Dear Ready to Retire
Dear Marotta Asset Management,
My wife and I are hoping to retire soon. What percentage of our investments can we withdraw each year? And, do you recommend a high-yield investment portfolio to create the necessary cash flow during retirement?
–Ready to Retire
Dear Ready to Retire,
Studies suggest that for people retiring between the ages of 62-65, withdrawal rates of 4% of their assets are safe, but 5% significantly increase the likelihood of running out of money during your lifetime. Unfortunately, those studies are not very helpful for real financial planning questions.
| Real clients want to know the specifics: “What percentage of my assets can I safely take out this year and still be able to provide for my spouse and me each year for the rest of our lives?” |
Not everyone is between 62 and 65. Nor do everyone’s withdrawal choices move in neat intervals between four and five percent. Real clients want to know the specifics: “What percentage of my assets can I safely take out this year and still be able to provide for my spouse and me each year for the rest of our lives?”
As a result, we’ve developed safe withdrawal rates for ages 0 to 100. Our rates are based on age-appropriate asset allocation mixes and assume that withdrawal rates will go up each year to meet the needs of inflation. Withdrawal rates should also be conservative enough to allow for constant increases even when the markets have a poor year.
Reproduced in this table are some of the results:
| Age: | Withdrawal Rate | |
| 62: | 4.11% | |
| 65: | 4.36% | |
| 70: | 4.77% | |
| 75: | 5.35% | |
| 80: | 6.22% | |
| 85: | 7.66% | |
| 90: | 10.42% | |
| 95: | 17.86% |
To illustrate this point, let’s take a real-world example of the Wahoos. Wally and Wilma Wahoo are 75 with a $1 million portfolio. If they withdraw $53,500 or 5.35% from their account at the beginning of the year, and their portfolio grows by or 9% over the next 12 months, then at the end of the year their account would be worth $1M -$53,500 = $946,500 + 9% growth = $1,031,685.
Next year, when they are 76 years old, their new withdrawal rate according to our table is 5.49%–slightly more. Since their account value and withdrawal rate are now larger they would get a raise. Following this plan, at the beginning of year two they would receive a 5.9% raise or $3,139 more for the year. (5.49% of $1,031,685 = $56,639 for the year.)
Since their monthly “allowance” increased $262, their standard of living can keep up with inflation and then some.
Many people make the mistake during retirement of thinking that they need to have mostly interest-paying and dividend-paying investments to generate cash for withdrawals. This is incorrect.
People often have an unwarranted fear that they can’t “touch the principle” and therefore, should not sell stock to generate cash. For retirement income, it doesn’t matter if you receive $50,000 in interest and dividends or if you receive $50,000 by selling assets that realized a capital gain. Either way, $50,000 is $50,000.
Let’s consider an example. If 100 shares of a stock double in value and then, the stock splits and you sell half your shares, have you “touched the principle?” The truth is, you are left with 100 shares of the exact same stock at the exact same value, plus a pile of cash. There is no difference between this case and getting paid that pile of cash in dividends.
Putting everything in one type of investment is usually more volatile than diversification. Therefore, we do not recommend an exclusively interest and dividend-paying portfolio. But, having said that, I must add that good dividend-paying stocks, sometimes called “value” stocks, get a higher return and at the same time are less volatile than “growth” stocks. We would recommend overweighting value stocks, even in a non-retirement portfolio.
Retirement plans should be reviewed annually. Doing a projection every year will help you determine how much you should be saving, or if you are retired, how much you can spend. A handy goal to aim for is to save 24 times your salary by the time you retire.
Sincerely,
David John Marotta
Marotta Asset Management, Inc. of Charlottesville provides fee-only financial planning and asset management. Visit www.emarotta.com for more information. Questions to be answered in the column should be sent to questions@emarotta.com or Marotta Asset Management, Inc., One Village Green Circle, Suite 100, Charlottesville, VA 22903-4619.
Wealth Building in Four Steps
First, a definition of wealth. I’m not talking about a wealth of friends, or interests, or experiences. Those kinds of wealth are wonderful, definitely. But right now, I’m talking about money - lots of money.
Exactly what “lots of money” means is subjective, but let’s say that when your annual income becomes your monthly income, you’re playing in the wealth ballgame.
Wealth building, for the most part, involves four financial aspects:
* Growing a cash machine
* Allocating assets
* Spending planning
* Managing/eliminating Debt
*Growing a Cash Machine*
This is the most important aspect of the wealth building foursome. In fact, it is the foundation for the other three areas, whose sequence depends on the nature of your particular cash machine.
Your cash machine is an incorporated business, which is ideally based on leverage of your existing skill set. For example, say you are an automobile mechanic. That’s a service. How can you leverage your skills so that you have a business that makes money while you sleep? (The definition of a cash machine).
Here’s a scenario: People buying used cars come to your shop for inspection before they buy, and you realize that many of the things you check during your inspection, the consumer could easily check for themselves. You teach a class at the community college and you package the hand-outs you’ve created for the class. Make them into an ebook, hire a marketer, and voila’ you have a cash machine.
