8 Financial Choices You’ll Regret in 5 Years

Financial success will come easier if you can avoid these common mistakes.

If your goal is getting ahead financially, the formula for success is simple: Maximize tax-advantaged retirement accounts early, boost your savings with a Roth or traditional individual retirement account, choose investments you feel comfortable with and avoid debt like the plague. If you do those four things, you’re bound to enjoy less stress and more wealth over time.

But is it always that easy? Absolutely not. As you move through the various stages of life, you’ll encounter myriad pitfalls and temptations that can knock you off track – some of which can seem like a smart idea at the time.

Speeding toward financial independence is easier when you know which financial choices can slow you down. I spoke to a handful of top financial advisers to get their takes on the most common financial choices their clients live to regret. Here’s what they said.

1. ‘Investing’ in a New Car

“At first blush, buying the latest and greatest version of the ultimate driving machine may seem like a value worthy of your hard-earned money,” says California financial advisor Anthony M. Montenegro of Blackmont Advisors.

Unfortunately, new cars depreciate the moment they leave the lot, and continue dropping in value until they’re worth almost nothing. If you finance the average new car priced at more than $30,000 for five years, you’ll pay out the nose for a hunk of metal worth a small percentage of what you paid. (Remember, a good credit score can qualify you for lower interest rates on your auto loan. You can see two of your scores for free on Credit.com)

Pro tip: Buy a used car and let someone else take the upfront depreciation, then drive it until the wheels fall off. Once five years has passed, you won’t regret all the money you never spent.

2. Not Watching Your Everyday Purchases

While big purchases like a new car can eat away at your wealth, the little purchases we make every day can also do damage, says Maryland fee-only financial adviser Martin A. Smith. If you’re spending $10 per day on anything — your favorite coffee or lunch out with friends — your seemingly small purchases can add up in a big way. (If you must feed a coffee habit, the right credit card can help make it more worthwhile.)

Keep in mind that $10 per day is $300 per month, $3,600 in a year and $18,000 after five years. While you may not regret your daily indulgences, you may regret the savings you could have had.

3. Not Refinancing Your Mortgage While Rates Are Low

While refinancing your mortgage is anything but fun, now may be the perfect time to dive in. That’s because interest rates are still teetering near lows, says Colorado financial adviser Matthew Jackson of Solid Wealth Advisors LLC.

Even one percentage point can cost you – or save you – tens of thousands of dollars in interest over the years. Since rates will eventually go up, you “don’t want to miss the opportunity now,” says Jackson.

4. Buying Too Much House

Buying the ideal home may seem like a smart idea, but does your dream home jive with your financial goals?

Unfortunately, buying more house than you need can lead to regret and financial stress, says Vancouver, Washington financial planner Alex Whitehouse.

“Too much income going to housing payments makes it difficult to fully furnish rooms, keep up with rising taxes, and often leads to struggles with maintenance and utility costs,” notes Whitehouse.

Banks may be willing to lend you more than you can reasonably afford. If you want to avoid becoming house-poor, ignore the bank’s numbers and come up with your own.

5. Borrowing Against Your Retirement Account

While you can borrow against your 401K plan with reasonable terms, that doesn’t mean you should. If you do, you may regret it for decades.

“Millennials often ask if it’s okay to access their 401K or IRA early (before age 59 ½) to buy a home, travel or pay off debt,” says Minnesota financial adviser Jamie Pomeroy of FinancialGusto.com.

However, there are numerous reasons to avoid doing so.

Not only do you normally have to pay a penalty to access retirement funds early, but you’ll pay taxes too. Most important, however, is the fact you’re robbing your future self. You will regret the lost savings (and lost compound interest) when you check your retirement account in five years.

6. Not Using a Budget

While many people buy the notion that budgets are restrictive, the reality is different. If used properly, budgets are financial tools you can use to afford what you really want in life.

“I would suggest that you create a budget that you stick to,” says financial planner David G. Niggel of Key Wealth Partners in Lancaster, Pennsylvania. “At the end of the year, you have the chance to evaluate your spending habits and make some serious changes if necessary.”

If you don’t, your finances could suffer from death by a thousand cuts.

7. Not Saving as Much as You Can

While it’s easy to think of your disposable income as “fun money,” this is a decision you could live to regret in five years.

The more money you have saved later in life, the more flexibility you’ll have, notes fee-only San Diego financial adviser Taylor Schulte. And if you don’t get serious about saving now, you could easily regret it in the future.

According to Schulte, you should strive to “play it safe” when it comes to your savings.

“I’ve never heard anyone regret having too much money,” says Schulte. “But, I’d be willing to bet we have all heard far too many people complain about not saving enough or not starting earlier.”

8. Not Buying Life Insurance When You’re Young

If you are married, own a home, or have children, you need life insurance coverage. Unfortunately, this is one purchase that becomes more difficult – and more expensive – as you age.

If you don’t buy life insurance when you’re 25, you can expect to pay a lot more for coverage when you’re 30, 35, 40 and so on. And if you wait long enough, you may not even be able to buy it at all, says New York financial planner Joseph Carbone of Focus Planning Group.

As Carbone notes, if you develop a chronic health condition before you apply for life insurance coverage, you could easily become uninsurable. To avoid regretting inaction in five or 10 years, most people would benefit from applying for an inexpensive, term life insurance policy as soon as they can.

Image: Ridofranz

The post 8 Financial Choices You’ll Regret in 5 Years appeared first on Credit.com.

Here’s How to Find Out How Much Social Security Income You’ll Receive

At what age will you retire? How much can you expect to receive each month when you do? These are important questions even if you are decades away from retirement, and there’s an easy way to get answers anytime. We’re going to show you how to get your Social Security benefits statement online and what to do with it once you’ve got it.

A little background:

Depending on your age, you may remember getting a printed Social Security benefits statement in the mail. Prior to 2011, the Social Security Administration (SSA) mailed statements to all workers every year. Those annual mailings were discontinued in 2011 as a cost-saving measure. The following year, the SSA made the statements available online, but their decision caused a bit of an uproar. Despite the agency’s outreach campaign, far fewer people registered for an account than there were eligible workers. So in 2014, Congress required the agency to resume sending printed statements every five years to workers age 25 and older who hadn’t registered for an online account.

