John D. Cargill CPA
Promptly Delivering Quality Services at Reasonable Prices

BASIC FINANCIAL PLANNING

One of the most critical areas of financial planning is planning retirement. How do you invest retirement funds so that they are safe, yet keep up with inflation and have some growth potential? Controlling costs, such as management fees, commissions, transaction fees and tax consequences, is a critical step in getting a good return on your retirement funds.

The overall approach to your investment strategy is called ASSET ALLOCATION.

This means that you need to come to a decision of what percentage of your investment dollars are put in EQUITIES compared to FIXED INCOME securities.

Equities (stocks and stock mutual funds) tend to have more ups and downs in value (risk) but are better at keeping up with inflation and have more gain potential. Fixed income investments tend to be more stable, especially if kept in short term, laddered, fixed income investments.

You might decide after consultation and review of your own outlook that your asset allocation should be 60% equities and 40% fixed income investments. We would refer to that as a 60/40 allocation. After you determine your personal asset allocation, you then have to pick the specific investments.

For the equity portion of your investments, one could use no-load, low management cost index funds that can be targeted at a particular area of investment such as domestic, foreign, or both. In any case, the investments should be diversified.

For the fixed income portion of your investments, you should use only short-term, high-quality investments such as U.S. Treasuries, insured CDs, short term corporate bonds, and government agency bonds. “Laddered” fixed income investments are relatively risk free and have a guaranteed return.

You need to maintain your asset allocation. So if your equity portion increases in value causing them to be, say 70% of the total, you would sell enough equities and purchase enough fixed income investments to bring the balance back to 60/40.

Fees: Financial planners who are “fee only” planners charge anywhere from ½% to 2% on assets under management. Some planners are “fee based” and charge a fee in addition to commissions. Then there are “commission” planners that get a commission on all the services sold. You need to be careful of commission based planners because you will generally “need” what they get a commission on. There are also “fee for service” planners who only charge an hourly fee.

You should normally avoid high-cost, illiquid investments such as annuities or limited partnerships. These investments are set up for the sales people and the issuing companies. You normally cannot beat the market by “timing” the market.

RETIREMENT PLAN REQUIRED WITHDRAWALS

In the year you become 70 ½ you are required to start withdrawing retirement funds. To determine how much you should withdraw, you refer to a table to find a divisor. You then divide the total value of your retirement funds as of the end of the previous year by that divisor to get the amount required to be withdrawn. Make separate calculations for each retirement plan.

Here are some divisors from the IRS chart:

Example - If you were 70 ½ this year, your age could be either 70 or 71 by December 31. Let’s say were 70 ½ but also age 71 this year. Since you are 71, your divisor from the above chart is 26.5. You then look at your retirement funds – IRAs for example. At December 31 of last year you total your IRA account values. Say you have two IRA accounts. One might be $100,000, and another might be $70,000, for a total of $170,000.

You would divide $170,000 by the 26.5 divisor and that would tell you that you would have to withdraw $6,415 before December 31 of the current year. We would recommend that you round up to $6,500. You can take more out but not less to avoid penalties. Also, you can take the full amount from either of the IRAs.

Your retirement fund custodian will notify you that a withdrawal is required. When that happens, mark your calendar as a reminder. If you forget, the penalty is 50% of the amount you should have withdrawn. The IRS knows how much you have in your accounts and how much should have been withdrawn.