Category Archives: Savings tips

The Retirement Dilemma Facing American Workers

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The way Americans fund their retirement has undergone a fundamental transformation in the last 30 years. According to the Bureau of Labor Statistics, the percentage of private-sector employees with a traditional defined benefit pension plan has dropped from about 45% in 1980 to a little over 20% in 2011. A defined benefit pension plan is one that provides the retiree with a guaranteed income for the rest of his or her life.

The guaranteed pension has been replaced by a defined contribution plan. Today, about 50% of the private workforce participates in one of these plans, which include 401(k) plans and 403(b) plans and allow the worker to set money from their paycheck aside to grow tax-deferred until they retire, at which point they can start pulling from it to fund their retirement. However, there is no guarantee that the amount saved will be adequate to meet their income needs once they retire.

Most government workers still have access to traditional defined benefit pension plans. However, most of these plans are severely underfunded and questions are being raised about cities and states being able to pay the benefits that were promised. A recent poll of people 25 years and older concluded that “Americans are united in their anxiety about their economic security in retirement.” Over 75% of those surveyed worry that economic conditions might hurt their chances for a secure retirement. (For related reading from this author, see: How Retirees Should Think About Retirement Income.)

Social Security and Medicare Concerns

The federal government provides a basic level of retirement income via Social Security, and provides a basic level of health insurance via Medicare and Medicaid. However, these programs are on shaky ground according to most actuaries. The Social Security Trust Fund will run out of money around 2034 unless it is reformed. That does not mean that checks will not go out to retirees, but it does mean that the amount going out will decrease.

Medicare is in even worse shape and, with the continued rapid rise in medical costs, may face a crisis even sooner. The costs of health care and increasing life spans are major issues for retirees, which explains the reason that so many Americans think they are facing a retirement crisis in the first place. Given the level of debt at the federal level and the rhetoric of the current administration, we do not see the government jumping in to fund the American worker’s retirement at levels above what it does now.

Even Denmark, an icon of the Welfare State, is proposing tax cuts, reducing welfare benefits and raising the retirement age.

“We want to promote a society in which it is easier to support yourself and your family before you hand over a large share of your income to fund the costs of society.”

Funding Your Own Retirement

If the government is not going to come to the rescue, and if corporations are going to continue to unload the financial risks and burdens associated with pension plans, what is the answer? Look to the old saying, “If you want something done, do it yourself.” Going forward, it’s increasingly going to be up to the individual American worker to fund his or her own retirement.

If people begin saving early, a large part of the retirement problem will be solved. The most valuable asset that people have when they are young is time. If workers begin putting money aside at an early age, it will grow and compound for 40 to 50 years until retirement, solving a large part of the problem. The compounding of returns is what makes so much of the difference.

Here is a little math exercise: assume you begin by saving $25 per month—much less than the cost of having one decent dinner at a restaurant—and invest it conservatively so that it grows at 5% per year. At the end of 45 years you will have $50,000. Now assume that you increase your savings by 10% each year—so that in year two you save $27.50 per month (still far less than the cost of just one dinner out)—at the end of 45 years you have $400,000 to use in retirement. These examples go to show that saving a modest sum for retirement does not require much cost or effort, just discipline, time and patience.

Financial Education is Key

The greatest asset that young workers have is time. Unfortunately, people rarely enter the workforce knowing much about saving or investing. That is one reason so many people live paycheck to paycheck. The solution to the retirement crisis is achievable by educating young people and raising awareness. Until schools and colleges begin having mandatory courses for our young people about managing money, parents should be doing this. If they are unsure, they can put their children in touch with a financial planner who will spend time to provide the education. Many financial planners are beginning to offer hourly rates to help people learn to plan and budget.

For most people, the retirement problem is the result of a lack of information. The solution is right in front of us, if we realize that times have changed and people must change with it.

(For more from this author, see: Are You Ready for the Retirement Challenge?)

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Would You Prefer to Have $1 Million Cash Right Now or a Penny that Doubles Every Day for 30 Days?

Albert Einstein is credited with saying “compound interest is the eighth wonder of the world.”

To get back to the original question, would you prefer to have $1 million today or one cent that will double every day for 30 days?  If you chose the million dollars, you would leave millions on the table.

If you chose the penny and passed up the million dollars, on the second day your penny would be worth two cents, on day three it would be four cents, on the fourth day it would be 8 cents.  By day 18 the penny will have grown to $1,310.72.  By day 28 it will be worth over a million dollars:  $1,342,177.  On the 30th day it would be worth an astounding $5,368,709!

If the penny were to be allowed to double for another 30 days, the penny would grow to over $5 quadrillion (five thousand trillion!) dollars.

One of the things this illustrates is that compound growth takes time to make a dramatic difference.  For the person who wants to have enough money to retire in comfort, starting early is the key to success, even if the starting amount is small.

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Pay No Commissions

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New clients to Korving & Company will pay no commissions on stock and ETF trades when they open an account with us between June 16th and December 31st 2016.

We use Charles Schwab as our custodian and Schwab has made this limited-time promotion to encourage new clients to open accounts with RIA’s like Korving & Company.

