Category Archives: Investing

A Review of the CalSavers Retirement Savings Program

A Review of the CalSavers Retirement Savings Program

If you’ve been following the California legislative process at all, or if you own a business that employs people in California, you may have heard of the CalSavers Retirement Savings Program.  In 2016, Governor Jerry Brown signed Bill 1234, requiring development of a workplace retirement savings program for private sector workers without access to one.  The resulting program is known as CalSavers.

Basically, the program forces employers with more than 5 employees to defer a portion of their employees’ paychecks into a state run Roth IRA.  These contributions are invested in default target date retirement funds, unless the employee directs their investments otherwise.  Employees may also opt out entirely, if they choose.

The benefit of such a program is easy access to a retirement savings account.  Employees could contribute to one on their own, of course, but that would require opening an account at a brokerage firm & making investment decisions.  CalSavers greases the wheels by providing a “done for you” program that employees are defaulted into.

The positive spin here is that the program will certainly result in more retirement savings for many thousands of employees.  The negative side of the story comes from the business community.  Businesses without retirement plans will be forced to take the time to open a plan, enroll their employees, and deposit their contributions.

CalSavers isn’t at all unprecedented.  At this point 21 states have enacted similar legislation.  The law is taking a good amount of “heat” though.  Several industry groups are suing the state treasurer in an attempt to derail the rule.  Some plaintiffs don’t care for the state government telling them what to do, while others in the financial industry probably see the program as a competitive threat.

Whatever your take on the matter, businesses will be required to comply beginning in June of 2020 as the law stands today.  This post will provide a quick overview of the program, including its benefits and shortcomings.

 

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How to Evaluate Real Estate Investments

How to Evaluate a Real Estate Investment

The concept of acquiring rental properties as a means to build passive income has become exceptionally popular recently.  In fact, it’s difficult to peruse the internet for content on personal finance without bumping into videos/podcasts/blogs/courses on how to build passive income through real estate investing.

My take on real estate investing is that it can indeed be a wonderful complement to your investment portfolio.  But the conditions need to be just right.  And given how quickly housing prices have risen since the depths of the financial crisis in 2009, the circumstances today are rarely compelling.

As you can imagine, this is a conversation I have with clients frequently.  Some have an existing property we need to evaluate.  Others fall in love with the idea of putting in sweat equity now & building an empire of properties that kick off income over time.  This sounds nice in theory, but in my experience rarely pencils out.  (At least of the opportunities I’ve seen recently in California & Oregon).

This post will explore how to evaluate real estate investing opportunities.  We’ll cover cash flow, return on investment, and go through a real life scenario of a property I pulled from Zillow.com.

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72(t) Distributions: The Ultimate Guide to Early Retirement

72t Distributions: The Ultimate Guide to Early Retirement

What’s the most common piece of retirement advice you’ve ever heard?  I bet it has something to do with tax advantaged retirement savings.  Most people are inundated with voices telling them to start saving early and take advantage of tax deferrals.  It’s solid advice.  Saving tax deferred money through IRAs, 401(k) plans, and other retirement vehicles is a wonderful way to grow your wealth over time.

The downside?  Those pesky withdrawal penalties.  The IRS will typically ding you 10% if you withdraw from these accounts before turning 59 1/2.  This can pose a problem if you’re considering an early retirement.  Fortunately there are a few loopholes.  eight of them, in fact:

  1. Roll withdrawals into another IRA or qualified account within 60 days
  2. Use withdrawals to pay qualified higher education expenses
  3. Take withdrawals due to disability
  4. Take withdrawals due to death
  5. Use withdrawals for a qualified first-time home purchase up to a lifetime max of $10,000
  6. Use withdrawals to pay medical expenses in excess of 7.5% of adjusted gross income
  7. As an unemployed person, take withdrawals for the payment of health insurance premiums
  8. Take substantially equal periodic payments pursuant to rule 72t

For those of you interested in an early retirement, the final loophole is likely the most interesting to you.