That’s simplified, but you get the idea. Wealth builders are generally entrepreneurs. Think of something similar you could do with your skill set, and grow a cash machine.
*Allocating Assets*
With the income from your cash machine, plus all your other assets, create a comprehensive plan for your assets to work for you. You’ve heard the saying, “Stop working for money and get money working for you.”
If you haven’t already put a team together to grow your cash machine, with asset allocation a team becomes critical. You’ll need advisors to set up an incorporated business for your tax strategy as well as asset protection. And, you’ll want a financial advisor to help create your overall plan.
One of your most important assets to allocate is time. Millionaires “hire” time. Invest in building yourself a team of experts and support personnel. In addition to expert advisors, hire bookkeepers, housekeepers, assistants, etc.
*Spending Planning*
When the cash starts rolling in, a common mistake is to allow spending to keep pace with the increased income. This makes for a cushy lifestyle, but isn’t part of a good wealth building plan.
When you create your spending plan, it should reflect your personal priorities. It doesn’t need to be restrictive (like a budget). Think of it more like a framework for financial decision-making that serves your long-term interests at the same time providing resources for you to enjoy the present.
*Managing/Eliminating Debt*
Once you’ve got your cash machine going, turn your attention to arriving at zero consumer debt: credit cards, mortgage, etc.
However, not all debt is bad. Sometimes, you want to leverage someone else’s money. Buying income real estate is an example of such a time. But for the most part, a focus on minimizing or eliminating debt is a sensible part of any wealth building plan.
The ultimate goal of wealth building is financial freedom - when your passive income supports your lifestyle, and you work because you choose to, rather than because you have to. Use the wealth building foursome to lay the foundation of your financial freedom.
Lila Norden is a business and financial consultant. Lila offers valuable information to help you make decisions about your business growth and financial development. Visit Lila’s web site FCI Money. Additional articles by Lila are also at Yes Investing and F-Com FinancesStart-up Costs - How to Deduct Them
A new business owner incurs start-up costs before beginning the business. Under Section 195(c)(1), start-up costs are costs the taxpayer incurs to investigate the creation or acquisition of a business or in creating a business. The costs must be costs that would be deductible as an ordinary and necessary business expense if the taxpayer was actively conducting the business.
In general, a taxpayer may not deduct start-up costs until the taxpayer sells the business. That is the default rule of Section 195(a). However, for start-up costs paid or incurred after October 22, 2004, a taxpayer may elect to deduct start-up costs to the extent allowed by Section 195(b)(1)(A). Under Section 195(d)(1), a taxpayer has until the due date of the tax return, including extensions, to make the election.
A taxpayer makes the election by claiming the deduction on the appropriate form. For example, a taxpayer who is a sole proprietor would claim the deduction on Schedule C of Form 1040. The taxpayer should attach a statement to the form showing the start-up costs for which the taxpayer is making the election.
If a taxpayer failed to make the election when the taxpayer filed a timely tax return, the taxpayer has six months to file an amended return and make the election under Regulations Section 301.9100-2(b). The IRS has no authority for allowing any other late elections.
If the taxpayer elects to deduct start-up costs, the taxpayer may deduct up to $5,000 of startup costs in the year the taxpayer begins the active conduct of the business. However, if the start-up costs exceed $50,000, the $5,000 limit on the deduction for start-up costs is reduced by the amount by which start-up costs exceed $50,000.
For example, assume that the start-up costs are $52,000. The taxpayer may claim an immediate deduction of $3,000 [$5,000 - ($52,000 - $50,000)]. If the start-up costs are $55,000 or more, the taxpayer may not deduct any of the start-up costs in the year the taxpayer begins the active conduct of the business except as an amortization deduction as explained below.
The taxpayer may deduct the remaining start-up costs ratably over 180 months beginning in the month in which the taxpayer begins the active conduct of the business under Section 195(b)(2). For example assume that a taxpayer’s start-up costs were $23,000. The taxpayer may deduct $5,000 immediately. In addition, the taxpayer deducts the remaining $18,000 of start-up costs at the rate of $100 a month [($23,000 - $5,000) / 180].
The ratable deduction of start-up costs over 180 months is called an amortization deduction. A taxpayer claims an amortization deduction on Form 4562 and then carries the total deductions on Form 4562 to the appropriate form.
If the taxpayer sells the business before deducting all of the start-up costs, the taxpayer may deduct the remaining start-up costs as a loss as allowed by Sections 165 and 195(b)(2).
A taxpayer should take advantage of these rules to ensure the highest possible tax deductions. Because the time for making the election is quite limited, a taxpayer should be sure to make the election in a timely manner.
Alan D. Campbell is a CPA in Arkansas and Florida and is self-employed primarily as an author of tax publications. He earned a Ph.D. in accounting with an emphasis in taxation from the University of North Texas. He is also admitted to practice before the United States Tax Court. He has published numerous articles on tax topics in professional journals. He is the co-author of the book Tax Strategies for the Self-Employed and the revision editor of CCH Financial and Estate Planning Guide, 15th edition. For more tax savings strategies, please see his blog: http://taxsavingsstrategies.blogspot.com