Five Reasons to Think About Your Finances in August

I admit it. This post is probably more for my entertainment than yours, but I stand by my points nonetheless. So, here they are: 5 reasons to think about your finances in August:

1. It's been six months since your heating bill was enough to make your fingers go numb (or was that just the draft from the window?). So at this point, you are thinking your household budget isn't nearly as bad as you thought, and you might even get that sense of smug responsibility looking over the household finances without the wincing (and numb fingers);
2. Your accountant can actually talk to you at this time of year. I know—it's great fun for everyone involved when we all gang up on the accountants at once in March and April (and in October for the businesses, by the way). Accountants love that. But you'd be surprised how much more relaxed they are taking your questions in August;
3. You can actually do something about your finances in August. Don't get me wrong, you can worry about your finances in December and January after the Christmas shopping. And you can wish that you'd started that IRA account, put money away, paid for last year's tax-deductible whatever in April, but wouldn't it be great if you did any of things before the regret set in?
4. You can amaze your neighbors and friends. Everyone is either on a fabulous vacation in Buenos Ares or trying to recover from the annual family trip to the beach by this point in the summer. If you have kids, the anticipation of sending them off to school is starting to make you antsy and unfocused (just think of the free childcare!!!). No one but no one does anything particularly practical in August, really. Revise your household budget, put a little extra in the investment account, meet with your advisor or accountant and then go sit by the pool mouthing off about how you took care of all that. And keep in mind that this sort of shameless boasting goes down especially well when you are sipping an umbrella drink;
5. You can have ice cream after. Yes, technically, you can have ice cream before or even while you are working on your finances (though, watch the dripping), but it tastes really, really good when you're done.

Happy vacationing, everyone.

Retirement Abroad

We have a client at the firm who has been planning for years to retire to Costa Rica. Another client has moved to Mexico where she enjoys the fruits of her labor from a little house surrounded by, well, fruit. As the snow piles up every February here in Boston, the whole idea of escaping to another life sounds more appealing. Even those of us who can't imagine not having some sort of work during retirement are tempted by the idea of retiring to a whole new adventure. And in some cases, moving to another part of the world promises a better standard of living. So what are the practicalities of a retirement outside your home country?

Moving Money

Retiring abroad almost always means having financial transactions going on in two countries. Fortunately, our global banking systems have made this significantly easier than it once was. Like most immigrants/expats, you will want to do some careful planning with your cash flow. Start by keeping a U.S. bank account open to receive your social security checks (in most cases, you are still eligible while living abroad), pension checks or any other income. The same account can automatically pay any expenses you have left in U.S. dollars—these might be related to insurance policies, properties you own in the U.S., cash support for family still in the states, or just having your favorite U.S. peanut butter shipped over once a month.

Keeping all of that income and expense in the same (U.S.) currency saves you the added expense of currency exchange—and that can be a big savings. On the other side of the financial border, figure out what your monthly budget will be in your adopted country and have that automatically deposited in a local account once a month (but be sure to account, again, for the exchange rate and any bank fees).

Living Expenses

Speaking of your monthly expenses, expect the unexpected in your new life. On one of our family's first trips to Singapore, we plunked ourselves down for lunch at a cafe designed for tourists on the island of Pulau Ubin.  After giving three rambunctious children and four hungry, tired adults license to order anything and everything they wanted, we ended up with two tables overflowing with food and specialty drinks...all for a tab of about $14 bucks.

On the other hand, owning a little tin can of a car in Singapore will cost you a small kingdom. My point? Look carefully at what is and isn't expensive in your new home. Your housing or groceries might be ridiculously cheap compared to what you had at home, but your utility bills or transportation might be higher than you ever dreamed possible. And as an aside, don't expect to find cheap food in Singapore anymore—inflation can happen anywhere.

Health Care

This one has been a big factor for U.S. citizens. In fact, our astronomical insurance premiums and health care costs in this country have made it almost inevitable that Americans save money on health care by going just about anywhere else in the world (why this hasn't been a red flag for us, I don't know). And the quality of health care in other countries hasn't been much of a compromise either. But you do need to know what the arrangements are in your new country before you move. Keep in mind that Medicare will not cover you abroad.

