3 Reasons to Consider a Roth IRA Conversion

By ROB WILLIAMS

MAY 11, 2018

Does it ever make sense to pay taxes on retirement savings sooner rather than later? When it comes to a Roth Individual Retirement Account (IRA), the answer could be yes.

That’s because, although a Roth IRA is funded with after-tax dollars, qualified withdrawals are entirely tax-free.1 What’s more, Roth IRAs aren’t subject to the required minimum distributions (RMDs) the IRS mandates you take from most other retirement accounts once you reach age 70½, giving you greater control over your taxable income in retirement.

The hitch is that you can’t contribute to a Roth IRA in 2018 if your income equals or exceeds certain limits ($135,000 for single filers and $199,000 for married couples filing jointly). But there’s a workaround: A Roth IRA conversion allows anyone, regardless of income level, to convert existing IRA funds to a Roth IRA.

Should you convert to a Roth?

You must pay income taxes on any converted funds in the year of the conversion, but there are three scenarios in which that might be to your advantage:

1. You believe your tax bracket will be higher in retirement: In this scenario, paying taxes at your current tax rate is preferential to paying a higher rate after you’ve stopped working. This may sound far-fetched, but it isn’t particularly difficult to do, especially if you haven’t yet hit your peak earning years or you’ve accumulated significant savings in your retirement accounts.

2. You want to maximize your estate for your heirs: If you don’t need to tap your IRA funds during your lifetime, converting to a Roth allows your savings to grow undiminished by RMDs, potentially leaving more for your heirs-who will also benefit from tax-free withdrawals during their lifetimes.

That said, the decision to convert to a Roth IRA doesn’t have to be all or nothing. You may find dividing your savings among Roth and traditional IRA and/or a Roth and traditional 401(k) is the optimal solution.

How do you convert to a Roth IRA?

If you do decide a Roth IRA conversion is right for you, you’ll need to determine two things:

1. When to execute the conversion: If you have a significant balance in your traditional IRA, you may want to carry out multiple Roth IRA conversions over several years. For example, you might convert just enough to keep yourself from being catapulted into the next tax bracket. If done properly, a multiyear approach could allow you to convert a large portion of your savings to a Roth while limiting the tax impact. Early in retirement-when your earned income drops but before RMDs kick in-can be an especially good time to implement this strategy.

2. How you’ll pay the resulting tax bill: Ideally, you’d have cash on hand outside your IRA to pay the income tax on any converted funds—for several reasons:

  • Any IRA money used to pay taxes won’t be accumulating gains tax-free for retirement, undermining the very purpose of a Roth IRA conversion.
  • If you sell appreciated assets to pay the conversion tax, capital-gains taxes could further undermine the benefits of a conversion. Plus, if you’re under 591/2 and withdraw money from a tax-deferred account, you’ll incur a 10% federal penalty (state penalties may also apply).

In short, converting to a Roth IRA can give you the potential to cut your tax bill in retirement, but be sure to consult a qualified tax advisor and financial planner before making the move.

1 Qualified distributions are those that occur at least five years after the account is established. At least one of the following conditions must also be met: the account holder is 59½ or older at the time of withdrawal; the account holder is permanently disabled; distributed assets (up to $10,000) are used toward the purchase or rebuilding of a first home for the account holder or a qualified family member; or withdrawals are made by the account beneficiary after the holder’s death.

Important Disclosures

This information is not intended to be a substitute for specific individualized tax, legal or investment-planning advice. Where specific advice is necessary or appropriate, Schwab recommends that you consult with a qualified tax advisor, CPA, financial planner or investment manager.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness and reliability cannot be guaranteed.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(0518-8N8V)

Roth vs Traditional IRAs: Which Is Right for Your Retirement?

By ROB WILLIAMS

MARCH 01, 2018

Both traditional and Roth IRAs can be effective retirement savings tools, but eligibility limitations mean one or both may not be right for you. Here’s a guide to help you choose.

What’s the difference between a traditional and Roth IRA?

A traditional IRA is an individual retirement account that allows you to make contributions on a pre-tax basis (if your income is below a certain level) and pay no taxes until you withdraw the money.¹ This makes traditional IRAs an attractive option for investors who expect to be in a lower tax bracket during retirement than they are now.

On the other hand, Roth IRA contributions are made with after-tax dollars. The benefit of a Roth IRA is that you can withdraw your contributions and earnings tax-free after 59½, if you’ve had the account for at least five years, or you meet certain other conditions.²  In addition, your after-tax contributions to the Roth account can be withdrawn at any time, tax and penalty-free (however, if you make an early withdrawal of any earnings you will have to pay taxes and penalties on them).

This makes a Roth an attractive option for investors who expect to be in a higher tax bracket during retirement than they are now. A Roth IRA can also offer some spending flexibility in retirement, as money can be withdrawn without increasing your tax bill and you won’t have to take annual required minimum distributions (RMDs) after you turn 70½.

How much can I contribute?

For the 2017 and 2018 tax years, the maximum amount you can contribute to a traditional or Roth IRA is $5,500 ($6,500 if you’re age 50 or older). However, there are some rules that affect IRA contributions and deductibility. Here’s an overview:

Traditional IRA

There is no income limit for contributing to a traditional IRA, and the contribution is fully deductible if neither you nor your spouse was covered by a retirement plan at work during the tax year. However, if either of you was covered by a workplace retirement plan, deductibility phases out depending on your filing status and income:

Source: Internal Revenue Service

Roth IRA

Roth IRA contributions are made with after-tax dollars. You can contribute to a Roth IRA only if your income meets certain limits:

Source: Internal Revenue Service

So if you do qualify for a traditional IRA (with the ability to deduct contributions) and a Roth IRA, how do you choose between them? Here are thoughts and guidelines to help you make a decision:

If you think your tax bracket will be higher when you retire than it is today, you should probably consider a Roth IRA—especially if you’re a younger worker who has yet to reach your peak earning years.

Roth and traditional IRA, now and in retirement

Note: Calculations assume a $5,000 starting pretax contribution in the deductible IRA and a $3,750 post-tax contribution, at a 25% tax rate, in the Roth IRA. The hypothetical examples assume a 6.5% average annual return over 25 years. The traditional deductible IRA taxes at withdrawal are a based on a 30%, 25%, and 20% marginal income tax rate.

  • If you think your tax bracket will be lower when you retire, you may be better off taking the up-front deduction of a traditional IRA. If you think your tax bracket will be the same when you retire, it’s almost a wash for income tax purposes. However, you aren’t subject to RMDs with a Roth, and if you leave it behind when you die, your heirs can stretch out their own tax-free withdrawals. A Roth IRA can also be a flexible source of retirement funding: You can withdraw a large sum, if you have a large one-time expense or other needs in retirement, without increasing your tax bill. Allocating a portion of your retirement savings to a Roth can increase the flexibility you have to manage taxes in retirement.

    Another advantage of a Roth IRA is that contributions may be withdrawn any time for any purpose without tax or penalty. However, just because you can do this doesn’t mean you should. The opportunity costs are high—taking money out of your Roth IRA means you may miss out on compounding interest. When you can put in only $5,500 for 2018, plus an additional $1,000 “catch-up” contribution if you’re age 50 or older, taking out previous contributions may be hard—or even impossible—to make up.

Direct rollovers

If you change jobs, you have the option to convert a traditional 401(k) directly into a Roth IRA without having to roll it into a traditional IRA first. Just remember you must pay federal income tax on pretax contributions and earnings at the time of the rollover. Also, remember that you have other options, including keeping your assets in your former employer’s plan, rolling over assets to your new employer’s plan, or taking a cash distribution (on which taxes and possible withdrawal penalties may apply).

Roth 401(k)

An increasing number of employers are offering Roth 401(k) options in addition to traditional 401(k)s. With a Roth 401(k), you can contribute a portion or all of your paycheck up to certain limits. You can also choose to have some of your paycheck go pre-tax into a traditional 401(k) and some post-tax into a Roth 401(k). Any employer match or contribution, however, must go into a traditional 401(k).

Unlike Roth IRAs, Roth 401(k) contributions are not subject to earnings limits. This means that if you aren’t eligible to contribute to a Roth IRA because your income is too high, you may be able to contribute to a Roth 401(k). Distributions from a Roth 401(k) are subject to the same general tax rules as a Roth IRA, with exception of an RMD requirement starting at age 70 ½. You can avoid this by rolling over a Roth 401(k) balance into a Roth IRA. So if you’re eligible, don’t forget the Roth 401(k) option if a Roth makes sense to you.

Roth IRA conversions

If you’re ineligible for a Roth IRA, some investors maximize contributions to a traditional IRA so you can convert to a Roth. However, there are some caveats:

You can’t pick and choose which portion of traditional IRA money is converted. The IRS looks at all traditional IRAs as one when it comes to distributions (including Roth conversions). Traditional IRA balances are aggregated so that the amount converted consists of a prorated portion of taxable and nontaxable money. So making nondeductible contributions to a traditional IRA with the goal of later converting to a Roth IRA would likely work best if you have little or no existing deductible IRA balance to muddy the waters. Still, any earnings leading up to conversion would be subject to income tax (which, as always, is best paid from outside funds).

High earners not eligible to make Roth contributions could make nondeductible contributions to a traditional IRA and then convert to a Roth (sometimes called a “backdoor Roth conversion”). The process is similar to any other Roth conversion, but typically takes place very soon after contributing funds to a traditional IRA. There is some debate among tax professionals about whether doing this conversion immediately or repeatedly could be outside Congressional intent when they changed the Roth conversion law in 2010.

The IRS has not formally weighed in on this topic, so be aware that there may be some risks to this strategy. If the IRS decides to question the conversion, you may owe a 6% tax or other taxes for overfunding your Roth. For some investors, this type of Roth conversion could be a viable way to obtain the benefits of tax-free growth, so long as they’re comfortable with the potential uncertainty, and work with a certified public accountant (CPA) or tax professional. If your employer offers it, you might also choose to make a contribution to a Roth 401(k). These have no earnings limits and have higher contribution limits.

The bottom line

A Roth IRA can be a great long-term savings tool, so try to take advantage of these rules if you can. Just remember that tax laws are subject to change, so check out the IRS’s Latest News page regularly for important updates. Also, be sure to talk with your accountant or other professional tax advisor about whether a Roth IRA makes sense for you.

¹ If you withdraw money from a traditional IRA before age 59½, your deductible contributions and earnings (including dividends, interest, and capital gains) will be taxed as ordinary income. You may also be subject to a  10% penalty on early withdrawals, and a state tax penalty may also apply. Consult IRS rules before contributing to or withdrawing money from a traditional IRA.

² If you take a distribution of Roth IRA earnings before you reach age 59½ and before the account is five years old, the earnings may be subject to taxes and penalties. You may be able to avoid penalties (but not taxes) in certain situations. If you’re older than 59½ but haven’t met the five-year holding requirement, your earnings may be subject to taxes but not penalties. If you’re under age 59½ and your Roth IRA has been open five years or more, you may be able to avoid taxes on the earnings in certain situations. Consult IRS rules before contributing to or withdrawing money from a Roth IRA.

Important Disclosures

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, or legal, tax, or investment advice, or a legal opinion. Individuals should contact their own professional tax advisors or other professionals to help answer questions about specific situations or needs prior to taking any action based upon this information.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The type of securities and accounts mentioned may not be suitable for everyone.

Investing involves risk, including loss of principal.

Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed.

A rollover of retirement plan assets to an IRA is not your only option. Carefully consider all of your available options which may include but not be limited to keeping your assets in your former employer’s plan; rolling over assets to a new employer’s plan; or taking a cash distribution (taxes and possible withdrawal penalties may apply). Prior to a decision, be sure to understand the benefits and limitations of your available options and consider factors such as differences in investment related expenses, plan or account fees, available investment options, distribution options, legal and creditor protections, the availability of loan provisions, tax treatment, and other concerns specific to your individual circumstances.

When a participant rolls a Roth 401(k) balance to a new Roth IRA, the five‐year qualification period starts over. This may impact the rollover decision. If the participant has an established Roth IRA, then the qualification period is calculated from the initial deposit into the IRA and the rollover will be eligible for tax‐free withdrawals when that five‐year period has ended (and the age qualifier has been met).

Each Roth conversion has a separate five-year holding period for determining withdrawal penalties.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(1117-7B83)

Are HSAs the New IRAs?

FEBRUARY 16, 2018

Like Flexible Spending Accounts (FSAs), HSAs allow you to set aside funds to pay out-of-pocket medical expenses. Unlike FSAs, HSAs can help those in high-deductible health plans1 sock away triple-tax-free money for retirement. Here’s how:

  • Contributions to HSAs are tax-deductible.2
  • Capital gains, dividends and interest accumulate tax-free.3
  • You pay no tax on withdrawals for approved medical expenses.
  • And whereas an FSA is attached to your employer and you forfeit any unspent money at the end of the year, an HSA is yours even if you change jobs and you can keep the money all the way into retirement (though you can no longer contribute once you’ve enrolled in Medicare).

“It’s really a unique opportunity to use a highly tax-advantaged strategy for retirement,” says Robert G. Aruldoss, a senior financial planning analyst at the Schwab Center for Financial Research.

A recent report from HealthView Services estimates that the average lifetime out-of-pocket health care costs for a 65-year-old healthy couple that retired in 2015 will be $394,954.4 Fortunately, HSA-qualified expenses include co-insurance, deductibles, dental and vision care, prescriptions and many other items not covered by Medicare.

And here’s the clincher: If you use HSA funds on nonmedical expenses before age 65, you pay not only ordinary income tax but also a 20% penalty; however, if you use HSA funds for nonmedical expenses after age 65, you pay only ordinary income tax. In other words, you’d take no worse a tax hit than you would with an Individual Retirement Account.

The bottom line: HSAs can help boost your retirement savings for health-related expenses triple-tax-free.

1Defined as those with a minimum annual deductible of $1,300 for individuals and $2,600 for families. Enrollees can’t be enrolled in Medicare, claimed as a dependent on someone else’s tax return or covered by another health plan without a high deductible.

2While HSA contributions are exempt from federal income tax, they are not exempt from state taxes in Alabama, California, New Jersey and Wisconsin.

3State taxes may vary.

42015 Retirement Health Care Costs Data Report.

Important Disclosures

This information is not intended 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.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness or reliability cannot be guaranteed.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(0817-XGJF)

Which IRA Is Right for You?

FEBRUARY 16, 2018

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness or reliability cannot be guaranteed.

This information is not intended to be a substitute for specific individualized tax, legal, estate-planning or investment-planning advice. Where specific advice is necessary or appropriate, Schwab recommends consultation with a qualified tax advisor, CPA, financial planner, attorney or investment manager.

