Retirement on a Budget

I was pleasantly surprised to read the recommendations by syndicated columnist Scott Burns regarding best investments for a retiree living on Social Security. He advised consideration be given to three major levers on retirement expenses:

• The biggest single expense for retirees is shelter. He advised purchasing a manufactured home in a resident-owned community, common in Florida and California. It is possible to purchase one with land for under $60,000 and have monthly ownership expenses under $300/mo. This is but one option.
• Another option is :"expense sharing," which is really communal living. As someone who rents out furnished rooms where I live, this was something I have enjoyed doing for many years before anyone ever heard of Airbnb or couch-surfing. Burns explains, "This suggestion usually brings cries of 'yuck' from readers, but those without adequate retirement income can 'create' income by developing their social skills and learning what it means to be amiable."
• And finally, becoming more of a smart shopper.

The "sharing economy" is the way of the future, and it was affirming to see it promoted in this way.

Happy Investing!

Tax Favored Environment

CPA and Attorney Mark Kohler, at a REAPS meeting last year, advised investors to own or start a small business (even MLM, but we will save that for another blog), invest in real estate, and take advantage of operating in a tax-free or tax-favored environment. These are notes from that talk.

Potential deductions for real estate investors, or anyone operating a small business are:

• medical insurance
• family employees, employees, subcontractors 
• annual meetings/retreats
• capital expenses
• equipment and furniture
• business travel
• meals and entertainment
• business board meetings
• job-related education
• legal and accounting fees
• office rents and utilities
• office supplies
• business gifts
• repairs and maintenance
• parking fees
• telephone, ipads, internet, office expenses
• professional dues
• postage and shipping

Travel is more carefully scrutinized, but some ideas for real estate investors are to buy something, negotiate an agreement, or submit offers, even if they are rejected; visit a rental, hold a corporate meeting, or meet with a client or vendor.

Keep in mind that these are typically paid with pre-tax dollars.

Here are a few reasons that Mark Kohler recommends investing in real estate:

• The tax write-offs are incredible when you treat it as a small business. You
  may get to use those deductions against your ordinary income, but if not, they
  will carry forward until you sell any rental property.
• The value of the property will grow tax deferred until you sell, and you may
  even use other strategies to delay or avoid the gain entirely.
•  The far majority of rental properties allow investors to create tax-free cash
  flow based on the amount of write-offs related to the property.
• You can leverage your money to buy more ‘investment’ and thus increase
  your ROI- Return on Investment (something you can’t do with stocks, bonds
  or mutual funds).
• You can involve family members, travel to check on your rentals as a valid
  business deduction, enjoy average appreciation and growth that out performs Wall Street, and a variety of other benefits. 
• MOST IMPORTANTLY…it’s like a forced retirement plan.

Happy Investing!

Taxes, Retirement, and Timing Social Security

The advantages of tax deferral are often emphasized when it comes to saving for retirement. So it might seem like a good idea to hold off on taking taxable distributions from retirement plans for as long as possible. (Note: Required minimum distributions from non-Roth IRAs and qualified retirement plans must generally start at age 70½.) But sometimes it may make more sense to take taxable distributions from retirement plans in the early years of retirement while deferring the start of Social Security retirement benefits.

Some basics

Up to 50% of your Social Security benefits are taxable if your modified adjusted gross income (MAGI) plus one-half of your Social Security benefits falls within the following ranges: $32,000 to $44,000 for married filing jointly; and $25,000 to $34,000 for single, head of household, or married filing separately (if you've lived apart all year). Up to 85% of your Social Security benefits are taxable if your MAGI plus one-half of your Social Security benefits exceeds those ranges or if you are married filing separately and lived with your spouse at any time during the year. For this purpose, MAGI means adjusted gross income increased by certain items, such as tax-exempt interest, that are otherwise excluded or deducted from your income for regular income tax purposes.

Social Security retirement benefits are reduced if started prior to your full retirement age (FRA) and increased if started after your FRA (up to age 70). FRA ranges from 66 to 67, depending on your year of birth.

Distributions from non-Roth IRAs and qualified retirement plans are generally fully taxable unless nondeductible contributions have been made.

Accelerate income, defer Social Security

It can sometimes make sense to delay the start of Social Security benefits to a later age (up to age 70) and take taxable withdrawals from retirement accounts in the early years of retirement to make up for the delayed Social Security benefits.