That schedule remained until earlier this year when the agency announced that due to budget restraints, paper benefit statements will only be mailed to people who are 60 or older, have not established an online account, and are not yet receiving Social Security benefits. Simply put, don’t expect to get a printed statement anytime soon.

How to get your Social Security benefits statement

Accessing your Social Security benefits statement online is pretty simple, as long as you have an email address and can provide some basic identifying information.

First, go to ssa.gov/myaccount and click on “Sign In or Create an Account.”

If you’ve never created an online account with the SSA, you’ll click on “Create an Account.” If you’ve set up an account before, you won’t be able to create a new account using the same Social Security number. If you’ve forgotten your username or password, the SSA website offers tools to help recover them.

When you select “Create an Account,” the site will lead you through a few questions to verify your identity. You’ll need to provide personal information that matches the information on file with the SSA as well as some information matching your credit report.

Ryder Taff, a Certified Financial Adviser with New Perspectives, Inc. of Ridgeland, Miss., helps many of his clients set up Social Security accounts and says the questions often have to do with past residences or vehicles that may have been registered in your name.

If you have trouble setting up your account online, you can call the SSA for help at 1-800-772-1213.

Information in a Social Security benefits statement

Your Social Security benefits statement provides several valuable pieces of information:

  • A record of your earnings, by year, since you began having Social Security and Medicare taxes withheld.
  • Estimated retirement benefits if you begin claiming Social Security at age 62, full retirement age, or age 70.
  • Estimated disability benefits if you became disabled right now.
  • Estimated survivor benefits that your spouse or child would receive if you were to die this year.

Here’s a sample of what your benefits statement will look like:

Keep in mind that the estimated benefits shown are just that — estimates. The amounts shown are calculated based on average earnings over your lifetime and assume you’ll continue earning your most recent annual wages until you start receiving benefits. They are also calculated in today’s dollars without any adjustment for inflation. The amount you receive could also be impacted by any changes enacted by Congress from now until the time you retire.

What to do with your Social Security benefit statement

It’s a good idea to check your earnings record for errors once per year. It’s not uncommon for earnings from certain employers or even all of your earnings from an entire year to be missing, and you’ll want to get that corrected right away because benefits are calculated on your highest 35 years of earnings. “Any missing years will be just as damaging as a zero on a test was to your GPA,” Taff says. “Gather your documents and correct ANY missing years, even if they aren’t the highest salary. Every dollar counts!”

If you do spot any errors, grab your W-2 or tax return for the year in question and call the SSA at 1-800-772-1213. You can also report errors by writing to the SSA at:

Social Security Agency
Office of Earnings Operations
P.O. Box 33026
Baltimore, MD 21290-3026

Reading your statement is also a good reminder of how much you need to save for retirement outside of Social Security. Chances are, you won’t be happy living on just your Social Security income in retirement.

The good news is, the longer you delay taking your benefit, the higher your annual benefit will be. You can begin taking Social Security retirement benefits at age 62, but your payments will be smaller than they would be if you waited until full retirement age (FRA). Currently, your annual benefit increases by 8% for each year you delay taking your benefit from FRA until age 70.

Colin Exelby, president and founder of Celestial Wealth Management in Towson, Md., says that using your Social Security benefits statement can be particularly useful for retirement planning for couples. “Depending on your age, health, family health history, and financial situation there are a number of different ways to claim your benefits,” he says. “Each individual situation is different, and many couples have different views on the decision.”

If you are nearing retirement, you can use your benefits statement to work with a financial adviser to help you maximize total benefits, or run through various scenarios using a free online tool like the one provided by AARP.

Setting up your Social Security account is simple, free, and helpful for retirement planning, but it’s also a good security measure. It’s impossible to set up more than one account per Social Security number, so registering your account is a good way to prevent identity thieves from establishing an account on your behalf.

Take the time to set up your Social Security account and find out how much you might be entitled to receive in benefits. It could help you feel more empowered to take charge of your retirement plan.

The post Here’s How to Find Out How Much Social Security Income You’ll Receive appeared first on MagnifyMoney.

Why the ‘Save 10% for Retirement’ Rule Doesn’t Always Work

To keep saving simple, many retirement experts and financial planners tout a general 10% rule for most savers: If you start saving at least 10% of your income in your 20s, you should have plenty saved up by the time you’re ready to retire.

Why save for retirement?

Social Security might not be around to help you make ends meet in retirement; that’s even more likely for millennials and the cohorts that follow. With the nation’s current birth and death rates, it’s estimated that Social Security funds will be exhausted by 2034.

Whether or not the future retirees of America will have Social Security to rely on, their benefit check alone likely won’t be enough to meet all of their needs in retirement.

According to the U.S. Bureau of Labor Statistics, retired households need to bring an average $42,478 to meet their annual expenses.

And yet, as of March 2017, the average monthly Social Security benefit for retirees was $1,365.35, or about $16,384 annually. That’s only slightly more than the U.S. Census Bureau’s 2016 poverty threshold for two-person households 65 and older ($16,480). Even in households where two spouses are receiving Social Security income, that’s still less than $32,000 per year.

That’s why it’s so important for workers to set additional income aside during their working years. When Social Security falls short, those extra savings will be essential.

Who does the 10% retirement rule work best for?

It’s likely that 10% became the rule of thumb simply because it’s easy to remember and makes the mental math a lot easier. But it’s important to understand who the rule is targeting: younger workers.

Since younger workers have more time to let their money grow, they can afford to save a bit less in their early days. But the advice changes as workers’ savings windows narrow with age. A 40-something worker, for example, who never saved for retirement may be encouraged to save twice as much for retirement since they have a shorter timetable.

“Ten percent may be enough, it may not be enough, and it may even be too much,” depending on your age and financial picture, says Amy Jo Lauber, a certified financial planner in Buffalo, N.Y. Someone paying off student loans or high-interest credit cards simply may not be able to put away 10% of their income.

It gets increasingly complicated when you consider your personal income and ability to save as well as your retirement goals.

“Typically, younger clients do not have complex situations and can get by with simple strategies. Once there are competing priorities, such as saving for a home, kids, and kids’ college, then things get complicated and more sophisticated strategies are required,” says Howard Pressman, a certified financial planner and partner at Egan, Berger & Weiner.

As Pressman suggests, you might need to tweak the rule if you’re starting to stash away retirement funds at an earlier or later age or want to put more money away now for a more lavish retirement.

