FIRE stands for Financial Independence, Retire Early. It’s a financial movement growing in popularity as more and more people seek to eliminate debt and build savings so they can retire earlier than usual. Regardless of your target retirement date, this movement focuses on some smart financial strategies:
One of FIRE’s focus is on eliminating all debt and reducing expenses. Paying off debt is the first step with a focus on not accumulating new debt. Start by scrutinizing how you spend your money to identify unnecessary expenses.
FIRE followers also look for ways to increase their income. Things like switching jobs for a significant pay increase, working side gigs or generating passive income from owning rental property add money toward the early retirement goal.
The last tenement of FIRE involves sound investing strategies. Start by maxing out retirement plan contributions. And if your employer offers a matching contribution, be sure you’re saving at least the minimum amount to get the maximum contribution.
One of the common retirement plans offered by employers is a 401(k) plan. These plans make saving for retirement convenient. But make sure you understand the basics so you can capitalize on plan options and determine how your 401(k) fits into your overall retirement strategy.
Some employers allow new hires to enroll in the company 401(k) plan on day one, and some even offer automatic enrollment. But employers can have waiting periods of a few months to a year before you’re eligible to participate. To get the most from the plan, however, sign up as soon as you’re allowed.
IT’S A MATCH
Many companies offer a matching contribution to employees who participate in the company plan. While amounts vary, matching contributions are usually a fixed percentage on a predetermined portion of an employee’s annual salary. For example, an employer may contribute fifty cents for every dollar you contribute, up to 10% of your salary. So if you earn $60,000 per year, you could receive a $3,000 annual contribution from your employer, provided you contribute $6,000 each year.
KNOW YOUR LIMITS
The IRS places limits on the amount you can contribute to qualified retirement plans each year. For 2021, the limit is $19,500, but if you’re 50 or older you can contribute an additional $6,500. Any 401(k) plan can set its own contribution limits, which may be less than the IRS limits.
The money you contribute to a 401(k) is yours to keep from day one. But the contributions from your employer may come with a contingency, also known as a vesting schedule. That means you may need to work for the company for a year or more before you gain 100% ownership of the company’s contributions.
Although you may not plan on tapping your 401(k) account before retirement, sometimes life’s events require you to do so. Some plans will let you take a loan that you repay with interest over time. Or you may be able to take a hardship withdrawal that doesn’t require repayment. But you’ll have to pay income tax on the amount withdrawn and if you are under age 59½ there is an additional 10% federal tax penalty. Consider this option as your last resort, because that money will no longer be there to grow for retirement.
Longer retirements mean inflation can put a serious dent in the best-laid plans. Most people factor in inflation when planning how much they will need when they reach retirement. But inflation does not stop the day you retire. In fact, your budget on the day you retire could look very different five, 10, or 20 years into retirement.
It’s important to set realistic expectations for both how long you may be in retirement and how much income you’ll need. Designing a realistic budget that considers essential, discretionary and unexpected costs is a smart first step.
With that as a start, you can review the ways high inflation and low interest rates may affect total rates of return on your investments and your annual income.
Maybe you’ll try to address inflation risk on your own by withdrawing no more than 4% of an asset and then increasing the withdrawal by the rate of inflation each year. But as those withdrawals grow, they could represent a large piece of your retirement account over time. This can seriously erode funds.
Some fixed index annuities and index variable annuities offer potential income increases every year to help address the effects of inflation. These annual increases are available by purchasing optional riders for an additional charge.
CHOOSE TO DELAY
If you can delay applying for Social Security benefits until you’re 70, consider doing so. Each year you put off collecting Social Security increases your annual payments 8%. This a cost-effective way to maximize your inflation-protected income.
As you think through your future expenses and how inflation may impact them, it’s essential to manage expectations, be realistic and focus on what you can control. Working with your financial professional can help address longevity, inflation risk and rising health care costs in retirement.
Are you thinking about setting up a retirement plan for yourself and your employees, but you’re worried about the financial commitment and administrative burdens involved in providing a traditional pension plan? Two options to consider are a “simplified employee pension” (SEP) or a “savings incentive match plan for employees” (SIMPLE).
