The earlier you start pursuing financial goals, the better your outcome may be.
As a young investor, you have a powerful ally on your side: time. When you start saving and investing for retirement in your twenties or thirties, you can put it to work for you.
The effect of compounding is huge. Most people underestimate it, so it is worth illustrating. We will use reasonable annual return rates to do so – we will assume an investor can earn an average of 6-7% a year on his or her portfolio.
What if you invest $500 a month at age 25 & realize a 6% annual return? Under those hypothetical conditions, you would become a millionaire at age 65. To be precise, you would need to invest $499.64 per month starting at age 25 and keep it up for 40 years.1
At age 25, saving and investing $500 each month may seem like a luxury. It is closer to a necessity. In 2055, having $1 million or more saved up for retirement may be essential. Over 40 years, inflation will make $1 million worth less than it is today. The good news is that if your investments return more than 6% in a year, you could reach and surpass that $1 million mark faster.
It need not take 40 years for compounding to make a difference for you. Shortening the timeline of this hypothetical example, after ten years of saving and investing $500 a month at a 6% annual return, you would end up with $81,939.67 compared to the $60,000 you would realize from merely saving the cash sans investment.2
The earlier you start, the greater the compounding potential. If you start saving and investing for retirement in your twenties, you gain a definite compounding advantage over someone who waits to save and invest until his or her thirties. Another comparison bears this out.
Take two investors, both contributing $200 per month into their retirement accounts. One does this for 40 years starting at age 25. The other does this for 30 years starting at age 35. Again, we assume a 6% annual return for each account. The investor who starts at 25 winds up with $402,492 at age 65, while the one who started at 35 amasses just $203,118 over 30 years.3
Just ten years of difference in the start time, yet the money almost doubles by age 65. This is a compelling argument for starting to save for retirement (and other goals) as early as possible.
Even if you start early & then stop, you may out-save those who begin later. What if you contribute $5,000 to a retirement account yearly starting at age 25 and then stop at age 35 – no new money going into the account for the next 30 years? That is hardly ideal, yet should it happen, you still might come out ahead of someone who begins saving for retirement later.
As J.P. Morgan Asset Management research notes, an investor who consistently directs $5,000 a year in a retirement account from age 25-35 with a 7% continued annual return ends up with $602,070 at age 65 even if contributions cease after age 35. The really startling part: that investor actually amasses more retirement savings than an investor who steadily contributes $5,000 a year from age 35-65 at the same rate of return – he or she realizes just $540,741.1
This is all worth noting, because many millennials seem wary of investing. This spring, a Bankrate MoneyPulse survey indicated that only 26% of Americans under age 30 are investing in equities. In July 2014, another Bankrate survey found that Americans 18-29 favored cash investments (i.e., bank accounts and bank-based investment vehicles) above all others. Student loans and child-rearing costs reduce investing potential for many millennials, but as these survey results hint, some are cynical about the whole investment process.4,5
If you were born in the late eighties to early nineties, you are old enough to remember the dot-com bust of the early 2000s and the crushing bear market of 2007-09. This may have given you an early negative view of equities; these events are clear examples of how risk plays a part in this type of investment.
The reality, though, is that most people planning for retirement need to build wealth in a way that outpaces inflation. Equity investing offers a route toward this objective, one many investors have successfully taken. Directing your savings into equities can be helpful, because broadly speaking, you will not retire merely on the contributions you make to your retirement accounts. You will retire on the compounded earnings those invested assets achieve.
This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
1 - businessinsider.com/amazing-power-of-compound-interest-2014-7 [7/8/14]
2 - quickenloans.com/blog/investing-101-how-to-get-started [8/27/15]
3 - businessinsider.com/saving-at-25-vs-saving-at-35-2014-3 [3/25/14]
4 - cnbc.com/2015/08/24/more-millennials-say-no-to-stocks-and-advisors-adapt.html [8/24/15]
5 - bankrate.com/finance/consumer-index/financial-security-charts-0714.aspx [7/21/14]
Values can help determine goals & a clear purpose.
Some millionaires are reluctant to talk to their kids about family wealth. Perhaps they are afraid what their heirs may do with it.
