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Investing Blog Roundup: How Much Can I Spend in Retirement?

Administrative note: There will be no articles next week, as I will be attending and speaking at the annual Bogleheads event. We’ll resume our regular schedule on 10/23.

Researcher Wade Pfau released a new book this week: How Much Can I Spend in Retirement?

I haven’t read it yet, as I’m waiting for the Kindle edition, which is supposed to be out within the next week. But I have no qualms about recommending it already, because when it comes to the question of retirement spending, there is no person I’d rather hear from than Pfau.*

Other Money-Related Articles

*Pfau has been prolific over the last several years, but here are a few of my favorite papers that he has authored/co-authored:

Thanks for reading!

Tax Planning for the “Pre-Social Security, Pre-RMD” Retirement Years

A reader writes in, asking:

“After retiring, I’ll have a window of a few years before Social Security and RMDs, during which my tax rate will be relatively low. What is your opinion on how best to use that period? Better to use long term capital gains or Roth IRA conversions to fill up that low tax rate space?”

It depends.

The goal is to figure out how much you save by doing a Roth conversion now (as opposed to the money coming out later), and compare that to the amount you save by realizing capital gains now (as opposed to later).

For example, if Roth conversions would currently face a 15% tax rate, but you expect that (if you didn’t do a Roth conversion), the money would come out later at a 25% tax rate, then your savings on each dollar you convert at that 15% rate would be 10%.

And if you’re in the 15% tax bracket right now, each dollar of long-term capital gains that you realize (while still staying in that bracket) would be taxed at 0%. And if you expect that you’ll be in the 25% bracket later, then LTCGs would be taxed at a 15% rate later (because LTCGs in the 25-35% tax brackets are taxed at a 15% rate). So you’d be saving 15% by realizing them now.

Point being: In this hypothetical case the 15% savings from realizing capital gains now exceeds the 10% savings from doing Roth conversions now, so realizing long-term capital gains is preferable.

To be clear though, this is a simplified analysis. In reality, you’d want to account for any factors that could cause your marginal tax rate (whether on Roth conversions or realization of LTCGs) to be different than the normal amount (e.g., because additional income is causing you to lose eligibility for a given tax break).

A good way to account for these complexities is to model via tax prep software. That is, you would create a hypothetical tax return in TurboTax or something similar, and see how your total tax changes if you do another $1,000 of Roth conversion or realize another $1,000 of long-term capital gains.

There can be an assortment of case-specific complicating factors as well. For example, if you expect to have a large portion of your portfolio left when you eventually pass away, it’s important to:

  1. Remember that long-term capital gains would go untaxed if you leave the appreciated assets to your heirs (because they would get a step-up in cost basis), and
  2. Consider your heirs’ future tax rates rather than just your own future tax rate when considering Roth conversions (i.e., if you don’t do a Roth conversion, money would be taxed at their rate when it comes out of an inherited traditional IRA).

As you might imagine, working with a tax planning professional is likely to be helpful.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Investing Blog Roundup: Why Use a Health Savings Account?

With a Roth IRA, you pay taxes now (before contributing) in order to avoid paying taxes later. With a traditional IRA, you get to avoid taxes now (via a deduction), but you have to pay tax when money comes out of the account. As Vanguard’s Andy Clarke explains this week, an HSA often provides the best of both worlds: a deduction for contributions now, and tax-free distributions later.

Other Money-Related Articles

Thanks for reading!

New Book Announcement: Cost Accounting Made Simple

Cost Accounting Book CoverJust a brief announcement for today. We’ll return to our more typical discussion material on Friday.

My new book Cost Accounting Made Simple is available on Amazon. The book is meant to serve as a followup to Accounting Made Simple, which has been my best-selling book over the last several years.

The print version is temporarily on sale for 50% off the normal list price (i.e., just $7.50 rather than the usual $15).

What is Cost Accounting?

Cost accounting is the process of measuring how much it costs a business to supply customers with the goods or services that it sells.

Cost accounting is important because it provides business owners/managers with information that is critical to running the business. For example, if a business doesn’t know how much it costs to produce each of its products, it will make poor decisions about how much to charge for them.

Similarly, if a business has inaccurate information about how much it is spending to run one of its divisions, it may continue running that division for years, losing money the whole time without even realizing it. The opposite problem can occur as well. For example, if costs are inappropriately allocated to a given product line, the business may incorrectly think that the product line is unprofitable (and choose to shut it down) when the division is actually earning a net profit for the company.

Cost accounting is also useful for finding the source of a problem. For example, if a business reaches all of its sales goals, but still has a less profitable month than it had anticipated, cost accounting provides the tools to figure out exactly which costs were higher than anticipated.

What Does the Book Cover?

As with the other books in the “in 100 Pages or Less” series, this book seeks to provide a concise, understandable introduction to the topic. The book discusses:

  • Fixed costs, variable costs, contribution margin, and how to use those concepts to project a business’s income or loss for a given level of sales;
  • Direct costs, indirect costs, and how to assign each of them to products/departments for better decision-making;
  • How to budget for a business;
  • How to use variance analysis to identify potential problems when results vary from budgeted amounts;
  • Product costs, period costs, and why the distinction is important;
  • Job order costing and process costing; and
  • How to use activity-based costing to allocate costs.

Click here to see the book on Amazon.

