By Justin Fundalinski, MBA | June 20, 2017

I was perusing through the introduction of Wade Pfau’s (a well published, well researched, retirement planning guru) book on Reverse Mortgages and I was just in awe as to how precisely his principals matched up to our office’s in regards to retirement planning. That said, he concisely addressed the retirement risks that that we at the office are ever challenged to overcome for our clients. In this month’s newsletter I wish to share his bullet points with some additional perspective.

Retirement Risks [1]:

• Reduced earnings capacity
• Visible spending constraints
• Heightened investment risk
• Unknown longevity
• Spending Shocks
• Compounding Inflation
• Declining cognitive abilities

Reduced Earnings Capacity:

We relate this to human capital (skills, knowledge, or experience) in the office, but reduced earnings capacity is pretty concise. The risk here is fairly clear.  Once you retire (or age) it will be much more difficult for you to use your human capital to generate earnings or return to the labor force.  The real risk is that you cannot respond to poor portfolio returns or unexpected expenses by earning income.  In some cases human capital can be included from a planning perspective as a buffer to other retirement risks because it may be easily capitalized on or used in consulting capacities; however it is very rare that we see such cases so don’t count on it.

Visible Spending Constraint:

We tend to relate this to the concept that retirees need to move from an accumulation portfolio (a portfolio that does not have any outgoing cash flow and has significant time to recover from market downturns) to a distribution portfolio (a portfolio that is constrained in growth by lower risk capacity and risk tolerance, outgoing cash flows and how disruptive distributions can be to a portfolio that is experiencing negative returns, and the need to stretch withdrawals for an unknown period of time). The risks of this come down to a few things:

• Growth is constrained
• Reducing your spending due to market conditions is difficult if not impossible
• Generating sustainable income is not addressed in traditional accumulation portfolio management styles
• Because of outgoing cash flows, a retiree’s portfolio simply does not recover when markets recover from downturns.

Heightened Investment Risk:

This is synonymous for sequential risk.  Sequential risk is the risk of receiving low or negative returns early in retirement while withdrawing from a portfolio for income needs.  This is a very well-studied concept and the effects are sequential risk are outstanding.  Think of it this way – a well portfolio may have significant average returns over a 30 year period (much of what history has shown us).  However, a portfolio that has poor returns early on may be on a catastrophic path to zero, compared a portfolio that has the same average return but poor returns in the middle or end of its timeline.  In a nutshell you can think of it this way; when you are withdrawing from a portfolio the timing of returns matters way more than your average return.

Unknown Longevity:

We talk about this a lot. It is really hard to make a plan when you don’t know how long somebody is going to live for. Pfau sums this up quite well when he reminds us half the population is going to outlive their statistical life expectancy, and that the statistic is only increasing as medical and scientific procedures become more effective at prolonging life. Appropriate income planning tends to be a great hedge to this significant unknown.

Spending Shocks:

It is really important retirees maintain a preservation of liquidity in the event of an unknown large expense. We all know the possibilities of emergency medical or long term care expenses, a divorce, a family emergency, or an act of god are real.  Think of the risk like this, a retiree might have a great pension that meets all of their day to day retirement needs and more, but if they don’t have a nest egg on the side any spending shock could derail what seemed to be an ideal retirement.

Compounding Inflation:

This is a personal favorite of mine. Not that I like the effects of compounding inflation, but that to this day every analysis that we do gives me a little shock when we visualize the effects of compounding expenses. I get it when Einstein called it the “eighth wonder of the world” – for me, it is amazing to look at no matter how many times I have seen it before. Combine compounding inflation with some of the other risks mentioned above (specifically sequential risk and a constrained portfolio) and the let’s just say the risks compound upon themselves.

Declining Cognitive Abilities:

We all know that as we age simple concepts or tasks become more difficult to understand or do. Apply this to managing a distribution portfolio along with day to day finances and you or your surviving spouse become vulnerable. You simply (but potentially catastrophically) may not be able to manage your finances, but more than that you likely you will be exposed to (or worse become a victim of) fraud or theft. Knowing this and having a plan is place is a very important part of retirement planning.

If you are interested in learning more about how we manage and hedge this risks in retirement please reach out to the office and just ask!

[1] Pfau, Wade D. “Overview of Retirement Income Planning.” The Retirement Researcher’s Guide Series, Reverse Mortgages, How to Use Reverse Mortgages to Secure Your Retirement.

By Justin Fundalinski, MBA | April 15, 2016

Next year, Jim Saulnier and Associates will be expanding its services into the realm of taxes.  The net result of this is that I have decided to move forward with an Enrolled Agent (EA) designation from the IRS.  Unfortunately, not too many know what an EA is, so why not inform our monthly readers on the topic?  This month, I will be discussing what an EA is, what it takes to become an EA, and how we intend to implement this license into the business.