In a 2015 CNBC Millionaire Survey, 44% of families having at least $1 million in investable assets said that they had not yet told their children about their future inheritance. Another 27% said they had refrained from mentioning it until their children were 30 or older.1
It can be awkward to talk about such matters, but these parents likely postponed discussing this topic for another reason: they wanted their kids to grow up with a strong work ethic instead of a “wealth ethic.”
If a child comes from money and grows up knowing he or she can expect a sizable inheritance, that child may look at family wealth like water from a free-flowing spigot with no drought in sight. It may be relied upon if nothing works out; it may be tapped to further whims born of boredom. The perception that family wealth is a fallback rather than a responsibility can contribute to the erosion of family assets. Factor in a parental reluctance to say “no” often enough, throw in an addiction or a penchant for racking up debt, and the stage is set for wealth to dissipate.
How might a family plan to prevent this? It starts with values. From those values, goals, and purpose may be defined.
Create a family mission statement. To truly share in the commitment to sustaining family wealth, you and your heirs can create a family mission statement, preferably with the input or guidance of a financial services professional or estate planning attorney. Introducing the idea of a mission statement to the next generation may seem pretentious, but it is actually a good way to encourage heirs to think about the value of the wealth their family has amassed, and their role in its destiny.
This mission statement can be as brief or as extensive as you wish. It should articulate certain shared viewpoints. What values matter most to your family? What is the purpose of your family’s wealth? How do you and your heirs envision the next decade or the next generation of the family business? What would you and your heirs like to accomplish, either together or individually? How do you want to be remembered? These questions (and others) may seem philosophical rather than financial, but they can actually drive the decisions made to sustain and enhance family wealth.
Feel no shame in exerting some control. A significant percentage of families seek to define a purpose for transferred wealth. In CNBC’s survey, 32% of parents aged 55 or younger said they were going to specify what their heirs could use their inheritances for, and that was also true for 15% of parents aged 55-69 and 9% of parents aged 70 or older.1
You may want to distribute inherited wealth in phases. A trust provides a great mechanism to do so; a certain percentage of trust principal can be conveyed at age X and then the rest of it Y years later, as carefully stated in the trust language.
This is a way to avoid a classic mistake: giving your heirs too much money at once. In fact, a 2015 Merrill Lynch Private Banking & Investment Group report notes that 46% of high net worth parents share that very concern.2
Just how much is too much? Answers vary per family, of course. In the aforementioned Merrill Lynch survey, 46% of families said that they wanted to avoid handing down the kind of money that would dissuade their heirs from realizing their full potential in their lives and careers.2
By involving your kids in the discussion of where the family wealth will go when you are gone, you encourage their intellectual and emotional investment in its future. Pair values, defined goals, and clear purpose with financial literacy and input from a financial or legal professional, and you will take a confident step toward making family wealth last longer.
1 - cnbc.com/2015/07/22/wealthy-parents-fret-over-inheritance-talk-with-kids.html [7/22/15]
2 - bankrate.com/finance/estate-planning/critical-questions-before-leaving-an-inheritance-1.aspx [8/6/15]
Two-thirds of us have no financial plan.
Only 48% of Americans say they think they are saving enough. And 30% feel that they are not even slightly confident that they are saving enough for retirement. That finding comes from the 2015 Consumer Financial Literacy Survey conducted by the National Foundation for Credit Counseling. (The survey collected data from 2,017 U.S. adults.)1
Only 40% of us keep a regular budget. If you are one of those two out of five Americans, you’re on the right track. While this percentage is on par with findings going back to 2007, the study also finds that only 29% of Americans are saving any part of their annual income towards retirement.1
Relatively few seek the help of a financial professional. When asked “Considering what I already know about personal finance, I could still benefit from some advice and answers to everyday financial questions from a professional,” 75% of respondents agreed with the statement. Yet only 12% indicated that they would seek out the help of some sort of financial professional if they had “financial problems related to debt.” While it isn’t surprising to think that 25% of respondents would turn to friends and family, it may be alarming to learn that 18% would choose to turn to no one at all.1
Why don’t more people seek help? After all, Americans of all incomes and savings levels certainly are free to set financial goals. They may feel embarrassed about speaking to a stranger about personal financial issues. It may also be the case that they feel that they don’t make enough money to speak to a professional, that a financial professional is something that millionaires and billionaires have, not the average American worker. Another possibility is that they feel that they have a good handle on their financial future; they have a budget and stick to it, they save in an IRA (like a quarter of Americans), or a 401(k) (nearly three out of ten Americans), and many use other investments (30%, according to the survey). But that 75% admission above indicates that a vast majority of Americans are not as confident.1
Defined goals lead to definite plans. If you set financial objectives and plan for them, you vault ahead of most Americans – at least according to these findings. A written financial plan does not imply or guarantee wealth, of course; nor does it ensure that you will reach your goals. Yet that financial plan does give you an understanding of the distance between your current financial situation (where you are) and where you want to be.
