for the government, you should question if it’ll be good for you.) Before the Act, you could use the Stretch IRA provision when leaving an IRA to your kids.

It allowed them to spread the required distributions (RMDs) over their lifetime. For a middle-aged child with good earnings, for example, this protected the inherited money from very high tax rates. Now, instead of lifetime distribution, the new Act says the IRA has to be distributed in 10 years or less. Ouch!

A good Certified Financial Planner can find workarounds for retiring and retired clients. For example, by making Roth conversions during low tax rate years before death, you can leave more tax-friendly IRAs to the kids. This change only applies to IRAs inherited after January 1, 2020. And, the Act exempts surviving spouses, minor children, and individuals who are not more than 10 years younger than the decedent.

If any of these changes can potentially impact your existing retirement plans, be sure to check with your financial advisor for a re-evaluation. Besides what is in this summary, many nuances exist that could be even more beneficial to you.

Traditional and Roth IRA Taxation

By Jo Madonna, E.A. | September 13, 2019

The Role of Traditional and Roth IRA Taxation

Ask anyone who is putting money aside for retirement what the first thing was that they invested in, and they’ll probably say, “An IRA.” It is, in fact, one of the easiest ways to save for retirement. It lets IRA owners make ongoing contributions and invest them in a portfolio of stocks, bonds, mutual funds or other instruments. Easy or not, the IRA taxation deserves a closer look.

Congress created the IRA (Individual Retirement Account) in 1974 for two purposes:

  • To provide individuals not covered by a retirement plan at work with a tax-advantaged savings plan; and
  • To act as a supportive piece to employer-sponsored retirement accounts that needed to be rolled over when individuals experienced a job change or moved into retirement.

In 1997, Congress added the Roth IRA, which offered a very different set of retirement opportunities.

Since their creation, IRAs have been a fast-growing component of the U.S. retirement market. The two most popular accounts are:

  • Traditional IRA
  • Roth IRA

For both traditional and Roth IRAs, contribution limits may change from year to year to reflect increases in the cost of living. Changes are usually made in $500 increments. In 2019, IRA contribution limits for both are:

  • Under age 50: $6,000
  • Age 50 or older: $7,000 (considered a catch-up contribution)

The tax implications of each type of IRA will determine which will offer an individual taxpayer the most significant advantage. If and when your funds and earnings get taxed may affect which you choose, and your decision could depend on whether you think your tax bracket will be higher now or later in life.

Traditional IRA Taxation

A taxpayer may contribute to a traditional IRA up to the dollar value listed above and may take a deduction, or above-the-line adjustment, when filing taxes. However, the ability to contribute may be reduced or eliminated if the taxpayer – or spouse – has a retirement plan at his or her workplace. If neither is covered at work by a plan, then the deductions are allowed. Keep in mind, though, that the deduction could be limited or phased out depending on income levels as well.

While contributing to a traditional IRA allows taxpayers to lower their tax burden a bit, it is not without tax consequences. The IRS will want to collect the taxes on the income at some point. Payment will occur when the funds (and earnings) are withdrawn from the IRA. The tax rate will depend on the taxpayer’s income level that year.

Some rules are associated with traditional IRAs:

  • You can only contribute to a traditional IRA up to age 70½.
  • You will pay a penalty of 10% above the taxes due if you withdraw funds from a traditional IRA before you turn 59½.
  • Starting at age 70½, the IRS will require you to take “required minimum distributions,” or RMDs, to finally capture its taxes.
  • The beneficiary of an IRA will eventually have to pay the taxes on the proceeds of the IRA, but depending on beneficiary status, could enjoy some flexibility in the timing of payments. 

Roth IRA Taxation

The second type of IRA, called the Roth IRA, offers some unique tax advantages. However, an immediate tax deduction is not one of them, since they cannot deduct the contribution from their taxable income. Many of the advantages stem from the fact that the taxpayer is contributing to a Roth IRA with ‘after-tax’ dollars.