Investing involves risk, including loss of principal.

(0218-7249)

Saving for Retirement: IRA vs. 401(k)

By ROB WILLIAMS

FEBRUARY 15, 2018

Not too long ago, retirement probably seemed simpler—if your employer offered a pension as part of your retirement plan, when you retired in good standing, you’d start to collect a pension check.

The world today for retirees has changed. Most workers are being asked to participate in and contribute to their own retirement plans, and traditional defined-benefit pension plans are on the decline. While Social Security is a valuable resource, if you’re a saver and investor, you likely don’t expect that Social Security alone will provide the majority of what you hope to spend in retirement.

As a result, your ability to save and invest while you’re working will likely play a significant role in your financial life in retirement.

Getting started

The first step is recognizing the need to save for retirement. Follow this with a disciplined, prudent retirement plan, starting with monthly savings, if possible. To get into the numbers, you can use a retirement calculator or, even better, a financial plan. But either way, start saving now.

Retirement workhorses: IRAs and 401(k)s

Your main workhorses for retirement savings may be a 401(k), 403(b), 457 or other qualified employer plan along with an IRA or other non-employer account, depending on your employment status and what your workplace offers. Which should you choose?

You can always start by putting money in a traditional IRA or Roth IRA, if your employer doesn’t offer a retirement plan. But if you have access to a 401(k) or other employer plan, and your employer offers a matching contribution, that’s usually the best place to start.

For example: Let’s say you make $100,000 per year. Your employer matches your 401(k) contributions dollar-for-dollar up to 6% of your salary. In this case, the first $6,000 of savings you earmark to retirement should go into your 401(k) plan. Your employer will add money, up to the employer match, if they offer it. Why give up free money?

After you fund your 401(k) to the match, you can still set aside more money using tax advantaged accounts—including additional contributions into your 401(k) or other employer-sponsored account, or into a traditional or Roth IRA—up to annual limits (as shown in the table below). For most people, if you have a 401(k) through your employer, you should continue to contribute, as much as you can afford or calculate you need to save, up to the annual limit.

One of the convenient features of a 401(k) or other employer-sponsored plan is you commit to a savings rate, then the amount is deducted automatically from each paycheck. This can help keep you from “missing” the money or changing your savings plan.

2018 contribution limits for selected tax-deferred accounts

IRA vs. Roth IRA

If you don’t have access to an employer sponsored plan like a 401(k), or if you max out contributions up to the annual limit in your 401(k) and want to save more, here are possible next steps:

  • If you’re under age 50 and eligible to make a deductible contribution to a traditional IRA, consider putting your first $5,500 there—especially if you expect to be in the same or lower income tax bracket in retirement when you take withdrawals.¹
  • If you’re under age 50 and not eligible to make a deductible contribution to a traditional IRA but you’re eligible for a Roth IRA, consider putting your $5,500 into a Roth.2 Contributions come from after-tax dollars and qualified withdrawals are income tax-free as long as you’ve held the account for at least five years. If you’re in a higher tax bracket when you make your withdrawals, the Roth would be especially attractive. Ending up in the same bracket would mean a wash for income tax purposes—but a Roth IRA has other advantages. Individuals 50 and over are eligible to make a $1,000 catch up.

    A Roth IRA doesn’t force you to take required minimum distributions at age 70½, as you’d have to do with a qualified employer plan or traditional IRA. That’s an advantage in terms of letting your Roth IRA continue to grow tax-deferred in your later years. It could also benefit your heirs, who’d be able take money out income tax-free after you’re gone.

The Roth 401(k)

More and more employers are making a Roth option available to 401(k) plans. A Roth 401(k) account works much like a Roth IRA, but there is no income limit to participate, and you are required to take the minimum distributions that would be required from a traditional IRA beginning at age 70½. There are also Roth versions of the 403(b) and 457 plans.

Eligible employees can contribute up to the 2018 contribution limit of $18,500 per individual, plus an additional $6,000 catch-up contribution for those 50 or older. Also, the balance from a Roth 401(k) can be rolled over directly into a regular Roth IRA when you leave the employer.

Assuming your employer offers the option, the choice of a Roth 401(k) could make sense if you think your tax bracket will be the same or higher in retirement, or if you want flexibility and diversification in the way distributions from your retirement accounts will be taxed when you reach retirement.

If you’re in a lower bracket when you retire, then a traditional 401(k) may end up being the better choice, depending on your situation.

One way to hedge against uncertainty about future tax rates or your tax situation may be to split your contributions between the traditional option and the Roth option, assuming your employer makes both available.

What if I’ve maxed out my 401(k) and IRA limits?

If you’ve maxed out your 401(k) and whatever IRA option makes the most sense, congratulations. You’re making significant steps to save for retirement.

Here’s where to go with those extra retirement dollars:

  • Regular brokerage account. Additional savings can go directly into brokerage account. While traditional brokerage accounts don’t offer the advantage of “tax-deferral” on investment earnings, remember, many types of investment earnings – such as long- term capital gains on stocks held for more than one year, qualified dividends, and municipal bonds – can also be relatively tax-efficient. Consider tax-efficient investing in “taxable” brokerage accounts if possible.
  • Nondeductible contribution to a traditional IRA. Even if you’re covered by an employer plan and you’re above the income limit for a Roth IRA3 or a deductible contribution to a traditional IRA,4 you can make a nondeductible (i.e. post-tax) contribution to a traditional IRA. Whether you should or not is a tough call. You receive no up-front deduction. And any earnings will be taxed as ordinary income when you withdraw them. So, in the end, a regular brokerage account, holding tax-efficient investments such as stocks held for the long-term, may be more advantageous in the end. The advantage of tax-deferral rests primarily on the potential for tax-deferred compounding.

The bottom line

If you haven’t begun to save for retirement—or you’re saving less than you should—what are you waiting for? Now that you know more about which retirement accounts may make the most sense, put your savings plan into action.

1 $6,500 if you’re 50 or older at any time in 2018.

2 $6,500 if you’re 50 or older at any time in 2018.

3 For 2018, you can contribute the maximum to a Roth IRA if your adjusted gross income (AGI) is at or below $120,000 for single filers and $189,000 for married couples filing jointly. You can contribute a reduced amount if your income is more than $120,000 but less than $135,000 for single files and more than $189,000 but less than $199,000 for married couples filing jointly.

4 A traditional IRA contribution for 2018 is fully deductible for single filers who are covered by a retirement plan at work with a modified AGI of $62,000 or below. For married couples filing jointly, the phase-out range for deductibility is between $99,000–$119,000.

Important Disclosures

Withdrawals prior to age 59 ½ from a qualified plan, IRA may be subject to a 10% federal tax penalty. Withdrawals of earning within the first five years of the initial contribution creating a Roth IRA may also be subject to a 10% federal tax penalty.

The information provided here, as of tax year 2018, is for general informational purposes only, and should not be considered an individualized recommendation or personalized investment, legal, or tax advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. Where specific legal, tax, or investment advice is necessary or appropriate, Schwab recommends that you consult with a qualified tax advisor, CPA, financial planner, or investment manager.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk including loss of principal.

Tax‐exempt bonds are not necessarily a suitable investment for all persons. Information related to a security’s tax‐exempt status (federal and in‐state) is obtained from third‐parties and Schwab does not guarantee its accuracy. Tax‐exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

A rollover of retirement plan assets to an IRA is not your only option. Carefully consider all of your available options which may include but not be limited to keeping your assets in your former employer’s plan; rolling over assets to a new employer’s plan; or taking a cash distribution (taxes and possible withdrawal penalties may apply). Prior to a decision, be sure to understand the benefits and limitations of your available options and consider factors such as differences in investment related expenses, plan or account fees, available investment options, distribution options, legal and creditor protections, the availability of loan provisions, tax treatment, and other concerns specific to your individual circumstances.

(0218-8UFJ)

Income Too High for a Roth IRA? Try These Alternatives

JANUARY 25, 2018

High earners may have a variety of options for saving for retirement—but income limits mean direct contributions to Roth IRAs generally aren’t among them. This is unfortunate because Roth IRAs offer tax-free earnings growth and withdrawals in retirement, making them a potentially valuable part of a broader investing and tax-planning strategy. Having both traditional and Roth accounts can help with tax diversification in retirement.

That doesn’t mean you don’t have other options for making your retirement savings plan more tax efficient. Your income doesn’t have to be a barrier. Here are some things to consider.

Are you getting the most from your 401(k)s?

Maxing out contributions to a traditional 401(k) is a good place to start. Such accounts have no significant income limits, so that shouldn’t be a constraint. Earnings will grow on a tax-deferred basis, though distributions in retirement will create future tax liability.

If your employer also offers access to a Roth 401(k), then you could consider using one to set aside at least some post-tax retirement savings. The good news here is that like their traditional counterparts, Roth 401(k)s don’t have strict income limits. As with a Roth IRA, you make Roth 401(k) contributions after taxes. Your earnings grow tax-free, and you pay no taxes when you take withdrawals in retirement.

Note that the annual contribution limit applies across all of your 401(k) accounts. For example, in 2018 contributions are capped at a combined $18,500 ($24,500 for those 50 and older), meaning you could consider contributing up to the maximum to between both a 401(k) and a Roth (401)k.

Consider a Roth conversion

Converting some or all of the funds in a traditional IRA into a Roth IRA is another option. This would mean paying tax on the converted funds up front and leaving them to grow tax-free for the future. This can make sense particularly if you expect to be in a higher tax bracket in the future than you are today and have a long time horizon.

Some advisors also see a so-called backdoor Roth IRA as another way to secure the tax perks provided by Roth accounts. It’s a unique—and for some tax advisors, controversial—strategy, but can work.

If you don’t already have a traditional IRA or rollover IRA, the backdoor Roth IRA route involves first opening a non-deductible traditional IRA and then at some point later converting it to a Roth account. How long you should wait is a matter of some debate as doing it too soon could cause complications with the IRS. The conversion would trigger income tax only on the portion of contributions that had grown in value since the initial funding. Once in the Roth IRA, the savings would compound tax-free.

If you already have a traditional IRA or rollover IRA, calculating your taxes can be more complicated. See The Backdoor Roth—Is It Right for You? for more details.

What about non-deductible IRAs?

Does it ever make sense to contribute to an IRA even if you can’t deduct the contributions? At the very least, you could still enjoy the potential for tax-deferred growth in the account.

“Think carefully before considering this option,” Rob Williams, managing director of financial planning at the Schwab Center for Financial Research, says. “You wouldn’t be getting any upfront tax break, and any future withdrawal of earnings would be taxed at your ordinary income tax rate.”

It’s possible that rate would actually be higher than what you would owe if you’d invested in a tax-efficient way in a regular taxable account. “With today’s low long-term capital gains and qualified dividend rates,  non-deductible contributions to a traditional IRA may make less sense,” says Rob.

Long-term capital gains are taxed at a maximum federal rate of 15% unless you’re in the top tax bracket (taxable income over $418,400 for singles, $470,700 for joint filers), in which case a 20% rate applies. A Medicare surtax of 3.8% on investment income for single filers with adjusted gross income over $200,000 ($250,000 for joint filers) may also apply, but even then the rate is still below the ordinary income tax rate .

Tax-efficient investing in a taxable account

There are other tax-efficient ways to invest in taxable accounts. Individual stocks, as well as most exchange-traded funds (ETFs) and index mutual funds, if you don’t trade often, can result in a lower tax bill.

You may owe only the long-term capital gains tax rate on earnings if you sell an investment at a gain, which is generally lower than the income tax rate. There may be some distributions along the way, but qualified dividends from stocks are taxed at the long-term capital gain tax rate, and ETFs and index funds can be managed tax-efficiently.

Having some money in taxable accounts can provide opportunities to reduce your tax bill by strategically harvesting losses. That’s not something you can do in your 401(k) or any IRA.

Saving in a taxable account could also help you achieve your estate planning goals. If you hold long-term investments in a traditional brokerage account, you can donate low-cost-basis securities to charity for a full fair market value deduction and no capital gains tax. You can also leave your appreciated shares to heirs who would receive a step-up in cost basis.

Finally, as noted above, having money in taxable accounts as well as tax-advantaged accounts can give you greater flexibility in managing your tax bracket as you plan your post-retirement cash flows. “This sort of tax diversification can be helpful, no matter your future tax rate,” says Rob.

Important Disclosures

For funds, investors should carefully consider information contained in the prospectus, including investment objectives, risks, charges and expenses. You can request a prospectus by calling Schwab at 800-435-4000. Please read the prospectus carefully before investing.

Investment returns will fluctuate and are subject to market volatility, so that an investor’s shares, when redeemed or sold, may be worth more or less than their original cost. Shares are bought and sold at market price, which may be higher or lower than the net asset value (NAV).

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

This information is not intended 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.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

(0118-8YCE)

The Backdoor Roth—Is It Right for You?

JANUARY 12, 2018

A Roth individual retirement account (IRA) would seem to be off limits for many higher-income earners, thanks to strict income caps on contributions to these accounts.

But some advisors suggest another way into a Roth—if you’re willing to take the backdoor route. By this method, you open a traditional IRA, make your desired contribution and then, at a later date, convert the funds to a Roth IRA.

Could it really be that easy to sidestep restrictions that have kept many investors from enjoying a Roth IRA’s tax advantages? This strategy has gained popularity with some higher-income earners, notes Rob Williams, managing director of financial planning at the Schwab Center for Financial Research. But the IRS hasn’t weighed in definitively on what’s allowed, so it’s helpful to understand some of the issues—and it’s highly recommended that you work with a professional accountant or tax advisor, Rob says.

The appeal and limitations of a Roth

With a Roth IRA, you get no up-front tax deduction, as you do with a traditional IRA, 401(k) retirement plan or other tax-deferred account. However:

  • You pay no tax on either principal or earnings when you withdraw your money (although you must be at least age 59½ and have had the Roth for five years).
  • There’s no time requirement on when you have to withdraw money, if ever—an appealing option for those wanting to leave the money to heirs.

The trouble has been, of course, that Roth IRAs technically are only available to those whose annual income is below certain levels. In 2018 those limits are:

  • $199,000 or less for married couples filing jointly
  • $135,000 or less for single filers

On the positive side, an increasing number of employers have added Roth options to 401(k) plans. You can choose this option and contribute post-tax payroll deductions into a Roth 401(k), with no income limits.

A two-step Roth conversion process

In 2010, Congress passed rules to provide more flexibility and allow retirement savers to convert savings held in a traditional IRA into a Roth IRA, paying taxes on the distributions when they make the conversion. Some higher-income earners use this approach, in a two-step process:

  1. Open a non-deductible traditional IRA and make after-tax contributions. For 2018, you’re allowed to contribute up to $5,500 ($6,500 if you’re age 50 or older). Make sure you file IRS Form 8606 every year you do this.
  2. Transfer the assets from the traditional IRA to a Roth IRA. You can make this transfer and conversion at any point in the future. Some advisors suggest waiting a few months.