What is an Enrolled Agent?

According to the IRS, “An Enrolled Agent is a person who has earned the privilege of representing taxpayers before the Internal Revenue Service. Enrolled Agents, like Attorneys and certified public accountants (CPAs), are generally unrestricted as to which taxpayers they can represent, what types of tax matters they can handle, and which IRS offices they can represent clients before.”

Do I plan on doing much representation of tax payers in front of the IRS? Not really, but it’s possible.   However, one can deduce from the definition that an EA has been through some rigors to even be allowed such representation privileges, and those rigors will be what is more applicable in my practice.

What it takes to be an Enrolled Agent:

To become an EA one has to pass three tests administered by the IRA (cumulative called the Special Enrollment Examination). In the most basic measures, each part is as follows:

• Part 1 – Individual Taxation
• Part 2 – Business Taxation
• Part 3 – Representation, Practice and Procedures.

To maintain an EA license once it has been earned, 72 hours of continuing education credit must be completed every three years.

Why all the efforts?

Why go through the effort to obtain the EA designation? Because tax preparation (short-term) and tax planning (long-term) can be two different things, and there is often a disconnect between the two.

1. We have listened to our clients and they are clamoring for tax preparation and advice from a professional that understands taxation in retirement. As many readers of this may already know, taxes don’t get easier in retirement and for the vast majority of retirees that we work with they get harder.
2. The knowledge gained will provide us with a far stronger capacity to implement long-term tax planning and tax consultation services for our clients. For example, we will be better address:
   1. Yearly liquidation (withdrawal) strategies from assets to optimize client’s tax brackets throughout retirement.
   2. Social Security claiming strategies on a tax adjusted basis.
   3. Roth conversion strategies prior to retirement to maximize tax efficiency before and after retirement.
3. Unfortunately, there is far too often a disconnect between current year tax advice and long-term tax/ financial planning. Tax planning advice can often be overshadowed by a current year tax burden and if the two are not done in conjunction with each other there is a greater chance one will be stuck with a higher tax liability in the future.

Wish me luck in my endeavors, and as always please feel free to reach out any time with questions on this article.

By Justin Fundalinski, MBA | September 15, 2015

As a client of ours, a radio show listener, or someone who just happens to get our newsletter, it is very likely that you have heard many appealing reasons to convert your Traditional IRA to a Roth IRA. Considering that the October 15^th IRS deadline to “undo” Roth conversions is upon us (technically the IRS calls it “Recharacterization” of Roth Conversions”) this month’s post will review some reasons why you may want to reverse some of your Roth Conversion as well as discuss a few mistakes that are often made.

Reasons for a Roth Conversion

You don’t want to pay the taxes:

Often, when one initially converts from a Traditional IRA to a Roth IRA, the exact amount that should be converted is unknown because tax implications are not yet clear. So you may end up converting too much, causing a tax impact that is more than you can handle.  Tax impacts could include not only more taxes paid, but could also cause your adjustable gross income to crest above thresholds for certain tax credits and/or financial aid.  Other times one may just decide they don’t want to pay the taxes that are caused by the conversion.  In either case you can undo a Roth Conversion and save on taxes for the current year.

Your account value dropped:

Another common reason to recharacterize is because your account value has dropped significantly since the conversion.  A quick downturn in the markets can cause an account value to drop markedly.   Such an event will cause you to pay taxes on a converted value that is significantly higher than the current actual value of the assets.   For example, if you converted $15,000, but after a market drop your account value is now $10,000 you will have paid taxes on $15,000 for something that is now only worth $10,000.

Recharacterization Mistakes

The amount your recharacterize is not the amount you transfer back:

When you decide to recharacterize a certain dollar amount for tax purposes, the actual amount that you transfer back to a Traditional IRA will be different.   Why?  Well, there will most likely be gains or losses on the holdings that you originally converted to a Roth IRA and the IRS treats a recharacterization as if the conversion never took place. So, any gains or losses must be reflected in the amount that is transferred back to an IRA.  Continuing the example above, if you converted $15,000 that is now worth $10,000 you would recharacterize $15,000 but only transfer $10,000 back to a Traditional IRA.  Seems simple enough, but when you have multiple assets that have gains and losses this simple math can get rather complicated.

You cannot flip flop:

If you’re feeling savvy, after reading the last paragraph you may be thinking that it would be beneficial to recharacterize so you don’t pay taxes on the $15,000 and then immediately turn around and convert the $10,000 back to a Roth IRA.  Well unfortunately you cannot do this without waiting a specific period of time.

The IRS says that you cannot reconvert the amount that you recharacterized until the later of 30 days after the recharacterization, or the year following the year of the original conversion.  For the most part, people tend to recharacterize in the year after the original conversion so generally the 30 day rule will be what applies. However, if you happen to be recharacterizing in the same year that you converted then the year following rule will apply.   On a sidebar, this rule applies only to the amounts that you recharacterize; you are free to convert other amounts without meeting this rule.