Roth IRAs have contribution phase-out rules based on income thresholds. In the case of married couples filing jointly, the phase-out range in 2019 is $103,000 to $123,000 if the spouse making the IRA contribution has a retirement plan at work. The deduction is phased out if the couple’s income is between $193,000 and $203,000 when the IRA contributor has no retirement plan at work but is married to a covered individual.

The Tax Cuts and Jobs Act of 2017 has made contributions to a Roth IRA more appealing. That act lowered the tax brackets and expanded them, so those taxpayers who are eligible to contribute can take advantage of the lower tax brackets while they last. (The ‘TCJA’ is set to sunset in 2025.)

The rules associated with Roth IRAs are:

  • You can contribute to a Roth IRA regardless of your age. However, your contributions must come from earned income.
  • The earnings generated in a Roth IRA can be held ‘tax-deferred’ within the account.
  • Taxpayers are never required to take distributions, so they can continue enjoying the tax-deferred growth of assets within the account.
  • Taxpayers can take tax-free withdrawals of both contributions and earnings after age 59½.
  • Beneficiaries may inherit a Roth IRA tax-free, so a Roth IRA provides a way to leave money to heirs free of taxes.

The Impact on Retirement Planning

Your IRA investment strategy can play a vital role in providing essential retirement income. Yet, many people contribute without thinking about IRA taxation and how to put those dollars to work to greatest effect. We would welcome the opportunity to create or review your tax strategy.

Retirement Planning and Sequence Risk

By Scott Roark, MBA, PhD | August 2, 2019

What Is Sequence Risk?

Sequence risk is an important notion in the world of retirement planning.  It refers to the risk that the sequence of returns in an investment portfolio will negatively impact the ability of the portfolio to deliver sufficient payouts throughout retirement.  In extreme circumstances, sequence risk may even mean a portfolio runs out of assets too soon.

Let’s look at the past 20 years of returns (including reinvested dividends) for the S&P 500 for example1:

The average rate of return for these 20 years is 7.16%.

Now consider the exact same returns, now with the returns occurring in the reverse order1:

The average rate of return for this hypothetical, alternate set of returns is also 7.16%, exactly the same as for the original set of returns.  With a static portfolio (where you are neither putting money in nor taking money out), you would have the exact same ending portfolio value under either scenario.

However, if you are in retirement and withdrawing from the assets, the sequence of returns has a dramatic effect on the portfolios.  Assume that you have a $1,000,000 at the start of retirement and that you will take out $40,000 at the start of the first year (4% withdrawal rate) to support your annual spending.  Each year, your withdrawal will increase by inflation (let’s assume 2.5%) to cover the increased costs of the goods and services you consume.

For the actual series of returns from 1999-2018, you would end up with a portfolio value of about $660,000.  For the hypothetical reverse order returns, the portfolio value after 20 years would be about $1,460,000 – more than twice as large as before.  Keep in mind that NOTHING has changed except the order of returns that the market experienced.  This gives some indication of the power of sequence risk when a portfolio is being consumed.

To take the example one step further, let’s pretend that retirement started not 20 years ago – but 19 years ago in January 2000 (right when the market was about to enter a three-year tailspin).  We’ll still start with $1,000,000 and still withdraw 4% of the account ($40,000) in the first year and then grow that amount by 2.5% inflation.  Now that portfolio has shrunk to $318,000 after 19 years.  And if we had accidentally decided we could afford a 4.6% withdrawal rate back in 2000 ($46,000 for that first year’s withdrawal) – the account would have hit $0 with our 2018 withdrawal.  On the other hand, our “alternate universe” portfolio – with the reversed returns – would have ended 2018 with over $1.5 million using the same set of assumptions.

The Lesson For Retirement Planning

Given these relatively straightforward assumptions, you can see how big of an impact the series of returns can have on a portfolio.  While there is never really a good time to have a bad year of returns, the sooner the bad returns happen after retirement, the worse it is for a portfolio.

There are a host of interesting observations one can make looking at historical returns, in considering different portfolio constructions (100% bonds, 50% bonds/50% stocks, 100% stocks) and different withdrawal rates.  One of the important takeaways (which we may explore further in a future post) is the importance of having some principal-protected assets for the early years of retirement along with a well-diversified portfolio.  Those two components of a retirement plan go a long way towards mitigating the dangers of sequence risk.


