Lazy Man and Money

Where Will Your Retirement Income Come From?

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The foundation for a secure future is proper retirement planning today. Unfortunately, too many people avoid retirement planning. In fact, according to the recent Retirement Confidence Survey from the Employee Benefit Research Institute, less than half of American workers have performed a retirement needs assessment. This means that most people don’t even understand how much they need to retire — much less have a clear idea of where their retirement income will come from.

As you prepare your retirement plan, you need to figure out what you need to retire comfortably, but you also need to consider where that money will come from. You need to figure out your sources of retirement income, and determine how they will work together to provide you with exactly what you need to improve your overall situation.

Sources of Retirement Income

Most people, when they think of retirement, consider employer-sponsored plans like 401(k)s, or they think of IRAs. However, these aren’t the only sources of income available to you. While a good portion of your retirement income will come from these types of accounts, you need to look beyond figuring out your withdrawal rate, and trying to build a nest egg big enough to handle your retirement needs.

Income diversity is a big deal in retirement, since there are a lot of things that can change between now and when you retire. Just relying on a single source of retirement income isn’t any better than putting all of your income eggs in one basket during your working years. It’s vital that you think about where else you will get income from in your golden years.

Some sources of retirement income to consider include:

  • Social Security: In spite of all the scary, scary rhetoric, Social Security isn’t out for the count completely. While you might have to moderate your expectations in terms of when you can expect to start taking Social Security, and while you might need to prepare for cuts in benefits, the reality is that you will still likely be able to draw — at least to some degree — on these promised benefits.
  • Real Estate Income: While real estate investing isn’t really my thing, I know a lot of people who do well at it. If you can build your real estate empire, you can create a source of retirement income that doesn’t go away when the stock market drops. Even if you end up having to hire property management to help you run your real estate, you can still do well, and get a regular income from this.
  • Some Sort of Earned Income: Many people like working part-time in retirement. You might also work on your business, or start a side business during retirement. Doing some sort of work during retirement is smart, since it can keep you engaged, fulfilled, and provide you with a bit of an income stream.
  • Investment Income: This can include the income that you receive as a result of withdrawing money from your tax-advantaged retirement accounts. You might also have other investments, held in taxable accounts, or assets in other places, that generate income for you.

In general, the more sources of income you have, the better off you’ll be in retirement. Your retirement plan should include ideas for cultivating multiple sources of income now, so that when you retire, you aren’t dependent on just one revenue stream to keep you in comfort.

Two Really Last Minute Tax Deductions: Traditional IRA and HSA

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Last year, during my annual tax visit to the accountant, we discovered that there was a close call with my income. One more deduction would have been just the thing. After a minute of thought, the accountant reviewed my Health Savings Account contributions and realized that I hadn’t maxed out the contributions. He pointed out that I could still make a previous year contribution to the account, and the deduction would bring my income down just enough for a fairly significant tax savings.

If you are still casting about for a last minute tax deduction for last year’s taxes, you might be in luck.

Contribution Deadline: Tax Day

There are some tax advantaged accounts with contribution deadlines on tax day. So, as long as you make your contribution to a tax-advantaged investment account by that time, you can still reduce your income for the previous year.

You can make contributions to a Traditional IRA up until tax day, so if you haven’t maxed out your contribution for the last tax year, you can do so now — without impacting your ability to contribute to your account this year. This also applies to the SEP IRA. Make sure you understand the contribution limits for the tax year of the contribution, though, since limits change in response to inflation.

You also have the opportunity to contribute to your HSA, if you have one. If you have a high deductible health insurance plan, it’s possible for you to make contributions up until tax day. So, if you have maxed out your contributions, now is a good time to do so. One of the great things about the HSA is that you get a tax deduction for your contributions, and the money grows tax-free on top of it, as long as you use the money for qualified health care expenses. The HSA is one of the most convenient tax-advantaged accounts — as long as you can handle the higher out of pocket costs that come with a high deductible plan.

When you make previous year contributions, you need to make sure you do it right. Your contribution should be clearly marked as a previous year contribution. When you contribute online, most institutions will ask you to check a box for the appropriate year. If you send in a check (it should be postmarked by tax day), the memo line should clearly state the year you want the contribution applied to. If you don’t mark it as a previous year contribution, it will be applied to the current year, and you’ll miss out on the deduction.