Timing is everything

This chart from JP Morgan’s 2017 Guide to Retirement demonstrates the power of saving early for retirement.

At a modest 6% annual growth rate, Consistent Chloe, a 25-year-old who puts away $5,000 a year until she reaches age 65 should have a retirement account balance of more than $820,000, according to the bank. And when all’s said and done, only $200,000 would have come out of her own pocket — the rest would have resulted from the power of compounding interest.

In comparison, Nervous Noah, a more timid 25-year-old saver, could put away the same $5,000 a year in a savings account earning far less annual interest on his cash. After the same 40-year period, he would only have a balance of $308,050.

Investing earlier can bring even greater success. If a person starts putting away $5,000 a year at 20, growing at 6%, their balance at 65 would be about $1,132,549, which we calculated using the U.S. Securities and Exchange Commission’s compound interest calculator. That’s more than $300,000 added to Consistent Chloe’s retirement balance for beginning just two years earlier.

The final balance at 65 drops below $1 million for anyone starting after 25. As you can see above, those who begin saving will have less and less to live on in retirement.

7 retirement savings tips

  1. Start early

The emphasis of this rule is starting early. The earlier you save, the more you can take advantage of compound interest.

“Compounding is earning interest on interest earned in prior periods and is the most powerful force in all of finance,” says Pressman. To make the most of this rule, start saving 10% of your income for retirement by the time you turn 25.
Start by maxing out your 401(k) or IRA contribution limits for the year. If you still have additional funds, it might be time to meet with a financial planner to find out how to best invest your surplus.

  1. Know your options

The best place to stash retirement savings is either an IRA or a 401(k). Your money simply won’t grow enough to beat inflation if you leave it in a low-interest-bearing account like a checking or savings account.

  1. Make debt and emergency savings a priority

“Before anyone starts focusing on retirement saving, the first thing they should do is to establish an emergency cash reserve. This is to protect them from a job loss, a health emergency, or even an expensive car repair,” says Pressman. He recommends saving three to six month’s worth of expenses in a savings account.

If placing 10% of your income in a retirement account is too much of an ask because you have more pressing financial obligations like higher-interest debts, or don’t earn enough to cover your expenses, you should address those before increasing your retirement contribution.

Generally speaking, if the interest rate on any debts you owe is higher than what you’d earn on your retirement savings, you’ll make more progress toward your financial goals by addressing the higher-interest debt first.

  1. Plan differently if you have irregular income

Lauber says those who are freelancing and cobbling together a living may need to put several financial policies in place to help them navigate with irregular income.

“The 10% rule works for them but only if other measures are in place for the immediate day-to-day needs,” says Lauber. You can still create a budget with irregular income, but you might need to approach retirement saving more aggressively when income is higher, and strategize your saving to compensate for months when income is nonexistent or low. Find more tips on how to manage irregular income here.

  1. Make the most of your match

Don’t leave free money on the table. If your employer offers to match your contribution, Kristi Sullivan, a certified financial planner with Sullivan Financial Planning in Denver, Colo., advises individuals to save as much as your employer matches immediately or 6% if there is not a match. That way, you won’t miss out on free additions to your retirement nest egg.

  1. Automate your contribution

Out of sight, out of mind. Automate your retirement contribution to ensure you pay yourself first.

“Typically, once it’s done through payroll deduction, the person seldom misses it,” says Lauber.

  1. Check in regularly

Don’t just “set it and forget it.” Mark R. Morley, certified financial planner and president of Warburton Capital Management, stresses “clients must be ‘invested’ in their own plan.”

He says to check periodically on your retirement account and make adjustments where necessary. If you have a financial adviser, you may want to schedule regular progress meetings.

“When a client is engaged in their own plan and can see real results, we can work on the two variables that affect the retirement accounts: time and money,” says Morley.

The post Why the ‘Save 10% for Retirement’ Rule Doesn’t Always Work appeared first on MagnifyMoney.

Why You Should Open Up a Roth IRA for Your Kids

A Roth IRA is probably one of the most powerful retirement vehicles available on the market. Unlike a traditional IRA, the contributions made to a Roth IRA are pre-tax, which allows you to withdraw your money tax-free after age 59½ .

When it comes to a Roth IRA, it’s important to think of how you can use it in other ways too, namely, how your kids can use one to become financially successful one day. There are two ways unique ways you can use a Roth IRA to help your children.

The first way is to open one in their name that they can use to save for their eventual retirement. The second is to use a Roth IRA in your name as a college savings account.

Both of these options come with pros and cons, and it’s important to know them before deciding if either of them is right for you.

Opening an IRA in Your Child’s Name for Their Retirement

The challenge of opening an IRA in your child’s name is that in order to open an IRA in your child’s name, the child has to have a paycheck. You can see exactly what qualifies as earned income here. It might seem like this is impossible, but it’s not. Entrepreneurial parents all over the country who see the value in early retirement savings are taking advantage of this.

For example, if you run a business, you can employ your children to stamp your mail, be models for your brochures, and even manage your social media. As long as you issue them a 1099 or a W2 for their work, they are eligible to open a Roth IRA.

Another negative is that you can’t supplement your child’s income to reach the $5,500 cap on Roth IRA contributions. They can only put in what they earn up to $5,500. So if your child only earns $1,500 from working part-time at an ice cream shop one summer, they can only invest $1,500. However, if they earn $6,000 from that same ice cream shop, they can only invest $5,500.

When children have a Roth IRA in their names, the money is officially theirs. This is different from earmarking a savings account for them in your name. Instead, this is money that they earned going into an account that can benefit them in retirement. The biggest pro is that this is an awesome teaching tool for them. You can really show them how their money can compound and grow over the years.

Even if you start the Roth with a small amount and never touch it again, a one-time $5,500 investment (the current Roth IRA contribution limit) can grow to over $100,000 at a 6% return if your child lets it grow from age 12 to age 62. Fifty years of compounding interest will do that!

What an awesome gift that would be if your child never touched this until they were at their retirement age and got a bonus six-figure payout from work they did when they were a kid. That’s a good memory to leave with them.

Opening a Roth IRA in Your Name as a College Savings Account

Many people don’t realize that another great benefit of a Roth IRA is that you can use it as a college savings account. You could use a Roth IRA in your child’s name for their college savings, but let’s say your child doesn’t work, or if they do, you’d rather they kept the IRA for their own retirement one day.