1Sources: https://ycharts.com/indicators/sp_500_total_return_annual ; https://www.slickcharts.com/sp500/returns

Excess IRA Contributions, Part 1: Basic Qualifications

By Jim Saulnier, CFP | May 24, 2019

Excess IRA Contributions: Basic Qualifications

We hear a lot about how important it is to contribute to an IRA. So, ‘how to contribute correctly’ becomes an important topic. Not that it is difficult, but there are some important rules regarding IRA contribution qualifications that you have to follow.

And since you put money into an IRA to allow it to grow in a tax-advantaged environment, you don’t want to break one of the rules and have it cost you money. One of the main ways that could happen is if you make excess contributions.

In this three-part guide on excess IRA contributions, we are going to review (1) the basic qualifications for making valid contributions, (2) some of the more complex situations you will have to navigate and (3) how you can fix accidental excess contributions and avoid costly penalties.

Why would you want to contribute to an IRA?

In a traditional IRA, your contribution may be fully or partially deductible from the amount of income on which you will be taxed this year. Your contribution will be made with ‘pre-tax dollars.’ Because you won’t pay taxes on those funds now, the portion you would have paid in taxes is also allowed to grow until it is withdrawn, or ‘distributed.’ You will pay the tax upon withdrawal, both on original funds and any gains.

When can you take money back out of an IRA?

You can withdraw money from an IRA whenever you want. However, if you are below age 59½ when you do so, you will pay 10% additional tax on the funds, above your applicable tax rate for that year. From age 59½ forward, you will pay just that year’s applicable tax rate. Then, at age 70½, you will start having to take out Required Minimum Distributions, or RMDs, based on an IRS formula. Not doing so may lead to hefty penalties.

How much can you contribute to an IRA?

For 2019, each person can contribute a total of $6,000 (or $7,000 if you are age 50 or older), as long as you have at least that much in ‘qualified income.’ Anything you contribute above your qualified income will be considered an excess contribution. You have to be particularly careful if you contribute to IRAs being held by multiple custodians (such as authorized banks and brokers), as it is your responsibility to monitor the total, and not the custodians’.

How do you define ‘qualified income’ for contributions?

In general, the IRS defines qualified income as wages, salaries, tips, professional fees, and bonuses. It also includes commissions, self-employment income, alimony, and separate maintenance, as well as nontaxable combat pay. However, you cannot consider Social Security, rental income, investment income, dividends, interest or royalties (among others) in your calculations. Using the wrong kind of income to justify contributing to a traditional IRA puts you at risk of making an excess contribution.

How does spousal income figure into IRA contributions?

You may not have any (or enough) qualified income to justify contributing fully to an IRA. However, if your spouse does and if you file a joint tax return, you can use your spouse’s income to qualify. Each spouse will hold a separate IRA, but the total of your combined contributions cannot be larger than the taxable income reported on the return. If it is, you will be facing penalties for excess contributions.

How long can you contribute to an IRA?  

You can only contribute to a traditional IRA until the year in which you turn 70½. Say you turn 70½ in December of 2019. You cannot contribute at all to a traditional IRA in 2019, even if you were still 69 in early 2019. When in the year you contribute is irrelevant. Any contribution you do make will be considered an excess IRA contribution.

What about Roth IRAs, how do they differ from traditional IRAs?

To start, contributions to a Roth IRA are not tax-deductible, so they are made with ‘after-tax dollars.’ As long as you meet the distribution qualifications, funds will not be taxed when withdrawn. (Remember, you already paid tax on the funds). However, because of the tax advantages Roth IRAs offer on gains, the IRS places caps on the income of those allowed to contribute. If your income is higher, you will have made an excess contribution.

Other differences? You can contribute to a Roth IRA regardless of age, that is, even after you reach 70½. You also do not have to start taking distributions at 70½ but can leave funds there for life.

What next?

Now you have the basic guidelines for contributing to an IRA without being penalized for excess contributions. More complex issues will be reviewed next. However, if you would like to make IRA contributions part of a strategic retirement plan, please reach out to our office so we can help.