Pay the tax due

The conversion triggers income tax on the appreciation of the after-tax contributions—but once in the Roth IRA, earnings compound tax-free. Distributions from the Roth IRA in the future are tax-free as well, as long as you are 59½ and have held the Roth for at least five years (note that each conversion amount is subject to its own five-year holding period as it relates to tax-free withdrawals).

If you have no other IRAs, figuring out your tax due will be simple. However, it can be more complicated if you have other IRAs. The IRS’ pro-rata rule requires you to include all of your traditional IRA assets—that means your IRAs funded with pretax (deductible) contributions as well as those funded with after-tax (nondeductible) contributions—when figuring the conversion’s taxes. Then, you pay a proportional amount of taxes on the original account’s pretax contributions and earnings.

Say you contribute $5,500 to a nondeductible traditional IRA. You also have a rollover IRA worth $94,500 from a previous 401(k) made with pretax contributions. In this case, 94.5% of any conversion would be taxable. Here’s the math:

  • Total value of both accounts = $100,000
  • Pretax contributions = $94,500
  • After-tax contribution: $5,500
  • $5,500÷$100,000 (expressed as percentage) = 5.5%
  • $5,500 (the amount converted) x 5.5% = $302.50 tax-free
  • $5,500 – $302.50 = $5,197.50 subject to income tax

Note: If your 401(k) allows you to “roll in” an IRA account, as some do, you can essentially take your existing IRA out of the conversion calculation.

The backdoor Roth may not last forever

Although this strategy has existed since 2010, the IRS has not officially commented or provided formal guidance on whether it violates the step-transaction rule. (When applied, this rule treats what are several different steps as if they were a single transaction for tax purposes.) Experts have mixed opinions on the likelihood of this happening, but the lack of a definitive ruling means there is some risk involved. If the IRS decides that the loophole is a violation, you could owe a 6% excise tax for overfunding your Roth.

If restrictions do come into play at some point, they could require backdoor Roth converters to pay a penalty or they might include a grandfather clause. In the meantime, it’s an option to consider.

Roth conversions generally can make sense, generally, for many higher-income investors with large amounts saved in traditional IRA or 401(k) accounts, Rob says. “Having investments in traditional brokerage accounts, IRAs, and Roth IRAs as well as 401(ks) can increase flexibility in retirement,” Rob says.

But Rob says if you use this backdoor Roth strategy solely to sidestep the earnings limits on Roth IRA contributions, you should be aware of the risks and seek the counsel and support of a tax professional.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

This information is not intended 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.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(1217-7RTA)

When Should You Take Social Security?

By ROB WILLIAMS

DECEMBER 15, 2017

Key Points

  • Taking Social Security benefits before you reach full retirement age may not be in your best interest.
  • We’ll cover Social Security benefit eligibility and factors to consider when deciding when to take Social Security.
  • The strategies for maximizing benefits can get complex—talk to your financial planner or tax professional if needed.

When you start receiving full Social Security retirement benefits is a key question for your retirement plans. The first thing to understand is that the concept of “full retirement age” is a moving target that depends on your birth year (see table below).

You can elect to take benefits as early as age 62 (or earlier if you are a survivor of another Social Security claimant or on disability), or wait until as late as age 70. There’s no “correct” claiming age for everybody. But, if you can afford to wait, starting Social Security later than age 62 can pay off over a long retirement.

Here we’ll take a look at some of the rules and guidelines.

What’s full retirement age?

Full retirement age (also known as normal retirement age) is when you’re eligible to receive full Social Security benefits. The full retirement age used to be 65 for everyone. That has changed.

Under current law, if you were born in 1951 or later, your full retirement age is now some point after age 65—all the way up to age 67 for those born after 1959. If you were born before 1951, you’ve already reached age 66 and full retirement age.

Retirement ages for full Social Security benefits

Source: ssa.gov

Your full benefit is reduced if you take Social Security early…

If you choose to start receiving your Social Security check up to 36 months before your full retirement age, be aware that your benefit is permanently reduced by five-ninths of 1% for each month. If you start more than 36 months before your full retirement age, the benefit is further reduced by five-twelfths of 1% per month, for the rest of retirement.

For example, if your full retirement age is 66 and you elect to start benefits at age 62, the reduced benefit calculation is based on 48 months. This means that the reduction for the first 36 months is 20% (five-ninths of 1% times 36) and 5% (five-twelfths of 1% times 12) for the remaining 12 months. Overall, your benefits would be permanently reduced by 25%.

Source: ssa.gov

… and you’ll get credit for delaying

If you retire sometime between your full retirement age and age 70, you typically get a credit. For example, say you were born in 1951 and your full retirement age is 66. If you started your benefits at age 68, you would receive a credit of 8% per year multiplied by two (the number of years you waited). This makes your benefit 16% higher than the amount you would have received at age 66.

That higher baseline lasts for the rest of your retirement, and serves as the basis for future increases linked to inflation. While it’s important to consider your personal circumstances—it’s not always possible to wait, particularly if you are in poor health or can’t afford to delay—the benefits of waiting can be significant.

Source: ssa.gov.

To review your situation, your annual Social Security statement will list your projected benefits at age 62, full retirement age, and age 70. If you need a copy of your annual statement, you can request one from the Social Security Administration (SSA).

If you feel like it will be difficult to wait, you’re not alone. Even though many people in good health would probably be better off in the long term by delaying benefits, more than two-thirds of eligible workers take Social Security early.1

Factors to consider

Consider the following factors as you decide when to take Social Security.

1. Your cash needs. If you’re contemplating early retirement and you have sufficient resources (adequate investments, a traditional pension, other sources of income), you can be flexible about when to take Social Security benefits. However, if you’ll need your Social Security benefits to make ends meet, you may have fewer options. If possible, you may want to consider postponing retirement or work part-time until you reach your full retirement age—or even longer so that you can maximize your benefits.

2. Your life expectancy and break-even age. Taking Social Security early reduces your benefits, but you’ll also receive monthly checks for a longer time. On the other hand, taking Social Security later results in fewer checks during your lifetime, but the credit for waiting means each check will be larger.

At what age will you break even and begin to come out ahead if you delay Social Security? The break-even age depends on the amount of your benefits and the assumptions you use to account for taxes and the opportunity cost of waiting (investment returns you could have made, inflation, etc.).

The SSA has several handy calculators you can use to estimate your own benefits. For example, if you’re a top wage earner turning 62 this year, then your break-even ages are as follows:

In this example, if you wait until age 66 to take Social Security instead of taking it at age 62, you’ll come out ahead as long as you live to at least age 77-78. The break-even age goes up the longer you wait. See the graph below for an illustration of sample break-even points.

Source: Estimates based on data from ssa.gov, shown in today’s dollars, using SSA’s Quick Calculator as of 10/31/2017 for a person born 5/1/1954, with earned income equal to or greater than the maximum Social Security wage base. The SAA calculator and table above does not include a cost of living adjustment. The chart above includes 2% annual cost of living adjustment to include that in the break-even calculation. Time value of money is not considered in the example.

Theoretically, it shouldn’t matter when you start to receive your checks, provided you have an average life expectancy. However, if you think you’ll beat the average life expectancy, then waiting for a larger monthly check might be a good deal. On the other hand, if you’re in poor health or have reason to believe you won’t beat the average life expectancy, you might decide to take what you can while you can.

While it may be tempting to look only at your break-even point and think about Social Security as a math equation or an investment decision, another approach may be to think about Social Security as a form of insurance.

Unlike conventional investments, Social Security isn’t affected by stock market changes, provides protection against inflation and is designed to pay out no matter how long you live. Social Security also provides guaranteed, inflation-adjusted income—which can be expensive and difficult to replicate with investments.

A quick note about life expectancy: According to the Social Security Administration, average life expectancy for a 65-year-old male is 84.3 years and 86.6 for females. Married individuals tend to live even longer, with a greater than average probability of at least one spouse living to age 90. To compute your own life expectancy, use the life expectancy calculator at SSA.gov.

Remember, though, that the average is just that—an average. If you have a shorter life expectancy than average, then early withdrawals might be a better option for you. If you don’t, starting Social Security later can be particularly beneficial if you live longer than average.

3. Your spouse. If you have a spouse covered by Social Security, you can explore additional strategies to maximize the benefits you receive between you. Start by taking your spouse’s age, health, and benefits into account, particularly if you’re the higher-earning spouse. The amount of survivor benefits for a lower-earning spouse could depend on the deceased, higher-earning spouse’s benefit—the bigger the higher-earning spouse’s benefit, the bigger the benefit for the surviving spouse.

Strategies for married couples

For spouses with equivalent work histories and life expectancy, it may make sense for both of them to delay their benefits up to age 70, if possible. In other cases, especially when there are material differences in work history, it might make sense for the lower-earning spouse to file earlier while the higher earner waits until age 70. This is called a 62/70 split strategy.

62/70 split strategy

With this strategy, the lower earner files early at age 62 (or at full retirement age) based on his or her own benefit. The higher earner later files at age 70.

When a lower-earning spouse files for benefits at age 62, the benefits are reduced based on the number of months before full retirement age.

  • If the higher earner has not yet filed, the reduced benefit will be based on the early filer’s own earnings record.
  • If the higher-earning spouse has already filed for benefits at his or her own full retirement age, the lower earner would receive an amount equal to 35% of the higher earner’s full retirement age benefit or their own benefit, whichever is greater.

Even though an early-filing penalty would still apply to any benefits the lower-earning spouse received before full retirement age (whether they’re calculated based on that spouse’s own earnings record or the higher-earning spouse’s record), in the event of the spouse’s death, the surviving spouse would be entitled to their own, or their spouse’s benefit, whichever is higher. In the meantime, the lower earner can still collect something while the higher earner waits until age 70 for their maximum benefit.

In the past, couples were allowed to use a strategy called “file and suspend,” under which the higher-earning spouse would file and suspend their benefit at full retirement age, and then wait until age 70 to start collecting, so their partner could claim a spousal benefit. However, that strategy is no longer permitted.

In addition, unless you turned 62 before Jan. 1, 2016, you can no longer file a “restricted application” to claim a spousal benefit. If you are grandfathered into this option, however, you can still consider it. Here’s how it works: At full retirement age the lower earner could file for his or her own benefit, while the higher earner would file a restricted application for spousal benefits. The higher earner would then wait until age 70 to switch to his or her own benefit, at which time the lower earner would switch to a spousal benefit, if higher than their own.

The process of trying to optimize your Social Security benefits over a joint lifespan can be complex. Talk with an advisor (such as a Schwab Financial Consultant) to provide an assessment and help with options.

4. Whether you’re still working. Earning a wage (or even self-employment income) can reduce your benefit temporarily if you take Social Security early. If you’re still working and you haven’t reached your full retirement age, $1 in benefits will be deducted for every $2 you earn above the annual limit ($16,920 in 2017).

The reduction falls to $1 in benefits deducted for every $3 you earn above a higher limit ($44,880 in 2017), deducted only for income earned before the month you reach your full retirement age in the year you reach your full retirement age. Starting the month you hit your full retirement age, your benefits are no longer reduced no matter how much you earn.

Again, any reduction in benefits due to the earnings test is only temporary. You receive the money back in the form of a higher benefit at full retirement age, so don’t use the reduction as the sole reason to cut back on working or worrying about earning too much.

Taxes on Social Security

Keep in mind that Social Security benefits may be taxable, depending on your modified adjusted gross income (MAGI), also known as “provisional” income. Your provisional income is equal to your adjusted gross income (AGI), plus non-taxable interest payments (e.g. interest payments on tax-exempt municipal bonds), plus half of your Social Security benefit. As your MAGI increases above a certain threshold (from earning a paycheck, for instance), more of your benefit is subject to income tax, up to a maximum of 85%. For help, talk with a CPA or tax professional.

In any case, if you’re still working, you may want to postpone Social Security either until you reach your full retirement age or until your earned income is less than the annual limit. In no situation should you postpone benefits past age 70.

For more information, see the SSA publication How Work Affects Your Benefits, and IRS Publication 915: Social Security and Equivalent Railroad Retirement Benefits.

Changing your mind

If you previously elected to receive early Social Security benefits at a reduced rate, but then change your mind, you have the option of paying back to the government what you’ve already received. After, you could restart benefits later to take advantage of a higher payout. But you can only do this for one year’s worth of benefits.

For example, let’s say you elected to receive early benefits at age 62, but then decided to go back to work at age 63. You could stop receiving Social Security, pay back the years’ worth of benefits you received, go back to work, and then wait until a later age to restart your benefit checks at a higher level.

For important details about repaying benefits please read the SSA publication If You Change Your Mind.

What about the future of Social Security?

Are you skeptical about the future of Social Security or wary of potential changes such as means testing—which could reduce or eliminate benefits for the wealthy—or an increase in the full retirement age? If so, you may be tempted to start benefits early, under the assumption that it’s better to have a bird in the hand than nothing.

The 2017 annual report from the Social Security Trustees projects that the Social Security Trust Fund has enough resources to cover all promised retirement benefits until 2035 without changing the current system. Over the longer term, changes such as later benefit dates or means testing (a reduction in benefits based on your other income sources) may be considered.

In any situation, if you’re particularly concerned about the future prospects for Social Security, that’s a good reason to save more, earlier, for your retirement.

To wait or not to wait? That is the question

The bottom line

If you have a choice and are in good health, think seriously about waiting as long as you can to take your benefits (but no later than age 70). For retirees in good health, a long retirement, coupled with uncertainty about markets and inflation, are the biggest risks. Delaying Social Security, if you can, is effectively an insurance policy against those challenges.

Your situation may differ, however, and there are many factors to consider. Get help from your financial planner if you need it.

1Source: OASDI (Old Age, Survivors and Disability Insurance) Monthly Statistics.

Important Disclosures

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The strategies mentioned here may not be suitable for everyone.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

This information is not intended 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.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

(1117-7T4J)

Should You Pay Off Your Mortgage Early, Before You Retire?

DECEMBER 04, 2017

Some people enjoy the peace of mind that comes with being debt-free in retirement. But warm and fuzzy feelings should be weighed against solid financial facts. Whether it makes sense to pay off your mortgage when—or before—you retire depends on your individual situation.

The interest rate on your mortgage may be the single biggest factor in this decision, according to Rob Williams, managing director of financial planning at the Schwab Center for Financial Research.