If that’s the case, you could use your own Roth IRA for their college savings, and here’s why. According to Certified Financial Planner, Matt Becker, “If the money is used for higher education expenses for you, your spouse, your child, or your grandchild, there is no 10% penalty.” (Usually, if you withdraw earnings from a Roth before age 59 ½ there would be a penalty, but not if the money is used for college.)

The downside to all this is that if you use this money for your child’s college education, then you’re not saving it in your Roth for your own retirement someday, and that’s pretty important! The pro is that your money isn’t locked into a 529 plan where you have to use the money for qualified higher education expenses. Another interesting pro is that 529 assets are counted toward your Estimated Family Contributions on the FAFSA, but investment accounts, like Roth IRAs are not.

That said, it’s important to look very closely at the differences between 529 plans and Roth IRA plans if you want to use your Roth as a college savings vehicle. Additionally, if you are a high-income earner, you might not be able to contribute to your own Roth IRA unless you do what’s called a backdoor IRA. The current 2017 income limit for Roth IRA contributions is a $186,000 annual income for those who are married and filing jointly or $118,000 for those who are single.

As you can see, Roth IRAs are great accounts for a variety of different savings purposes, and you should try to think outside the box when it comes to using them to help your children create a bright financial future.

The post Why You Should Open Up a Roth IRA for Your Kids appeared first on MagnifyMoney.

6 Tips for Gen-Xers Who Haven’t Prepared for Retirement

Here's how you can start saving for your future today.

An actor in New York City for most of his 20s, Aaron Norris got a late start on saving for retirement. It wasn’t until he became a 30-something that Norris finally began setting aside money, and he has spent the past decade playing catch up.

“I wasn’t even really cognizant of retirement,” said Norris of his thinking in his 20s. “I was just trying to make it work, and live, and stay out of debt.”

Norris’ story is not unique.

A study from the Transamerica Center for Retirement Studies found the median household retirement savings for Generation X (those born between 1965 and 1978) is $69,000. The same study found 40% of Generation X agrees with the statement: “I prefer not to think about or concern myself with retirement investing until I get closer to my retirement date.”

But that attitude could have serious consequences.

Those who wait until they’re around 45 years old to begin saving for retirement are likely to end up with a retirement portfolio at age 65 of about $285,000, according to a report from Edward Jones. But those who start around age 30 and save about $550 per month while realizing a 7% average return will end up with about $990,000 — which let’s face it, would make many people feel a whole lot more confident about sailing off into their golden years.

The question then becomes what to do if you’ve started late. What’s the best approach for gaining ground as quickly as possible? Here are tips from experts.

1. Don’t Delay Any Further

This may sound like obvious advice, but start saving now.

“Don’t view it as ‘I’m so far behind what’s the point?’ or ‘I have to save so much it’s unrealistic to even bother,’” said Scott Thoma, principal and investment strategist for Edward Jones.

Starting now is the most important thing you can do and the obvious first step.

2. Get Financial Therapy (i.e. Develop a Strategy)

Generation X, Generation Y and Millennials start building wealth later in life. Often that’s because they opt for experiences over settling down and accumulating money, said Norris, now a California-based real estate investor.

“We don’t buy houses so that we have the freedom to move,” said Norris. “But we certainly don’t have access to the same golden parachute retirement plans our parents enjoyed. So sit down with a good CPA and look at what you want your financials to look like when you retire…Some good financial therapy will go a long way toward helping set goals and priorities.”

Thoma, from Edward Jones agrees. He refers to it as “developing a strategy.”

People often settle on a random number they think is a good amount of money to have for retirement, without any idea how they’ll reach that number or how long that money will last.

Pro tip: You’ll be able to save more for retirement if you’re not paying a lot in interest on auto loans, mortgages or credit cards. You can get the lowest interest rates possible by having solid credit scores. (Want to check your scores? You can view two free, updated every 14 days, on Credit.com.) If you don’t, here are some tips for getting your credit back on track.

3. Max Out Your 401K Contributions

Contributing large sums to a retirement account can often be a challenge for a generation whose members face both raising children and caring for aging parents, but here are some basic rules of thumb to keep in mind.

If your employer offers a match for your 401K contributions, contribute at least up to the match amount. If you don’t, you’re leaving free money on the table.

If you’re in your 40s and have zero saved for retirement, and you’re aiming to replace 80% of a $60,000 annual salary upon retirement, it will require setting aside 25% of your pay right now, said Thoma. This scenario assumes retirement at 65 years old.

While 25% may seem like a lot, this percentage includes any employer contributions to retirement, said Thoma. It’s also based on the assumption that the individual is not supplementing their income in retirement with other sources of income, like working part-time.

Keep in mind: If you make more than $72,000 you won’t be able to put that total 25% into your 401K because annual contributions are capped at $18,000. If that’s your situation, you need to look into other investment vehicles like individual retirement accounts, certificates of deposit or buying shares directly. Talk to a financial professional to help decide the best option.

4. Consider Switching Jobs

Generation X is famous for living in the “now.” That approach to life even impacts the job choices, says Norris.

The gig economy, which provides the freedom to work from anywhere in the world, and work only when you want to, has become a popular option among this generation. But when it comes to preparing for retirement, the gig economy is probably not the best career choice.

Norris advised asking whether taking a more stable job might pay off more in the long run.

Roslyn Lash, a North Carolina-based accredited financial counselor, suggested seeking out companies that offer a pension. Options include government entities and school systems, she said.

5. Move

If you’re spending 50% to 60% of your take-home pay on rent, you’re wasting a lot of money, said Norris.

“You get nothing but the benefit of a roof over your head when you’re renting,” Norris said. “Consider moving to a location that will allow you to save more.”

6. Have a Flexible End Point

Delaying retirement even just a few years could have a considerable impact on your potential income. For instance, every year you continue to work adds 8% to your Social Security income, said Thoma.

“Not only will it provide you with more years to save, it also provides more years to earn Social Security credit,” said Thoma. “Doing this also means you will have fewer years of retirement to provide funding for.”

Image: PeopleImages

The post 6 Tips for Gen-Xers Who Haven’t Prepared for Retirement appeared first on Credit.com.