It is not a DIY project:

The recharacterization has to be via a Trustee to Trustee transfer.  You cannot do it yourself by using the 60 day rollover rule to recharacterize your IRA.  Simply put, the Traditional IRA Custodian has to request the transfer of funds on your behalf.

In summary, you can see that there are sometimes reasons to convert back to a Traditional IRA and plenty of traps along the way.  We recommend that you work with a professional that has experience and working knowledge of recharacterizations. More often than not, a CPA can help you figure out how much to recharacterize and a financial planner can help you with the actual action of getting it done correctly.  As always, if you have any questions on this topic we are here to help.

By Justin Fundalinski, MBA | August 15, 2015

Helping Kids Retire

Here at the office we talk a lot about Roth IRAs and the benefits of tax deferral and exemption.  However, much of the benefits derived from tax deferral are demonstrated the longer taxes are deferred and the longer the account is allowed to grow.  Of course, some variation of this concept has been drilled into many of us over and over.  I remember countless times that my mother, father, aunt or uncle told me to always save X% of my check and I will set myself up for retirement.  But who really understands the concept of the time value of money when they are 16, let alone ever?  Mix that with tax deferral, inflation, and a bunch of meaningless letters and numbers (IRA, ROTH, 401k, etc…) and I figured I may as well play it safe and deposit that money into a savings account earning next to nothing.  Well therein lies the problem!  I didn’t have any guidance outside of “save for retirement.”  This article is put together to introduce custodial Roth IRAs and describe how you can truly help a child save for retirement.

Contributing to a Custodial IRA

Anytime a child earns income they can contribute to an IRA[1], however they cannot set this IRA account up on their own if they are under the age of 18 (age is different is some states).  This is where the adult comes in.  You can simply open up what is called a custodial IRA on their behalf.  As the custodian you govern (but do not own) this account until your child’s 18^th birthday – at which time the custodial IRA is turned over to the child.   While the money is in a custodial IRA it is a perfect time to start the education on retirement savings, IRAs, and the effects of compounded earnings.

Traditional IRA or Roth IRA?

There are Traditional and Roth Custodial IRA options that can be used; however we recommend that a Roth account be used. The primary reason is that generally children under the age of 18 are in the lowest tax bracket that they will ever be in (if any at all), negating any argument of the upfront tax savings that Traditional IRA advocates may have.   Also, we feel that the very favorable tax treatment of Roth IRAs makes them subject to major changes or even possibly elimination in the distant future as laws are passed to generate more tax revenue (think of it as a – “take advantage while you can”- attitude). Talking about these things to a 16 year old may have little impact, but doing it and getting that IRA statement in the mail may just start to engrain the concepts and the desire to save.

The Value of Time

Another fascinating thing to discuss is what that investment in a Roth IRA could potentially do.  As a quick example, say for instance your 16 year old child earns $6,000 working part time at the local grocery store.  You convince them to stash away $1500 by matching their contribution dollar for dollar (or maybe grandpa does J).  So, $3,000 total is contributed at age 16.  That single investment growing on average at 7% could turn into over $80,000 when they are 65 and looking to retire.  Not only is there now the potential for over $80,000, because this is a Roth account all of this money can be withdrawn tax free!

Discouraging Withdrawals

As we know sometimes we need money for other things.  Notably, the child should be made aware of the penalties that are built into IRAs if the money is withdrawn at the wrong time.  These are great talking points to have with the child to discourage withdrawals.  Specifically, with Roth IRAs you can withdraw your contributions any time without any taxes or penalties.  The earnings however, can only be taken without taxes or penalties if they are withdrawn after the account has been  open for 5 years and the IRA owner is over 59½.

There are few exceptions to these rules, but some exceptions could very well apply to the child later in life. For instance, a withdrawal of up to $10,000 of earnings can be made to pay for a first time home purchase without taxes or penalty.  Or, if earnings withdrawals are used to pay for qualified education expenses there are no taxes or penalties.   Remember, these two exceptions are in regards to the earnings on the account and they can be used in conjunction with withdrawals of contributions.

We Can Help

The point of this article is to simply get you thinking of other ways to teach your kids or grandkids about saving for retirement.   On that note, not too many people are experts on this and we welcome having that conversation with you and your kin in tow.  Please feel free anytime to schedule an appointment with us for a complementary meeting to start the discussion.

[1] Interestingly enough, the actual money that is contributed does not have to be the actual income earned.  As long as there is income earned a contribution can be made to a custodial IRA up to the total amount earned or a maximum of $5,500 in 2015.  Using this to your advantage, this could be an excellent way to encourage savings.  That is, get the child to save 10% of their income in an IRA and you can “match” their contribution as long the total contributions do not exceed the previously mentioned limits.