“If the rate on the mortgage is low, you might choose not to pay off a mortgage early,” he says. “It may be better to keep ahold of your cash, for liquidity, and diversify your assets.”

Rob says you should consider these factors when deciding whether to retire your mortgage or keep it:

Reasons to retire your mortgage

  • Limited or reduced income stream in retirement: Your monthly mortgage payment may represent a significant chunk of your income. Eliminating this payment can greatly reduce the amount of cash you need to meet monthly expenses. Ideally, you purchased a home that you could afford to pay off before retirement through the regularly scheduled mortgage payments. If not, you face a trade-off.
  • Savings on interest: Depending on the length of your mortgage term and the size of your debt, you may pay thousands or tens of thousands of dollars in interest. Paying off your mortgage early frees up that future money for other uses. While you would lose the mortgage interest tax deduction, the after-tax savings on the cost of the debt can still be substantial. Besides, as you get closer to paying off your loan, more of each monthly payment goes to principal and less to interest, so the amount you can deduct from taxes decreases.
  • A predictable return: While there’s a potential upside to keeping the loan and investing your money elsewhere, market fluctuations could curtail the gains on your investments—or even reduce their value. On the other hand, by no longer paying interest on your loan, paying it off can be like earning the equivalent risk-free return.
  • Peace of mind: For folks who feel it’s important to be debt-free, Rob acknowledges that the numbers aren’t everything. If you decide to pay off your mortgage before you retire, consider tapping funds from taxable accounts first, depending on the amount you need. “Withdrawals of pre-tax contributions and earnings from IRA or 401(k) accounts will be taxed as ordinary income in the year they’re withdrawn, reducing the effective savings on mortgage interest expense,” he says.

Reasons to keep your mortgage

  • Behind on retirement savings: If you haven’t contributed the maximum amount to your 401(k), IRA or other retirement accounts, and you’re still eligible to do so, this should be the first step. Savings in these accounts have an opportunity to grow without taxes on earnings until you withdraw them.
  • Higher-interest debt: Before you pay down the mortgage, use extra cash to pay off other kinds of debt that carry higher interest rates, especially non-deductible debt, such as credit card balances.
  • Lower cash reserves: The money you use to pay off your mortgage could significantly reduce the amount of cash you have available for general expenses, discretionary spending and emergencies. While you’re still working, Rob recommends you keep a cash reserve of up to six months’ worth of living expenses in an emergency fund. Make sure retiring your mortgage won’t hobble your ability to maintain a reserve. You don’t want to end up being “house rich and cash poor.”
  • Opportunity costs: While you don’t need to worry about volatility when paying off a mortgage, you risk losing out on potential gains you might have made by investing the money elsewhere. Just don’t get overly optimistic about your potential to generate above-market returns without taking a lot of risk. One simple way to determine if investing the funds is a better option than paying off the mortgage is by comparing the mortgage interest rate to the after-tax rate of return on a low-risk investment with a similar term—such as a high-quality, tax-free municipal bond. If the rate of return on such an investment is lower than the interest rate of your mortgage, reconsider investing those funds.
  • Diversifying your investments: If you do choose to invest, it’s best practice to hold a variety of investments in different asset classes, including stocks and bonds. Having a large chunk of your money tied up in your home could leave you inadequately diversified. Even if your house appreciates in value, you would have to either sell or refinance it to tap into that equity. And concentration of your nest egg in a few assets, even something that seems as stable as a home, comes with risks as well.
  • A possible move: If you contemplate moving in the next few years, you might as well carry the existing mortgage until then. If you downsize, you may have the cash you need to pay off the mortgage without tapping savings.

If your mortgage has no prepayment penalty, an alternative to paying it off entirely before you retire is paying down the principal. You can do this by making an extra principal payment each month or by sending in a partial lump sum. This tactic can save a significant amount of interest and pay off the loan much quicker while preserving liquidity and diversification. In some circumstances, refinancing with a lower interest rate may make sense.

The bottom line

Does it make sense to pay off your mortgage before you retire?

  • Do the math. A mortgage payoff calculator can help you weigh the facts and figures of your particular situation.
  • Think it through. Weigh the emotional impact as well as the financial facts. Paying off debt can bring peace of mind, but it may feel like a risk to part with the cash. Make a choice that makes sense to you, working with a financial planner to see how retiring a mortgage fits with the rest of your retirement plans.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

This information does not constitute and is not intended 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.

Tax-exempt bonds are not necessarily a suitable investment for all persons. Information related to a security’s tax-exempt status (federal and in-state) is obtained from third-parties and Schwab does not guarantee its accuracy. Tax-exempt income may be subject to the Alternative Minimum Tax (AMT). Capital appreciation from bond funds and discounted bonds may be subject to state or local taxes. Capital gains are not exempt from federal income tax.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(1217-7JXP)

Rethinking the 4% Retirement-Spending Rule

NOVEMBER 10, 2017

Faced with the prospect of outliving their savings, many retirees tend to be overly cautious, unnecessarily preserving wealth at the expense of a more comfortable and fulfilling retirement. Indeed, a recent study found that today’s retirees are so committed to pinching pennies that their portfolios are actually growing, rather than shrinking, as they enter their 80s.1

“Most people know how to save for retirement,” says Rob Williams, managing director of income planning at the Schwab Center for Financial Research, “but they often struggle with spending what they’ve saved.”

Rob notes that although many financial advisors tout the merits of the 4% rule—in which a retiree withdraws 4% of her or his assets in the first year of retirement, adjusting for inflation each year thereafter—there’s often a better way to go. “You want a plan that’s specific to your situation, not one that’s based on a generic rule of thumb,” he says. “You aren’t a math formula and neither is your retirement-spending plan.”

While those who expect to live well into their 80s or even 90s—or who wish to pass money on to their heirs—should aim for smaller withdrawals, those who are further along in retirement or otherwise less concerned with outlasting their savings may be able to live a bit larger (see “What’s your number?” below).

What’s your number?

Your time horizon should inform your withdrawal level.

Source: Schwab Center for Financial Research. Percentage withdrawal amounts are for a 75% level of confidence that funds will not be completely depleted over the given time horizon. Assumptions are based on a moderate-portfolio allocation. For illustrative purposes only.

No matter which withdrawal rate you land on, remember that you can always reassess, as necessary. “Even the most optimistic among us may need to adjust our plans from time to time to make our retirement savings last,” Rob says.

The bottom line: Make sure your retirement-spending plan is realistic—but not overly pessimistic.

1Ben Steverman, “Rich Retirees Are Hoarding Cash Out of Fear,” bloomberg.com, 05/16/2017.

Important Disclosures

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Confidence level is defined as the number of times a simulated portfolio ended up with a balance greater than zero, using forward-looking portfolio return projections and the spending rate.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness and reliability cannot be guaranteed.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

(1117-7C96)

Social Security: How Much Does It Pay to Wait?

NOVEMBER 10, 2017

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness or reliability cannot be guaranteed.

(1117-7B1V)

Structuring Your Retirement Portfolio

By ROB WILLIAMS

OCTOBER 25, 2017

According to the Social Security Administration, the average 65-year-old retiree can expect to live roughly 18–20½ years after leaving the workforce.1 However, with advances in health care leading to increasing longevity, it’s widely recommended that you plan for a retirement of 30 years or longer. Therefore, how you invest your savings in retirement is crucial.

The first aspect of our three-pronged approach to generating retirement income is creating a plan. After you’ve completed the planning stage, your next step should be to determine your portfolio allocation. Lastly, you’ll make a plan for withdrawing from your portfolio in retirement.

The portfolio allocation step is all about choosing the right mix of investments. Here’s a guide for how to approach it.

The key is staying invested—and that means having at least part of your portfolio allocated to stocks, but in the right balance with other investments.

1. Set aside one year of cash

Try to set aside enough cash—minus any regular income from rental properties, annuities, pensions, Social Security, investment income, etc.—to cover a year’s worth of retirement expenses. Ideally, this money would be held in a relatively safe, liquid account, such as an interest-bearing bank account, money market fund or short-term certificate of deposit (CD).

With this cash on hand, you won’t have to worry as much about the markets or a monthly paycheck. Spend from this account and replenish it periodically with funds from your invested portfolio. Then invest the rest of your portfolio sensibly.

2. Create a short-term reserve

Within your main portfolio, starting with accounts that you may need to tap soon, create a short-term reserve to cover withdrawals from your portfolio and help weather a prolonged market downturn—we recommend two to four years’ worth of living expenses, if you can. This short-term reserve will help prevent you from having to sell more volatile investments, like stocks, in a down market.

This money can be invested in high-quality, short-term fixed income investments, such as short-term bonds or bond funds. Or, if you’d rather manage individual investments, you might want to create a short-term CD or bond ladder—a strategy in which you invest in CDs or bonds with staggered maturity dates so that the proceeds can be collected at regular intervals. When the CDs or bonds mature, you can use the money to replenish your bank account.

3. Invest the rest of your portfolio

When it comes to your main portfolio, remember that your overarching goal is to create a mix of investments that work together to preserve capital, generate income and grow. Your specific mix of stock, bond and cash investments should be appropriate for your age, income needs, financial goals, time horizon and comfort with risk.

With a year’s worth of cash on hand and a short-term reserve in place, invest the remainder of your portfolio in investments that align with your goals and risk tolerance. For example, it’s perfectly acceptable to focus on growth in the early years of retirement in order to take advantage of potential compounding and boost your savings over time. As you move through retirement, you may want to shift to a more conservative investing approach that seeks to preserve capital and generate income.

What to do if you have an annuity

Many retirees use annuities to provide a steady paycheck that they won’t outlive, and to help protect part of their portfolios from market risk. If you have predictable income from any type of annuity, you may be comfortable reducing the balance in your cash account and short-term reserve, as well as investing the rest of your portfolio in stocks and bonds for growth potential.

Annuity guarantees are subject to the financial strength and claims-paying ability of the issuing insurance company.

Adapt your strategy over time

Here’s an example of how you might adjust your asset allocation throughout retirement, if you plan to use your portfolio including principal to support spending, rather than spending only your investment earnings and leaving your nest egg to your heirs.

Retirees who adopted this plan would have seen the following results in their portfolios*:

*Based on data collected from 1970 through 2016.

Source: Schwab Center for Financial Research with data provided by Morningstar, Inc. The return figures represent the best and worst total returns, as well as the compound average annual total returns, for the hypothetical asset allocation plans. The asset allocation plans are weighted averages of the performance of the indexes used to represent each asset class in the plans and are rebalanced annually. Returns include reinvestment of dividends and interest. The indexes representing each asset class are S&P 500® Index (large-cap stocks), Russell 2000® Index (small-cap stocks), MSCI EAFE® Net of Taxes (international stocks), Barclays U.S. Aggregate Bond Index (bonds) and Citigroup U.S. 3-month Treasury bills (cash investments). The conservative allocation is composed of 15% large-cap stocks, 5% international stocks, 50% bonds and 30% cash investments. The moderately conservative allocation is 25% large-cap stocks, 5% small-cap stocks, 10% international stocks, 50% bonds and 10% cash investments. The moderate allocation is 35% large-cap stocks, 10% small-cap stocks, 15% international stocks, 35% bonds and 5% cash investments. CRSP 6-8 was used for small-cap stocks prior to 1979, and Ibbotson U.S. 30-day Treasury Bill Index was used for cash investments prior to 1978.

The key is staying invested—and that means having at least part of your portfolio allocated to stocks, but in the right balance with other investments. Why? Over time, equities historically have been an adequate defense against inflation and taxes—even better than bonds and cash.2 However, as you get older, limit your exposure to stocks because there will be less time to recover from a bad year in the market.

1. Social Security Administration, Actuarial Life Table, 2014. The average life expectancy for a person age 65 is 17.84 years for males and 20.44 years for females.
2. Schwab Center for Financial Research.

Important Disclosures

Past performance is no guarantee of future results.

Investing involves risks, including loss of principal.

Asset allocation strategies do not ensure a profit and do not protect against losses in declining markets.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks, including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.

The Russell 2000 Index is a subset of the Russell 3000® Index, and includes approximately 2,000 of the smallest securities based on a combination of their market capitalization and current index membership.

The MSCI EAFE Index is a free float-adjusted market-capitalization-weighted index designed to measure the equity market performance of developed markets, excluding the United States and Canada. Net total return indexes reinvest dividends after the deduction of withholding taxes, using (for international indexes) a tax rate applicable to non-resident institutional investors who do not benefit from double taxation treaties.

The Barclays U.S. Aggregate Bond Index is made up of the Barclays Capital U.S. Government/Corporate Bond Index, Mortgage-Backed Securities Index, and Asset-Backed Securities Index, including securities that are of investment-grade quality or better, have at least one year to maturity and have an outstanding par value of at least $100 million.

CRSP 6-8 Index is a small-cap index created and maintained by the Center for Research in Security Prices (CRSP) at the University of Chicago’s Graduate School of Business.CRSP capitalization-based indexes include common stocks listed on the NYSE, AMEX and the NASDAQ National Market. The CRSP 6-8 Index refers to the 6th through the 8th deciles and represents a small-cap index that excludes micro-caps.

The Ibbotson U.S. 30-day Treasury Bill Index is an unweighted index that measures the performance of one-month maturity U.S. Treasury bills.

Indexes are unmanaged, do not incur management fees, costs or expenses, and cannot be invested in directly.

The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities and investment strategies mentioned may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation.

Charles Schwab & Co., Inc., a licensed insurance agency, distributes certain life insurance and annuity contracts that are issued by non-affiliated insurance companies. Not all products are available in all states.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

(1017-7VKS)

Planning for Retirement When You’re Single

OCTOBER 10, 2017

Whether or not you’re currently in a relationship, there’s a good chance that your second act could be a solo one. Some 36% of women and 19% of men over age 65 live alone, according to a 2014 Census Bureau report.

Of course, whether or not you have a partner, the usual planning basics apply: You need to save diligently, invest in a diversified portfolio, and maintain an emergency fund. “Those recommendations apply to any marital status,” says Rob Williams, managing director of financial planning at the Schwab Center for Financial Research.

Yet people who are single face additional challenges compared to their married peers. Among workers, 31% of unmarried men and just 19% of unmarried women say they feel very confident about their financial aspects in retirement, according to the 2016 Retirement Confidence Survey by the Employee Benefit Research Institute and Greenwald & Associates. And solo retirees are likely to confront specific hurdles, depending on whether they are divorced, recently widowed or simply don’t have a long-term partner. Here, some key considerations for each of those three situations:

When you’re newly divorced

So-called “gray divorces” are more commonplace nowadays: A quarter of new divorcees in the U.S. are 50 or older, according to 2013 research from Bowling Green State University. When a marriage ends as you’re approaching retirement, you may face the possibility of lower savings, higher expenses or a smaller income-or some combination of these.