If you delay the start of Social Security benefits, your monthly benefits will be higher. And because you've taken taxable distributions from your retirement plans in the early years of retirement, it's possible that your required minimum distributions will be smaller in the later years of retirement when you're also receiving more income from Social Security. And smaller taxable withdrawals will result in a lower MAGI, which could mean the amount of Social Security benefits subject to federal income tax is reduced.

Whether this strategy works to your advantage depends on a number of factors, including your income level, the size of the taxable withdrawals from your retirement savings plans, and how many years you ultimately receive Social Security retirement benefits.

Example

Mary, a single individual, wants to retire at age 62. She can receive Social Security retirement benefits of $18,000 per year starting at age 62 or $31,680 per year starting at age 70 (before cost-of-living adjustments). She has traditional IRA assets of $300,000 that will be fully taxable when distributed. She has other income that is taxable (disregarding Social Security benefits and the IRA) of $27,000 per year. Assume she can earn a 6% annual rate of return on her investments (compounded monthly) and that Social Security benefits receive annual 2.4% cost-of-living increases. Assume tax is calculated using the 2015 tax rates and brackets, personal exemption, and standard deduction.

Option 1. One option is for Mary to start taking Social Security benefits of $18,000 per year at age 62 and take monthly distributions from the IRA that total about $21,852 annually.

Option 2. Alternatively, Mary could delay Social Security benefits to age 70, when her benefits would start at $38,299 per year after cost-of-living increases. To make up for the Social Security benefits she's not receiving from ages 62 to 69, during each of those years she withdraws about $40,769 to $44,094 from the traditional IRA--an amount approximately equal to the lost Social Security benefits plus the amount that would have been withdrawn from the traditional IRA under the age 62 scenario (plus a little extra to make the after-tax incomes under the two scenarios closer for those years). When Social Security retirement benefits start at age 70, she reduces monthly distributions from the IRA to about $4,348 annually.

Mary's after-tax income in each scenario is approximately the same during the first 8 years. Starting at age 70, however, Mary's after-tax income is higher in the second scenario, and the total cumulative benefit increases significantly with the total number of years Social Security benefits are received.*

*This hypothetical example is for illustrative purposes only, and its results are not representative of any specific investment or mix of investments. Actual rates of return and results will vary. The example assumes that earnings are taxed as ordinary income and does not reflect possible lower maximum tax rates on capital gains and dividends, as well as the tax treatment of investment losses, which would make the return more favorable. Investment fees and expenses have not been deducted. If they had been, the results would have been lower. You should consider your personal investment horizon and income tax brackets, both current and anticipated, when making an investment decision as these may further impact the results of the comparison. Investments offering the potential for higher rates of return also involve a higher degree of risk to principal.

 Happy Investing!

Today's blog courtesy of Rebecca J. Faught, Waddell & Reed. Photo courtesy of Vicky Kaseorg.

Tax Free Retirement Funds

High-income earners have a new incentive to make after-tax contributions to a 401(k) plan: They can later shift the money into a Roth individual retirement account, tax-free.

Thanks to a recent Internal Revenue Service ruling, eligible employees can now move after-tax contributions directly from their employer-sponsored retirement plan to a Roth account. The catch: They have to do it at the same time they roll their existing 401(k) pretax savings into a traditional IRA.

The potential tax savings are huge, depending on an investor’s tax rate in retirement.

Money in a Roth IRA grows tax-free and is not taxed when it is withdrawn, and Roth IRA withdrawals does not raise an investor’s adjusted gross income. That, in turn, can help lower Medicare premiums or the 3.8% surtax on net investment income.

The IRS’s decision helps high-income people funnel potentially significant amounts of money directly into a Roth. Normally, couples with adjusted gross incomes of $191,000 or more and individuals with incomes of $129,000 or more cannot directly contribute to a Roth IRA.

Most contributions to a company-sponsored plan are made with pretax money. That reduces a worker’s current tax bill, but withdrawals in retirement are taxed as ordinary income, at rates up to 39.6%.

Such withdrawals could push an IRA owner into a higher tax bracket.

Once a retiree hits age 70½, when required minimum distributions (RMD) from retirement savings kick in, the advantages of Roth IRAs become even more clear. Roth’s do not have required minimum distributions, while other savings do, and Roth withdrawals don’t run the risk of pushing a person into a higher tax bracket because they don’t count as income.