How much planning have you done? Retiring without a financial plan is an enormous risk; retiring with a financial plan that hasn’t been reviewed in several years is also chancy. A relationship with a financial advisor can help to bring you up to date about what you need to do, and provide you with more clarity and confidence when it comes to the financial future.
1 - nfcc.org/wp-content/uploads/2015/04/NFCC_2015_Financial_Literacy_Survey_FINAL.pdf [4/15]
What steps could you take to catch up?
If life has not allowed you to build substantial retirement savings, what can you do to improve your retirement prospects? Here are some suggestions.
Play catch-up. If at all possible, take advantage of the catch-up contributions the IRS allows you to make to IRAs and other retirement accounts starting in the year in which you turn 50. For example, this year a worker age 50 or older can put $24,000 into a 401(k) account compared with $18,000 for someone younger.1
Get the match. If your employer matches your retirement plan contributions to some degree when you contribute to a workplace retirement plan at a certain level, you should make every effort to get the match and take advantage of what amounts to an offer of free money.
Work a little longer. More years contributing to retirement accounts means additional inflows into those accounts, and additional growth and compounding for those assets. It means you claim Social Security later, resulting in a larger monthly benefit. It also leaves you with fewer years of retirement that you must fund.
Alternately, think about working a little early in retirement. It is true, your Social Security benefits could be docked as a result – but the tradeoff might be worthwhile.
If you are a Social Security recipient and younger than full retirement age in 2015, Social Security will withhold $1 in benefits for every $2 you earn over $15,720. This is called the Social Security earnings test. Social Security essentially balances this penalty out, however, by boosting your benefit as you reach full retirement age – and for that matter, you can earn as much as you want at full retirement age or later with no reduction to your benefits.2
If you retire at 62 and make $25,000 a year through a part-time job you hold during the first five years of your retirement, you are putting a dent in any Social Security income you receive until age 67 – but that $25,000 yearly income can represent $25,000 you do not have to withdraw annually from your retirement savings. You could also invest some of that income, and the annual yield on your investment could exceed annual consumer inflation. Not a bad move in many eyes.
Think about long-run growth investing. One of the biggest risks retirees face is the erosion of purchasing power. Some seniors invest in such a risk-averse way that they lose ground versus even minor inflation. Keeping a foot (or both feet) in the market may be essential if your retirement nest egg is small – not just because it needs to grow, but because it will need to grow faster than inflation.
Whittle down your debt. As Ben Franklin wrote in the 1758 edition of Poor Richard’s Almanac, “A penny saved is a penny got” (he never actually said “a penny saved is a penny earned”). While you may be thinking “mortgage,” reducing your credit card debt can produce the savings you want now. So can eliminating certain household expenses. Speaking of family expenses...3
Tell your adult children that you will not be supporting them. If you desperately need to catch up on your retirement savings effort, the last thing you want to do is provide your kids with a financial lifeline. You have 15 years or less until retirement; they may have 40 or 45. Helping them pay off their college loans may feel like the right thing to do for them, but it is not the right thing to do on behalf of your retirement.
Take one crucial step before you pursue any of these options. Turn to a financial professional to see what kind of retirement income you may need to live comfortably. (Any such consultation should include a Social Security analysis.) When you retire, having adequate income becomes just as important as having adequate savings.
1 - money.usnews.com/money/retirement/articles/2014/12/01/how-to-max-out-your-retirement-accounts-in-2015 [12/1/14]
2 - ssa.gov/retire2/whileworking2.htm [7/2/15]
3 - forbes.com/sites/realspin/2014/08/18/a-penny-saved-was-never-a-penny-earned/ [8/18/14]
Some baby boomers are supporting their “boomerang” children.