To Learn More, Check Out the Book:

Cost Accounting Made Simple: Cost Accounting Explained in 100 Pages or Less

Topics Covered in the Book:
  • Cost accounting terminology (fixed costs vs. variable costs, product costs vs. period costs, direct costs vs. indirect costs, etc.)
  • Cost-volume-profit analysis
  • Job order costing, process costing, activity-based costing
  • Budgeting and variance analysis
  • Click here to see the full list.

Investing Blog Roundup: Retirement Spending Strategies and Annuitization

This month we’ve discussed fixed retirement spending strategies as opposed to variable spending strategies, as well as the concept of using RMD tables to calculate retirement spending.

This week, financial planner/actuary Joe Tomlinson shared some of his recent research comparing the efficiency of those same three retirement spending strategies — as well as the impact of annuitizing part of the portfolio. The article is written for advisors, so it’s more technical reading than what you’d normally find here. But it’s directly applicable the things we’ve been discussing here lately.

Other Money-Related Articles

Thanks for reading!

Who Should Buy Long-Term Care Insurance?

Last week a few readers wrote in asking about long-term care (whether to purchase policies in the first place, or whether to keep existing policies when premiums rise sharply).

Unfortunately, the question of long-term care insurance is one for which I don’t have a very good answer. Long-term care poses a significant financial risk for most people. Yet there are a few good reasons why a person might be better off opting not to buy a long-term care policy.

You Can’t Afford the Premiums

If you can’t afford to pay the premiums, you’re in an unfortunate situation, but the decision is easy.

Coverage via Medicaid

In addition, many people are in a position such that Medicaid would kick in relatively quickly in the event of a long-term care need. For those people, buying LTC insurance usually doesn’t make sense because the policy would mostly be protecting the government rather than protecting the insured person.

In fact, a 2014 study from the Center for Retirement Research at Boston College found that, largely because of the protection offered by Medicaid, only 22% of single 65 year old men and 34% of single 65 year old women could expect an improvement in overall economic outcome by purchasing LTC insurance. (You can find the study here or a summary paper here.)

Of note, that study only looks at single individuals rather than married couples. Presumably, married couples would have a higher willingness to pay for LTC insurance because of worries that one spouse’s uninsured LTC needs could leave the other spouse with a lower standard of living than desired. (Medicaid does have rules for preventing spousal impoverishment, but the limits are low enough that in many cases the healthy spouse would still be left in an undesirable situation.)

You Can Pay Out of Pocket for Long-Term Care

As with any insurance, you will on average lose money by purchasing long-term care insurance. That is, because a part of the premium goes to pay for the insurance company’s overhead and profit margin rather than to pay benefits for policy owners, policy owners will on average have a negative outcome.

To be clear, this is not in itself a reason not to buy long-term care insurance. The same thing can be said (i.e., that you will, on average, lose money) about purchasing term life insurance, health insurance, disability insurance, and auto insurance, yet they’re all considered to be wise purchases in many/most cases.

Rather, the point here is that, because insurance is on average a losing proposition, it generally only makes sense to insure against a cost that you cannot reasonably pay out of pocket.

As far as whether or not it’s possible to pay out of pocket for a long-term care cost, it’s helpful to remember that long-term care cost isn’t purely in addition to current living expenses, as the cost of such facilities typically includes some things that are currently a part of your normal budget — meals, for instance. Plus, other expenses (e.g., travel and possibly housing) naturally disappear or nearly disappear when a person enters a long-term care facility.

According to a 2016 report from the National Association of Insurance Commissioners (with credit to Christine Benz’s excellent “75 Must-Know Statistics About Long-Term Care” for directing me to the report), for people turning age 65 in 2015-2019:

  • 48% are expected to have no long-term care costs during their lifetimes,
  • 15.4% will have costs of up to $50,000,
  • 9.7% will have costs of $50,000-$100,000,
  • 11.7% will have costs of $100,000-$250,000, and
  • 15.2% will have costs that exceed $250,000.

Another noteworthy point: people with lower incomes are more likely to have an extended need for long-term care. (See Table 5 on page 35 of the NAIC report.) This isn’t surprising, since people with lower incomes are often in worse health than people with higher incomes. But it certainly makes planning even more challenging for lower-income people.

Policies are Problematic

The turmoil of the LTC insurance market (i.e., premiums increasing significantly and unpredictably and insurers choosing to leave the business entirely) is another reason that would make me leery of buying LTC insurance if I felt that I did not have a need for it.

Even if you had perfect information about the probability of needing long-term care at each year in your life and perfect information about the expected cost of that care, it would still be a challenge to determine whether a policy is a good deal or not, because we don’t have a good way to predict how much most policies will cost over an extended period.

recent paper from John Ameriks of Vanguard together with four other researchers concluded that, “better quality LTCI would be far more widely held than are products in the market, be held in large quantities, and generate substantial consumer surplus.” In other words, there are plenty of people out there who want long-term care insurance and who would be willing to pay for an ideal version of it, but who do not actually own a policy because of undesirable characteristics of the products available today.

So Who’s Left?

So, after considering all of the above points, who does that leave as the people who should be buying policies? People who meet all of the following requirements:

  • You can afford a policy.
  • You could not easily pay out of pocket for long-term care.
  • The protection from Medicaid is not acceptable/sufficient protection for one reason or another (e.g., because you have sufficient assets that Medicaid wouldn’t kick in for far too long).
  • The undesirable characteristics of currently available policies are not sufficient to deter you.

While that’s a list of requirements, it still leaves quite a lot of people.

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."
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