The new rules—which also apply to nonprofit-sponsored 403(b) plans—are supposed to go into effect next year, but the IRS said in September that investors could start making the transfers now.

The IRS’s announcement means that savers no longer have to follow complicated strategies to reduce their tax hit when moving money from a company plan to a Roth IRA. It also means that people whose incomes are too high for them to fund a Roth IRA now have a new way to do just that.

After-tax contributions to a workplace 401(k) can be shifted into a tax-free Roth account, the IRS says.

The annual limit on pretax contributions to 401(k) plans is $17,500 for individuals under 50, and $23,000 for those 50 and older. Those limits will rise to $18,000 and $24,000, respectively, next year.

Savers who want to take advantage of the new rule must first contribute the maximum pretax amount to their 401(k) or similar plan. In addition, the plan must allow contributions of after-tax funds.

The total amount a worker can save annually in such accounts—including pretax contributions, pretax employer matches and after-tax contributions—is $52,000 ($57,500 for workers 50 and over). The added after-tax dollars allow them to accumulate far greater savings that can be eligible for Roth conversion at retirement.

Even now, after-tax contributions—if allowed by the plan—could make sense for people who have extra cash they won’t need until they are 59½ or those who have unique or low-cost investment options in their company plans, experts (experts…really?) say.

The latest decision gives people an easier way (really?) to distinguish pre- and after-tax contributions and maximize (really?) their potential tax savings, making it much easier to move tens or hundreds of thousands of dollars (really?) they have had accumulating in their 401(k)s into a Roth IRA with no tax bite.

Happy Investing!

Get Seattle Real Estate Investor delivered by email.


Today's guest blog courtesy of Paul F. Carag, Aquila Legacy

Retire with Rentals

How many rental properties do you need to retire?

The answer to that question will be unique to each individual, depending on what they may need to feel comfortable in retirement. The internet is full of suggestions, and here are a few.

http://investfourmore.com/2014/04/28/many-rental-properties-need-retire/

http://propertyupdate.com.au/how-many-properties-do-you-need-to-retire/

http://www.lifestylesunlimited.com/how-22-rent-properties-can-retire-you-faster-than-401k/

http://www.marketwatch.com/story/how-to-retire-early-35-years-early-2014-01-17

The surprising answer is that the number will likely be fewer than you might expect, assuming rents keep pace with future inflation. After 15-30 years, tenants have paid for the mortgage, and what is coming in the mailbox is pure cash flow.

Buy for cash flow now, and watch your retirement nest egg grow!

Happy investing!

Retire in Style

The Washington Landlord Association recently published a summary of remarks by long-time commercial broker and investor Virgil Wells from Tacoma. I enjoyed his "Rules of Investing" below:

1) Always buy - never sell (for now)
2) Never buy anything today that you cannot sell for more tomorrow
3) Always use other people's money!
4) Buy anything you want, as long as it doesn't cost you anything (e.g.tenants paying with rents)

His formula for retiring in style is to buy at least four rental houses to keep for cash flow:

one, to pay for added costs of necessities, such as groceries;
a second, to pay for the increased cost of consumer goods, such as gasoline;
a third, to pay for health care; and
a fourth, to pay for vacations.

Sounds like a plan to me!

Happy Investing!

Retirement Planning

USAA, which serves the military community, featured a series of financial articles on retirement planning in their most recent spring magazine. The outlook for investors in traditional stocks and bonds is not good.<br><br>Current rates on 10-year Treasury bonds: Less than 2%<br>Dividend yields on stocks: Less than 2%<br>Your bank account? Ditto<br><br>R. Matthew Freund, senior vice president of investment portfolio management with USAA says: "We think stocks will return less than they have historically. Typically, most stocks have shown a 3 to 5 percent real return."<br><br>Based on historical data, a balanced portfolio of stocks and bonds returned a real [after inflation] 4.7 percent return from 1972 to 2011. Freund expects this to be around 3 to 4 percent NOMINAL return (before inflation) moving forward. The future growth of your portfolio is up to the markets, not you, when you invest in traditional equities like stocks and bonds.<br><br>If you are falling short of a savings or retirement goal, there are other options. This is a major reason why my business partner Bob Malecki and I have established a private equity fund invested in residential real estate.

Real estate is an asset class that has traditionally outperformed inflation, and our equity fund pays investors a preferred rate of return higher than the current and projected interest rates described above.<br><br>For more information on investing in REI Capital, visit our website at www.reicapitalusa.com.