Sequential Risk

By Justin Fundalinski, MBA | May 20, 2018

sequential risk“Sequential risk” or “sequence of returns risk” is a well-defined and highly discussed term in the retirement planning and investment industry. Under certain circumstances it can be one of the largest risks pre-retirees and early retirees face. Much of the basis of our firm’s retirement planning strategies is formed around managing this risk, and the highly recognized “4% withdrawal rate rule” was developed in lieu of this risk. Unfortunately, many who are reaching retirement or already retired simply don’t understand sequential risk, and do not place enough weight on managing it effectively. In this month’s article I intend to define in simple terms what sequential risk is and hopefully inspire people to take action.

What is Sequential Risk?

A little thought experiment will help describe how the sequence of returns makes a difference. Imagine your portfolio averages a 6% return over 5 years. Now imagine you have $1,000,000 invested but you need to withdraw $100,000 per year over the next five years.

We all know that you will never get an easy 6% every year and one year your portfolio can be up big while other years it can suffer losses.

You have a choice between two options that will return annual rates as follows:

Both options return the same average return of 6% year over the 5-year period and have the exact same return rates, however the year the returns occur are reversed. If you simply invested the $1,000,000 for the five years your total return and portfolio values would be exactly the same both options.

However, if you need to withdraw money yearly, the ending value of each option is drastically different. In these cases, when you start with $1,000,000 and need $100,000 each year, Option A ends with a total value of about $818,000 while Option B ends with a total value of about $671,000. Option A is 22% greater than Option B and the only difference is when the returns occurred not the size of the returns! This is sequential risk and once withdrawals begin being taken from a portfolio it becomes a reality.

That all said, you can now hopefully see why people who had retired before or close to the market downturn in 2007 and 2008 (and thus were withdrawing funds from their portfolios to meet their income needs) were negatively affected and quite possibly in the long run bad timing could ruin their retirement prospects.

When Does Sequential Risk Impact You the Most?

Without hesitation I can say the actual impact of sequential risk is at its greatest level in year one of retirement. The reason behind this a because day one of retirement is when withdrawals begin from the portfolio (withdrawals being what subjects retirees to the risk itself – as described above) and because the portfolio must last for its longest period of time (30+ years of retirement). However, and with emphasis, the actual sequence of returns leading up to retirement cannot be ignored because they play into the portfolio value for years after they occurred.

Negative or bad returns leading up to retirement can and will undoubtedly subject retirees to sequential risk if a portfolio does not have time to recover before withdrawals being. That said, depending on your level of conservatism, pre-retirees should start addressing sequential risk at least 7 years before withdrawals will be needed and retirees can start phasing out the worry of such risk around 7 years into retirement as the portfolio won’t have to last as long anymore.

How Can Sequential Risk Be Addressed?

Addressing sequential risk can be done in many ways and the strategies vary for every person depending on how exposed they are to the risk as well as their personal investment philosophies. Getting into the details is outside the scope of this article, however we highly recommend some in-depth retirement planning be done in advance of addressing the risk itself (hence why we recommend advance retirement planning 5-10 years prior to retirement).

It is important to identify expenses that make up your minimum dignity floor which cannot be reduced during down markets. It is important to accurately project income sources such as Social Security, Pension, and Annuities that are guaranteed to always be paid. It is important to project the size of withdrawals needed in relation to your total portfolio. It is important to consider longevity and health concerns. Everybody is different and there is no one size fits all answer to this question, but effectively managing downside risks on funds needed early in retirement is necessary.

If you have any questions regarding this article or would like to discuss your exposure to sequential risk, please feel free to set up a meeting with us.

Can an HSA be a Retirement Account?

By Justin Fundalinski, MBA | December 22, 2017

HSAHealth Savings Accounts (HSAs) are very interesting from a tax perspective.  Compared to well-known retirement account types (for example – 401k, IRA, Roth IRA, etc.)  HSAs are the only accounts that are tax deductible in the year you contribute to them, that have tax free growth as you defer them, and are tax free when you withdraw from them. They are what we call “triple tax-free.”  Unfortunately, far too many people do not recognize the benefits of these accounts from a tax perspective and how they can be used to generate tax advantages in the future. This month’s article will address the basics of what an HSA is as well as some general planning points that should be considered when using an HSA.