For example, splitting from your partner may leave you with a larger housing payment-or require you to sell your home or other property. You might have to fork over a portion of your income or your retirement savings to your ex. Any of these issues could get your solo plan off to a rocky start. Some steps to take:

Revisit your savings and your timeline. Recalculate your retirement income based on the amount in your own accounts (especially if you’ve split them with your ex). Then add in your expected Social Security benefits: If you are age 62, unmarried and divorced from someone entitled to Social Security retirement or disability benefits, you may be eligible to receive benefits based on his or her record. You may not realize that even if your ex-spouse passes away, you may also be eligible to  a claim a widow’s benefit as early as age 60 if you are not disabled.

Now a hard question: Do you need to reconsider the age at which you’d planned to retire? Run the numbers again based on a later retirement age. “You might be surprised by how much your savings can increase if you work just a bit longer,” says Rich Johnson, a senior fellow at the Urban Institute.

Do a portfolio review. The stock/bond mix you created with your spouse may prove too aggressive or conservative for your solo savings goals-or for your personal risk tolerance. Now is a good time to bring these questions to the attention of a financial professional who can help you reassess your investment strategy based on your new circumstances.

A final note: Now that you’re single you’ll probably need to change beneficiaries on your retirement and brokerage accounts, and revise your estate plan.

If you’ve lost your spouse or partner

Like a divorce, bereavement typically entails adjustments on many fronts-but the grieving process (or the suddenness of the loss) can make managing a solo retirement even more complicated. The key issue here is managing both the emotional and financial demands of this transition: “Suddenly you’re the financial planner, property manager and insurance agent all in one,” says Bart Astor, author of AARP Roadmap for the Rest of Your Life.

Get help. There are multiple tasks when you have to reconfigure your future plans, but don’t expect to handle them all yourself, given all that’s at stake. You may want input from:

  • An attorney who can help with the probate process and your estate plan.
  • A CPA who can help you manage taxes.
  • A financial advisor who can help you assess everything from your portfolio allocation to how your goals may change (for example, your shared dream of retiring abroad may not appeal to you now).

Postpone big decisions. If you’ve received a lump-sum payout from life insurance or a retirement plan or pension, put the money in a high-yield savings account for the time being. Don’t make any major money decisions for at least six months. Instead, focus on the next steps, like filing the appropriate paperwork and managing your day-to-day expenses.

Take stock. Besides life insurance and your spouse’s 401(k) or IRA, you may be eligible to receive Social Security survivor benefits provided you were married for at least one year, in most cases. A divorced spouse must have been married 10 years to be eligible for an ex-spouse’s benefits. If you’ve inherited retirement funds, it may make sense to roll them over into your own tax-advantaged account.

When you’ve been single for a while

If you’ve been flying solo for some time, you’ve had the luxury of avoiding spousal squabbles about your plan. But longtime singles face specific hurdles around saving and having the right supports in place for the future.

Save more while you can. While married couples have the potential to save twice as much, they don’t typically spend twice what singles do. Even though your 401(k) and IRAs have the same limits as anyone else’s, your lifestyle needs could cost proportionally more. Living expenses when you’re solo aren’t necessarily 50% of a couple’s, as many basic life expenses—such as rent or mortgage payments—may remain relatively constant. And some tasks previously performed by a partner, whether household chores, financial tasks or caregiving, could lead to extra expenses when you’re alone. So be sure to take advantage of savings vehicles available to you, such as an IRA or 401(k), and make sure your current savings are in sync with your retirement goals.

Put the right legal documents in place. If you don’t have children or family that you trust to make financial decisions on your behalf, you must take steps to ensure that decisions about your health and money don’t wind up being made by a court if you become incapacitated. You may want to designate a trusted friend to make those decisions for you; just make sure you discuss your wishes with him or her first. Have an attorney draw up a will that spells out which people or charities will receive your assets after you pass away, and make sure the executor of the will knows how to get access to your accounts and other critical documents.

Fill the necessary roles. You’ll also want to name someone as your decision-maker for money and health needs via what’s called a springing power of attorney and a springing durable power of health care, which only take effect in the event of incapacity, says Schwab’s Rob Williams.

You may also want to consider purchasing long-term care insurance. It’s a big expense, particularly once you’re in your 50s or 60s, but it’s a smart option if you don’t have loved ones who can care for you.

Important Disclosures

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

This information is not intended 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.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(1017-7DMN)

Will You Have Enough for Retirement?

By ROB WILLIAMS

OCTOBER 05, 2017

Did you know that the vast majority of lottery winners blow through their money very quickly, some within just five years of their payday.1 Why? It’s simple: They fail to plan ahead.

Retirement savers face the same risk, though the average saver has far less at his disposal than lotto millionaires. Most of us understand that we need to save for retirement, and to do it, we’ve been diligently setting aside a portion of our income on a regular basis for years. But it’s far rarer—and no less important—to have a plan on how to convert savings into retirement income.

Creating income during retirement may sound daunting, but it doesn’t have to be. We recommend that you approach this challenge with three simple steps to help guide you into and through retirement: plan, allocate and distribute.

Here, we’ll take at a look at the first of these three steps: Planning.

Creating income during retirement may sound daunting, but it doesn’t have to be.

Your life, your plan

No two retirement plans are going to be the same. We each have different goals, resources and circumstances.

Your plan should encompass your vision for your retirement: what you want to do and what resources you will need to help you meet those goals. It should also involve an assessment of your savings and whether you will have outside income sources available.

Here are questions to ask yourself before you begin the planning process:

  • How do you see yourself spending time in retirement?
  • How much have you saved?
  • What future expenses are unavoidable?
  • How much do you expect to earn from a pension or Social Security?

With the answers in mind, you can move forward with the first part of retirement planning: determining whether your desired spending is achievable, given the amount you’ve saved.

How much will you need?

To evaluate whether you’ll have the money to maintain the standard of living you want, you first need to anticipate your annual spending.

One school of thought says you’ll need 75–80% of your current income. That’s based on the assumption that during retirement, certain costs—such as mortgage payments or work-related expenses like clothing and commuting—might decrease or go away. However, while some costs may be reduced, others, such as travel, entertainment and health care, may increase. Therefore, it might be safer to assume that you will need roughly the same level of annual income that you have now, minus the amount you currently save for retirement each year.

As an example, let’s take someone earning $100,000 a year and saving $10,000 for retirement. Based on the 75–80% school of thought, that person would anticipate spending between $75,000–80,000 a year in retirement. But it’s safer to assume that person will spend $90,000 annually—that is, $100,000 minus the $10,000 she is currently allocating to retirement savings.

How much can you afford to pay yourself?

Another approach is to create a more detailed budget, and more detail becomes more important as you near retirement. When you create a budget, we recommend you approach the process by breaking anticipated expenses into two groups: essential and discretionary.

Essential expenses are those you can’t do without, such as housing, food, clothing, utilities and health care. Discretionary expenses include travel, entertainment and gifts. Be sure to factor in taxes and extras, such as health care costs, long-term care and financial responsibilities to children or elderly parents. If you own your home, set aside a little extra for expenses like major appliance replacements, improvement projects and other major repairs that may occur during your retirement. You might also include known or planned future one-time expenses, such as travel early in retirement, or a large purchase.

Once you have an idea of how much you’ll spend, you can begin to calculate whether you’ll have the resources to sustain that level of spending. Before you do this, tally up all sources of income other than your portfolio, such as Social Security, pensions, rental income, etc. Then subtract that amount from your estimated expenses to determine how much of your income will come from your existing savings.

For example, let’s say you’re shooting for $90,000 in annual spending. Assuming that your non-portfolio income will amount to $30,000 per year, you will need $60,000 a year from your portfolio.

According to the Schwab Center for Financial Research, if your portfolio is roughly 25 times as large as the amount you withdraw from your portfolio in the first year of retirement, you can feel reasonably confident that your savings will last 30 years.2 So to generate the $90,000 in our example, you would need an aggregate portfolio of approximately $1.5 million ($60,000 x 25).

This is a general guideline. Another, even better approach, is to work with a financial planner to work with you through the steps above, and create your own personalized financial calculations and plan. As you near retirement, it’s a great time to discuss options and build your plan.

Ongoing planning

The planning stage can be revealing. While some investors will find themselves on target, others will discover that their current vision is out of sync with their savings. That’s never a welcome realization, but it does provide the incentive to think carefully about your spending or to delay retirement in order to bridge the gap.

It’s also important to remember that retirement income planning isn’t a one-time activity and a retirement plan isn’t a “set it and forget it” document. Rather, your retirement plan should be a working document that is reevaluated annually to account for any changing needs, preferences, spending, taxes, inflation, market conditions and life expectancy. For example, you might be comfortable spending a bit more early in retirement, if you think you’ll be able to reduce your spending later. It’s helpful to think about and talk with an advisor about alternatives as you create and regularly review your plan.

Savings falling short?

If you find that your current vision for retirement is not in sync with your savings, start thinking about different ways you can bring the two together.

Step up savings:

Take advantage of your full-earning years to put extra money away.

  • Contribute the maximum to your 401(k).
  • Consider opening and and funding an individual retirement account (IRA) with automatic monthly contributions.
  • Make additional catch-up contributions if you’re over 50.
  • Earmark bonuses, raises and tax refunds for retirement.
  • Consider opening a SEP-IRA if you’re self-employed.

Consider waiting:

Spend a few more years at your current job to help preserve savings.

  • Keeping your company health plan may reduce or eliminate the need for pricey private coverage before you’re eligible for Medicare.
  • Working longer may allow you to delay taking Social Security. You can begin collecting benefits as early as age 62, but your payment amounts will increase the longer you wait. You’ll get your highest monthly payments by starting to take Social Security at age 70.

Prioritize spending:

One of the most impactful things you can do to help your savings last is to prioritize and manage spending.

  • When creating your retirement budget, ask yourself which expenses are truly essential, and which are “nice to haves.”
  • To establish a comfort level with your current plan and spending rate, determine whether you’ll be able to change spending if necessary. Flexibility can have a major impact on your plan.

This may sound like a lot of work, but remember the story of the average lottery winner.  You only retire once, and the stakes in having a plan are even higher.  Following these steps will help guide you through the process so you can plan confidently.

1. Patt Morrison, “Lottery Winning 101: How to Not Blow $500 Million,” Southern California Public Radio, March 29, 2012.

2. This is a general estimate only. It is recommended that investors use a retirement plan calculator with Monte Carlo simulations for a more refined, customized estimate.

Important Disclosures

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

The information presented does not consider your particular investment objectives or financial situation and does not make personalized recommendations.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, please consult with a qualified tax advisor, CPA, financial planner or investment manager.

(1017-7VDL)

Go Ahead, Live a Little (and Still Keep Your Plan on Track)

OCTOBER 02, 2017

You’ve been doing the right thing for decades—saving for retirement and being financially responsible—all toward a good end. You’ll visit the grandkids more often, take that trip to Asia, everything you’ve been looking forward to for years.

But what about today? Is it possible to spend a little more freely now without throwing your future plans off track?

“It may be,” says Rob Williams, managing director of financial planning with the Schwab Center for Financial Research. “Remember that your money is ultimately meant to be spent.”

As long as you do a few calculations to gauge what you’ll need for the future, you might be able to enjoy more of your money sooner. These four steps will help you plan ahead.

Step 1: Think spending plan, not budget

To many people, the term “budget” implies what you can’t have. But the emphasis here is the opposite, Rob says. “Your spending plan tells you what luxuries you can afford.” Planning your expenditures seems less tedious when you focus on getting what you want.

Start by writing down and adding up your monthly outlays for necessities like your mortgage, utilities, basic groceries, insurance, taxes. Though it’s not always easy to distinguish needs from wants, try to figure out a monthly average for your truly essential expenditures. Then, looking through a year of bank and credit card statements, do the same for your discretionary expenditures—gifts, vacations, entertainment—any purchases you didn’t have to make.

Separating essential from discretionary spending allows you to reflect on how the spending choices you make affect your quality of life—and to identify any areas you’d like to change. Your basic living expenses should remain fairly predictable, but how (and how much) you use discretionary funds is ultimately up to you.

Step 2: Do a retirement projection

Retirement income typically consists of three things: Social Security, company pensions or retirement plans, and the income or sales proceeds generated by your investments. Start by finding out how much you (and your spouse, if you’re married) are likely to receive from Social Security, pensions and retirement accounts. Then compare that amount to your current total monthly expenses. The Social Security Administration offers a retirement estimator on its website, and your employer or retirement plan administrator may do the same.

For example, if you currently spend $8,000 a month and expect $4,000 from Social Security and pensions, your monthly gap in income amounts to $4,000 a month, or $48,000 a year, assuming your retirement lifestyle will mirror your current one. Will your savings be sufficient to cover that gap?

One rule of thumb is to multiply your gap—in this case, the $48,000 annually—by 25, which amounts to $1.2 million. If you’ve already saved that amount or are easily on track to do so, you should be in good shape. But if it looks like you’ll have a shortfall, consider adjusting your current retirement contributions to fill the gap before thinking about any additional discretionary spending.

You can also explore how much you need to save—and whether changes might be in order—with the Schwab retirement calculator.

Step 3: If you’re ahead of the curve, focus on happiness now

If you already have enough savings to pay for your future retirement, or you are definitely on track, you should feel comfortable spending more money sooner. You may even be able to redirect some of your retirement contributions. (Be careful not to overlook other long-term saving needs. You may want to check on college funds, too, for instance.)

These are personal decisions, Rob notes, but running the numbers as you did above could help you to identify a spending comfort zone—in other words, a sense of surplus you can use to enrich your life right now.

Now comes the fun part. What have you always wanted to do before retirement? You can safely use the “newly discovered” cash to make your dreams come true—or make up new ones that suit who you are now.

These aren’t just splurges; you might even view them as investments of a kind, because not all discretionary expenses provide equal returns. It’s one thing to commit $10,000 or $20,000 a year to taking great vacations, but what about exploring new skills or bringing the family together? Such experiences can pay different types of personal dividends.

If you’ve always wanted to buy a second home, a boat or a Corvette Stingray, however, be sure to consider unforeseen expenses they might incur. Purchases that come with ongoing costs like a mortgage, property taxes, slip fees, maintenance, insurance and so on could become more burdensome than beneficial. So before you go out on that limb, plug the full cost into your spending plan to ensure that it stays intact. If you’re still on solid ground, go for it.

Step 4: Revisit your plan annually

Life can be complicated, and over the course of the years, many things could affect your plans. A record year in the stock market could leave you with way more income than you expected. Or suppose your child gets married or has a baby—you’ll probably want to spend more than you anticipated.