According to rule 72t, you may take withdrawals from your qualified retirement accounts and IRAs free of penalty, IF you take them in “substantially equal period payments”.

This post explores how.

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A Beginner's Guide to Cash Balance Plans

A Beginner’s Guide to Cash Balance Plans

In my financial planning practice I work with a good number of business owners who want to make aggressive contributions to their tax deferred retirement accounts.  This helps put them on strong footing for retirement, but also provides a generous tax deduction.  While the 401k plan is the primary retirement plan most business owners are familiar with, a cash balance plans is one I often recommend in addition.  In fact, cash balance plans can actually allow for far greater contributions & tax advantages.

A cash balance plan could be a good fit if you’d like to contribute over $50,000 per year to a tax advantaged retirement plan.  They don’t come without their nuances though.  This guide will explain how cash balance plans work and whether they might be a good fit for you.

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Investing in Yourself as an Entrepreneur

Investing In Yourself as an Entrepreneur

Many of us feel an innate need to make contributions to tax advantaged retirement plans every year.  When it comes to personal finance, much of what we read, hear, and see in the media centers on plowing money into your 401k every single year, no matter what.

In general it’s great advice.  Save early and often, and take advantaged of tax deferred compound income.  And if you’re lucky, your employer might match your contributions or make a profit sharing contribution.  If we’re going to build up enough savings to sustain our lifestyle through retirement, this makes perfect sense.

Every once in a while I’ll speak with an entrepreneur who is really working hard to build their business, but they can’t quite scratch together enough cash to fund their retirement plan for the year.  They’re putting all their effort into their company and things are still just a bit tight financially.  They feel like they should be contributing to the 401k they set up for themselves and their employees, but they can’t quite pull the funds together to do so.

For many business owners I speak with, the fact that they can’t fund their 401k for the year makes them feel inadequate.  Like they’re not good at their job.  Like they’re unsuccessful.

I wanted to write a post on this topic because entrepreneurs who feel this way are missing the forest from the trees.  Regardless of whether you contribute to a retirement plan in a certain year, it’s far more important to sustain & grow your business.  Because if you can find a way to grow your business each year, the increased value in your ownership stake will dwarf what you could ever contribute to 401k!

 

It’s OK to Skip a Few 401(k) Contributions

Aswath Damodaran is a professor at NYU who teaches corporate finance, investing, and business valuation.  He publishes estimates of EBITDA multiple benchmarks for use by his students, and anyone else who’s interested.  EBITDA is an accounting measure that stands for “earnings before interest, taxes, depreciation, or amortization”.  It’s a decent proxy for free cash flow, and is often used in quick and dirty business valuations.

For example, let’s say your business does $350,000 in revenue one year.  If your costs & operating expenses totaled $250,000, you’d be left with EBITDA of $100,000.  Here are Professor Damodaran’s valuation estimates for 2018.  The list of multiples ranges from 5-6x EBITDA on the low end to nearly 20x on the high end.  Meaning, it’s very possible that a business with $100,000 in recurring annual EBITDA is worth at least $500,000 ($100,000 * 5).

Now, when I mean quick and dirty, this example is very quick, and very dirty.  Business valuation is a field of its own, and not something I claim to be half way competent in.  There are a ton of factors that go into what a business is worth, and EBITDA certainly doesn’t paint the whole picture.  Nevertheless, the takeaway is important: if you can build a business with recurring annual revenue, that will persist even if you’re not around to drive sales, there’s a good chance you’re creating far more wealth than what you would maxing out your 401k contributions.

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Should Your Portfolio Change After You Retire?

Should Your Portfolio Change After You Retire?

One question that’s come up several times over the last couple months centers on whether your portfolio should change after you retire.  In fact, one person I’ve spoken with recently assumed that once he retired, his advisor would by default sell all the stock funds in his accounts and replace them with income producing bonds.