SEPs are intended as an alternative to “qualified” retirement plans, particularly for small businesses. The relative ease of administration and the discretion that you, as the employer, are permitted in deciding whether or not to make annual contributions, are features that are appealing.
If you don’t already have a qualified retirement plan, you can set up a SEP simply by using the IRS model SEP, Form 5305-SEP. By adopting and implementing this model SEP, which doesn’t have to be filed with the IRS, you’ll have satisfied the SEP requirements. This means that as the employer, you’ll get a current income tax deduction for contributions you make on behalf of your employees. Your employees won’t be taxed when the contributions are made but will be taxed later when distributions are made, usually at retirement. Depending on your needs, an individually-designed SEP — instead of the model SEP — may be appropriate for you.
When you set up a SEP for yourself and your employees, you’ll make deductible contributions to each employee’s IRA, called a SEP-IRA, which must be IRS-approved. The maximum amount of deductible contributions that you can make to an employee’s SEP-IRA, and that he or she can exclude from income, is the lesser of: 25% of compensation and $58,000 for 2021. The deduction for your contributions to employees’ SEP-IRAs isn’t limited by the deduction ceiling applicable to an individual’s own contribution to a regular IRA. Your employees control their individual IRAs and IRA investments, the earnings on which are tax-free.
There are other requirements you’ll have to meet to be eligible to set up a SEP. Essentially, all regular employees must elect to participate in the program, and contributions can’t discriminate in favor of the highly compensated employees. But these requirements are minor compared to the bookkeeping and other administrative burdens connected with traditional qualified pension and profit-sharing plans.
The detailed records that traditional plans must maintain to comply with the complex nondiscrimination regulations aren’t required for SEPs. And employers aren’t required to file annual reports with IRS, which, for a pension plan, could require the services of an actuary. The required recordkeeping can be done by a trustee of the SEP-IRAs — usually a bank or mutual fund.
Another option for a business with 100 or fewer employees is a “savings incentive match plan for employees” (SIMPLE). Under these plans, a “SIMPLE IRA” is established for each eligible employee, with the employer making matching contributions based on contributions elected by participating employees under a qualified salary reduction arrangement. The SIMPLE plan is also subject to much less stringent requirements than traditional qualified retirement plans. Or, an employer can adopt a “simple” 401(k) plan, with similar features to a SIMPLE plan, and automatic passage of the otherwise complex nondiscrimination test for 401(k) plans.
For 2021, SIMPLE deferrals are up to $13,500 plus an additional $3,000 catch-up contributions for employees age 50 and older.
Contact us for more information or to discuss any other aspect of your retirement planning.
Retirement is something almost all of us look forward to. But have you considered how your retirement income will be taxed? Not all retirement income is taxed the same, so it is important that you understand the details.
If your total income is more than $25,000 for an individual or $32,000 for a married couple filing jointly, you must pay federal income taxes on your Social Security benefits. The tax rate is based on your total income from all sources, maxing out at the rate of 85%. Some states also tax social security income.
401(K) AND IRA WITHDRAWALS
Withdrawals from tax-deferred retirement accounts, such as a 401(k), are taxed as ordinary income. The taxability of a traditional IRA depends on how you treated your contributions before you retired. If you took a tax deduction in the years you contributed, your withdrawals are likely taxable.
Qualified withdrawals from a Roth IRA are non-taxable. Since your investment was made with after-tax dollars, you won’t be taxed again when you withdraw it. Although these accounts are long-term assets, they don’t enjoy capital gains treatment.
You’ll pay taxes on dividends, interest and capital gains just as you did before you retired. The length of time you held an asset before selling it will determine your capital gains tax rate. It can be as low as zero if your total income for the year isn’t high.
SELLING YOUR HOME
If you’ve downsized and sold your home, you may be able to avoid paying tax on the gain. If you lived in your home for two of the five years prior to the sale, you may be able to exclude up to $250,000 in gain. The rules are a little more complex if you rented your home out, so consult with your tax professional to determine if you have taxable gains.