Whatever happens, it’s a good idea to revisit your spending plan and projections once a year to make sure you’re on track. “Balancing your future goals with the need to live in the here and now is an ongoing process, not a one-time event,” Rob explains.

Naturally, if you are on course, the reassessment process is mainly an opportunity for you to plan how to spend your discretionary cash. It might be more painless than you expect. If you’re married, make it an annual date night. It might even turn out to be one of your favorite nights of the year.

Important Disclosures

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

(1017-7DN8)

Retiring Abroad? Financial Facts You Need to Know

SEPTEMBER 26, 2017

In recent years, many U.S. retirees have headed abroad. In 2016, about 400,000 retired Americans received their Social Security checks overseas—about a 30% increase from 2008. The exotic locales and a luxe standard of living for less are enticing. But as exciting as the dream may be, managing your money in another country is much more complex, notes Robert Aruldoss, senior financial planning research analyst at the Schwab Center for Financial Research.

When abroad, everything from buying real estate to paying taxes and managing your estate plan typically comes with a new set of rules (and more paperwork). Here’s what you need to know.

Investigate your new address

Before buying real estate, consider renting for a year to get oriented. Be sure to research forms of ownership and property titling for the country you’re interested in. For example, buying property in some countries could mean purchasing shares in a corporation. If you plan to sell the property later on, consider the rules and regulations that apply to selling. “Some countries restrict the transfer of cash or profits out of the country, so you’ll need to be extra prepared,” Robert notes.

You can find professionals through the American embassy or a nonprofit like American Citizens Abroad who can help with local real estate laws and rules on international currency transfers. Also, make sure to check the State Department website for visa and residency requirements. Finally, plan visits to your desired destination in different seasons to get a better sense of what you’ll experience when living there year-round.

You still have to file from foreign soil

Even if you’re no longer earning or living in the U.S., as a U.S. citizen you’re still required to file an annual tax return. No matter where you live, you’ll still owe taxes on your worldwide income—including traditional 401(k) and IRA withdrawals, taxable pensions, and other taxable income, no matter the source. This extends to up to 85% of your Social Security benefits, depending on your income level. Also, if you have income sourced from your home state—from a business or rental property, for example—you may owe state taxes.

With the passage of the 2010 Foreign Account Tax Compliance Act, filing from overseas has gotten more complex, so consult a tax expert to make sure you’re complying with the latest rules.

Avoid being taxed twice

You’ll likely have to file a tax return in your country of residence as well. How can you avoid being taxed twice? The U.S. has treaties with more than 65 countries that help you avoid double taxation in the U.S. and in your home overseas. Expats can get a foreign tax credit on their U.S. return for taxes paid elsewhere.

In fact, if you earn money in the country where you have chosen to reside, you could benefit from the Foreign Earned Income Exclusion, which allows expats to exclude up to $102,100 of foreign earnings from their total yearly income.

Manage your Medicare benefits

Retirees living abroad are not eligible for Medicare. But what if you visit the U.S. or decide to return permanently, as many retired expats eventually do?

To avoid a break in your eligibility (and the higher fees and penalties that come with re-enrollment), you might want to keep paying premiums for Medicare Part B, which includes all outpatient services. Then when you move back, you’ll also still be eligible for Medicare Part A, which includes hospital coverage.

Get health care coverage overseas

Health care options are often cheaper abroad—indeed, so affordable that some expats opt to simply pay out of pocket. Still, you might want to purchase an international health plan through an American insurer or a private company with a large global network.

You can also consider a group plan through an organization like the Association of Americans Resident Overseas or purchase an HMO-like plan through foreign hospitals. “This can be a good option, since many countries have American-trained doctors practicing in their hospitals and one of the reasons why ‘medical tourism’ has grown in popularity,” says Robert.

Set up your banking with care

The Foreign Account Tax Compliance Act of 2010 requires foreign banks to report all accounts held by U.S. citizens with balances of $10,000 or more to the federal government. This criterion has made banking and obtaining a foreign credit card more difficult. In fact, some foreign banks avoid doing business with Americans. Your best bet is to consider a foreign-based branch of a U.S. bank.

And remember to do some research in advance to help protect your money: “When conducting financial transactions and holding money in banks of foreign institutions, there are no SEC rules or FDIC insurance to safeguard your dollars,” Robert warns. There may be international equivalents, but don’t assume that the protections are the same.

Prepare to adjust your estate plan

This may come as a surprise, but your estate plan and other documents (wills, powers of attorney, health care directives) may not be valid abroad. “This applies even when you move to another state within the U.S., you should always have your estate plan reviewed by an attorney in that state,” Robert says. This step is even more critical when you move overseas. The U.S. Consulate, as well as American Citizens Abroad, can provide lists of local attorneys who can help. Also, make sure your family members are aware of any changes you make.

How will your income translate into local currency?

Most of your retirement income will likely be in dollars that are then converted to local currency, so you’ll be more vulnerable to fluctuations in currency markets. “It’s crucial to take a good look at your retirement portfolio and regularly revisit your income strategy and emergency funds before you retire abroad,” says Robert. Your retirement “paycheck” may look ample while the dollar is strong, but could you weather a prolonged period of its weakness?

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

This information is not intended 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.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Schwab Bank High Yield Investor Checking® accounts are available only as linked accounts with Schwab One brokerage accounts. The Schwab One brokerage account has no minimum balance requirements, and there is no requirement to fund this account when it is opened with a linked High Yield Investor Checking account.

Unlimited ATM fee rebates apply to cash withdrawals using your debit card wherever it is accepted. ATM fee rebates do not apply to any fees other than those assessed for using an ATM to withdraw cash from your Schwab Bank account.

If you use your debit card to withdraw foreign currency from an ATM or to pay for a purchase with foreign currency, we charge your account only for the U.S. dollar equivalent of the transaction. There is no additional percentage added for the foreign currency transaction. See the Schwab Bank Visa® Debit Card Agreement for details.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

American Citizens Abroad is not affiliated with The Charles Schwab Corporation or any of its affiliates.

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Financial Planning for the Self-Employed

AUGUST 18, 2017

Entrepreneurs and independent contractors tend to be proactive. However, they can sometimes neglect seemingly mundane administrative tasks—setting up a retirement plan, for example, or getting the right kinds of insurance coverage. Those items may not be passion points, but they’re vital to long-term security.

Being he steward of your own financial fate isn’t easy, but neither is it rocket science. In fact, it boils down to a few basics:

Retirement

Robert G. Aruldoss, a senior research analyst at the Schwab Center for Financial Research, says the self-employed should do the same thing all workers should: Start saving for retirement today. “If you can’t save a lot, save a little,” Robert says. “The most important thing is to save regularly.” (See “Four plans for the self-employed,” below.)

This can be especially challenging if you’re self-employed and have a highly variable income. One solution is to put any windfall you receive—for example, a bonus on a consulting contract or an unexpected tax refund—straight toward retirement. Another approach is to treat your retirement like any other recurring expense: Cut a check for a set amount on the same date each month.

“Employers spend considerable effort helping their employees make forward-thinking financial decisions, like automatically enrolling them in the company 401(k) plan,” Robert says. “When you’re self-employed, it helps to create those kinds of behavioral reinforcements for yourself.”

Independence day

The rate of self-employment rises precipitously with age.

Source: U.S. Bureau of Labor Statistics, 03/2016.

Insurance

Chris Miller, a financial planner with Schwab’s Wealth Strategies Group, notes that self-employed workers typically buy health insurance because the consequences of not doing so can be so catastrophic. However, they’re less likely to look down the road and consider disability or long-term-care coverage. “The cost of disability insurance varies greatly, depending on your chosen profession,” Chris says. “But while the expense can be quite high for, say, a surgeon, less-lofty policies can be had for far more reasonable rates.”

Depending on your type of work, you may also want to consider general-liability insurance, which protects your business from claims, including personal injury, bodily injury, property damage and other liabilities.

All of this coverage can add up. However, it helps that out-of-pocket health care expenses and premiums—for disability, health, liability, long-term care, and even Medicare and Medigap insurance for self-employed workers 65 and older—are tax-deductible.

Professional support

“I’ve found that those just starting out, in particular, are hesitant about hiring other professionals to help with insurance, retirement and even taxes,” Chris says. “But it’s usually better to put your time into what you know—building your business. Just because you’ve finally hung out your own shingle, doesn’t mean you need to do all the legwork yourself.”

Four plans for the self-employed

Retirement-saving options abound. Which one’s right for you?

Each of the four main possibilities comes with pros and cons regarding contribution limits, tax considerations and employing others. Discuss the finer points with a tax professional before deciding what’s best for your situation.

Individual 401(k)

As the name implies, Individual 401(k)s work much like the 401(k) plans employers offer. The difference, says Robert Aruldoss, a senior research analyst at the Schwab Center for Financial Research, is that the individual is considered both the employer and employee—and can contribute more as a result.. As an employer, you can contribute as much as 25% of your salary. As an employee, you can also put away up to $18,000 a year—plus an additional $6,000 if you’re over age 50 (a so-called catch-up contribution)—for a total tax-advantaged contribution of up to $54,000 a year.

Another benefit is that you can make employee contributions post-tax—as with a Roth 401(k)—so that withdrawals in retirement are tax-free.

Individual 401(k)s are generally best if you’re self-employed and working alone. If you have employees, your own retirement contributions are limited by how much you set aside for your workers.

SIMPLE IRA

The setup and administration of a SIMPLE IRA lives up to its acronym (if not its official name, Savings Incentive Match Plan for Employees Individual Retirement Account). This is an easy way for a small-business owner to set up a retirement plan that can be used to match employee contributions dollar for dollar up to 3%. Alternatively, you could make a 2% minimum contribution to each employee earning at least $5,000 a year. A SIMPLE IRA is most appropriate for small businesses with up to 100 employees. That said, employee contribution limits are relatively low ($12,500 a year, plus another $3,000 in catch-up contributions for those age 50 and over); you’re required to make contributions every year; and penalties may be more severe for withdrawals from SIMPLE IRAs before age 59½ than those for 401(k)s or SEP IRAs (see below).1

SEP IRA

A Simplified Employee Pension Individual Retirement Arrangement (SEP IRA) is easy to set up, and the tax-advantaged contribution limit is the lesser of 25% of your earnings or $54,000 a year. You’re not required to contribute to a SEP IRA every year, which can be helpful if you happen to hit a dry patch. However, if you’re using a SEP IRA to provide employees with retirement benefits, only the employer can contribute; there’s no provision for employee contributions.

Personal Defined Benefit Plan

Although somewhat anachronistic, it’s possible to set up a defined benefit pension plan. This option entails higher administrative costs and greater responsibilities, but it can be a boon to older, self-employed workers with a stable cash flow who want to contribute considerable sums toward retirement. You set the benefit you want in retirement—up to $215,000 a year—and then hire an actuary to determine your annual contributions based on age and expected investment returns. Unlike Individual 401(k)s, however, which give the self-employed the flexibility to contribute more in a good year and less in a bad year, a Personal Defined Benefit Plan establishes a set schedule of predetermined contributions, from which you cannot vary.

1Early withdrawals from 401(k)s and SEP IRAs are subject to income tax and a 10% penalty. Early withdrawals from SIMPLE IRAs are also subject to income tax and a 10% penalty—unless the withdrawal is made within the first two years of participation in the plan, in which case the penalty is 25%.

Important Disclosures

This information does not constitute and is not intended 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.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness or reliability cannot be guaranteed.

Schwab wealth strategists and financial planners are employees of Schwab Private Client Investment Advisory, Inc., a Registered Investment Advisor and an affiliate of Charles Schwab & Co., Inc.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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Lost Your Old 401(k)? Here’s How to Find It

AUGUST 18, 2017

Impossible as it may seem, Americans misplaced $7.76 billion in 2015.1 How? By switching jobs or financial institutions and unwittingly leaving assets behind.

The majority of unclaimed money comes from brokerage, checking and savings accounts, along with annuities, 401(k)s and Individual Retirement Accounts.

Companies are required by law to mail abandoned funds to the owner’s last known address. If they’re returned or the owner can’t be reached, the assets must be relinquished to the state.

The good news is that it’s relatively painless to locate lost funds. Online resources such as missingmoney.com and unclaimed.org allow you to search for assets in any states in which you’ve lived or worked. And if you do find money that’s owed to you, it’s often as easy as filling out a simple online form to get it back.

Darin Bostic and James Koller, two Orlando, Florida-based Schwab financial planners, point out that the best way to keep track of your funds is not to lose them in the first place. “Consolidating similar accounts, such as old and new 401(k)s, can help you keep track of your savings,” says Darin.

“What’s more, consolidation helps ensure your assets are working in harmony toward your long-term goals,” says James. “It’s difficult to follow a comprehensive investment strategy when your money is spread out all over the place.”

The bottom line: Consolidating your accounts can help ensure none of your hard-earned money goes missing.

1National Association of Unclaimed Property Administrators.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers are obtained from what are considered reliable sources. However, their accuracy, completeness or reliability cannot be guaranteed.

This information does not constitute and is not intended 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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Retirement Savings Milestones: How Much Should You Have Now?

By ROB WILLIAMS

JUNE 02, 2017

Key Points
  • Measuring progress toward your retirement savings goals can be a challenge.
  • We’ve developed some savings milestones you can use to see how your current savings stack up against your goals.
  • If your savings fall short of where they should be for your age, we offer some suggestions about how to get caught up.

Knowing how much to save for retirement is a challenge. And it should go without saying that if you’re not sure how much you’ll need tomorrow, then you can’t really know for sure if you’re setting enough aside today.

Unfortunately, for many Americans the answer is clearly “not enough.” A report by the U.S. Government Accountability Office found that nearly a third of households aged 55 or older had no retirement savings at all.1 While that’s discouraging, it shouldn’t be cause for despair. Successfully saving for retirement is within most people’s reach—but it does require financial discipline and periodic checkups along the way.

To give readers a better understanding of their finances, we’ve developed the equivalent of savings milestones you can use to see how your current savings stack up against your retirement goals. We also offer suggestions for making up for any shortcomings.

What does the “average couple” need to retire?

Everyone has different expectations for retirement, but we can still apply some basic rules of thumb for working out how much you might need to save. One approach is to assume you’ll simply maintain the same lifestyle in retirement that you had while working. That doesn’t mean you’ll also need to maintain your current annual salary, though.

Imagine a married couple earning $70,000 a year—which is about average for a married household, according to Census Bureau data—that wants to retire at 65 and afford the same life that they had while working. To work out what they’ll need in retirement, they would start with their $70,000 of current income and then subtract whatever they are saving each year for retirement, as well as whatever they pay in payroll taxes, since they’ll no longer have to do either once they actually retire. If we assume they save $5,000 a year and pay an equal amount in payroll taxes, that would mean they could continue their current lifestyle with $60,000 a year.

