Running the Numbers
Richard Connor | Dec 11, 2022
THE HOLIDAY SEASON is upon us. Our thoughts—or mine at least—turn to family, friends, wine, decorations, gifts, wine, food, fun and wine. But before I ring in the new year, I have a few financial questions I need to resolve. Our 2022 income hasn’t been what I expected. I earn consulting income in two ways. I’m a part-time employee of a small engineering consulting firm. In this role, I’m an hourly employee with no benefits. I get a paycheck with federal, state and Social Security payroll taxes withheld. At the end of the year, I receive a W-2 tax form from my employer. This year, the work I expected hasn’t materialized and, to date, I’ve earned just $850. I also own a small business—a sole proprietor LLC. I use this for direct consulting to several small businesses. I invoice customers and receive a check based on an hourly rate and how much time I put in. At the end of the year, I’m sent a 1099-NEC form by the companies I’ve worked for. The primary project I expected to support this year seems to have been delayed until 2023, so I’ve earned a mere $280. As you can see, it hasn’t been a lucrative year for my consulting. That’s okay. We don’t count on me collecting a specific amount of earned income. Anything I make is nice, but it isn’t necessary. The previous two years were better, but not greatly so. The pandemic limited both my consulting opportunities and my willingness to travel. To handle the variations in the income collected by my wife and me, I developed a spreadsheet that tracks our income, tax withholding and expected tax bills. I update it as things change. I found this necessary because, as a business owner, I’m required to pay quarterly…
Read more » Hierarchy of Savings
Richard Connor | Mar 4, 2021
EARLY IN MY CAREER, one of my mentors at work used to talk about “excess paychecks.” He was a single, senior engineer who lived frugally. Back then, the concept seemed ridiculous to me. But I’ve come to realize he was right: Most of us don’t need every dollar we’re paid for living expenses, so we should think carefully about where to stash the excess. That notion came to mind recently when taking to a friend. She’s five years from retirement, concerned about today’s high stock market valuations and wondering if maxing out her 401(k) is her best choice. Would it be smarter, she wondered, to use her extra money to pay down consumer debt, pay ahead on her mortgage or make some home improvements? Here’s my take on the “hierarchy of savings”: Emergency fund. I would make this a top priority. An annual Federal Reserve survey has found that 37% of U.S. families can’t handle an unexpected $400 expense. The pandemic’s economic fallout has highlighted how perilous that can be. My advice: Depending on how secure your job is, set aside between three and six months of living expenses in conservative investments as an emergency reserve. High-interest debt. After you’ve established an emergency fund, it’s time to attack high-cost debt. For most of us, that means credit card balances. Even in today’s low-rate environment, credit cards charge an average 16%, according to Bankrate. Paying down high-interest debt is smart financially, plus it provides a great psychic win. Employer retirement plans. There’s a host of tax-favored employment-based retirement plans, including for self-employed individuals. The standard financial guidance is to invest at least enough to capture any matching employer contribution. I recommend to my sons that they start with a minimum 10% of their income. Health savings accounts. As I’ve written before,…
Read more » Showing Up
Richard Connor | Feb 9, 2022
MY WIFE AND I recently re-watched a video made by one of our nephews. In the video, he interviewed his grandparents—my wife’s parents—about their lives. He wanted to understand what they’d done or taught that built such strong family bonds that lasted over such a long time. My wife is one of five children: three boys and two girls. Each of her four siblings is married with at least two children—11 kids in total. Eight of those 11 are married and have, so far, produced 12 grandchildren. Not an enormous family, but a family event usually consists of at least 40 attendees. Far from perfect, the family represents the broad spectrum of humanity. But there are some obvious similarities. First, I’d say everyone possesses a strong work ethic. All work or—in the case of those who have retired—once worked. This they surely got from their parents. My father-in-law drove a truck for almost 50 years, regularly logging 60-plus hours a week. My mother-in-law was a nurse. When the youngest child was old enough to be on his own, and with college costs looming, she went back to work. She handled the midnight shift as a nursing supervisor at a major Philadelphia hospital. She had an amazing ability to work from 11 p.m. to 7 a.m., come home, sleep four hours, and then get up and run the household. All of their five children share a reasonable approach to money. No one lives a flashy, wasteful life. Their parents somehow owned a home, raised, fed and educated five children, and saved for retirement. They lived well within their means, didn’t spend wastefully, and saved regularly. This allowed them a comfortable retirement. The strongest and most important trait they share is devotion to family. They had lots of aunts, uncles and cousins…
Read more » Rates Up Lumps Down
Richard Connor | Nov 29, 2022