Are you providing some financial support to your adult children? Has that hurt your retirement prospects?
It seems that the wealthier you are, the greater your chances of lending a helping hand to your kids. Pew Research Center data compiled in late 2014 revealed that 38% of American parents had given financial assistance to their grown children in the past 12 months, including 73% of higher-income parents.1
The latest Bank of America/USA Today Better Money Habits Millennial Report shows that 22% of 30- to 34-year-olds get financial help from their moms and dads. Twenty percent of married or cohabiting millennials receive such help as well.2
Do these households feel burdened? According to the Pew survey, no: 89% of parents who had helped their grown children financially said it was emotionally rewarding to do so. Just 30% said it was stressful.1
Other surveys paint a different picture. Earlier this year, the financial research firm Hearts & Wallets presented a poll of 5,500 U.S. households headed by baby boomers. The major finding: boomers who were not supporting their adult children were nearly 2½ times more likely to be fully retired than their peers (52% versus 21%).3
In TD Ameritrade’s 2015 Financial Disruptions Survey, 66% of Americans said their long-term saving and retirement plans had been disrupted by external circumstances; 24% cited “supporting others” as the reason. In addition, the Hearts & Wallets researchers told MarketWatch that boomers who lent financial assistance to their grown children were 25% more likely to report “heightened financial anxiety” than other boomers; 52% were ill at ease about assuming investment risk.3,4
Economic factors pressure young adults to turn to the bank of Mom & Dad. Thirty or forty years ago, it was entirely possible in many areas of the U.S. for a young couple to buy a home, raise a couple of kids and save 5-10% percent of their incomes. For millennials, that is sheer fantasy. In fact, the savings rate for Americans younger than 35 now stands at -1.8%.5
Housing costs are impossibly high; so are tuition costs. The jobs they accept frequently pay too little and lack the kind of employee benefits preceding generations could count on. The Bank of America/USA Today survey found that 20% of millennials carrying education debt had put off starting a family because of it; 20% had taken jobs for which they were overqualified. The average monthly student loan payment for a millennial was $201.2
Since 2007, the inflation-adjusted median wage for Americans aged 25-34 has declined in nearly every major industry (health care being the exception). Wage growth for younger workers is 60% of what it is for older workers. The real shocker, according to Federal Reserve Bank of San Francisco data: while overall U.S. wages rose 15% between 2007-14, wages for entry-level business and finance jobs only rose 2.6% in that period.5,6
It is wonderful to help, but not if it hurts your retirement. When a couple in their fifties or sixties assumes additional household expenses, the risk to their retirement savings increases. Additionally, their retirement vision risks being amended and compromised.
The bottom line is that a couple should not offer long-run financial help. That will not do a young college graduate any favors. Setting expectations is only reasonable: establishing a deadline when the support ends is another step toward instilling financial responsibility in your son or daughter. A contract, a rental agreement, an encouragement to find a place with a good friend – these are not harsh measures, just rational ones.
With no ground rules and the bank of Mom and Dad providing financial assistance without end, a “boomerang” son or daughter may stay in the bedroom or basement for years and a boomer couple may end up retiring years later than they previously imagined. Putting a foot down is not mean – younger and older adults face economic challenges alike, and couples in their fifties and sixties need to stand up for their retirement dreams.
1 - pewsocialtrends.org/2015/05/21/5-helping-adult-children/ [5/21/15]
2 - newsroom.bankofamerica.com/press-releases/consumer-banking/parents-great-recession-influence-millennial-money-views-and-habits/ [4/21/15]
3 - marketwatch.com/story/are-your-kids-ruining-your-retirement-2015-05-05 [5/5/15]
4 - amtd.com/newsroom/press-releases/press-release-details/2015/Financial-Disruptions-Cost-Americans-25-Trillion-in-Lost-Retirement-Savings/default.aspx [2/17/15]
5 - theatlantic.com/business/archive/2014/12/millennials-arent-saving-money-because-theyre-not-making-money/383338/ [12/3/14]
6 - theatlantic.com/business/archive/2014/07/millennial-entry-level-wages-terrible-horrible-just-really-bad/374884/ [7/23/14]
Estate planning vehicles created with disabled heirs in mind.