The Common HSA Approach:              

A very standard approach of a HSA is to use it as a means to fund current medical expenses in a tax free manner.  Most often people place money in a HSA account on a tax free basis and then withdraw it tax free shortly thereafter (relatively) when health expenses are incurred.  While this method is better tax treatment than using a normal medical expense tax deduction (which is limited to 10% of your Adjusted Gross Income), it is not necessarily the best way to take advantage of HSA tax benefits because it only takes advantage of two of the three tax benefits associated with these accounts and forgets about one of its greatest advantages – tax free growth.  As we know, growth takes time and the HSA is not allowed the time to grow this benefit if forgone.

HSAs for the Long Run:

HSAs should be earmarked for medical expenses, however unlike their Flexible Spending Account (FSA) counterpart, HSA contributions are not “use it or lose it” come January 1st.   There is no expiration date on HSA contributions and the funds can remain in the account for an extensive period of time[1]. Fortunately (or maybe unfortunately) medical expense are pretty much guaranteed to be a large part of future retirement expenses and just like we save for future expenses in retirement in accounts like IRAs or 401(k)s, we should save for future medical expenses in HSAs.  Saving in an HSA for an expense that is far into the future allows you to take advantage of the “triple tax-free” aspect of these accounts.

HSA Distributions:

If you withdraw funds that do not qualify as medical expenses you will pay ordinary income taxes on these funds, and if you are not older than age 65 when this “non-qualified” withdrawal occurs there is also a 20% penalty.  Wait – did you read that right? The penalty only occurs if you are younger than 65?  That’s right! So, even if you didn’t use it for medical expenses you could still benefit from the tax free growth similar to how a Traditional IRA works minus those pesky RMDs[2].

Of course, it would be better to use it for medical expenses and avoid taxes entirely, but if you already appreciate the value Traditional IRAs bring to retirement planning, viewing HSAs from this stand point emphasizes that tax deferred growth maybe your worst case scenario as long as you can defer withdrawals beyond age 65.  Considering this, I could easily argue that in many cases it would make more sense to max out an HSA before you max out other retirement accounts because of the high potential that medical expenses will occur throughout retirement and the “triple tax-free”  benefit will then be taken advantage of.

No Time Frame on Qualified Medical Expenses

Strangely enough, under current law, there is no time frame as to when qualified medical expenses need to be incurred compared to when the withdrawal from an HSA must occur. That is, if a medical expense was incurred this year but an HSA owner waited to take the distributions from the HSA for 20 years this would be perfectly acceptable as long there is proof of the expense and no tax deductions had been taken on the expense previously.  Extrapolating this loophole, one could essentially save all their medical receipts for the next 20 years and then take one large distribution completely tax free.  Why isn’t everybody doing this?!?!

The Downsides:

To avoid this article dragging on too long, I am going to sum up the downsides of using HSAs as a retirement vehicle in a few bullet points:

  • One needs to have enough income year over year to be able to not only fund the HSA but also pay for any medical expenses that pop up along the way (remember we don’t want to use the HSA in the short term)
  • One has to be in a high deductible medical plan to be eligible for an HSA. This means one must forgo other medical plans that do not have high deductibles (although these types of health plans often have much higher premiums [i.e. HMOs and PPOs], so this may not be that much of a deterrent depending the particular situation).
  • As (foot)noted, at death these accounts may not be very income tax friendly to the beneficiary. If the HSA passes to anyone other than the original HSA owner’s spouse, the account ceases to be a HSA and while the 20% penalty no longer applies this is a distribution that is considered taxable income.


[1] Withdrawals can be deferred for the lifetime of the account owner and the account can continue to exist after death of the original owner because a surviving spouse can step in and continue the account in their own name.

[2] Keep in mind there is far different treatment of these accounts upon death compared to IRA’s. If the HSA passes to anyone other than the HSA owner’s spouse, the account ceases to be an HSA and while the 20% penalty no longer applies this is a distribution that is considered taxable income.

