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WA Changes Socially Responsible Investment Option for DCP and Plan 3 Members

WA Changes Socially Responsible Investment Option for DCP and Plan 3 Members

A huge change just occurred for Socially Responsible Investors participating in WA’s DCP and Plan 3 Retirement Systems. And if you haven’t made any changes to that account since the fund change went into effect (April 2024), you may suddenly be invested in a far more aggressive portfolio than you were before.

What is the change and who does it impact? 

Prior to April 2024, the Socially Responsible Investment (SRI) Option for DCP, Plan 3, and JRA Members was the Boston Trust Walden Balanced Fund. A 70% Equity, 30% Fixed Income Blended Fund that would be a relatively suitable “whole portfolio” investment for the average investor. 

As of April 2024, the approximately $350 million dollars that WA state investors had in that fund are now invested in the Alliance Bernstein Global Thematic Fund – which is a 100% Equity fund. That means the stock-bond blend you may have been holding in your portfolio is now 100% stocks (about 60% U.S. stocks, and 40% international stocks).

So, if your entire DCP or Plan 3 account was invested in the SRI option, and you haven’t changed it at all, your portfolio has just taken on 30% more equity, increasing both your opportunity for long-term growth, but also substantially increasing your risk. This may be perfectly okay if you are 30 years old with a high level of risk tolerance, but if you’re in or nearing retirement and/or simply have a lower risk tolerance related to your investments, this change has a substantial impact. 

This is particularly concerning considering that a much higher percentage of SRI fund investors in the WA State plan are over the age of 50 years old, and a much lower percentage are younger investors. (Source: DRS Record Keeper Data)

What’s the rationale behind it?

The Washington State Investment Board (WSIB) started working on this analysis in 2021 and announced this choice along with the rationale behind it about a year ago. You can see the highlights of that recommendation here.

The rationale behind moving to a more aggressive equity-only fund was essentially that the fund was most commonly being used as a portion of an investor’s overall account rather than as a single investment designed to “do everything.”

According to their report, once it was determined that an equity-only fund would be a suitable replacement for the current fund, the WSIB screened investment fund options by looking for a fund that had stated, intentional objective alignment with the United Nations 17 Sustainable Development Goals (SDG’s). 

The other main difference between the two funds was in overall strategy – with the new fund claiming a predominantly active investment strategy in SRI causes/themes, and the Walden fund being more of an exclusionary-only approach, designed to keep investors out of certain types of investments. 

Is the new fund more socially responsible or a better investment? 

On paper, it all sounds great:

  • more proactive investment (active vs exclusionary-only) 
  • a wider range of SRI targets based on the UN’s SDGs
  • more opportunity for investment growth due to a more aggressive investment strategy

But does the new fund really pass muster? 

Realistically, most SRI funds fall well short of what SRI investors are asking of them and what they are claiming to do, and both the previous fund and the new fund are no exception. 

But in an independent comparison by the non-profit As You Sow, while the two funds scored similarly on fossil fuel exposure, prison industrial complex exposure, and civilian firearms exposure, the new fund actually scored worse on military grade weapons exposure, and substantially worse on gender equality and deforestation than the old fund did. So, while the stated objectives of the new fund as they relate to the 17 SDGs is certainly admirable, a closer look at whether they’re doing a better job meeting those objectives reveals something less impressive. 

Additionally, although the average annual return over time of the new fund is higher than the old fund (which we would naturally expect given its more aggressive investment approach), its measure of risk-adjusted performance is not nearly as good as the previous fund. So, I would generally say no, I don’t think this is as shiny of an object as WSIB is trying to convince us that it is. But as an investor in these accounts, it is, now, the only SRI option that you have. And it is certainly better screened than any of the other funds within the state’s investment offerings.

How does it impact investors in the socially responsible fund? 

Possibly a lot, and possibly not much at all. It really depends on what percentage of your overall current and ongoing investments are in the socially responsible fund.

At its most extreme (100% of your investments in this fund) your portfolio just increased its stock exposure by 30%, which is not insubstantial. But if you only have 10% of your current and ongoing investments in this fund, your stock exposure only increased by 3%, which is likely not that big of a deal.

What should I do about it?

You really have two main options for making sure your investments are invested the way you intended them:

If you want your old allocation back

If maintaining the pre-April 2024 stock-bond ratio is important to you, then you need to make an adjustment in your overall investments in order to reset that ratio. 

Remember, before this change, if you were invested in this fund, you had some money invested in stocks and some money invested in bonds. The easiest way to re-implement this is to just offset the new SRI fund with the Washington State Bond Fund using the following formula: 

Old Percentage SRI Fund * .30 = New Percentage Washington State Bond Fund

Old Percentage SRI Fund * .70 = New Percentage SRI Fund

If formulas are not your thing – here’s an example to show you how it works: 

Let’s say, in your DCP account, your current investments are 55% in the SRI fund, and your future ongoing investments are set to go 50% into the SRI fund, and 50% into other plan investments. 