If you recently launched a business, you may want to set up a tax-favored retirement plan for yourself and your employees. There are several types of qualified plans that are eligible for these tax advantages:
A current deduction from income to the employer for contributions to the plan,
Tax-free buildup of the value of plan investments, and
The deferral of income (augmented by investment earnings) to employees until funds are distributed.
There are two basic types of plans.
Defined benefit pension plans
A defined benefit plan provides for a fixed benefit in retirement, based generally upon years of service and compensation. While defined benefit plans generally pay benefits in the form of an annuity (for example, over the life of the participant, or joint lives of the participant and his or her spouse), some defined benefit plans provide for a lump sum payment of benefits. In certain “cash balance plans,” the benefit is typically paid and expressed as a cash lump sum.
Adoption of a defined benefit plan requires a commitment to fund it. These plans often provide the greatest current deduction from income and the greatest retirement benefit, if the business owners are nearing retirement. However, the administrative expenses associated with defined benefit plans (for example, actuarial costs) can make them less attractive than the second type of plan.
Defined contribution plans
A defined contribution plan provides for an individual account for each participant. Benefits are based solely on the amount contributed to the participant’s account and any investment income, expenses, gains, losses and forfeitures (usually from departing employees) that may be allocated to a participant’s account. Profit-sharing plans and 401(k)s are defined contribution plans.
A 401(k) plan provides for employer contributions made at the direction of an employee under a salary reduction agreement. Specifically, the employee elects to have a certain amount of pay deferred and contributed by the employer on his or her behalf to the plan. Employee contributions can be made either:
On a pre-tax basis, saving employees current income tax on the amount contributed, or
On an after-tax basis. This includes Roth 401(k) contributions (if permitted), which will allow distributions (including earnings) to be made to the employee tax-free in retirement, if conditions are satisfied.
Automatic-deferral provisions, if adopted, require employees to opt out of participation.
An employer may, or may not, provide matching contributions on behalf of employees who make elective deferrals to the plan. Matching contributions may be subject to a vesting schedule. While 401(k) plans are subject to testing requirements, so that “highly compensated” employees don’t contribute too much more than non-highly-compensated employees, these tests can be avoided if you adopt a “safe harbor” 401(k) plan. A highly compensated employee in 2020 is defined as one who earned more than $130,000 in the preceding year.
There are other types of tax-favored retirement plans within these general categories, including employee stock ownership plans (ESOPs).
Small businesses can also adopt a Simplified Employee Pension (SEP), and receive similar tax advantages to “qualified” plans by making contributions on behalf of employees. And a business with 100 or fewer employees can establish a Savings Incentive Match Plan for Employees (SIMPLE). Under a SIMPLE, generally an IRA is established for each employee and the employer makes matching contributions based on contributions elected by employees.
There may be other options. Contact us to discuss the types of retirement plans available to you.
Did COVID-19 change your plans to work? Layoffs, forced retirement, reluctance to return to the office to dodge exposure or being an early survivor. Whatever the reason, retiring before planned is stressful and requires a lot to think about and do.
Look at how you’re spending money. Are there expenses you can eliminate or reduce? For example, consider using a mail order pharmacy to save co-pays. Can you find less expensive plans for cell phones, internet or television? Maybe now is the time to downsize into a smaller house.
Make sure that your retirement funds are diversified and in sync with your needs, goals, risk tolerance and timeline. You will want to conserve assets but being too conservative could deprive you of growth. That’s why is it important to review your portfolio allocation with your financial professional.
If you’re at least 62, you can start collecting Social Security retirement benefits. However, each year you can delay the start date, your monthly check will increase. Understand your options and after you’ve reviewed your budget and retirement account balances, decide when is the best time for you to start collecting Social Security.
Stopping work unexpectedly can be emotionally challenging. Without a plan for your new free time, you may feel lonely or lost. Consider how you’d like to fill your day. Consider your options including, dedicating time to your hobbies, learning something new, more time with family and friends, volunteer work or finding a part-time job.
Instead of stopping work cold turkey, you may wish to pursue part-time employment opportunities. You can earn money to cover some of your expenses and reduce your reliance on retirement accounts. Also, it can help you feel productive and keep you mentally stimulated. But remember, it could trigger taxation of your Social Security income. Companies with tight budgets may value your work experience.
This year, the optional standard mileage rate used to calculate the deductible costs of operating an automobile for business decreased by one-half cent, to 57.5 cents per mile. As a result, you might claim a lower deduction for vehicle-related expense for 2020 than you can for 2019.
Calculating your deduction
Businesses can generally deduct the actual expenses attributable to business use of vehicles. This includes gas, oil, tires, insurance, repairs, licenses and vehicle registration fees. In addition, you can claim a depreciation allowance for the vehicle. However, in many cases depreciation write-offs on vehicles are subject to certain limits that don’t apply to other types of business assets.
The cents-per-mile rate comes into play if you don’t want to keep track of actual vehicle-related expenses. With this approach, you don’t have to account for all your actual expenses, although you still must record certain information, such as the mileage for each business trip, the date and the destination.
Using the mileage rate is also popular with businesses that reimburse employees for business use of their personal vehicles. Such reimbursements can help attract and retain employees who drive their personal vehicles extensively for business purposes. Why? Under the Tax Cuts and Jobs Act, employees can no longer deduct unreimbursed employee business expenses, such as business mileage, on their own income tax returns.
If you do use the cents-per-mile rate, be aware that you must comply with various rules. If you don’t, the reimbursements could be considered taxable wages to the employees.
The rate for 2020
Beginning on January 1, 2020, the standard mileage rate for the business use of a car (van, pickup or panel truck) is 57.5 cents per mile. It was 58 cents for 2019 and 54.5 cents for 2018.
The business cents-per-mile rate is adjusted annually. It’s based on an annual study commissioned by the IRS about the fixed and variable costs of operating a vehicle, such as gas, maintenance, repair and depreciation. Occasionally, if there’s a substantial change in average gas prices, the IRS will change the mileage rate midyear.
Factors to consider
There are some situations when you can’t use the cents-per-mile rate. In some cases, it partly depends on how you’ve claimed deductions for the same vehicle in the past. In other cases, it depends on if the vehicle is new to your business this year or whether you want to take advantage of certain first-year depreciation tax breaks on it.
As you can see, there are many factors to consider in deciding whether to use the mileage rate to deduct vehicle expenses. We can help if you have questions about tracking and claiming such expenses in 2020 — or claiming them on your 2019 income tax return.
As you’ve probably heard, a new law was recently passed with a wide range of retirement plan changes for employers and individuals. One of the provisions of the SECURE Act involves a new requirement for employers that sponsor tax-favored defined contribution retirement plans that are subject to ERISA.
Specifically, the law will require that the benefit statements sent to plan participants include a lifetime income disclosure at least once during any 12-month period. The disclosure will need to illustrate the monthly payments that an employee would receive if the total account balance were used to provide lifetime income streams, including a single life annuity and a qualified joint and survivor annuity for the participant and the participant’s surviving spouse.
Under ERISA, a defined contribution plan administrator is required to provide benefit statements to participants. Depending on the situation, these statements must be provided quarterly, annually or upon written request. In 2013, the U.S. Department of Labor (DOL) issued an advance notice of proposed rulemaking providing rules that would have required benefit statements provided to defined contribution plan participants to include an estimated lifetime income stream of payments based on the participant’s account balance.
Some employers began providing this information in these statements — even though it wasn’t required.
But in the near future, employers will have to begin providing information to their employees about lifetime income streams.
Fortunately, the effective date of the requirement has been delayed until after the DOL issues guidance. It won’t go into effect until 12 months after the DOL issues a final rule. The law also directs the DOL to develop a model disclosure.
Plan fiduciaries, plan sponsors, or others won’t have liability under ERISA solely because they provided the lifetime income stream equivalents, so long as the equivalents are derived in accordance with the assumptions and guidance and that they include the explanations contained in the model disclosure.
Critics of the new rules argue the required disclosures will lead to confusion among participants and they question how employers will arrive at the income projections. For now, employers have to wait for the DOL to act. We’ll update you when that happens. Contact us if you have questions about this requirement or other provisions in the SECURE Act.