Defaulting on a 401(k) Loan

By Justin Fundalinski, MBA | November 20, 2017

401k loanConsidering many people’s 401(k)s are usually one of their largest retirement savings assets and many 401(k) providers offer the ability to borrow money, it can be very enticing to take out a loan from your 401(k) to help fund your next big purchase. 401(k) loans are quick, easy,  and do not need a credit check. Unfortunately, there are some downsides to borrowing money from a 401(k) and understanding certain issues can help you make the right lending decisions as well as potentially avoid steep tax consequences. Particularly in this article I will focus on what happens when a 401(k) loan defaults and what options you have.

401(k) loan basics:                                    

While this article is not focused on all the details of a 401(k) loan it is important to know a few basics prior to digging into the main topic of this article.

  • Most plans allow for loans of 50% of your 401(k) balance with a maximum loan of $50,000. That is, if you have a 401(k) valued at $80,000 the maximum you could borrow up to $40,000, while if your 401(k) is valued at and amount greater than $100,000 you could borrow a maximum of $50,000.
  • You must amortize the loans over a five year period and make regular payments (usually through payroll deductions). The IRS defines timely payments as level amortized payments at least quarterly. Prepaying the loan is completely acceptable and there are no prepayment penalties.
  • If you cannot pay the loan back (the loan defaults), then the unpaid amount is considered to be a taxable distribution and you could face a 10% penalty if you are under the age of 59½.

How can a 401(k) loan default?

Because most loan payments are generally required to be paid back with deductions from your paycheck the default rate on 401(k) loans is relatively low. However, the single biggest cause of loan defaults is the loss of one’s job.  Once separated from employment (whether voluntary or involuntary), your employer can no longer just debit your paycheck to ensure timely payments and the full balance of the loan must be repaid promptly (usually within 60 days) to avoid the loan going into default.

Less commonly, loan payments are not required to be paid back via deductions from your paycheck and you become fully responsible for ensuring timely payments. Of course, laying the responsibility of making timely payments on the loan recipient opens up the door to loan defaults. Falling behind on payments can cause a loan to default.

What happens when the loan defaults?

When default is on the horizon you essentially have two options to avoid it.  You can pay back all remaining principal on the loan (or catch up on your timely payments if you are not separated from your job) to avoid it being considered a default, or you can let it default and deal with the consequences.

The consequences can be relatively steep. While this type of “default” will not be reported to the credit bureaus causing your credit rating to be damaged, the IRS plays its hand and collects the taxes  and penalty due.

The remaining balance that is left unpaid is considered a distribution from your 401(k).  Income taxes will be due on this distribution at your highest marginal tax bracket(s).  This “distribution” has a double negative effect. First you will have to pay taxes on what is considered to be a lump sum of income. If this occurs in a year of high earnings you could see a substantial tax hit on funds that otherwise may have been removed a lower tax rates.  Second, you have removed a sizable chunk of money from tax deferred retirement savings and will never be able to get this money back into its preferred tax deferred status.

Additionally, there could be an early withdrawal penalty tax.  As you may already know, early withdrawals from your 401(k) plan are generally subject to a 10% Federal tax penalty if taken prior to age 59 1/2. However, if you left your employer in or after the year in which you turned 55, you may not be subject to the 10% early withdrawal penalty, so the age limit on this early withdrawal penalty on defaulted loans is often bumped down to age 55..

Are there any loop holes to avoiding default?

Depending on how someone defaults there are few opportunities to avoid steeper taxes and penalties.

If you are separated from your job:

  • There it not much wiggle room in this scenario. However, if you are retiring and in control of when you technically separate from your job it would be a good idea to allow the loan to default in a year when you will not have a lot of taxable income.  So, in a best case scenario you would retire at the beginning of the year, allow the loan to default, not earn a lot wages for the remainder of the year, and cause the “distribution” from your 401(k) to be taxed at lower marginal rates.