These Are the Areas Where It Costs the Most to Retire

How much will you need to retire? $500,000? $1 million? $2 million? There’s no easy answer. Some people won’t be able to enjoy their dream retirement without millions of dollars in the bank. Others will try to get by with $100,000. It depends on your lifestyle.

It also depends on where you live, according to data from the Employee Benefits Research Institute. Many retirement-savings recommendations are based on national benchmarks, noted the authors of the report on geographic variations in spending in older households. But because there can be huge differences in how much people in different parts of the country have to pay for housing, health care and other necessities, it’s probably more useful for those who are planning for retirement to consider how much people in their region spend.

Nationwide, the average household with people between the ages of 65 and 74 spent $45,633 per year, including nearly $21,000 on housing costs, $4,300 annually on health care and $4,700 on food. (Data on spending came from the University of Michigan’s long-running Health and Retirement Study.) As people age, overall expenses decline and a greater share of the typical household’s budget goes to housing and health care, while spending on travel and entertainment falls. (The survey didn’t include people who were living in nursing homes or other care facilities.)

But when the Employee Benefits Research Institute’s authors broke down the data by Census division, they found big differences, with retirees in the most expensive regions spending $15,000 per year or more than those in cheaper states.

Where is it cheapest to retire? Let’s take a quick look to find out how much the average retiree spends in your part of the country.

Average spending is for households with residents ages 65 to 74, unless otherwise noted.

9. West South Central

Average spending: $28,540

Younger retirees in Texas, Oklahoma, Arkansas and Louisiana spent less than retirees in any other part of the U.S. At $11,742 per year on average, their housing costs are lower than anywhere else in the country. (Go here to see how much house you can afford.) They also spent less on health care. But unlike most regions of the country, where retiree spending falls over time, people in the West South Central region spend more as they get older. By the time people are between the ages of 75 and 84, they’re spending $33,257 per year, in part because of a jump in health care spending to $2,600 per year.

8. East South Central

Average spending: $29,140

Retirees in the East South Central region (which includes Mississippi, Alabama, Tennessee and Kentucky) have the second-lowest spending in the country. They also have the biggest difference in spending between pre-retirees (those ages 50 to 64) and people ages 64 to 74, with annual expenditures falling from $42,261 annually to a little less than $30,000. Downsizing might be the main reason. The older survey respondents spent nearly $7,400 less per year on housing than those in the 50-to-64 age group.

A low cost of living is another reason this region is also home to four of the 10 best cities for people who hope to retire early.

7. East North Central

Average spending: $35,201

People in the Great Lakes states of Wisconsin, Michigan, Illinois, Indiana and Ohio had the lowest average spending outside of the South. That’s good news for people retiring in that region, but it comes with a caveat. Average spending in this region didn’t decrease as dramatically with age as it did in some parts of the country. By the time people reached age 85, they were still spending $31,059 per year on average, more than any other region except New England.

6. Middle Atlantic

Average spending: $38,125

Retirees in the mid-Atlantic states of New York, Pennsylvania and New Jersey spend an average of $38,125 every year, only slightly less than those in the 50-to-64 age group. Their average expenses included $13,440 on housing and $1,940 on health care. (You can determine your housing budget here.)

5. Pacific

Average spending: $38,464

Retirees in Washington, Oregon, California, Hawaii and Alaska spent about $38,000 per year on average, including $2,360 on health care and $18,300 on housing. Their housing costs were the second-highest in the country after New England, which may not be surprising considering this region is home to eight of the 10 least affordable cities in the United States.

4. Mountain

Average spending: $39,411

Living isn’t cheap for retirees in the vast Mountain region, which includes Montana, Idaho, Wyoming, Nevada, Utah, Colorado, Arizona and New Mexico. But things get better as you age. People in these states spend about $10,000 less per year between ages 75 and 84 than they do in the first decade of retirement.

If you end up retiring in the Mountain region, you’ll have lots of company. States such as Arizona, with its sunny skies and relatively low taxes, are perennially popular with retirees.

3. West North Central

Average spending: $42,240

Stereotypically frugal Midwesterners actually had the third-highest spending in the U.S. People in Minnesota, North Dakota, South Dakota, Iowa, Nebraska, Kansas and Missouri spent more than $42,000 per year on average from ages 65 to 74. About $20,000 went to housing and health care, with $22,000 left over for expenses, including food, transportation, travel, entertainment and dining out.

One reason retirees in this region can spend big? Some are quite wealthy. Minnesota, North Dakota, Nebraska and Iowa are all in the top 25 states in the number of millionaires per capita, according to a study by Phoenix Marketing International.

2. South Atlantic

Average spending: $44,350

Retirees in the sprawling South Atlantic region, which stretches from Delaware to Florida, have some of the highest spending in the U.S. People living in Delaware, Maryland, West Virginia, Virginia, North Carolina, South Carolina, Georgia and Florida spend $44,350 per year, on average, including $16,980 on housing and $3,000 on health care.

1. New England

Average spending: $46,019

New England retirees are the biggest spenders in the U.S., with annual expenditures of a little more than $46,000 per year. People in Maine, New Hampshire, Massachusetts, Vermont, Rhode Island and Connecticut have the highest housing costs in the country, at $19,507 annually — almost twice as much as those in the cheapest states — though costs fall significantly as people age. Health care spending among 65- to 74-year-olds is also higher than anywhere else, at nearly $6,000 per year, almost twice as much as what retirees in other parts of the country pay.

This article originally appeared on The Cheat Sheet.

Image: AleksandarNakic

The post These Are the Areas Where It Costs the Most to Retire appeared first on Credit.com.

This Is Not Your Father’s 401K: The Retirement Product You Should Know About

Want guaranteed income for life? Here's how you can get it.

Chances are you’re like most Americans and, regardless of your age, you aren’t saving enough for retirement, if you’re actually saving anything at all.

Nearly 40 million U.S. households (45%) have no retirement assets, according to a recent report by the National Institute on Retirement Security, and half of those households are headed by someone aged between 45 and 65. In fact, savings rates are so bad that many Americans are dying with an average of $62,000 in debt.

Even if you are saving enough for retirement, you might still wonder if that money will last your entire lifetime. Defined contribution plans like 401Ks are great at helping employees save for retirement, but they provide no guarantee of income as pensions do. On top of that, most 401Ks are self-directed, meaning those who do a poor job handling their investments could end up with significantly less money than they need in retirement.