Next, they should subtract their Social Security benefit. The average annual benefit for a couple like this comes out to about $25,000, according to Social Security Administration data. If we assume they won’t receive any other income in retirement, then their nest egg would have to generate about $35,000 (or $60,000–$25,000) of income each year for this couple to maintain their current lifestyle.

How do you determine if you’re on track?

Once you have an idea about how much income you’ll need each year to pay for retirement, you can measure how your current savings compare—which can help you decide whether you need to do more. The calculations are a little complex, so we’ve created a table showing the different “multipliers” you can use to work out where your savings portfolio should be at a given age.

We’ll use our couple from the example above again. We know they want a nest egg that can generate $35,000 of annual income when they retire at 65 and are currently setting aside $5,000 a year. Using the multiplier in the table, we can work out how much they theoretically should have saved by a particular age if they want to hit their goal.

We start with their annual savings rate and then compare that with their age. As you can see, a couple saving $5,000 a year (outlined in green) at age 40 should multiply their annual income target by 7.5. That gives us a portfolio value of $262,500 (or $35,000*7.5). In other words, if they’ve already saved $262,500 by age 40, then they should be on course to hit their target, assuming they continue to save $5,000 adjusted for inflation annually.

At age 50, they will need to have saved $423,500 ($35,000*12.1), and so on.

Source: Schwab Center for Financial Research. This is a hypothetical example for illustrative purposes only. The table illustrates the required portfolio size as a multiple of the retirement income need at 65 for a 30-year retirement with a 75% confidence level based on current age and annual savings rate. Confidence level is defined as the number of times the portfolio taking withdrawals ended with a balance greater than zero. Annual savings increase by a constant 1.93%. Assumes an aggressive asset allocation (6.7% annual return) from age 30 to 40, a moderately aggressive asset allocation (6.1% annual return) from age 40 to 50, and a moderate asset allocation (5.3% annual return) for age 50+.

What can you do now?

If you’re saving regularly and on track for what you think you’ll need in retirement, congratulations. If not, you can still take a few steps to get back on track:

1. Increase your savings now. Albert Einstein is said to have called compound interest “the most powerful force in the universe.” There’s no way around the math. Unfortunately, it doesn’t get easier as you age. Every $100 saved at 30 has the potential to generate $34 annually in retirement. Every $100 saved at 50 has the potential to generate $10 annually in retirement. If you don’t save enough when time is on your side, you should consider doing more later to make up the difference.

Source: Schwab Center for Financial Research. This is a hypothetical example for illustrative purposes only. Assumes you save $100 at a certain age. Potential annual retirement income calculation assumes an initial withdrawal rate of 4.6%— our calculation of the first-year sustainable withdrawal rate for a 30-year retirement from a portfolio with a moderate asset allocation, assuming a 75% confidence level. While saving, we assume an aggressive asset allocation (6.7% annual return) from age 30 to 40, a moderately aggressive asset allocation (6.1% annual return) from age 40 to 50, and a moderate asset allocation (5.3% annual return) for age 50+.

2. Make savings automatic. Why do you brush your teeth every night before bed? Though we all understand the importance of proper dental care, it’s probably because you’ve been doing it from a very early age and it has become a habit. Saving is the same. Regular saving is easier if you set up automatic deposits from your earnings. If your company offers an employer match for any retirement contributions, make sure that you’re contributing at least that amount. Contributing less is like leaving money on the table.

3. Take an appropriate amount of risk. Be sure you are comfortable with the amount of risk you are taking with your investments. Can you stomach a 20% or more decline in a single year or will that cause you to abandon your plan? We generally suggest that investors who are younger should invest more aggressively than older investors. A more aggressive asset allocation has a greater potential to generate higher returns over time. If you have time on your side and are invested conservatively, consider taking on more risk—though obviously not more than you’re comfortable with.

A larger annual return will result in a larger ending portfolio value

Source: Schwab Center for Financial Research. This is a hypothetical example for illustrative purposes only. Assumes a starting portfolio value of $10,000 at 30 and a 35-year investing horizon. Does not assume taxes or fees.

4. Consider how much you really need in retirement. You may want to spend $100,000 in retirement but do you really need to spend $100,000? We think you should break your spending down into expenses that you classify as needs, wants and wishes. If you discover you’re not on track toward hitting your goal, then maybe it’s time to identify some expenses classified as wants or wishes that you could reduce or do without in retirement.

5. Create a more flexible retirement. If your nest egg falls short of what our guidelines suggest, don’t get discouraged. Our calculation is based on a retirement age of 65 and a 30-year retirement. Retiring later could allow you to save more and plan for a shorter retirement. Working longer, or working part-time in a “phased” retirement could also help you to delay starting Social Security, which could increase your eventual benefit. That would also take some of the pressure off your portfolio.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market or economic conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Investing involves risk including loss of principal.

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3 Steps to Get More Income From Your Portfolio

MAY 26, 2017

These are still tough times for investment income seekers. Even though the Fed recently raised short-term interest rates—and has signaled more increases are coming—yields for bonds and money market funds remain low by historical standards.

So if you’re nearing retirement, how will you generate enough income from your portfolio?

The answer doesn’t have to involve a lot of fancy footwork, says Rob Williams, director of income planning at the Schwab Center for Financial Research. With the right perspective, a combination of familiar strategies and investments can be an effective way to maximize your portfolio’s income potential.

“You can use a lot of building blocks,” Rob says, “some to help secure your income, some to provide growth. In today’s market, building a broad portfolio is the best approach.”

Step 1: Build in downside protection

Given the volatility in the markets, a smart income strategy should include cash reserves for living expenses—and for downside protection, Rob says. By setting up “buckets” within your portfolio, you can have income when you need it, reduce potential losses and still keep part of your portfolio focused on longer-term growth.

• Set aside 12 months’ worth of expenses, after accounting for other non-portfolio income sources, in a liquid cash account. This reserve is the money you need to supplement your regular income sources, such as Social Security or a pension.

• Keep an additional two to four years’ worth of expenses in short-term bonds or bond funds in case there is a market downturn. With this cushion, you’ll be less likely to have to sell more volatile investments at a loss. (On average, over the last 50 years, it took the S&P 500 about three years to recover from a downturn.)

Having these reserves in place may also help protect you from sequence-of-returns risk. If the market dips early in your retirement, when you’re first taking withdrawals, it can be harder for your portfolio to recover from those losses, increasing the chance that you will run out of money. Having sufficient short-term reserves can help save you from having to deplete your core portfolio.

Another way to add downside protection is to purchase an annuity. An annuity can provide a steady income stream. But the terms, quality and cost of annuities vary widely. Annuity guarantees depend on the financial strength and claims-paying ability of the issuing insurer. It’s best to consult with a financial professional to select an annuity that will suit your specific needs.

Step 2: Focus on growth

With some protection in place, you can now consider investing the remainder of your portfolio in assets that have greater potential to grow, depending on your time horizon and risk tolerance.

Dividend-paying stocks are one option worth looking into, says Brad Sorensen, managing director of market and sector analysis at the Schwab Center for Financial Research, especially given that many equities are paying higher dividends than they have in the past.

“Just remember, these stocks are not a substitute for fixed income,” Brad cautions. But you may want to consider integrating more dividend payers into your equity allocation.

When choosing stocks for income, “look at more than just the current dividend rate,” Brad advises. It pays to examine a company’s cash flow to see if it can continue to cover its dividend. Other factors to consider before buying an income stock include whether the company is selling any assets and how consistently it has offered its current yield over the past five years.

Also be sure to account for broader economic issues, Brad adds. For example, energy stocks could trim their historically impressive dividends because of depressed oil prices. By contrast, financial services and many established tech companies have been increasing their dividends in recent years.

Investors seeking yield may be tempted to consider real estate investment trusts (REITs). These securities invest in income-producing properties and are required by law to pay out at least 90% of their taxable income to shareholders in the form of dividends. But Brad warns that many REITs are sensitive to interest rates, with the asset class as a whole tending to underperform in rising-rate environments.

Step 3: Consider a “total return” approach

Think of the methods above as a way of structuring your portfolio for retirement. When it comes to distribution, one strategy that may help you meet your income needs is the “total return” approach.

Given today’s low-rate environment, it’s not practical for many investors to expect to live on dividends and interest alone, Rob notes. Nor is it necessary to to try, given the other potential sources of return in your portfolio. Consider generating income by selling assets as well.

This approach doesn’t necessarily mean “tapping principal” or “drawing down your portfolio,” which both might sound taboo to some investors. Ideally, a total return approach allows you to harvest some of your portfolio’s gains—including price appreciation—for income. Depending on how much you withdraw, your portfolio may continue to grow.

Often, the routine process of rebalancing presents the ideal time to sell assets and harvest gains. Rebalancing involves selling the securities (stocks, bonds, etc.) that have grown beyond their percentages in your asset allocation plan due to the relative gains and losses across your portfolio. By selling the outsize positions, you can reallocate to your targets, help manage your risk exposure and add to your income stream.

You may want to enlist the help of a professional to decide which investments to buy and sell to bring your portfolio back in line with your plan and generate the income you need.

If you structure your portfolio to include short-term reserves and income-producing equities—as well as considering total returns in your distribution strategy—we believe it’s possible to maximize your portfolio’s income-generation potential without being held captive to low interest rates today.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

All annuity guarantees are subject to the financial health and claims-paying ability of the issuing insurance company. Neither Schwab nor its affiliates provides insurance guarantees. Unlike a CD, which is an FDIC-insured bank product, an annuity’s payment guarantees are provided by and only as strong as the financial position and claims-paying ability of the issuing insurance company. Schwab does not provide any insurance or other guarantee. Consult the insurance company’s ratings for its financial strength, and read the annuity contract and/or prospectus before investing. Insurance company ratings do not apply to the performance of variable subaccounts. Ratings are subject to change. There is no guarantee current ratings will be maintained.

Charles Schwab & Co., Inc., a licensed insurance agency, distributes certain life insurance and annuity contracts that are issued by non-affiliated insurance companies. Not all products are available in all states.

Rebalancing and diversification strategies do not ensure a profit and do not protect against losses in declining markets.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The information presented does not consider your particular investment objectives or financial situation (including taxes), and does not make personalized recommendations. Any opinions expressed herein are subject to change without notice. Supporting documentation for any claims or statistical information is available upon request.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

Past performance is no guarantee of future results, and the opinions presented cannot be viewed as an indicator of future performance.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

© 2016 Charles Schwab & Co., Inc. All rights reserved. Member SIPC.

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Should You Consider a Roth 401(k)?

MARCH 30, 2017

Many companies now offer employer-sponsored Roth 401(k) retirement accounts alongside traditional 401(k) plans, giving employees another way to save for retirement. What’s the difference? And should you open one?

The answer will depend on a variety of factors. Here we’ll take a look at how Roth 401(k) plans stack up against their traditional counterparts.

Roth vs. traditional 401(k): the differences

Most people are familiar with how traditional 401(k) retirement plans work: Employees contribute pre-tax dollars into employer-sponsored plans, the money is invested and any earnings grow tax-deferred until they are withdrawn, usually in retirement.

With a Roth 401(k), the main difference is when the taxman takes his cut. You make Roth 401(k) contributions with money that has already been taxed (just as you would with a Roth individual retirement account, or IRA). Your earnings then grow tax-free, and you pay no taxes when you start taking withdrawals in retirement.

Another difference is that if you withdraw money from a traditional 401(k) plan before you turn 59½, you pay both taxes and a 10% penalty.1 With a Roth 401(k), you can withdraw your principal tax-free before you turn age 59½, as long you’ve held the account for more than five years. (Any earnings withdrawn earlier, however, will be taxed and subject to a 10% penalty.)

Roth vs. traditional 401(k): the similarities

In terms of the similarities between Roth 401(k)s and their traditional counterparts, the first thing to point out are the high contribution limits—which are far higher than those for IRAs, meaning you can save a lot more with a Roth 401(k) than you can with a Roth IRA.

  • In 2017, you can contribute up to $18,000 a year to a 401(k) (or $24,000 if you’re over 50). IRA contributions are capped at $5,500 per year (or $6,500 if you’re over 50).
  • Also, there are no income limits for Roth 401(k) contributions. In 2017, you can contribute to a Roth IRA only if your modified adjusted gross income is less than $133,000 a year (filing single) or $196,000 for married couples filing jointly

You can also still get matching contributions from your employer. However, such contributions will have to be made in a traditional 401(k) account, since they can only be made on a pre-tax basis. You’ll just need to have one of each kind of account. One thing to note here is that the annual contribution limit would apply across both accounts. For example, you wouldn’t be able to contribute $18,000 to both types of 401(k) in 2017. You would have to divide that amount, say by putting $9,000 in each account.

A final similarity between Roth 401(k)s and traditional ones is that you must start taking required minimum distributions (RMDs) once you reach age 70½, or face a penalty. However, you can avoid this requirement when you retire by rolling your Roth 401(k) into a Roth IRA—which has no RMDs—so your assets can continue to grow tax-free and they can be passed along to your heirs.

“This flexibility is a significant difference between a Roth account compared to a traditional 401(k) or IRA,” says Rob Williams, managing director with the Schwab Center for Financial Research.

When a Roth 401(k) can make sense

Taxes are a key consideration when it comes to deciding on a Roth 401(k).

If you’re young, in a low tax bracket now and expect to be in a higher tax bracket when you retire, then a Roth 401(k) could be a better deal than a traditional 401(k). Think of it this way: With a Roth 401(k) you can get your tax obligation out of the way when your tax rate is low, and then enjoy the earnings tax free later in life.

This can actually work for mid-career workers, as well, especially those concerned about the prospects for higher tax rates in the future. After all, taxes are currently fairly low by historical standards. The top rate for married couples filing jointly is 39.6% in 2017, but it was 70% as recently as 1981 and an eye-watering 91% back in 1963.2

“On the flip side, it may make less sense to contribute to a Roth 401(k) if you think your tax bracket will be lower in retirement than it is now,” Rob says.

And high earners who expect to maintain their income and spending standards into retirement could also consider using Roth 401(k)s to simplify their taxes by paying them up front while they’re still working. Doing so would also limit the tax impacts of having to take RMDs, which are treated as taxable income.

The potential for tax diversification

If you’re not sure whether a Roth 401(k) makes sense for you, one strategy would be to contribute to both a Roth 401(k) and a traditional 401(k) as well. The combination will provide you with both taxable and tax-free withdrawal options, which is particularly useful if you’re on the fence about what your tax rate will be in your future retirement.