Typically the longer your time horizon, the more risk you have the capacity to take in your investment portfolio.  Most people in their 20s and 30s have a high capacity to take risk, since they have a long time until they’ll need to live off their savings.  A significant portfolio loss won’t impact their life, and they have a long time to recover.  Because of that, many choose to hold mostly equities in their retirement accounts since they’ll provide the greatest long term returns.

The closer you get to retirement, the lower your capacity to take risk.  Prudent investors tend to shift their asset allocations more and more toward bonds as this progression evolves.  But for most people it should level out at some point.  Most of us will need some growth out of our portfolios in retirement if our assets are going to last the rest of our lives, meaning that we probably don’t want to be 100% in bonds.

But how should our investment strategy change when transitioning from the accumulation to the distribution phases of our lives, and should it change at all?  This post will explore the issues, and what you might consider when making the transition yourself.

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What You Need to Know About the SECURE Act Retirement Bill

What You Should Know About the SECURE Act Retirement Bill

Every now and then, lawmakers in Washington make noise about changing various sections of the tax advantaged retirement accounts I’m so fond of recommending to my clients.  Now that we’re living substantially longer, and a greater portion of our lives is actually spent in retirement, there’s a good argument that we should increase age limits, mandatory distributions, and other rules governing IRAs, 401(k)s and other types of accounts.

I usually don’t pay much attention to this speculation until there’s a bill on the floor that has a strong chance of becoming law.  The majority of the legislation drafted in this area doesn’t get far, and often doesn’t even get out of committee.

Nevertheless, the house and senate have both recently introduced bills that would change how retirement accounts work.  I’m no political expert, and don’t have the foggiest idea what the chances are of one of these bills passing.  But from what I’m reading there’s more momentum for retirement reform now than there’s been in the last several years.  Plus, more than one client asked my thoughts on the subject recently so I felt a summary post would be appropriate.  This post will cover what happened & why it might be important to you.

 

Pending Legislation

In February the senate introduced a bill called the “Retirement Enhancement and Savings Act” (or RESA), aimed at fixing America’s retirement savings problems – both in the public and private sectors.  This isn’t the first bill on retirement reform that’s been introduced recently.  Multiple versions containing similar provisions have been introduced since 2016, which speaks to the growing interest in helping Americans save for retirement.

Meanwhile, the house passed the SECURE Retirement bill (Setting Every Community Up for Retirement Enhancement Act) about a week and a half ago in a 417-3 vote.  This bill contains many of the same provisions as RESA, and the bipartisan support on both sides of congress could mean one of the bills may actually make it into law sometime soon.

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Setting Up a 401(k) to Take Advantage of the 'Mega' Back Door Roth Conversion

Setting Up a 401(k) to Take Advantage of the ‘Mega’ Back Door Roth Conversion

If you’re a personal finance nut you may have heard of a strategy called the “back door Roth IRA conversion.”  This maneuver essentially allows you to contribute money to a Roth IRA, even if your income is otherwise to high to make a direct contribution.  You make a non-deductible contribution to a traditional IRA, convert those funds to a Roth IRA, and presto!  You have cash in the Roth that won’t ever be taxed again.  While it seems like this is a glaring loophole in the tax code, Congress has endorsed the strategy in a conference committee report from the Tax Cut & Jobs Act.

But as great as it is to take advantage of Roth IRAs while you’re in high tax brackets, you’re still limited to the annual IRA contribution maximums of $6,000 per year (or $7,000 if you’re 50 or older).  The “Mega” back door Roth conversion is a similar strategy, but allows for up to $37,000 per year in additional Roth contributions using a 401(k) plan.

 

Why the “Mega” Back Door Roth Conversion Strategy Works

 

The Three Types of 401(k) Contributions

To start, let’s review the three types of contributions you could make to a 401(k) plan.  The first is the most common: your employee deferrals.  You can instruct your employee to defer funds from your paycheck and deposit them on your behalf into the company’s 401(k) plan.  Some plans allow you to make these deferrals on a Roth basis, and the limit in 2019 is $19,000 per year.

