| Rich People Know that Things Don't Satisfy
November 23, 2009 at 4:45 pm
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| Here are some interesting thoughts from the preface of Stop Acting Rich: ...And Start Living Like A Real Millionaire . Let's start with a short summary of what the book is about: [In this book] I detail why so many people who are not rich hyperspend on luxuries. Often they think that collecting these expensive toys will enhance their overall satisfaction with life. But, as you will read in detail, happiness in life has little to do with what you wear, drive, eat, or drink. The people with the greatest satisfaction are those who live well below their means. Wow, lots to digest here. I'll comment on this in a minute, but let's continue with a bit more for now. Author Thomas Stanley then offers a thought on why some people spend so much: So who are hyperspenders really emulating? They are merely mimicking the behaviors of people like themselves, who are not rich but act in ways they think economically successful people act. And, on the opposite end of the spectrum, here's why others don't spend as much: Why is it that some people worth $10 million, $20 million, or even $30 million own few or no luxuries whatsoever? They know that satisfaction in life is not a function of what you can buy in a store. Several thoughts from me: 1. This may go without saying, but I'm going to say it anyway. This book highlights the habits and thoughts of the wealthy as defined by their net worth (the author doesn't count the value of housing in calculating net worth), not by their income. He contrasts this with others who make great incomes and yet have virtually no wealth to show for it. In other words, a high income often does not lead to a high net worth. Again, this is Money 101 for some of you, but I just wanted to be perfectly clear. 2. The book will highlight (and I'll post on this for sure) how many of the most wealthy (high net worth) people in America are those with "average" salaries/incomes. 3. Overall, what he's saying is very similar (almost identical) to what we just covered when I highlighted a few pieces from The Difference: How Anyone Can Prosper in Even The Toughest Times . Is anyone starting to see a trend here? Guess what they're saying must be at least somewhat valid, huh? (I'm being sarcastic -- of course it's valid. And yet, some will try and make excuses for why it's not really true.) 4. We've already discussed the fact that possessions often don't satisfy -- experiences do. And, experiences often get better with time while possessions tend to lose their luster with age. 5. "The people with the greatest satisfaction are those who live well below their means." Ha! Told ya so!!!! 6. Hyperspenders seem to be the ultimate keep-up-with-the-Joneses sort of people. 7. There are many, many things in life more important than money. Looks like the truly wealthy people have this figured out -- and, in part, it's a reason they are so well off. 
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| 2010 Roth Conversion: Factors to Consider Before Making a Decision
November 23, 2009 at 11:45 am
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| The following is a guest post by Bryan Olson, CFA, Vice President, Head of Portfolio Consulting for Charles Schwab & Co., Inc. For more than a decade, Roth IRAs have been offering investors a number of benefits generally including tax free growth in earnings, tax free withdrawals assuming you begin your withdrawals after the age of 59 1/2 and have held the Roth account for the minimum five-year holding period, and no required minimum distributions as is the case with traditional IRAs. Through the end of 2009, conversion to a Roth IRA from other retirement accounts including a traditional IRA or 401(k) plan is limited to people with a modified adjusted gross income of $100,000 or less. But as of January 1, 2010, all investors will be eligible to convert funds from a traditional IRA or 401(k) to a Roth IRA, regardless of income level. While this change will present some attractive options for certain investors, people should weigh the costs and the benefits unique to their own specific financial plans and tax situation before deciding if a Roth IRA conversion is right for them. What is Roth IRA? How is it different from a traditional IRA? Roth IRAs offer several unique characteristics that differ from a traditional IRA. First, growth in a Roth IRA is generally income-tax-free, meaning that while you pay taxes on your initial contributions, you do not pay income tax or capital gains on any earnings in your Roth account, assuming you begin your withdrawals after the age of 59 1/2 and have held the Roth account for the minimum five-year holding period. Second, qualified withdrawals after the age of 59 1/2 are tax-free, which can be very useful for people seeking to manage their income tax bracket in retirement. In addition, unlike a traditional IRA, in which required minimum distributions (RMDs) are mandatory beginning age 70 1/2, a Roth IRA does not require withdrawals at any time during a person's lifetime, so investments can remain in the account and continue to grow until they are needed. Third, contributions can be withdrawn from a Roth IRA at any time tax-free, but they are not tax-deductable up front. Conversely, contributions made to a traditional IRA may be eligible for a tax deduction when contributed and are taxed upon withdrawal, but cannot be withdrawn without penalties until the age of 59 1/2. The case for converting: What are the potential benefits? While the two main reasons that investors typically consider converting to a Roth IRA are to achieve a greater ending portfolio value or to capture estate planning benefits, there are a few additional potential benefits as well. Here a few reasons converting to a Roth IRA might make sense: - Potentially greater ending portfolio value: If you think your future tax rate will be the same or higher than the rate you're currently paying, you may enjoy a greater ending portfolio value if you convert your funds to a Roth IRA now, because the taxes you pay on the conversion amount today will likely be less than the taxes you'd pay on withdrawals from a traditional IRA in the future.
- Estate planning: If you don't think you will need to utilize your IRA to live off of in retirement (including emergency expenses such as health care) and your goals include maximizing the assets you leave to heirs and beneficiaries, a Roth IRA can offer some unique estate planning benefits. While the value of a Roth IRA will still be included in a person's gross estate, because there are no required minimum distributions, the account could grow larger than it otherwise might under traditional IRA distribution rules. This can leave more for heirs to withdraw income tax-free over their lifetimes. In addition, the income tax paid at conversion (preferably from assets other than the IRA) will reduce the owner's gross estate. In effect, the account owner is prepaying income tax on behalf of future beneficiaries without such payment being recognized as a taxable gift.