As a retired individual or married couple with both Roth and traditional 401(k) accounts, you could determine which account to tap based on your tax exposure.

“You cannot always know what your future tax bracket will be, of course, and the flexibility to use multiple accounts to manage taxes is important and helpful,” says Rob.

For example, you could take RMDs from your traditional account and withdraw what you needed beyond that amount from the Roth account, tax free. That would mean you could withdraw a large chunk of money from a Roth 401(k) one year—say, to buy a dream home—without having to worry about taking a big tax hit.

Besides having the added flexibility of being able to manage your marginal income tax bracket, reducing your taxable income in retirement may be advantageous for a number of reasons, including lowering the amount you pay in Medicare premiums, paring down the tax rate on your Social Security benefits, and maximizing the availability of other income-based deductions.

1 Individuals separating from service on or after the year that they turn 55 are exempt from the 10% penalty.
2 Source: The Tax Foundation, 3/22/2017.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

This information is not intended 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.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc. Schwab Intelligent AdvisoryTM is made available through Charles Schwab & Co., Inc. (“Schwab”), a dually registered investment adviser and broker-dealer. Schwab Intelligent Portfolios® is made available through Charles Schwab and Co., Inc. (“Schwab”) a dually registered investment adviser and broker dealer. Portfolio management services are provided by Charles Schwab Investment Advisory, Inc. (“CSIA”). Schwab and CSIA are affiliates and subsidiaries of The Charles Schwab Corporation.

Please read the Schwab Intelligent Portfolios disclosure brochure for important information.

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Nearing Retirement? Assess Downside Risk, Upside Potential

By ROB WILLIAMS

AUGUST 05, 2016

Investors at every stage in life should be keeping a careful eye on risk—but limiting your exposure to risk is particularly important when you shift from building retirement wealth to actually living on that money.

That’s because the distribution phase, as it’s sometimes called, is a tricky juncture where you have to address competing goals. On the one hand, you need to preserve the savings you’ve worked so hard to build. On the other hand, you still need some exposure to risk if you want your savings to keep up with inflation and grow enough to last through a potentially long retirement.

And market risk isn’t the only type of risk you’ll have to manage as you enter retirement. Here are three others:

  • Longevity risk. This is the risk that you’ll outlive your savings. The latest research on longevity shows that today’s 65-year-olds have a 50% chance of living past their mid-80s. Many financial planners use age 90 as an estimate, but it’s best for each individual to gauge how long he or she might live.
  • Loss aversion risk. Your instincts may tell you to avoid losses. But if you’re too sensitive to losses, it could have a negative long-term effect on your investments. Being aware of how fear can color your choices can help you make better decisions.
  • Sequence-of-returns risk. This is a big one. In essence: If the market dips during early retirement—when you’re first taking withdrawals—it can be harder for your portfolio to potentially recover than if you sustain losses later in retirement.

Understanding sequence risk

At Schwab, we think the best time to add downside protection is when volatility is low and markets are high. We’re bullish on the current cycle for U.S. equities, and on a well-diversified portfolio invested for the long term. However, we also expect heightened volatility through the remainder of 2016, given current market and economic dynamics, and that could increase sequence-of-returns risk for anyone beginning to take withdrawals.

The table below depicts two hypothetical retirees, Marcus and Susan, each with a $1 million portfolio. They both withdraw $50,000 in year one of retirement and gradually increase their withdrawals for 20 years to keep up with inflation. The difference is that for Marcus, the stock market falls 15% in each of the first three years of retirement and grows 10% per year thereafter. Susan has 10% annual returns at first, then three years of 15% annual losses at the end of the 20-year period.

As you can see, Susan’s total loss from those down years is greater than Marcus’s—his portfolio lost about $500,000, while hers dropped by about $1.1 million. But the real story is that Marcus runs out of money in year 18, while Susan still has $1.34 million left in year 20—all because of a difference in the timing of those bad years.

Think of retirement distributions as the reverse of dollar-cost averaging (that is, when you invest a fixed amount at regular intervals, which allows you to buy more shares when the market is down, fewer when it’s up). When your portfolio’s value is lower, you have to sell more shares to get the same amount of cash—leaving you with fewer shares to compound in the future.

In this example, Marcus’s portfolio is permanently hampered by early losses, while Susan’s portfolio has plenty of time to grow (in both dollar value and number of shares) before losses occur.

It would be nice if you could just delay having years of negative returns until later in retirement, but of course, no one can predict that—which is why understanding how to cope with sequence of returns and other downside risk factors is so important, especially right now.

The economic environment right now

First, let’s look at stocks. They’ve had a big run: At the beginning of July 2016, the S&P 500® Total Return Index was up over 242% (nearly 18% annualized) from the market bottom in March 2009. When select markets perform well for a sustained period, it is a good time to revisit your risk and focus on protecting the downside of your portfolio. That doesn’t mean you need to be wary of an imminent downturn if you’re invested for the long-term, but a strong defense may help protect the growth you’ve enjoyed.

Next, there’s the bond market. Bond yields are very low. That limits the ability for bond investments to generate strong total returns going forward.

The Fed is transitioning from a cycle of loose monetary policy to tightening for the first time in seven years. We believe that diverging global monetary policies—that is, tightening in the U.S., and loosening in Europe, China and Japan—could increase volatility across global markets.

Britain’s recent “Brexit” vote, negative interest rates in many developed countries, and uncertainty about global growth have led to sharp market dips and rebounds, increasing risk in our view.

The prospect of increased volatility makes this an especially smart time for investors nearing or in the early years of retirement to consider adding downside protection to their retirement strategy.

Ways to add downside protection

One classic form of asset protection is to divide your portfolio into “buckets”: For example, you could invest one portion in relatively safe, liquid assets, providing you with cash flow for the next few years. Then the second bucket is invested for long-term growth, based on your risk tolerance.

There are different ways to think about these subdivisions, as you can see in this video, but the general idea is to have enough cash to cover you in the event of a downturn—which gives the growth portion of your portfolio the chance to recover when the market does. Over the past 50 years, it took the S&P 500 slightly more than three years, on average, to recover from a downturn.

The second downside strategy to consider is the purchase of an annuity, which can act as a form of retirement income insurance. Typically, the size of your payout is based on your age and prevailing interest rates at the time of purchase, as well as the amount of your one-time premium.

Insurance that protects your retirement income

Not all annuities are created equal. First, annuity guarantees depend on the financial strength and claims-paying ability of the issuing insurance company. Second, some annuities offer better protections—with less onerous fees—than others. Whether they make sense for you will depend on how comfortable, and able, you are to manage their specific risks, and the cost of doing so. We’ll focus on two types of annuities that can potentially deliver protection against downside risk at a fair cost:

  • Fixed (or “single premium”) immediate annuity. With an immediate annuity you pay an insurer a premium, and then you’re guaranteed a fixed monthly payout, typically for the rest of your life or the life of your surviving spouse. The tradeoff for this cushion is that the money you invest in a fixed immediate annuity is no longer invested for growth.
  • Variable annuity with a guaranteed lifetime withdrawal benefit. With a variable annuity you have some control over how your premium(s) are invested. Your insurance company will have a number of sub-accounts with different investment objectives for you to choose from. When you reach the “payout phase” in retirement, your payout is based in part on the underlying value of those sub-accounts. The advantage is that your money remains invested, and you choose the types of investments you want to own, so you have the potential to earn returns that can outpace inflation over time.

But sequence of returns risk is still a concern, and that’s where the guaranteed lifetime withdrawal benefit (GLWB) rider comes into play. For an additional cost, this optional rider sets a minimum level of annual withdrawals for life, even if the contract value falls to zero.

So, by purchasing this benefit, you are creating a floor for your retirement income that remains in effect even when markets are down. And it allows for the possibility that your payout can increase, if a rising market boosts your investments within the variable annuity. Note that the GLWB is not a contract value and not available for withdrawal like a cash value. Your actual contract value will decrease with each withdrawal.

Adding an annuity to your retirement strategy doesn’t have to be an all-or-nothing proposition. In fact, it is often wisest to commit just a portion of your retirement assets to an annuity. This money will be your guaranteed income stream while you invest the rest of your money for growth.

That’s the extra value of downside protection: It permits you to enjoy greater confidence that your income will last through what can be a very long life.

Important Disclosures

Variable annuities are sold by prospectus only. You can request a prospectus by calling 1-888-311-4887 or by visiting schwab.com/annuity. Before purchasing a variable annuity, you should carefully read the prospectus and consider the investment objectives and all risks, charges and expenses associated with the annuity and its investment options.

Past performance is no guarantee of future results. Forecasts contained herein are for illustrative purposes, may be based upon proprietary research and are developed through analysis of historical public data.

Variable annuities are long-term investment vehicles designed for retirement purposes. The value of a variable annuity may be more or less than the premiums paid and it is possible to lose money.

Variable annuities offer tax deferral on potential growth. Withdrawals prior to age 59½, however, may be subject to a 10% federal tax penalty in addition to applicable income taxes. Variable annuities are also subject to a number of fees including mortality and risk expense charges, administrative fees, premium taxes, investment management fees, and charges for additional optional features. Although there are no surrender charges on the variable annuities offered by Schwab, such charges do apply in the early years of many contracts.

A guaranteed lifetime withdrawal benefit (GLWB) is an optional rider available for an additional cost. Withdrawals in excess of the specified annual amount may permanently and significantly reduce future income. Certain contracts may limit you to a pre-specified selection of investment options when you elect the GLWB.

Charles Schwab & Co., Inc., a licensed insurance agency, distributes certain insurance and annuity contracts that are issued by insurance companies that are not affiliated with Schwab. Not all products are available in all states.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

S&P 500® Index is a market-capitalization weighted index that consists of 500 widely traded stocks chosen for market size, liquidity and industry group representation.

Schwab Intelligent Advisory is made available through Charles Schwab & Co., Inc., a dually registered investment advisor and broker-dealer.

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Does Your Retirement Portfolio Need More Stocks?

MAY 13, 2016

How big should your stock allocation be when you retire? The financial industry has devoted much intellectual muscle to the search for an “ideal” allocation. Unfortunately, there is no one-size-fits-all solution.

The case for stocks is pretty straightforward: Historically, they’ve been one of the best sources of growth and returns. But they’re riskier than other investments. The success of your retirement plan depends in part on how you balance these qualities. On one hand, your portfolio needs to continue growing even after you retire so you don’t outlive your savings. On the other, you don’t want to endanger your savings by taking unnecessary risks.

So the “right” amount of stocks really comes down to your individual needs and preferences, which we’ll explore in more detail below. And what makes sense at the beginning of retirement may not make sense later on, so you will need to make adjustments over time.

“You don’t need all of the money for your retirement on the day you retire. Your portfolio should continue to grow over the years,” says Rob Williams, Managing Director of Income Planning at the Schwab Center for Financial Research. “What’s important is that you have the right balance at the beginning of retirement.”

So how do you strike that balance? That depends on a few things.

What’s in your portfolio?

For most investors, stocks should account for anywhere from 40% to 60% of their portfolios in the years just prior to and after retirement, with the rest invested in bonds and cash.

Where you fall on that range depends on factors including your risk tolerance, wealth, how much you expect to rely on your portfolio for income, and your anticipated longevity.

For example, if you have a long time horizon, are more risk tolerant and worry your savings will fall short, you might aim for a stock allocation of 60% when you retire. If you have a shorter time horizon, adequate savings and are less comfortable with risk, you might fall closer to the 40% end of the spectrum. What’s important is that your portfolio is geared to go the distance.

“You may retire, but your portfolio shouldn’t retire with you,” Rob says. “Your portfolio should continue growing over the course of your retirement.”

Once you’ve set your allocation, you will generally need to adjust it over the next 15 to 20 years by reducing your risk as you shift from saving to stability. The diagrams below show one approach to managing this transition.

A portfolio for all seasons

With an appropriately balanced allocation, you should be ready for whatever the market throws your way. This is important: How the markets are doing at the start of your retirement can have an impact that lasts for years.

If you retire during a bull market, congratulations. Your portfolio could get an extra boost that will add to your savings and give you a little more freedom in your spending plans.

But what about a bear market? This is where the value of good planning is most obvious, as a well-structured portfolio can provide some cushion to help manage market risk.

The key is to minimize a phenomenon known as sequence-of-returns risk. Basically, this refers to the possibility that your savings could be permanently damaged if you start withdrawing from your retirement account at the same time that it’s losing value. Selling assets when prices are down often means you burn through them faster—and that leaves you with little fuel to drive growth if markets recover. If the decline is steep or lasts a while, that could make it even harder to make up lost ground.

To help protect yourself against sequence-of-returns risk, you could consider using a “bucketing” approach. It works like this:

Bucket one: Set aside enough cash to cover your spending needs, after nonportfolio income sources like Social Security or a pension, for the next 12 months. In other words, if your plan is to withdraw $40,000 a year from your portfolio, you would keep that entire amount in your cash bucket. Treat this money as “spent.”

Bucket two: Put another two to four years’ worth of cash into assets that can be liquidated if needed. For example, if we stick with the $40,000-a-year plan, you’d put $80,000–$160,000 in easily liquidated assets such as cash alternatives or short-term bonds.

Bucket three: This is where you’ll keep your stock allocation and other more aggressive investments.

The idea is that you should have enough cash or cash alternatives on hand to cover your expenses over the near term, while at the same time aiming to preserve your portfolio’s growth potential over the longer term. After all, over the past 50 years, it took the S&P 500® Index slightly more than three years, on average, to recover from a downturn, according to research from the Schwab Center for Financial Research.

“With several years’ worth of living expenses positioned in lower-volatility investments, like cash, cash alternatives and bonds, you can feel more comfortable taking on the risks that can help you get to your goals,” says Rob.

At the end of the day, your target allocation—that mix of stocks, bonds and other assets—should reflect your long-term priorities in retirement. You shouldn’t change it just because of a temporary setback in the market.

Making your portfolio last

The bottom line is that you’ll likely need at least some stocks throughout retirement for diversific­ation and growth potential.

It also helps to stay flexible. Check on your portfolio regularly—say, once a year—to make sure it still fits with your plans. You can always adjust as needed.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

This information is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, please consult with a qualified tax advisor, CPA, financial planner or investment manager.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Fixed income securities are subject to increased loss of principal during periods of rising interest rates. Fixed income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.

Diversification and asset allocation strategies do not ensure a profit and do not protect against losses in declining markets.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

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Pre-Retirement Playbook

MARCH 10, 2016

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

This information is not intended 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.

This example is hypothetical and provided for illustrative purposes only. It is not intended to represent any specific investment products and not intended to be reflective of results you can expect to achieve.

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