Bonus: 529 State Tax Deduction

You don’t receive a federal tax deduction for contributions made to a 529 plan. However, there are some states that will offer you a tax deduction when you contribute to your state’s 529 plan. Check your state’s policy to find out if you can get a tax deduction. This is a great way to grow your child’s college fund with the help of compound interest, and reduce your tax liability at the state level.

In many cases, states that offer deductions for 529 contributions also allow you to make previous year contributions up until tax day. That way, even if you missed out on contributions in the previous year, you can still get help on your state taxes when you make an extra contribution. As with the Traditional IRA and HSA contributions, though, you need to make sure you haven’t already maxed out your contribution for the previous year, and you need to clearly indicate which year the contribution is meant for.

Just because December 31 has passed doesn’t meant that all hope is lost. You can still get another tax deduction. Look at your tax-advantaged accounts, and see if there is room for a previous contribution.

Filed Under: Tax

Tax Planning for the Year to Come

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The books are closed on another year, but that doesn’t mean that you can’t start planning your taxes better for the year to come. In fact, you might be better off if you look ahead to possible credits and deductions for the year ahead. If you were scrambling to squeeze in one more deduction at the end of last year, make it a point to figure out how to improve your situation right now. Looking ahead can make the entire process easier next year, and you are less likely to miss out on deductions and credits to which you are entitled.

Where Will You Spend Your Money?

Your first step is to look ahead and see where you are likely to spend your money. What are your necessary expenses? Figure out how much you need to spend, and then determine whether or not you will be able to deduct those expenses.

If you want to give more to charity, figure out a smoother way to go about it, putting aside money each month for the purpose, rather than rushing in at the end of the year to make it happen. You’ll provide better for the cause of your choice, and your cash flow will improve. Plus, you can get a bigger tax deduction. This process applies to your mortgage payments, child care costs, retirement account contributions, student loans, and your business expenses.

Look ahead and do your best to plan your year. Then keep track of which spending is likely to be tax deductible or result in a credit. Determining that ahead of time can save you trouble later — and ensure that you don’t forget something come tax time.

What About Your Income?

You can also keep in mind your income in your tax planning for the coming year. Here are some things to consider now, before tax filing season rolls around next year:

  • Tax withholding: The first thing that many financial gurus suggest you do is review your tax withholding. Are you withholding too much? Too little? Look at where you can improve your withholding to better fit your goals. Do you want to give the government an interest-free loan? Or are you more concerned with using your tax withholding as a forced savings to ensure that you have money for something specific later? Do what works for you, and adjust your withholding to help you reach your goals.
  • Quarterly taxes: If you have side income, you might need to pay quarterly taxes. Plan for this now so that you aren’t caught by surprise later. Set money aside each month so that you have what you need when quarterly taxes are due.
  • Investment planning: Remember that your investment gains can impact your income tax. Make sure that you understand the difference between long-term and short-term gains, and how they are taxed. Long-term gains come with a favorable rate, so you don’t owe as much. Your investment gains can provide you with income, as long as you are smart about how you sell. It’s also possible to use investment losses to offset some of your income, reducing your tax liability.
  • Marriage penalty: Realize that there are cases, if you and your partner both have high incomes, in which your marriage can mean a tax penalty. As you both earn more money, take this into consideration during your tax planning. Married filing jointly usually makes more sense for couples in which partners have large disparities in income.

If you aren’t sure about what to do about your tax situation, consult with a tax professional. There are reputable accountants who can help you figure out the best way to plan your finances for the coming year so that you get the best tax advantage.

Filed Under: Tax

3 Reasons to Pay Off High-Interest Debt

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There is a subset of people that are very comfortable with their debt. Even if it’s high-interest debt, like what you see with credit cards, they are comfortable with it. That’s because it is “affordable” for now. However, before you get too comfortable with high-interest debt, it’s a good idea to step back. Your finances might be in better shape if you tackle this bad debt, getting rid of it once and for all. Here are 3 reasons getting rid of high-interest debt is a good idea.

1. It Doesn’t Usually Provide You With a Future Return

In most cases (but not all), high-interest debt is associated with consumer spending. When you only pay the minimum payment on your high-interest debt, you stretch out how long you are paying for those consumer items. The problem with taking years to pay for consumer items is that you end up with diminishing returns for your efforts. You pay more over time, but the value of the item goes down.

This isn’t the case with many low-interest debts. A case can be made for mortgages, business loans, and student loans. These low-interest loans often (but, again, not always) represent investments in your future. What you get back has the potential to return more than you borrow and pay in interest. This is rarely the case with consumer items bought with high-interest credit cards.

2. You Usually Can’t Deduct the Interest You Pay

The interest you pay on credit card debt doesn’t come with a tax benefit. You just pay the money into someone else’s pocket. With a low-interest loan, like a mortgage or student loan, and even some business loans, you might be able to deduct the interest (you may have to itemize to get this benefit).

As a result, even though it’s still debt, at least a low-interest loan made for many so-called “good” purposes probably comes with a tax benefit. This is just another reason to pay off high-interest debt before you move on to low-interest debt.

3. Your Investment Returns Probably Won’t Overcome High Interest Rates

Many of the folks I know who are content with their debt levels are investing. They invest their money in taxable and tax-advantaged accounts, even as they pay 19.99% APR on their credit cards. There is no way that their investment returns are going to overcome that interest rate. From 1926 to 2012, the annualized return for the S&P 500 was 9.82%. That basically amounts to a 10% loss annually.

You have a reasonable chance of beating low-interest debt with your investment returns. If you get a tax benefit for your low-interest debt, and you have a tax benefit for the investments you make, the chance of overcoming what you spend on your low-interest debt increases. This just isn’t going to happen if you have high-interest debt, because high-interest consumer debt doesn’t come with any of the possibilities that mark low-interest debt that is considered “non-consumer.”

As you consider which debts to pay off, and whether or not it’s worth it to pay off debt, don’t forget to consider the various attributes of the debt you have. It might make sense to invest instead of paying off your mortgage early, but it almost never makes sense to pay off your high-interest debt slowly.

How to Figure Your Retirement Needs

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Many of us look forward to retirement. However, as with all things in life, retirement requires money. This means that you need to determine how much money will be required to live your desired lifestyle. As you do your best to figure out how much you need, here are some hints for getting a reasonable idea of what to expect:

What Does Retirement Mean to You?

The first step is deciding what retirement means to you. The “traditional” definition of retirement involves working until you are somewhere between 55 and 65 years old and then quitting to live off money amassed in your nest egg.

For many, though, retirement means something else. It might mean starting a side business and building it so you can leave the rat race at age 40. Perhaps it means building passive income streams so that you can become a digital nomad, traveling the world. And maybe it means quitting your job at 50 and traveling around to visit your grandkids while you live off your nest egg.

Everyone is different, and you need to figure out your own definition of retirement before you start turning to online resources that can help you with the next steps in your retirement journey.

Estimate Your Retirement Expenses

Once you know what you expect to do in retirement, it’s time to estimate your retirement expenses. I like to start by looking at my current expenses. This gives me a rough idea of what to expect in retirement, since the reality is that my expenses will not decrease (the old rule of thumb states that you can live off 75 percent of your current income in retirement); they will just be different.

List out your necessities, and then list out your wants. If you plan to travel a lot, that’s going to be a big expense added to your retirement costs, if you aren’t careful. This is a good time to plan out how you’ll make it happen. Travel costs can be significantly reduced if you make a “home base” for a month or more, and choose your destinations carefully. From food to utilities to housing to hobbies, estimate what it will cost you to live during retirement.

You can also attempt to figure out likely health care costs and the impact inflation is will have on your expenses. These are costs that many people leave out when performing calculations, but they can cut in to your quality of life when they aren’t accounted for.

It seems like a lot to figure out, but it makes sense to sit down and do it. Most Americans haven’t taken the time to perform a retirement needs calculation, and that can put them behind, since they might not be saving enough. There are plenty of online resources and retirement planning apps that can aid you in this process, and if all else fails, a fee-only financial planner that specializes in retirement planning can help you with a one-time assessment that can put you on the right path.

If you haven’t determined your retirement needs yet, there is no better time than now.