- Tax-risk diversification: Risk diversification is a key tenant of investing and diversifying tax risk can be an important factor to consider. Diversifying income tax risk means considering whether and how assets should be divided among three primary types of accounts:
- Taxable accounts in which taxes on investment income and capital gains are paid as they occur,
- A tax-deferred account such as a traditional IRA in which taxes are paid at the ordinary rate in the future when you make withdrawals,
- And a tax-free Roth IRA account in which contributions are after-tax and/or taxes are paid upon conversion for investments going into the account, and qualified withdrawals are income tax-free.
- Flexibility to influence income tax bracket in retirement: Individuals in a higher tax bracket at age 70 1/2 might be forced to take RMDs from a traditional IRA even though they do not need the money at that time. This can also result in taxation in a higher tax bracket. Converting some assets to a Roth IRA will lower RMDs from a traditional IRA, thereby lowering taxable income and potentially even an individual's tax rate. Roth IRAs allow for additional flexibility in retirement since Roth IRA qualified withdrawals are tax-free and there are no required minimum distributions from a Roth IRA.
Roth IRA conversion considerations to keep in mind: Know the consequences! The act of converting a traditional IRA or 401(k) to a Roth IRA might have consequences that make it less attractive or appropriate for certain people. The most significant of which is the tax that becomes due at the time assets are withdrawn from a traditional IRA, but there are some other things to keep in mind as well. - Income taxes due: Converting traditional IRA assets to a Roth IRA triggers a taxable event. It does not make sense to convert to a Roth IRA if you cannot afford to pay these taxes from a readily available source other than the IRA. Investors who are younger than age 59 1/2 will incur a 10% early withdrawal penalty if they use funds from their traditional IRA to pay the conversion taxes. Investors over the age of 59 1/2 could pay taxes from their traditional IRA with no additional penalty, but this would significantly diminish the potential tax-free growth benefits of a Roth conversion versus paying the tax from sources other than the IRA.
- Five-year lock up on conversions: Funds converted into a Roth IRA are subject to a five-year rule, which will result in a penalty if broken before age 59 1/2. There is a five-year waiting period for withdrawals for each conversion amount, which starts on the first day of the year in which the conversion is made. This rule only applies to the specific assets that were converted, not to withdrawals of earnings, contributions or previous balances.
The bottom line is that converting to a Roth IRA can be a complicated, individual decision with tax implications, so you should be sure to consult a professional tax advisor before making any final decisions. Additional details about the 2010 Roth IRA conversion rule changes and Roth IRAs in general are available at www.Schwab.com/Roth. This information is for general informational purposes only and is not intended as an individualized recommendation or to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner or investment manager. 
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| Americans Still Not Ready for Retirement
November 23, 2009 at 5:29 am
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| Here's some information that's a good follow-up to our discussion about Americans not being ready for retirement. We'll start with a summary of how most people fund their retirement. Americans typically build retirement savings in three ways, says Laibson. For all of us, our required contributions to Social Security will provide a guaranteed monthly check. Owning a home and gradually paying off the mortgage during your working life generates housing wealth that supports retirees' standard of living (if you've paid off your mortgage, you don't have to pay out of pocket for housing). Finally, company plans, such as 401(k)s and defined pensions, provide the other key source of financial support in retirement. So, the three-legged stool for retirement is Social Security, having a home paid off, and company plan (aka "personal savings" in my book), huh? Sounds right to me. I'm not counting on receiving anything from the first option and I already have my home paid off. So my entire focus right now is saving up as much as I can in both my 401k as well as in other personal accounts. Of the three legs, there's one that is more important than the others in determining retirement savings success: Laibson, who studies retirement issues as well as the psychological factors influencing savings behaviors, observes: "The most important driver (of whether an individual ends up retirement-rich) is the savings institutions at the workplace." About half of all private sector employers don't offer any type of 401(k) or pension plan. That's a big reason why some 60 percent of Americans aren't building the savings they'll need. "If their workplace isn't helping them save, they're not doing it on their own," Laibson says. Of the rest, some 30 percent are saving just about adequately and 10 percent will wind up retirement-rich, according to Laibson. His estimates aren't based upon his own research, but rather upon sifting through dozens of research reports and integrating the findings. Ok, a few thoughts here: 1. While not having a mortgage is key to a good retirement, four in ten people aged 60 to 69 have a mortgage. Oops. 2. Basically, I'm getting out of this that people don't have the motivation to save on their own. If their company doesn't force/encourage them to save, they don't do it. 3. 60% aren't saving enough. I'd say that's a big problem. 4. 10% are "saving too much." How actually is that done? Can't they run the numbers and simply retire earlier if they are indeed "saving too much"? For instance, if someone is 40, wants to retire at 65, and at his present rate of savings will have enough to retire at 60, why doesn't he simply do so (and is he really saving too much up to that point)? Another way of looking at it is that he is not saving too much until he gets to 60 and keeps saving at his current rate. At that point, he's "saving too much", not when he's 40. Or looked at from a different perspective (one I prefer), he's building in a margin of safety with his retirement saving. It's much easier to give some away once you have too much than it is to save too little then try and earn more with limited opportunities and potential health problems at age 70. 
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