The promotion is called “Make the Move” and it’s designed to:
• Give you an opportunity to experience the value and benefits of working with us.
• Execute commission-free trades to offset the cost of realigning assets to one of our portfolios.

Contact us for more information.

Is your money going in the right direction?

An acquaintance recently asked me how his money should be invested.  With banks paying virtually zero on savings, it’s a question on everyone’s mind.  Should he invest in stocks or bonds? If it’s stocks, what kind: Growth, Value, Small Cap or Large Cap, U.S. or Foreign?  The same can be asked of bonds: government or corporate, high yield or AAA, taxable of tax free?  That’s a question that faces many people who have money to invest but are not sure of where.

It’s a dilemma because we can’t be sure what the future holds. Is this the time to put money into stocks or will the market go down? If we invest in bonds will interest rates go up … or down? How about investing in some of those Asian “Tigers” where economic growth has been higher than in more developed countries?

There is no perfect answer. We are not gifted with the ability to read the future. And what is this “future” anyway? Next week? Next year? Or 20 years from now when we will need the money for retirement?

We know that generally, people who own companies usually make more money that people put their money in the bank. Another word for “people who own companies” is “stockholders.” That’s why, over the long term, stockholders do better than bondholders. On the other hand, bonds produce income and are generally lower risk than stocks. So my first answer to the question I was asked is: invest in both stocks and bonds.

Choosing the right stocks and bonds is a job that is best left to professionals. That’s the benefit of mutual funds. Mutual funds pool the money of many investors to create professionally managed portfolios of stocks and bonds. They are an easy way of creating the kind of diversification that is important for reducing risk.

To circle back to the original question our friend asked: the answer is to create a well diversified portfolio. We know that some of the time stocks will do better than bonds, and vice versa. We know that some of the time foreign markets outperform the U.S. market. We know that some the time Growth stocks will do better than Value stocks. We just don’t know when. So we select the best funds in each category and measure the over-all result. With so many funds to choose from, the smart investor will get help from a Registered Investment Advisor like the folks at Korving & Company.

Call us for more details.

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Retirement Plan Contribution Limits for 2016

One of the most common questions we get from clients throughout the year has to do with retirement plan contribution limits.  We put together this quick-reference chart, which shows the limits for most people:

2016 IRS Retirement Plan Contribution Limits

Not much has changed from 2015, except that the income limits for Roth IRA contributions have increased by $1,000.

For the official IRS announcement, click this link to the IRS website.

If you want more clarification on what all of the above means for you, contact us.

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This Simple Tip Could Make a Big Difference in Your Retirement Account

You can make a 2016 contribution to your IRA or Roth IRA as early as January 1, 2016 and as late as April 15, 2017.  It would seem obvious that the sooner you contribute to your retirement account and invest the money, the more money you’ll have by the time you retire.

However, according to research from Vanguard, people are more than twice as likely to fund their IRAs at the last minute as opposed to the first opportunity!  When Vanguard looked back at the IRA contributions of its clients from 2007 to 2012, only 10% of the contributions were made at the optimum point in January, and over 20% were made at the very last month possible.

IRA Contribution Month

To demonstrate the type of real, monetary impact this can have on someone’s retirement savings, take the following hypothetical example.  On January 1 each year, “Early Bird” contributes $5,500, while “Last Minute” makes their $5,500 contribution on April 1 of the following year.  Assume that each investor does this for 30 years and earns 4% annually, after inflation.  Early Bird ends up with $15,500 more than Last Minute.  Put another way, Last Minute has incurred a $15,500 “procrastination penalty” by waiting to make his contribution until the last possible month.

Procrastination Penalty

At the beginning of every year, make fully funding your IRA contributions a habit. (And if you’re the type of person who works better when things are automated, look into setting up an automatic savings & investment plan from your paycheck or bank account to your IRA to save on a monthly or per-paycheck basis.)

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What the tortoise knows about financial security.

Remember the race between the tortoise and the hare? The tortoise won because he kept plugging along while the hare took a nap. Everyone would like to get rich quick; it’s the reason that people buy lottery tickets. But the chances of actually striking it rich are astronomical.

The way to get financially well-off is within the reach of almost anyone, even people who start out poor. What it takes is following a few simple rules.

  • Avoid destructive behavior.
  • Get an education and acquire a skill.
  • Spend less than you earn.
  • Start saving early.

The temptation to parlay a small bundle of cash into a fortune is what gets most people into trouble. Consistent saving over time is much more likely to pay off than strategies such as timing the market. Risk-the-farm investing strategies have a high probability of failure, but saving and prudent investing always wins.

Getting rich slowly is the primary way that most people achieve their financial dreams. The advantage of saving 10% or more of your income cannot be overemphasized. Do that and then let compounding go to work for you.

Compounding does a lot of the heavy lifting for investors. But it needs time to work. That means starting the process as early as possible and staying with it as long as possible. Waiting until you’re in your 40s or 50s means that you have given up twenty to thirty years of financial growth that you will never get back.