WE HAVE ALL BEEN affected by rising interest rates in 2022, from skyrocketing mortgage rates to plunging bond prices. A less-publicized casualty: Higher interest rates are having a big effect on those approaching retirement who are eligible for a pension. How so? Many pension plans offer a choice between a lifetime stream of monthly income and a onetime lump sum payment. Rising rates could reduce the lump sum payment that many employees would receive next year by 25% or 30%. My former employer’s pension plan offers a good example. It’s a final average pay plan that provides a lifetime monthly annuity payment at retirement, typically defined as age 65. The monthly income amount is based on three factors: an employee’s years of service, an accrual factor usually expressed as a percentage of annual pay and the employee’s average salary over his or her final three years of employment. In 2014, my company added a lump sum option to the pension plan. An employee could elect to get a large, onetime payment instead of a monthly annuity. We were told the plan would follow the IRS section 417e method and use the minimum interest rates. It turns out the calculation uses the time value of money. Specifically, the lump sum can be thought of as the amount you’d need to invest today, at a specified interest rate, to generate a stream of payments equal to or greater than the monthly annuity. The calculation uses an employee’s age to model his or her expected longevity. The critical factor, however, is the chosen interest rate. The higher the interest rate, the smaller the lump sum. This makes intuitive sense. If you can earn a higher rate of return on your money, you need less of an investment to generate a stream of payments equal to…
Read more » Pay as You Leave
Richard Connor | Aug 6, 2021
MY BROTHER AND sister-in-law are approaching retirement age and will likely relocate so they can be nearer their children. The last time they sold a house, it took more than a year to find a buyer. But they’ve spent time and money fixing up their current home, and it’d likely sell quickly, especially in today’s hot real estate market. Their thought: Why not sell now, and then rent for a few years until they retire and move? That possibility raised a key question: Would the sale of their home be taxable? It’s an issue that confuses many. The Taxpayer Relief Act of 1997 created a permanent capital-gains exclusion for those selling their main home. Today, the tax code provides a $250,000 exclusion on the sale of a primary residence for tax filers who are single and a $500,000 exclusion for those married filing jointly. IRS Publication 523 provides detailed explanations and instructions—and it does a good job of making the topic understandable. Want to know more? Here’s a look at four key questions: 1. Are you eligible? To qualify for the exclusion, you must pass an ownership test, a residency (or use) test and a look back test. The quick answer: To be eligible, you must have owned and used your home as your main residence for a period totaling at least two years out of the five years prior to the date of sale. In addition, there’s a look back test, meaning you can’t have used the exclusion in the last two years. There are some exceptions to the eligibility test for divorce, death and military or government service. Under certain circumstances, you may be eligible for a partial exclusion. These circumstances include a work-related move, a health-related move or unforeseeable circumstances. 2. Do you have a gain? To determine…
Read more » Making Your Claim
Richard Connor | Feb 16, 2022
THE SOCIAL SECURITY claiming decision is one of the most complex—and contentious—choices that retirees have to make. I was reminded of that in December, while at a Christmas party. Two former colleagues were discussing their Social Security decision. Both are male, single, childless, retired engineers. Each has a traditional pension, a paid-off home and significant retirement savings. Ted is age 77. Fred is 66. Ted took his Social Security at 62. His reason was longevity or, rather, the lack thereof. He had been a smoker for many years. He calculated his breakeven age as 77, at which point he would get back as much as he’d paid into the system. He decided to collect a lower benefit as early as allowed and then invest the money. Ted lives frugally, and will leave a handsome legacy to his nieces and nephews. Fred is waiting until age 70 to collect. He’s in generally good health, and family history suggests he could live a long life. Although retired, he does some consulting for his former employer. It provides mental stimulation, while covering the extras—travel, electronics, cigars, wine—in his budget. If you're younger than your full Social Security retirement age, which is 66 or 67, depending on the year you were born, Social Security has rules limiting how much you can receive if you're also earning an income. Since Fred hasn’t yet reached his full retirement age, his benefit would be reduced if he claimed early. That was another reason he decided to wait. In short, here we have two retirees in fairly similar situations who made entirely different choices based on their circumstances. Still, unlike many retirees, they’re fortunate: Both have the financial wherewithal to make taking Social Security an option, not a necessity. Many retirees have no choice but to start Social Security as soon…
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