But what if you could guarantee yourself income for life, just like ubiquitous company pension plans used to provide (and government pension plans still do)?

Well, you can. Here’s how.

Back in 2014, the Treasury Department started an initiative focused on “putting the pension back” into 401K retirement savings. (Need to brush up on retirement lingo? Here’s a handy guide.) Through loosened restrictions and some tax-law changes, the Treasury made it easier to convert funds from retirement savings into plans known as longevity income annuities, or LIAs, that provide guaranteed lifetime income.

Income for Life

LIAs are deferred annuities and, while they’ve been for a while, they’ve only recently become a part of mainstream retirement planning. The Treasury initiative could even cause them to become an integral part of 401K target funds. Here’s how they work: Say you have $100,000 in retirement savings. At age 65, you use $10,000 of that money to purchase an LIA. “Even in the current low-interest-rate environment, a deferred single-life annuity purchased at age 65 for a male costing $10,000 can generate an annual benefit flow from age 85 onward of $4,830 ($3,866 for a female) per year for life,” a recent National Bureau of Economic Research working paper concluded.

It’s easy to see how helpful this kind of guaranteed income could be, particularly given larger investment amounts. Of course, it’s a hedge that you’ll live long enough to take advantage of those funds, but some programs provide for reimbursement should you die before accessing all of your money. More on that in a minute.

According to Olivia S. Mitchell, a professor at the Wharton School of the University of Pennsylvania and a co-author of the working paper mentioned above, LIAs are available to investors but are not yet tied to defined-contribution plans.

“There has been discussion about including them in the target-date suite of funds, and some employers are actively looking for options,” she said in an email. “Relatively few insurers have them available as yet.”

“One reason annuities or lifetime income streams are not a standard feature of 401K plans is that many people don’t understand these products,” she wrote in an article for Forbes. “For instance, some older individuals tend to underestimate their chances of living a long time, so they don’t take proper precautions against outliving their assets. Others don’t understand financial concepts, and so they’re reluctant to take unfamiliar financial decisions. After all, retirement is usually a once-in-a-lifetime event!”

Just because they aren’t directly tied to defined-contribution plans just yet doesn’t mean LIAs aren’t easily accessed. AARP, for example, has been offering its Lifetime Income Program through New York Life since 2006. AARP’s plan has a cash refund feature so, as we mentioned earlier, if you die before your payments equal your annuity purchase price, your beneficiary will be paid the difference.

Is an LIA Right for Me?

As with most financial tools, some people will benefit from an LIA more than others. “People in poor health might not want to elect deferred annuities, particularly if they have a poor survival prognosis,” Mitchell said. “Some very wealthy people will not need the LIA as they can self-insure against outliving their assets. Retirees with a (well-funded) defined benefit pension probably don’t need additional annuitization. And people with a very small nest egg might not find it worthwhile to annuitize, say, $10,000. But much of the middle class could benefit.”

In considering LIA plans, Mitchell recommends asking how highly rated the insurer is who provides it. She also suggests knowing how well the state insurance guarantee fund is being run and the maximum amount you’d recover should the insurer go bankrupt. (As you’re planning your retirement, you should also make sure you have a full picture of your finances, including your credit. You can get a free snapshot of your credit report on Credit.com.)

So how much should you consider putting into an LIA? “Older individuals would optimally commit 8% to 15% of their plan balances at age 65 to a LIA, which begins payouts at age 85,” Mitchell, et al, wrote in their working paper.

As for timing, it doesn’t really make sense for someone who isn’t at or near retirement age to purchase an LIA. For one thing, you can’t access your retirement funds without penalty until age 60.

“It makes sense to decide how much to devote to the LIA in your mid-60s, since that gives 20 years over which the annuity value can build up,” so you can begin taking payments at age 85, Mitchell said.

Of course, there are a variety of annuity products to suit different personal needs, such as earlier payout options, so it’s a good idea to speak with a financial professional who can help you decide what product might be best for your financial situation.

Image: wundervisuals

The post This Is Not Your Father’s 401K: The Retirement Product You Should Know About appeared first on Credit.com.

Guide to Choosing the Right IRA: Traditional or Roth?

The Roth IRA versus traditional IRA debate has raged on for years.

What many retirement savers may not know is that most of the debate about whether it’s better to contribute to a traditional IRA or a Roth IRA is flawed.

You’ve probably heard that young investors are better off contributing to a Roth IRA because they’ll likely be in a higher tax bracket when they’re older. You’ve probably also heard that if you’re in the same tax bracket now and in retirement, a traditional IRA and Roth IRA will produce the same result.

These arguments are part of the conventional wisdom upon which many people make their decisions, and yet each misses some important nuance and, in some cases, is downright incorrect.

The Biggest Difference Between Traditional and Roth IRAs

There are several differences between traditional and Roth IRAs, and we’ll get into many of them below.

The key difference is in the tax breaks they offer.

Contributions to a traditional IRA are not taxed up front. They are tax-deductible, meaning they decrease your taxable income for the year in which you make the contribution. The money grows tax-free inside the account. However, your withdrawals in retirement are treated as taxable income.

Contributions to a Roth IRA are taxed up front at your current income tax rate. The money grows tax-free while inside the account. And when you make withdrawals in retirement, those withdrawals are not taxed.

Whether it’s better to get the tax break when you make the contribution or when you withdraw it in retirement is the centerpiece of the traditional vs. Roth IRA debate, and it’s also where a lot of people use some faulty logic.

We’ll debunk the conventional wisdom in just a bit, but first we need to take a very quick detour to understand a couple of key tax concepts.

The Important Difference Between Marginal and Effective Tax Rates

Don’t worry. We’re not going too far into the tax weeds here. But there’s a key point that’s important to understand if you’re going to make a true comparison between traditional and Roth IRAs, and that’s the difference between your marginal tax rate and your effective tax rate.

When people talk about tax rates, they’re typically referring to your marginal tax rate. This is the tax rate you pay on your last dollar of income, and it’s the same as your current tax bracket. For example, if you’re in the 15% tax bracket, you have a 15% marginal tax rate, and you’ll owe 15 cents in taxes on the next dollar you earn.

Your effective tax rate, however, divides your total tax bill by your total income to calculate your average tax rate across every dollar you earned.