Some nations let immigrants participate in the national health system; others offer private health alternatives (often still cheaper than what we have here). Make sure you look into eligibility requirements and take into account your particular health care needs when choosing where in the country you will live; as is the case here, cities often offer more sophisticated care. And if you still need more coverage, look into international health insurance, which will cover you just about anywhere in the world (with the frequent exception of—you guessed it—the U.S.).

Taxes

Surely this is the least appealing part of retiring abroad! If you are a U.S. Citizen, you will almost certainly need to keep filing a U.S. tax return, even if you don't owe anything. And you will have local taxes to think about. If your new home country has a tax treaty with the U.S., you might be able to avoid paying income taxes in both countries simultaneously. But there are all sorts of taxes to think about. For those in retirement who are buying property in their adopted nation, estate taxes are likely to be a concern. And if you have more than $10,000 during the year in almost any sort of account abroad, including an insurance policy, make sure to file an FBAR (Report of Foreign Bank and Financial Accounts). Even if you were one of those people comfortable doing her own tax returns and estate planning before, taking on the taxes and procedures of two national treasuries will probably require some professional help.

An Extra Seat At The Table

Ready to start planning your second life as an immigrant to some charming foreign nation? Research thoroughly, plan carefully and most of all, be flexible. And one more thing, make sure there's extra seat at the table for friends and family visiting from back home. After all, it gets pretty cold here in February.

The Secretary of State's Bureau of Consular Affairs has a web page to guide you through the basics of planning a retirement abroad.

Is Your House A Home Or An Investment?

Ask this question of just about any American and they will happily tell you that it is both. And why not? From home improvement centers and real estate agents to government programs and tax breaks, the clear message is that it is always better in the U.S. to own a home. The reality is a little trickier, though. And if you plan to use your home as an investment—that is, to actually get additional value out of it at some point in the future—you need to think more clearly about the limitations of living in one of your biggest savings accounts. Here are a few key points to consider:

1. You don't buy a house for the land.

We have a tendency to think that buying a house is somehow a more "stable" investment, as if the fact that we can still touch and see the land means that it's value is not going anywhere. Sure, you can probably still grow potatoes on the land  even if the economy tanks. But let's face it, you didn't pay a quarter of a million dollars so you could grow veggies and no one else is going to either. The value of property, like the value of any other investment, comes from only one factor—what someone else will pay for it at the moment you want to sell;

2. Home values can be just as unstable as stock markets.

Our most recent U.S. Census data shows that median household net worth went up by about 30% between 2000 and 2005 (an increase from $81,821 to $106,585)! This was great news, and it was almost entirely due to the fact that people's home values went up during those years. But when home prices dropped in the 2008 crash, Americans' net value also went down...by about 35% as of 2011. That crash wiped out almost a decade worth of gains, and it left many homeowners with mortgages that were more than the home's value. We haven't all recovered, yet. According to Zillow's 2014 report, 16.9% of U.S. homes were still "underwater" (worth less than their home loans) as of the end of October, 2014. Which brings me to my next point—

3. You can't live in a mutual fund.

Generally speaking, this is a point in favor of buying a home as an investment. Since you were going to pay housing costs anyway, why not put it toward an asset of your own? But if your stock prices crash, you can usually leave them be and wait it out until the market recovers. If your home price crashes and you can't afford your mortgage or you have to move for a new job, you just don't have that luxury. That means you may be forced to "cash in" at the worst possible time, making you a lot more vulnerable to losing all of that money you've put in and possibly more;

4. Your mortgage is someone else's investment.

In our rush to celebrate the great American home-buying dream, we often forget that the reason economists love home buyers is because home owners borrow so much money. Home owners not only tend to take out large mortgages (which can be bundled and sold off into all sorts of investments by financiers), they also borrow more through auto loans, education loans and credit cards because of the sense of safety provided by their home values. It's great for the economy, but it might not be so great for you. If we assume that the average U.S. mortgage is a 30-year fixed rate at about 4.5% interest on a $222,000 loan, then the average home owner is paying a total of about $183,000 in interest for the privilege of being rent-free. This, of course, does not include any of the closing costs, maintenance, taxes and upgrades you choose to do on your home (not to mention the added temptation of new sofa cushions, shelving, curtains, etc...);

5. There's no profit until you sell.

All of us are happy when we get word that our home price has gone up. And thanks to refinancing, we can access some of that money (for a price) by borrowing against the new value. But nothing will change the fact that investments don't make you any money until you sell them, and this applies to your home, as well. If you are counting on the value of your home to help you in retirement, keep in mind that without some creative help from family members, this will mean a reverse mortgage or a sale. And if you choose the latter, you are going to have to find somewhere else (somewhere less expensive) to live.