If you are not separated from your job:

  • There is a whole lot of opportunity in this case. The IRS has permitted for retirement plan administrators to allow for what is called a cure period. A cure period is essentially a grace period on your loan payment and can last no later than the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.
  • If your employer allows for a cure period (it is their option) there are two ways to get back on track and avoid default:
    • You can pay back all missed payments during the cure period and avoid the loan going into default.
    • You can refinance the loan (pay off the loan and the missed payments with a new loan) and essentially re-amortize your payment over a new five year period.

In conclusion:

Loss of a job can come at any time. One may separate from a job due to cut backs, under performance, promotion opportunity at another company, or simply because it is time to retire. Because separation from a job requires prompt payment of the outstanding loan balance, this life event may cause a burdensome taxable event.



Joint With Rights of Survivorship or Joint Tennants in Common

By Justin Fundalinski, MBA | September 21, 2017

JTWROSIn general , there are two ways to own property with somebody else and how you title it makes all the difference. Maybe over the years you have seen the acronyms JTWROS and TIC on an account statement, and maybe you even know what they stand for. But, do you know what happens to property titled as such when you die? This article focuses on sorting out the very subtle yet important technicalities between these two Joint ownership registrations.

JTWROS and TIC – What do these acronyms stand for?

JTWROS stands for Joint Tenancy with Right of Survivorship and TIC stands for Tenants in common. A couple of letters make all the difference! Let’s take a look at ownership rights, how the property is treated when one co-owner dies, and how basis is stepped up for whoever inherits this property.

Ownership rights:

JTWROS gives each co-owner equal rights to the entire asset or account. That is, both parties own 100% of the property (it’s not split 50/50). If the asset is sold, the consent of both parties is often necessary. You cannot just cash out 50% and ask for a check to be made out directly to you.

On the other hand, TIC assigns an interest percentage to each owner. That is, one party can own 30% and the other 70% (or whatever split is appropriate). You can sell your portion of the asset independently or you could contribute more to the asset independently. As you contribute to or sell parts of the asset your ownership interests adjust up and down pro-rata.

When you die:

When you die the titling distinction becomes very apparent. With JTWROS assets the property is not disposed of via your will or state intestacy law. It is passed directly to the surviving owner(s) without going through probate, and the surviving owner then owns 100% of the asset/account. For my tax geeks out there, the amount of the property that is passed through the gross estate for estate tax purposes depends on whether or not the joint owners are spouses. If they are spouses then 50% of the asset automatically passes through the estate. If not, then it depends on the decedent’s percentage of contribution.

TIC is very different. The assets are disposed of via your will or state intestacy law and must go through probate. The property is not passed directly to the other property owner and will not be passed to the other owner unless your will or intestacy law says so. Since there are independent ownership interests, only the portion attributable to the decedent goes through probate and is eventually inherited based on what the will or intestacy law dictates. Of course, this share of the decedents account is passed through their gross estate for estate tax purposes.


Basis is essentially the cost of the asset that is not subject to taxes when you receive it back. In a very simplified example, if I bought a rental house for $100,000 and then later sold it for $150,000 I would be taxed only on the $50,000 gain and my $100,000 that I originally contributed (it’s basis) is received back tax free. However, if instead of selling the property that day I died then my beneficiary would receive a “step up” in basis bringing the basis of the property up to $150,000. Now my beneficiary could turn around and sell the property for $150,000 and not pay taxes at all. Easy enough right? Well, often is much more convoluted than this and account titling plays its hand here too.

Reflect back to the previous paragraphs that touch on how much of the property passes through the decedent’s gross estate. This is your guiding light regarding how much of a step up in basis is received. If it passes through the estate, it receives a step up in basis.

JTWROS property’s step up in basis depends on whether or not the owners are married. If married there will be a 50% step up in basis. If not, it is based on the decedent’s percentage of contribution.

TIC property receives a step up in basis depending on the ownership interest percentage of the decedent.

In conclusion:

Titling matters a lot! If you don’t know the ins and outs of ownership, what happens when you die, and how basis is affected you could be putting yourself or your heirs and a major disadvantage due to a silly titling mistake. We recommend you seek professional guidance when making/reviewing such decisions.

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