Category

Retirement

How Social Security Works

By Financial Planning, Retirement, Social Security

We’ve been paying into Social Security from the time we earned our first paychecks as teens or twentysomethings. But what can we expect to get back when we retire ten, fifteen or twenty years from now?

“Nothing!” you cry.

Yeah, yeah, the system needs fixing to stay solvent, but I’m confident that the politicians will come up with a solution for two reasons. Seniors care about Social Security. And seniors always vote.

Right now, the government collects 12.4% of the first $132,900 of our income with half (6.2%) coming out of our paychecks and the other half coming from the employer. (The self-employed pay both halves, but can deduct the “employer half” from their income to level the field with corporate employees.) Because the amount of our income that is taxed for Social Security is limited, the amount of Social Security benefits we can receive in retirement is capped.

The exact amount you or I will receive in retirement depends on two factors. The first is our individual earning history. Social Security will use a worker’s highest 35 years of earnings to calculate the amount she receives monthly in retirement. The second is at what age we elect to collect benefits. For those of us born in 1960 or later, we will receive 100% of what we have earned, from Social Security, if we collect benefits at age 67 – our “Full Retirement Age” or FRA. We can elect to receive benefits as early as 62, but our benefits will be reduced.

Collecting at age… Benefits reduced by…
62 30%
63 25%
64 20%
65 13%
66 7%

We can also delay collecting Social Security benefits past 67 and receive more in monthly benefits as a result.

Collecting at age… Benefits raised by…
68 8%
69 16%
70 24%

For many of us, our earnings history will be what it will be. Years when we stayed out of the official workforce to raise children or take care of aging parents will get factored in as zero earnings years and reduce our ultimate Social Security benefits. Decisions about when to start collecting benefits on our own work record or that of a spouse are complex and deserve careful consideration. Delaying claiming will let your ultimate Social Security benefit grow, yes, but if you are relying on savings to pay the bills until claiming, you may be putting your financial security in retirement at too much risk. This is where a CFP® professional can help guide you towards the right decision.

What does a “personal financial plan” really look like? (And why should I pay a professional to craft one?)

By College Planning, Financial Planning, Retirement

It’s a question I get asked often.  After all, there are plenty of online calculators out there. They’ll take some basic inputs about your big picture goals – like private college for your child or retiring at 60 – and spit out a number for how much you should be saving every year. They’re easy to use – and free!

My answer? The reason those tools are easy to use is because they make so many simplifying assumptions.  And we all know that real life is always little more complicated…. Financial planning – when done thoughtfully and rigorously – creates a detailed, customized map to help you navigate your way to where you want to go.

Your plan should include a detailed analysis of your income streams and expenses, now and in the coming years. It should allow for the running of different scenarios around big decisions that you control, like

  • sending your child to an in-state university or more expensive private college;
  • plowing some of your savings into that dreamed-of vacation home;
  • retiring early to travel or pursue other hobbies; and/or
  • electing to take your Social Security benefits earlier v. later.

Your plan must also take into account what you cannot control, namely the potential pitfalls along the way – like stock market downturns, unexpected medical diagnoses and runaway inflation – and help you steer your way through them.

A financial planner worth their salt knows how to ask the right questions to help enunciate your goals and prepare a plan that shows you how you can achieve them.

What does such a plan cost, you ask?  Well, it depends. At McPeake & Company, we are happy to discuss your current situation and future goals in a free hour-long consultation. Following that, we’ll prepare a detailed proposal and cost estimate for you. If you decide to move forward with us, we’ll get to work!

Why Target Date Funds Miss Their Mark

By Investing, Retirement

Funds that let you pick a “target date” for your retirement and invest accordingly have grown in popularity. It’s easy to see why. Analogies have been made to a plane that is now flying at 30,000 feet towards a destination – retirement – that may be 10 or 20 years or more in the future. As the plane makes its gradual descent over time, the portfolio manager shifts the fund’s allocation, reducing the share to stocks and raising the share to bonds. In retirement, the fund continues to get more conservative by adding bonds and shedding stocks. Thus, target date funds let an investor “set it and forget it.”

Target date funds are a welcome innovation for Do-It-Yourself investors and 401(k) plan administrators, but they come with significant limitations that make them a less-than-ideal retirement investment vehicle.

First, they are significantly more expensive than building a portfolio of individual ETFs. Four of the top five 2030 target date funds charge between 0.57% and 0.74% (see table below). This is 9-12x more expensive than what it would cost an individual to build a similarly diversified portfolio of ETFs (0.06%). The fifth, from Vanguard, charges much less – 0.14% – but this is still more than double the cost to DIY.

Second, target date funds don’t give investors enough exposure to foreign stocks. The United States’ share of global economic output is 25%. Because more American companies are publicly-traded (v. privately-held) and because of our greater transparency when it comes to accounting and reporting standards, the American share of the global stock market capitalization is a little more than 40%. This means that almost 60% of the money invested in stocks worldwide is invested in foreign companies. The five leading target 2030 funds allocate only 20-25% in foreign markets, however. That’s three times less than they should invest to create a truly global portfolio.

Third, target date funds are also off the mark when it comes to emerging market exposure. Emerging market countries – think China, India, South Korea and Brazil – make up about 40% of the world’s GDP. Because more of their companies are state or family owned, however, they make up only about 11% of the global stock market. A fund that aims to give its investors exposure to the totality of global growth should thus invest about 11% in the emerging markets. The leading target 2030 funds, however, invest much less, typically 5% or less.

Fourth, target date funds are not aggressive enough in their allocation to equities now and are too aggressively invested in equities in retirement. A person in their mid-40’s who expects to retire in their mid-60’s should typically have 80% of their total retirement savings invested in stocks. The leading 2030 fund, however, has only 70% allocated to equities right now. In 2030, the year of retirement, a person in their mid-60’s should have about 45% of their overall retirement savings in stocks. The leading target date funds have only 50-55% however.

For all of the above reasons, investors should re-consider using target date funds for their retirement savings. A financial advisor who is a fiduciary and who charges reasonable fees and uses low-cost ETFs can build a superior portfolio for the same price or better.