All of this is not to say that your home in not a good investment. It may very well be! The mortgage tax deduction can offset some of those interest payments, and if you buy in the right time and place you could make a lot of money when it is time to sell. What all of this does mean is that averages will do you no good in determining whether you should by a home. You need to do the calculations based on things like how long you plan to stay in the area, what other resources you have in case of a downturn, what the rental market looks like in your area and what other financial and familial obligations you have.

Most importantly, though, you need to account for the fact that what you are buying is not a house...it's a home. If flexibility, adventure, ease or mobility are what you need at this point in your life, there are probably better investment options for you. If, on the other hand, buying a house ensures that you can keep the kids in school with their friends or that you can finally set down roots in a community, well, that is another kind of investment—one that doesn't come with a calculator but makes a world of difference.

Who Needs an Annuity and Why?

My clients might well be surprised to see this post—I spend a lot of time railing about the over-selling of annuities and the hefty commissions that go to the advisors who sell them. But the annuity has a long, respectable history and can actually be a good financial tool for the right situation. So what is that situation?

First, it helps to know how annuities work. They aren't quite as dreary as they sound. Way back in the 17th and 18th centuries, annuities were a great way for a very wealthy person to fund the retirement of a widow, an artist or a beloved servant. For that matter, they were one of the original prizes in government lotteries. Essentially, an annuity is a contract that gives the beneficiary the right to receive a certain sum of money every month or every year for the remainder of his or her life. Sounds great, right?

There is a little more to it, though. These days, annuities are insurance products. Like any insurance policy, the insurance company has used statistics about people's life spans to predict how much they need to charge you (and how much they could pay to the beneficiary) in order for the insurer to make a profit on the deal. So, for instance, Wholesome Life Insurers, Inc. are happy to sell you an annuity that costs $100,000 up front and pays $20,000 per year to your Aunt Betty for $100,000 if they think she'll drop dead after the second year of payouts.

And there are necessary costs. In addition to paying the people who sell you the annuities, the insurance company needs to pay people to file the required reports, process the applications, run the office, etc... That isn't all, though. In point of fact, your insurance company is hoping to make most of their profit by investing your initial $100,000 until it needs to be paid out. For that, of course, they need to pay investment managers. All of these costs are built into how much the annuity costs you.

So why not just invest the $100,000 yourself and skip the other costs? This is the question at the heart of the matter when it comes to annuities. In most cases, it is cheaper to fund your own (or your Aunt Betty's) annuity. But relying on your $100,000 investment to grown enough that it can pay you back the money you need in retirement is a gamble—a gamble on the investments and a gamble on your lifespan not going longer than planned.

In the Bloomberg article with which I started this series, David Little, Director of the Retirement Income Planning Program at the American College of Financial Services, chose to take care of most of his own investing, trusting that he would do better than the relatively high fees and low returns that an insurer would get. But he also purchased an annuity as a supplement to the investments. The annuity offers him a baseline amount that he will get every month during retirement to prop up his social security benefits in case the investments disappoint or in case he lives to, well, 103.

As Little's plan suggests, annuities make sense in those instances when security matters to you much more than cost. Whether it's being able to insure a comfortable living for your Aunt Betty, or locking in a baseline for yourself, annuities are about covering a basic need—often psychologically as much as financially.

Just one last note on annuities—there is no such thing as a "guaranteed" investment. Make sure you feel as confident about the insurance company you buy from as you do about your choice to buy. If you want to learn more about the types of annuities out there, check out the SEC's online guide to annuities.

Understanding Retirement Accounts

Of all of the topics that come up in my line of work, this has to be the one that creates the most confusion. We Americans are at the point where we have all heard about 401k's and pensions and probably about IRA's and Roth's. And for the most part, we are relying on these strange creatures to feed and house us in the last years (decades?) of our lives. But precious few of us really understand retirement accounts. This post is meant to give you a bit of a run-down on how retirement plans work with a  quick graphic at the end to get you thinking about the plans that might work for you.