If you have a child with special needs, you face long-run financial demands that cannot be fully met through federal and state assistance. What can you do to try and meet them?
A special needs trust may provide an answer to this dilemma. This is a trust designed to provide for assorted care and lifestyle needs not covered by public benefits – medical and dental needs, transportation needs, therapy and more. A trustee uses such a trust to make purchases of goods and services on behalf of a “permanently and totally disabled” person (as defined by the federal government’s Supplemental Social Income standards). In addition, a properly implemented special needs trust lets a disabled heir receive assets without the inherited funds reducing their chances of securing Medicaid, SSI or state benefits.1,2
There are two kinds of special needs trusts, defined by who funds them. A third-party special needs trust is funded by someone other than the beneficiary. Should the beneficiary of the trust die before the trust assets are exhausted, the remaining assets may be distributed to secondary beneficiaries. Third-party special needs trusts can be either living trusts (i.e., created during a grantor’s lifetime) or testamentary trusts established by a will.2
A first-person (or “self-settled”) special needs trust is funded by the beneficiary, often by assets received from a personal injury lawsuit or legal settlement. You have probably heard stories of lump sum cash settlements quickly evaporating; this trust is designed to guard against that. A trustee can oversee the distribution of the assets with an eye toward conserving them. The beneficiary maintains eligibility for public benefits. When the beneficiary of a first-person special needs trust dies, assets remaining in the trust go to the state to repay Medicaid benefits conferred to the disabled person during his or her life. Any assets left over after that may be distributed to secondary beneficiaries.1,2
In either special needs trust variation, a beneficiary cannot withdraw funds from the trust or directly receive distributions from it (distributions are overseen by the trustee). The beneficiary is also legally prohibited from revoking the trust.2
Informal arrangements have their drawbacks. It is still common for a sister or brother of a newly disabled person to hold assets that once belonged to that sibling. Too often, these assets became “easy pickings” in a bankruptcy or divorce. A special needs trust protects such assets from litigation and creditors.1
Standard estate planning efforts may fall short. Some families set up basic life insurance trusts for disabled heirs, but these trusts are often flawed. The trust language fails to specify that the life insurance proceeds should head directly into a special needs trust. If that next step never occurs, the beneficiary of the life insurance trust loses eligibility for Medicaid due to inheriting that large, tax-free insurance benefit.1
Anyone with more than $2,000 of countable assets ($3,000 for a married couple) loses Medicaid and SSI eligibility. So if you want to bequeath or gift assets to the beneficiary of a special needs trust, you have to name the special needs trust as the heir or beneficiary of those assets, rather than the individual named as beneficiary of the trust.1,3
How do these trusts function? The core principle is that the trust assets supplement government benefits, so they work according to a sliding needs scale; for example, should public benefits somehow be able to provide for 100% of the beneficiary’s needs, the trust will provide 0% and vice versa. Trust assets may be invested conservatively, with the resulting income stream paying expenses for the beneficiary.4
The trust language must express a goal to provide “supplemental and extra care” to the trust beneficiary in addition to public benefits (as opposed to basic financial support). The trust must also be without a Crummey clause (a proviso allowing future interest gifts to be treated as present interest gifts, thereby making them eligible for the annual gift tax exclusion).4
ABLE accounts are also emerging. The federal government has authorized a new tax-favored account to benefit disabled individuals, on track to appear in 2016. Distributions from an ABLE account will be tax-free if they are used to cover qualified disability expenses; individuals will be able to contribute up to $14,000 a year to these accounts. Even with this tax break, families may prefer the special needs trust as it has no limits on contributions and permits funds to be spent on a wider range of expenditures.5
The bottom line: if you wish for your loved one to have a good quality of life for years to come, a special needs trust may prove instrumental in allowing you to provide it.
1 - tinyurl.com/meqw7va [4/8/15]
2 - getevolved.com/trust-fiduciary/special-needs-trusts [5/14/15]
3 - pacer.org/publications/possibilities/saving-for-your-childs-future-needs-part1.html [5/14/15]
4 - nsnn.com/frequently.htm [5/14/15]
5 - tinyurl.com/mbufwvy [2/2/15]