And these tax rates are different because of our progressive federal income tax, which taxes different dollars at different rates. For example, someone in the 15% tax bracket actually pays 0% on some of their income, 10% on some of their income, and 15% on the rest of their income. Which means that their total tax bill is actually less than 15% of their total income.

For a simple example, a 32-year-old couple making $65,000 per year with one child will likely fall in the 15% tax bracket. That’s their marginal tax rate.

But after factoring in our progressive tax code and various tax breaks like the standard deduction and personal exemptions, they will only actually pay a total of $4,114 in taxes, making their effective tax rate just 6.33% (calculated using TurboTax’s TaxCaster).

As you can see, the couple’s effective tax rate is much lower than their marginal tax rate. And that’s almost always the case, no matter what your situation.

Keep that in mind as we move forward.

Why the Conventional Traditional vs. Roth IRA Wisdom Is Wrong

Most of the discussion around traditional and Roth IRAs focuses on your marginal tax rate. The logic says that if your marginal tax rate is higher now than it will be in retirement, the traditional IRA is the way to go. If it will be higher in retirement, the Roth IRA is the way to go. If your marginal tax rate will be the same in retirement as it is now, you’ll get the same result whether you contribute to a traditional IRA or a Roth IRA.

By this conventional wisdom, the Roth IRA typically comes out ahead for younger investors who plan on increasing their income over time and therefore moving into a higher tax bracket or at least staying in the same tax bracket.

But that conventional wisdom is flawed.

When you’re torn between contributing to a traditional or Roth IRA, it’s almost always better to compare your marginal tax rate today to your effective rate in retirement, for two reasons:

  1. Your traditional IRA contributions will likely provide a tax break at or near your marginal tax rate. This is because federal tax brackets typically span tens of thousands of dollars, while your IRA contributions max out at $5,500 for an individual or $11,000 for a couple. So it’s unlikely that your traditional IRA contribution will move you into a lower tax bracket, and even if it does, it will likely be only a small part of your contribution.
  2. Your traditional IRA withdrawals, on the other hand, are very likely to span multiple tax brackets given that you will likely be withdrawing tens of thousands of dollars per year. Given that reality, your effective tax rate is a more accurate representation of the tax cost of those withdrawals in retirement.

And when you look at it this way, comparing your marginal tax rate today to your effective tax rate in the future, the traditional IRA starts to look a lot more attractive.

Let’s run the numbers with a case study.

A Case Study: Should Mark and Jane Contribute to a Traditional IRA or a Roth IRA?

Mark and Jane are 32, married, and have a 2-year-old child. They currently make $65,000 per year combined, putting them squarely in the 15% tax bracket.

They’re ready to save for retirement, and they’re trying to decide between a traditional IRA and a Roth IRA. They’ve figured out that they can afford to make either of the following annual contributions:

  • $11,000 to a traditional IRA, which is the annual maximum.
  • $9,350 to a Roth IRA, which is that same $11,000 contribution after the 15% tax cost is taken out. (Since Roth IRA contributions are nondeductible, factoring taxes into the contribution is the right way to properly compare equivalent after-tax contributions to each account.)

So the big question is this: Which account, the traditional IRA or Roth IRA, will give them more income in retirement?

Using conventional wisdom, they would probably contribute to the Roth IRA. After all, they’re young and in a relatively low tax bracket.

But Mark and Jane are curious people, so they decided to run the numbers themselves. Here are the assumptions they made in order to do that:

  • They will continue working until age 67 (full Social Security retirement age).
  • They will continue making $65,000 per year, adjusted for inflation.
  • They will receive $26,964 per year in Social Security income starting at age 67 (estimated here).
  • They will receive an inflation-adjusted investment return of 5% per year (7% return minus 2% inflation).
  • At retirement, they will withdraw 4% of their final IRA balance per year to supplement their Social Security income (based on the 4% safe withdrawal rate).
  • They will file taxes jointly every year, both now and in retirement.

You can see all the details laid out in a spreadsheet here, but here’s the bottom line:

  • The Roth IRA will provide Mark and Jane with $35,469 in annual tax-free income on top of their Social Security income.
  • The traditional IRA will provide $37,544 in annual after-tax income on top of their Social Security income. That’s after paying $4,184 in taxes on their $41,728 withdrawal, calculating using TurboTax’s TaxCaster.

In other words, the traditional IRA will provide an extra $2,075 in annual income for Mark and Jane in retirement.

That’s a nice vacation, a whole bunch of date nights, gifts for the grandkids, or simply extra money that might be needed to cover necessary expenses.

It’s worth noting that using the assumptions above, Mark and Jane are in the 15% tax bracket both now and in retirement. According to the conventional wisdom, a traditional IRA and Roth IRA should provide the same result.

But they don’t, and the reason has everything to do with the difference between marginal tax rates and effective tax rates.

Right now, their contributions to the traditional IRA get them a 15% tax break, meaning they can contribute 15% more to a traditional IRA than they can to a Roth IRA without affecting their budget in any way.

But in retirement, the effective tax rate on their traditional IRA withdrawals is only 10%. Due again to a combination of our progressive tax code and tax breaks like the standard deduction and personal exemptions, some of it isn’t taxed, some of it is taxed at 10%, and only a portion of it is taxed at 15%.

That 5% difference between now and later is why they end up with more money from a traditional IRA than a Roth IRA.

And it’s that same unconventional wisdom that can give you more retirement income as well if you plan smartly.

5 Good Reasons to Use a Roth IRA

The main takeaway from everything above is that the conventional traditional versus Roth IRA wisdom is wrong. Comparing marginal tax rates typically underestimates the value of a traditional IRA.

Of course, the Roth IRA is still a great account, and there are plenty of situations in which it makes sense to use it. I have a Roth IRA myself, and I’m very happy with it.

So here are five good reasons to use a Roth IRA.

1. You Might Contribute More to a Roth IRA

Our case study above assumes that you would make equivalent after-tax contributions to each account. That is, if you’re in the 15% tax bracket, you would contribute 15% less to a Roth IRA than to a traditional IRA because of the tax cost.

That’s technically the right way to make the comparison, but it’s not the way most people think.

There’s a good chance that you have a certain amount of money you want to contribute and that you would make that same contribution to either a traditional IRA or a Roth IRA. Maybe you want to max out your contribution and the only question is which account to use.

If that’s the case, a Roth IRA will come out ahead every time simply because that money will never be taxed again.

2. Backdoor Roth IRA

If you make too much to either contribute to a Roth IRA or deduct contributions to a traditional IRA, you still might be eligible to do what’s called a backdoor Roth IRA.

If so, it’s a great way to give yourself some extra tax-free income in retirement, and you can only do it with a Roth IRA.

3. You Might Have Other Income

Social Security income was already factored into the example above. But any additional income, such as pension income, would increase the cost of those traditional IRA withdrawals in retirement by increasing both the marginal and effective tax rate.

Depending on your other income sources, the tax-free nature of a Roth IRA may be helpful.

4. Tax Diversification

You can make the most reasonable assumptions in the world, but the reality is that there’s no way to know what your situation will look like 30-plus years down the road.

We encourage people to diversify their investments because it reduces the risk that any one bad company could bring down your entire portfolio. Similarly, diversifying your retirement accounts can reduce the risk that a change in circumstances would result in you drastically overpaying in taxes.

Having some money in a Roth IRA and some money in a traditional IRA or 401(k) could give you room to adapt to changing tax circumstances in retirement by giving you some taxable money and some tax-free money.

5. Financial Flexibility

Roth IRAs are extremely flexible accounts that can be used for a variety of financial goals throughout your lifetime.

One reason for this is that your contributions are available at any time and for any reason, without tax or penalty. Ideally you would be able to keep the money in your account to grow for retirement, but it could be used to buy a house, start a business, or simply in case of emergency.

Roth IRAs also have some special characteristics that can make them effective college savings accounts, and as of now Roth IRAs are not subject to required minimum distributions in retirement, though that could certainly change.

All in all, Roth IRAs are more flexible than traditional IRAs in terms of using the money for nonretirement purposes.

3 Good Reasons to Use a Traditional IRA

People love the Roth IRA because it gives you tax-free money in retirement, but, as we saw in the case study above, that doesn’t always result in more retirement income. Even factoring in taxes, and even in situations where you might not expect it, the traditional IRA often comes out ahead.

And the truth is that there are even MORE tax advantages to the traditional IRA than what we discussed earlier. Here are three of the biggest.

1. You Can Convert to a Roth IRA at Any Time

One of the downsides of contributing to a Roth IRA is that you lock in the tax cost at the point of contribution. There’s no getting that money back.

On the other hand, contributing to a traditional IRA gives you the tax break now while also preserving your ability to convert some or all of that money to a Roth IRA at your convenience, giving you more control over when and how you take the tax hit.

For example, let’s say that you contribute to a traditional IRA this year, and then a few years down the line either you or your spouse decides to stay home with the kids, or start a business, or change careers. Any of those decisions could lead to a significant reduction in income, which might be a perfect opportunity to convert some or all of your traditional IRA money to a Roth IRA.

The amount you convert will count as taxable income, but because you’re temporarily in a lower tax bracket you’ll receive a smaller tax bill.

You can get pretty fancy with this if you want. Brandon from the Mad Fientist, has explained how to build a Roth IRA Conversion Ladder to fund early retirement. Financial planner Michael Kitces has demonstrated how to use partial conversions and recharacterizations to optimize your tax cost.

Of course, there are downsides to this strategy as well. Primarily there’s the fact that taxes are complicated, and you could unknowingly cost yourself a lot of money if you’re not careful. And unlike direct contributions to a Roth IRA, you have to wait five years before you’re able to withdraw the money you’ve converted without penalty. It’s typically best to speak to a tax professional or financial planner before converting to a Roth IRA.

But the overall point is that contributing to a traditional IRA now gives you greater ability to control your tax spending both now and in the future. You may be able to save yourself a lot of money by converting to a Roth IRA sometime in the future rather than contributing to it directly today.

2. You Could Avoid or Reduce State Income Tax

Traditional IRA contributions are deductible for state income tax purposes as well as federal income tax purposes. That wasn’t factored into the case study above, but there are situations in which this can significantly increase the benefit of a traditional IRA.

First, if you live in a state with a progressive income tax code, you may get a boost from the difference in marginal and effective tax rates just like with federal income taxes. While your contributions today may be deductible at the margin, your future withdrawals may at least partially be taxed at lower rates.

Second, it’s possible that you could eventually move to a state with either lower state income tax rates or no income tax at all. If so, you could save money on the difference between your current and future tax rates, and possibly avoid state income taxes altogether. Of course, if you move to a state with higher income taxes, you may end up losing money on the difference.

3. It Helps You Gain Eligibility for Tax Breaks

Contributing to a traditional IRA lowers what’s called your adjusted gross income (AGI), which is why you end up paying less income tax.

But there are a number of other tax breaks that rely on your AGI to determine eligibility, and by contributing to a traditional IRA you lower your AGI you make it more likely to qualify for those tax breaks.

Here’s a sample of common tax breaks that rely on AGI:

  • Saver’s credit – Provides a tax credit for people who make contributions to a qualified retirement plan and make under a certain level of AGI. For 2017, the maximum credit is $2,000 for individuals and $4,000 for couples.
  • Child and dependent care credit – Provides a credit of up to $2,100 for expenses related to the care of children and other dependents, though the amount decreases as your AGI increases. Parents with young children in child care are the most common recipients of this credit.
  • Medical expense deduction – Medical expenses that exceed 10% of your AGI are deductible. The lower your AGI, the more likely you are to qualify for this deduction.
  • 0% dividend and capital gains tax rate – If you’re in the 15% income tax bracket or below, any dividends and long-term capital gains you earn during the year are not taxed. Lowering your AGI could move you into this lower tax bracket.

Making a Smarter Decision

There’s a lot more to the traditional vs. Roth IRA debate than the conventional wisdom would have you believe. And the truth is that the more you dive in, the more you realize just how powerful the traditional IRA is.

That’s not to say that you should never use a Roth IRA. It’s a fantastic account, and it certainly has its place. It’s just that the tax breaks a traditional IRA offers are often understated.

It’s also important to recognize that every situation is different and that it’s impossible to know ahead of time which account will come out ahead. There are too many variables and too many unknowns to say for sure.

But with the information above, you should be able to make a smarter choice that makes it a little bit easier to reach retirement sooner and with more money.

The post Guide to Choosing the Right IRA: Traditional or Roth? appeared first on MagnifyMoney.