The Magic of Tax Deferral

Let's start with the basics—anytime we call something a "retirement" account, we are actually saying that the account has some special mention in the IRS's regulations that will amount to a temporary tax break. You noticed the word "temporary", right? Except for the Roth, which I'll get to in a minute, retirement plans allow you to put a certain amount of your income into the account instead of paying taxes on it...for now. It's called tax deferral, and you not only get out of paying the taxes the year you earned them, you also don't have to pay any capital gains taxes when you sell investments in that account over the years. That gives you the ability to freely move in and out of investments without the usual tax consequences and lets the income you originally put in keep compounding—assuming those investments you chose are any good.

But you do have to pay taxes eventually. In the case of retirement accounts, this happens when you start taking money out— a process known as taking distributions. What's more, the IRS has something to say about when you will be doing this. In most cases, you will pay a penalty for "early withdrawal" if you take your first distribution before age 55. And you will be required to start taking your money at age 70 1/2, because after all, the IRS won't wait forever.

The Roth IRA (often just called a Roth) is a little different. Like 401k's and regular IRA's, your money can grow free of capital gains taxes over the years in a Roth. But if you open one of these accounts, you put your money in after paying the income taxes. This means you won't get that immediate tax break, but believe it or not, this might actually work out well for you. When you do go to take money out of the Roth account, you don't have to worry about the taxes on the money you first put in the account (you already paid those taxes, after all). This can reduce the strain of taxes in retirement and may even mean paying a lower tax rate on that money, say, if you are in a higher tax bracket in your mature years.

In reality, the most successful savers will use both Roths and whatever other accounts they can. The caps on how much you can contribute to a retirement account often mean layering accounts to the extent you are able.

Defined Benefit vs. Defined Contribution

This is the biggest change in the U.S. retirement system over the past 50 years. Defined benefit plans are exactly that—the plan defines in advance how much you will get in benefits. Most of us just call these pensions, and they were the most common type of retirement income for most of our history. Based on the length of time you've worked at a job and the amount you earned, your HR department will calculate how much you get in your monthly check during retirement. Nowadays, though, you are far more likely to be offered a defined contribution plan. These plans set terms for how much you can contribute and make no promises whatsoever about what you get back later.

This change is a big deal— and not just because people are less likely to contribute to the often-voluntary defined contribution plans. In the case of a pension (defined benefits) someone else is taking the risk that the markets will go down or that the beneficiaries (including you) will live longer than expected. If you have a defined contribution plan, that risk is all on you. This means that you need to do some careful calculating and some educated guessing to come up with a balance of investments that will grow enough to cover your needs and will likely be there when you need them. The change over from defined benefits to defined contributions has made it necessary for Americans to become smart investors.

The Magic of Timing

If you are worried about living for more than a few years after your retirement, you are going to want to focus on your timing when it comes to retirement accounts. I am not referring to when you start putting money away here—the earlier the better, of course. Honestly, though, most successful retirees started saving at the peak of their careers, not the beginning. Get started when you can and work from there.

But you should be strategic about which accounts you put money into first and which accounts you start withdrawing from when.

The timing of adding to accounts is relatively simple for most people. We always start by looking to see if a client's employer will "match" contributions. If so, we maximize that first (getting someone else to fund your retirement is always good). If the client has his or her own business, even if it is a "side" business, we have a lot more to play with and timing will often depend on the needs of the business, which is often itself part of the retirement solution.

Taking out the money is different matter. The trick here is to take advantage of the incentives that employers and the government give you and to recognize the requirements. Social security, for instance, gives you all sorts of incentives to wait until 70, so if you can draw from a 401k account or an IRA instead during your 60's, you probably should. Likewise, an old company pension might give you a much better monthly payment for waiting. But you can only wait so long on IRA's and 401k's—as I mentioned above, the IRS requires that you start taking at least some distributions when you reach 70 1/2. The Roth, always the exception, allows you to keep money in that account as long as you want. Choosing which accounts to draw from and when is a delicate game of knowing your income needs, getting the most you can from the incentives and keeping an eye on the taxes you will pay as your start taking that retirement income.

Which Retirement Accounts Should You Use?

Retirement accounts are only one piece of the puzzle when you are coming up with a plan for enjoying life after 65. But they are one of the most important pieces. Here is a quick graphic showing the most popular types of retirement accounts and which ones you might want to learn more about: