Asset Protection??

Normally, retirement plans are generally considered safe from creditors. A recent ruling by the Bankruptcy Panel for the 8^th U.S. Circuit Court of Appeals has called that safety into question. An individual was awarded ½ of his ex-wife’s 401(k) plan and her entire individual retirement account in their divorce settlement. He later filed for Chapter 7 bankruptcy and claimed those assets were exempt from creditors because they were in retirement plans. The Bankruptcy Panel disagreed on the basis that the retirement plans were not originally his; thus, they were subject to creditor claims.

Defined contribution 401(k) plans are sheltered from creditors in bankruptcy filings for individuals who own the plan. IRAs are also usually exempt from bankruptcy as well (subject to a cap under federal law that is approximately $1.2 million). However, once the assets are separated from the original owner, you should expect that the asset protection will go away. In the Supreme Court ruling of Clark v. Rameker, the Court held that inherited IRAs are not considered retirement funds for bankruptcy protection.

Although the 8^th Circuit ruling applies only in that district, other courts may follow suit. For protection, IRA assets received in a divorce settlement should not be intermingled with the individual’s own IRA. Co-mingling funds could possibly jeopardize the creditor protection of the entire IRA.

Please note that this discussion does not constitute legal or tax advice; it is informational only. Your individual circumstances should be discussed with your legal and/or tax counsel.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

Taxes and Investments

The single greatest expenditure that most individuals face is taxes. Google “tax freedom day” and you’ll find the number of days you work during the year just to pay taxes. In 2017 that day was April 23; or 114 days (about 1/3 of the year) before you begin to keep what you earn. The Tax Foundation estimated that you work January to pay off federal taxes. In February, you pay Social Security, Medicare, other payroll taxes, and state income tax. In March, you pay state and local sales taxes, property taxes, and excise taxes. The first 23 days in April paid corporate income taxes (through higher prices on goods/services), motor vehicle taxes, and severance and estate taxes.

Tax Priorities

Given the impact of taxes on an individual’s financial well- being, tax discussions warrant a discussion in financial planning. Conventional wisdom on taxes is:

1. If legally possible, avoid taxes.
2. If avoidance is not possible, defer the tax to sometime in the future.
3. If deferral is not possible, pay the tax at the least tax rate possible.

The income tax and investing consequences above can best be exemplified by contributions to a 401(k) defined contribution plan. Such contributions fulfill the planning priorities because:

1. Contributions into a 401(k) plan are not counted as taxable income in the year earned. Those contributions are excluded from taxable gross income for the year (avoid taxes).
2. Contributions grow tax deferred in the 401(k); no income taxes are paid until money is withdrawn from the plan (tax deferral).
3. Retirement plan distributions are generally mandated by age 70 ½ (well past the normal retirement age for most individuals). Assuming the individual is retired, income should be lower than in working years, and, income tax rates should be less (pay at the least tax rate).

Taxes and Investing

Tax circumstances should be considered in the financial planning process in the context of investing. Why? Different investments are more suitable in specific investment accounts than others. There are two main types of investment accounts: 1) taxable (where taxes are due depending on actions in the current tax year), and 2) tax deferred accounts (IRAs, 401(k)s, etc.) where taxes are payable at some time in the future.

There are specific taxes consequences associated with these two types of accounts that can potentially impact investments in each.

• Tax deferred accounts—While taxes on the growth of investments in these accounts are not due until money is withdrawn from the account:
• When money is withdrawn from the account, the money (tax deferred contributions plus all earnings on those contributions) is taxed at ordinary income rates.
• Losses on investments in the account are not deductible against ordinary income or other investment gains.
• Taxable investment accounts—Current taxes are due depending on activities in the account during the year.
• Investments in the account which are sold within one year at a profit are taxable as ordinary income.
• Investments in the account which are sold after one year at a profit are taxable at a lower, long-term capital gains tax rate.
• Investments sold during the year at a loss can use that loss to offset gains on investment sales or to offset other income (currently limited to $3000 per year).
• Some dividends and interest are deemed “qualified” and are taxable at lower tax rates.

The characteristics above can provide some general guidelines for investments in specific types of accounts. Those investments less subject to loss of principle and more stable income (bonds) would be more suitable in tax deferred accounts. Investments subject to possible significant fluctuations in value (positive or negative) such as stock would be more appropriate in taxable accounts. Again these are general rules; specific circumstances may make deviations from the rule entirely appropriate.

Other Tax Consequences

Financial planning should also include possible tax consequences of estate transfer. While the Tax Cuts and Jobs Act of 2017 significantly increased the estate tax exemption amount to approximately $11 million per person, that increase may expire in 2027 or with other political changes.

We at Paragon Financial Advisors help our clients minimize the tax consequences on financial planning. Of course, we recommend that specific actions associated with particular client circumstances be discussed with the client’s tax professional. Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

Goals Set-Goals Met!

The base of your financial planning should be your goals and objectives. Goals are basically a result or achievement toward which you are willing to expend time and effort. Goals vary with the individual’s wishes; hence, you set your own. Defining effective goals requires developing some particular characteristics for those goals. For example, “I want to retire comfortably” is not a well-defined goal. Additional information is required.

Goal Characteristics

A well-defined goal requires the following characteristics:

1. Specific- An effective goal is specific in nature. It clearly defines the desired result or achievement in an unambiguous manner.
2. Measurable- Goals must be measurable, i.e. you must have a way to determine the attainment of the goal and monitor the process toward goal attainment. Financial goals would be measured in dollars.
3. Achievable- Effective goals must be achievable. For example, a goal of playing quarterback for an NFL football team would not be achievable for me given my age, size, and athletic ability. Achievable does not necessarily mean easy. “Stretch” goals requiring significant effort are permissible as long as it is possible to achieve the final goal.
4. Relevant- Goals must be relevant; a relevant goal provides incentive for expending the effort required for goal attainment.
5. Priority- Most individuals will have multiple goals as they go through the goal setting process. Some goals will be more important to the individual than others. Therefore, goals should be ranked by priority. Which goals are most important and which goals have lesser importance? Identify and rank according to priority.
6. Time frames- An effective goal has associated time frames for completion and “mile posts” to monitor progress toward goal achievement.
7. Action Items- Action items outline the actions necessary to attain the goal. What needs to be done in order to successfully reach the goal?

Goal Definition

Let’s restate our retirement goal according to these parameters.

“My first priority is to retire in 30 years at an income level equal to 85% of my current income adjusted for inflation at 3% per year. In order to accomplish this goal, I need to save X dollars per year and my investment portfolio needs to grow at Y % per year.”

• This restatement clearly provides better definition with the characteristics discussed above.
• Specific/Measurable- “…retire… at an income level equal to 85% of my current income adjusted for inflation at 3% per year.”
• Achievable- certainly.
• Relevant/Priority- “…first…”
• Time frame- “… in 30 years…” with measurable mile posts—the value of the portfolio each year based on an assumed savings rate and portfolio appreciation rate can be identified and monitored.
• Action Items- “… save X dollars per year.”

We at Paragon Financial Advisors help our clients appropriately define, and attain, their financial goals. Please give us a call and we’ll help you.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

Social Security, If Not Now-When?

Social Security benefits are a component in the retirement planning of most Americans. However, those benefits pose questions for both younger and older employees. Younger employees are faced with the long term viability of the system (see our previous posting of “Social Security, Medicare, and You”. Older employees are faced with the question of how, and when, to start taking their benefit.
 
Social Security benefits are a function of age, length of working career, and earnings level. Therefore, we urge you to contact the Social Security Administration to determine your specific benefits. Our discussion here will be more general in nature and cover only the Old Age & Survivor Insurance (OASI) benefit.
 
Full Retirement Age (FRA)
 
Full retirement age is the age at which one is eligible to draw 100% of Social Security benefit earned. Retiring earlier than FRA reduces the amount received; retiring later increases the amount of benefit. Once benefits are begun, the amount is constant, subject only to cost of living adjustments (COLAs); that adjustment amount is tied to inflation. Full retirement age for benefits is shown in the following table:

 

Full Retirement Age

Year of Birth	Age Required for Full Benefits
1954 or Earlier	66 years
1955	66 years + 2 months
1956	66 years + 4 months
1957	66 years + 6 months
1958	66 years + 8 months
1959	66 years + 10 months
1960 and Later	67 years

The earliest age at which one can begin drawing benefits is 62. However, for those born in or before 1955, starting Social Security before FRA reduces the in full benefit by 6.25% per year. For those individuals born in 1960 or later, the reduction is 6.0% per year. Waiting until after FRA to begin drawing benefits increases the benefit by 8% per year until age 70. There are no further benefit increases after age 70.
 
Cost of living adjustments for Social Security are tied to inflation. In 2017, benefits increased by 0.3%. There have been years in which benefits did not increase; however, the average cost of living adjustment for 1985-2017 has been 2.6%.
 
Age 62 or Later?
 
When should one begin drawing Social Security benefits? Should one draw a lesser amount for a longer period of time (longer life expectancy) or a greater amount for a shorter period of time (shorter life expectancy)? That’s a complex question with many variables. What is one’s current financial situation (i.e. does one need the money)? What’s the long term prognosis for life expectancy (current health, heredity, etc.)? How can a couple plan benefits to maximize lifetime income received? There is a “breakeven” point which can be calculated. Consider the following example:
 
John Smith is entitled to $1500 monthly benefit at his FRA of age  66. If he chooses to begin benefits at age 62, his FRA amount will be reduced by 25% (i.e. 6.25% for 4 years) resulting in a benefit payment of $1125 per month. If he waits until FRA and begins  drawing $1500 per month, he will forgo the $1125 per month that he could have been receiving or $54,000 ($1125 x 48 months =   $54,000). If he begins benefits at age 66, that forgone amount will be recovered at $375 per month ($1500 benefit at 66 vs. $1125 at 62) which will require 144 months ($54,000 ÷ $375 = 144 or 12 years). Therefore, John’s breakeven age is 78. If he dies before   age 78, he made the correct decision to take benefits at age 62; if he lives past age 78, delaying until FRA would have been more  advantageous.
 
Obviously, life expectancy is a key component here. In previous postings we have referenced mortality tables. For the above example, the probability of a male at age 62 living to at least age 76 is 73%. There is a 60% probability he will live to age 80, and a 21% probability of living to age 90.
 
To compound the problem, beginning Social Security benefits prior to FRA and continuing to earn income has consequences. There is an annual earnings amount allowed ($16,920 in 2017); for each $2 earned above that amount, Social Security benefits are reduced by $1. That restriction no longer applies if one draws benefits at FRA. There are special rules that may apply here, so individual circumstances must be considered.
 
The Bottom Line
 
Social Security benefits are a key component in retirement planning. How and when those benefits are begun can have a significant impact on long term financial well-being. We at Paragon Financial Advisors can assist our clients in planning for their future. Please call us to discuss your specific circumstances.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

 

 

Factors in Retirement-Longevity and Working Career

In previous postings, we discussed some of the factors facing prospective/current retirees. These factors were classified in three general categories: 1) factors over which we have total control, 2) factors over which we have some control, and 3) factors over which we have no control. The second category (factors over which we have some control) included:

1. Longevity, and
2. Employment earnings and duration.

The second category is the subject of today’s posting.

 

Longevity

 

Genetic factors play a significant role in how long we live; so do life style choices. While individual life spans are difficult to predict, actuarial data allow us to view life spans in aggregate. First, women live longer than men and life span has been increasing.

 

Average Life Expectancy at Age 65¹

Year	Women	Men	Difference
1990	84.1	80.1	4.0
2015	85.5	83.1	2.4

Second, if you are 65 today, then:

Probability of Living at Least to (or Beyond) a Specific Age²

Age	Women	Men	Couple (1 alive)
75	85%	73%	97%
80	73	63	90
85	55	43	74
90	33	22	48
95	13	7	20
100	3	1	4

These figures are mid-points, not an end-point. The bottom line: you may need to plan on living much longer in retirement (perhaps as long as your working career). Consequently, a portion of your investment portfolio should be structured for growth in order to maintain purchasing power over the retirement years.

Employment Duration

Income in retirement has been compared to a “three legged stool” composed of pensions, Social Security, and investment/savings. Now a fourth leg has been added (a chair??) with employment income in retirement. As the population ages, the percent of older people in the work force has been increasing. In 1994 there were 31 million people age 65+ in the civilian population; that number had risen to 45 million in 2014 and is projected to be 62 million in 2024.³  By age groups, the number working is even more interesting.

Percent of Individuals in the Civilian Labor Force³

Age	1994	2004	2014	2024 (Est.)
65-69	22%	28%	32%	36%
70-74	12	15	19	23
75-79	7	9	11	14

People work in retirement for various reasons:

Major Reasons People Work in Retirement⁴

Reason	Need	Desire
Buy extras	26%	-
Make ends meet	25	-
Keep insurance/benefits	23	-
Decreased value of savings/investments	21	-
Stay active/involved	-	56%
Enjoy working	-	54
Job opportunity	-	24
Try new career	-	8

Finally, the age at which one retires is not always the date of anticipated retirement. Sixty-seven percent of workers expected to retire at age 65 or older. Only 23% retired as planned; the actual median retirement age was 62.⁵ Reasons for earlier retirement included the following:

Reasons for Retiring Earlier Than Planned⁵

Reason	Percent
Health problems/disability	60
Employer changes (downsizing/closings)	27
Other work related items	22
Care for spouse/family member	22
Superannuated work skills	10
Ability to afford early retirement	31
Choose to do something else	17

The Bottom Line

The “law of large numbers” whereby we look at aggregate statistics can provide some information for use in financial planning. Those “large numbers” indicate that an individual may have a much longer time in retirement than anticipated, and there may be fewer working years to save for retirement. Individual circumstances vary of course; please see us at Paragon Financial Advisors to review your “retirement readiness.”  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas.  We offer financial planning and investment management services to our clients. 

 

¹ Social Security Administration 2016 OASDI Trustees Report

² Social Security Administration Period Life Table 2013 (published 2016)

³ Bureau of Labor Statistics, Monthly Labor Review, December 2015

⁴ Employee Benefit Research Institute, Matthew Greenwald & Assoc. Inc. 2014 Retirement Confidence Survey

⁵ Employee Benefit Research Institute, Matthew Greenwald & Assoc. Inc., 2016 Retirement Confidence Survey