The second type of contribution is an employer contribution.  This is anything your employer puts into the plan on your behalf, and includes matching contributions, or contributions based on a percentage of your compensation or company profitability.  It may be subject to a vesting schedule, and is always made on a pre-tax basis.

The third, and widely unknown type of contribution is an after-tax deferral.  Some 401(k) plans allow you to make additional contributions beyond your employee deferral on an after-tax basis, once you’ve reached the $19,000 annual limit.  Note here that 401(k) plans are not required to allow this feature, and not all do.

There are two limitations to annual 401(k) contributions.  The first is the $19,000 limit on employee contributions ($25,000 if you’re over 50 years old).  The second is on the total amount contributed to the plan on your behalf.  This limit is $56,000 in 2019, and consists of the three contribution types listed above.

So, to determine how much you could contribute in after-tax deferrals, you’d need to subtract $19,000 (again, $25,000 if you’re over 50) and the total amount of your employer contributions from $56,000.

Theoretically you could make up $37,000 per year in additional Roth IRA contributions using this maneuver ($56,000 – $19,000).  You’d need to be under 50 though, and you couldn’t receive any contributions from your employer.

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A Review of Providence's 457(b) Plan

A Review of Providence’s 457(b) Plan

In my financial planning firm I work mostly with business owners and medical professionals.  A good number of my clients are employees of Providence, which is one of the major medical providers in the Pacific northwest.  Providence offers its employees a very strong benefits & retirement package.  Employees can contribute to a 403(b) plan on a tax-deferred or Roth basis and Providence contributes to a 401(a) plan on their behalf, depending on compensation and years of service.

Providence also offers a 457(b) plan to its employees.  While it’s convenient to have another tax-deferred savings vehicle available, 457 plans come with some quirks – especially surrounding distribution options once you separate from service.

Recently, one my of my clients and I discussed the possibility of them leaving to take another job.  So to wrap our heads around the ins and outs of the 457 plans, we jumped on the phone with one of Providence’s retirement plan administrators.  The administrator helped to explain the unique features of the plan, which I’ll explain in this post.  Hopefully this review is helpful to anyone thinking about participating in Providence’s 457 plan.

 

A Quick Primer on 457(b) Plans

457(b) plans are sometimes mistakenly considered an alternative to a 403(b) plan.  There is actually some nuance to 457(b) plans, and much of it depends on whether the plan is sponsored by a governmental entity.

457(b) plans sponsored by governments have nearly identical rules to 403(b) plans.  The contribution limits are the same, the distribution options & limitations are the same, and by and large the plans operate in the same way.

Non-governmental 457(b) plans are different, in several ways.  Whereas the contribution limits are the same, the distribution options are not.  For non-governmental 457(b) plans, you are not allowed to roll your balances into an IRA.  Yes, you read that correctly.  Whereas participants in government sponsored 457(b) plans may roll their balances into IRAs after separating from service without triggering a taxable event, participants in non-governmental plans may not.

Instead, as a participant in such a plan you’re limited to the unique distribution options of the plan.  This is worth some investigation, as some plans require full distribution shortly after separating from service.  There isn’t an early distribution penalty for withdrawals prior to age 59 1/2, but withdrawals are still taxed as income.  Think about that for a moment.  You participate in a non-governmental 457(b) plan for years, accumulating potentially hundreds of thousands of dollars in the plan.  Then when you separate from service you’re forced to take everything out, and be taxed on it, in one year.

Another unique difference is creditor protection.  Whereas 403(b) and 403(k) plans are held in trust, 457(b) plans are held in the name of the organization sponsoring the plan.  This seems like a subtle difference, but can be impactful in the event of liquidation.  If the sponsoring organization falls into bankruptcy, your assets in the plan would be exposed to creditors.  The chances of this happening are probably quite small (especially for an organization like Providence), but I’m sure that’s what everyone at WorldCom and Enron thought as well.

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