Want to have a million dollars by the time you’re 65? If you begin when you’re 25 with $25,000, save $3000 a year and invest the money to get a 7% return you’ll have $1 million when you’re 65. Of course as you get older and make more money you’ll be able to increase your savings rate, and end up with more than a million.

Finally, control your emotions or – better yet – hire an investment manager who will help control your emotions for you. Markets don’t go in one direction forever and that’s a good thing to keep in mind when the inevitable correction happens. An investment portfolio that lets you sleep well at night helps to cushion the blow of a decline and avoid the temptation to “bail out” at exactly the wrong time. In fact, investing more when the market’s “on sale” is a way to increase your wealth.

This is New Year‘s Eve; 2016 starts at midnight. It’s a great time to start if you have not done so already.

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Virginia Pre-Paid Tuition: What You Need to Know

Virginia offers a prepaid tuition program to residents looking to save for future college educational costs, called Virginia529 prePAID.  The plan allows you to prepay future tuition and mandatory fees for Virginia colleges or universities.  However, there are several catches that you must be aware of that make this college savings option somewhat tricky to plan around.

You can only open accounts during a limited enrollment period each year.  Either the account owner or beneficiary must be a Virginia resident when opening the account.  This is not a big hurdle, but it is something that you should know.

You purchase the credits in semester increments, and this is where things really start to get confusing.

  • First, you can only buy the credits from the child’s birth through the time they complete the ninth grade.  After the beneficiary has completed the ninth grade, you can no longer purchase any more prepaid tuition credits for them.
  • Next, when purchasing semester credits, you can purchase either Tier1 or Tier2 credits.  Tier1 credits cover one semester of tuition at a Virginia public four-year college, where Tier2 credits cover one semester of tuition at a Virginia two-year or community college.  Applying a Tier1 credit to a Tier2 school will cover more than a semester of tuition, while applying a Tier2 credit to a Tier1 school will cover less than a semester of tuition.
  • Furthermore, if you apply either Tier1 or Tier2 credits to an out-of-state college or a private college (even a Virginia private college), the credits do not necessarily transfer one-for-one and your pre-paid tuition might be worth less than what you thought it would be.

Those things, in our opinion, make planning around the Virginia pre-paid tuition plan very difficult.  Before the ninth grade, college planning is a distant goal.  Narrowing down college choices is something that probably very few people sit around and do with their 4th grader.  Knowing where that child will eventually decide to go to school, or even whether your family will still live in-state when that 4th grader eventually heads off to college, is a wild guess for most.  Even if your child loves one particular school, knowing whether they will eventually be able to make it into that school is a whole other issue.

The benefit to the plan, and its allure, is that you can lock in the future tuition and fee payments now so that you will not have to worry about whether tuition prices continue their rapid increase.  However, you should at least be aware of some of the potential pitfalls involved with the plan before jumping in.  For more information, visit the Virginia prePAID plan website, or feel free to contact us.

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8 Things Every Parent Should Know About 529 College Savings Plans

We often are asked by parents (or grandparents) of young children about college savings plans.  529 college savings plans offer tax-advantaged ways to save for the various costs of higher education.  While these plans have a lot of name recognition, many people still have questions about the details.  Since it is the first day of school for most kids here in Virginia, it seemed an appropriate time for us to share these eight things you should know about 529 college savings plans:

  1. Earnings on 529s are tax-free, as are withdrawals, as long as you use the money for qualified educational expenses.  Qualified expenses include tuition and fees, books, room and board, supplies, and even computer-related expenses.
  2. There are no income restrictions to open and contribute to a 529 account.  Even high-income earners can open and fund college savings plans.
  3. The money in a 529 account can be used towards in-state or out-of-state schools, both public and private.
  4. The contribution amounts are very high: you can contribute up to $350,000 per beneficiary into a 529 account.  (Keep in mind that you will need to get a little deeper into gift tax rules if you intend to contribute more than $14,000 to a 529 account in any one calendar year.  You can do it, but you should know the rules first.)
  5. The beneficiary is portable.  If your child decides they want to do something else instead of going to college, you can name someone else the beneficiary (sibling, first cousin, grandparent, aunt, uncle, or yourself).  You do not need to decide on a new beneficiary the moment that your child decides not to go to college.  For instance, you could hold onto it and eventually name your grandchildren the beneficiaries.
  6. Charitable family members can contribute to an existing 529 account that you own or set up their own 529 and name your child as beneficiary.
  7. In Virginia, putting money into a 529 plan has the added bonus of providing a state tax deduction for contributions up to $4,000.  Thirty-three other states also offer state tax deductions for contributing to a 529.
  8. If your child gets a scholarship, you will not lose the money.  You can use the plan to cover expenses that the scholarship does not, such as books, room and board, or other supplies.  You can keep the plan open in case your child goes on to graduate school.  You can change the beneficiary and name another college-bound relative.  A final option would be to simply cash out the plan.  Doing so would subject you to income tax and a 10% penalty on the earnings.  If you were feeling generous, you could name your child the owner and let them cash it out at their (presumably) lower tax rate.

If you have questions, or are interested in finding out how to start a 529 plan, please let us know!

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