To make your current investment allocation reflect what you had it at before this change: 

55% * .30 = 16.5% to Washington State Bond Fund 

55% * .70 = 38.5% to SRI Fund

To make your future investment allocation reflect what you had it at before this change: 

50% * .30 = 15% to Washington State Bond Fund 

50% * .70 = 35% to SRI Fund

Without making this adjustment, in the example above, you’d end up with 15-16% more ongoing stock exposure than you had before they made this change.

If you’re fine with increased stock exposure

It may be that the increased market volatility and risk is fine with you, and that you’re happy with the new, more aggressive investment strategy. If that’s the case, no changes will be needed.  However, considering the overall age demographic of most people currently utilizing the SRI option, I think it’s important to make sure your investment strategy stays well aligned with your risk tolerance and financial planning goals, and this fund change may have substantially impacted that strategy if you haven’t actively made any adjustments to your investments.

If you’re not sure whether your investment strategy is aligned with your risk tolerance and financial planning goals, feel free to schedule a free 30-min call here, and we’ll see if we can help point you in the right direction.

Using Difficult Financial Stretches as a Metric for Measuring Progress

Using Difficult Financial Stretches as a Metric for Measuring Progress

Back when I was teaching, I used to have a lot of conversations with high school students about how we show up on our “worse than average” days as being far more important to the general trajectory of our lives than how we show up on our “better than average” days. That if they wanted to make substantial and significant changes in their lives, to their wellbeing and their success (however they chose to define it), that their energy would be best spent thinking about how to make small, incremental improvements to the 50% of days that were below the median.

Why?

It’s relatively easy for most of us to show up on our “better than average” days—to do what we need to do to progress. On the best of those days we might be hitting figurative home runs, and on the just slightly “better than average” days, we might just be getting on base because we got hit by a pitch. But hey, we’re still on base, making progress in meaningful ways towards a life that we want.  

Then there are the days that ask a lot of us. And the truth is – financial days and financial stretches are no different. We will have days where it feels like the world has been generous with us and we are making great financial decisions effortlessly, and days when it feels like everything bad that can happen has happened to us, including some of the financial decisions we’ve made. And we will likely have a lot of ho-hum days in between.

And while I’ve talked about strategies for coping with and getting through the worst of these financial seasons in the post Getting Through A Money Slump, the topic of this post is a bit different. I want to talk about using our slumps as metrics of our progress. Because if we’re going to place a high value on improving the “worse than average” 50% of our financial days, we ought to have some way to acknowledge our progress.

The Problem with Best Day Metrics:

I love things that I’ve learned how to do as an adult because I have a much clearer memory of the trajectory of my progress. Skiing, golfing, playing guitar – these are all things I’m quite average at now, but I remember being quite bad at them. And unlike things I learned to do as a kid, I have a good memory of my learning curve and critical points along its path, including all those highs that came when I accomplished something that had at one time felt impossible.

Best day metrics are relative, depending on skill level, but I can clearly remember the first time I broke 110, or 100, or 90 on the golf course, the first (and, so far, only) time that I skied down a run with a black diamond on its sign, the first time I played a song all the way through with no mistakes on my guitar. It was a rush, a total high, and a pretty good recipe for a let-down because it usually brought with it the expectation that this was the new normal, creating a wildly unrealistic metric for the average and bad days that would follow.

Best days make good metrics for future best days. They make terrible metrics for the other kinds of days. It’s no different with money.

Consider this situation:

You’ve been working hard to manage your money and seeing incremental progress, saving each month and building up your emergency fund. You’ve almost hit your goal of $10,000. Then, you happen to coast through an inexpensive month with no unexpected bills, and you also get a bigger than expected tax refund. Then another month goes by, similarly, no major unexpected expenses. For the first time ever, in your whole life, you now have a $10,000 emergency fund—something that at one point felt like an impossible goal to achieve. Suddenly, everything feels like it’s starting to work for you, and you’re feeling great about your money management and all the hard work you’ve put into getting here.

But then, your water heater and your transmission go out the next month, $10,000 walks out the door, and your savings account is empty. And maybe nothing at all has actually changed about how you’re managing money (or maybe because you were tired and frustrated you did some online shopping and got some takeout, adding a little insult to life’s financial injury). But emotionally, you’re crashing—you were feeling so good you accidently created a new normal out of a best-day metric and now things feel really bad. In that moment it might even feel worse than if you had $10,000 of expenses come up and no money in your savings account, because at least then, you would have continued to believe that hitting that $10,000 goal was impossible.

And even though we instinctively can’t help but make that comparison… it’s a bit like comparing your personal deadlift record to the amount you can deadlift when you have the flu.

It doesn’t really make any sense.

The Case for Bad Day Metrics:

Bad days and how you progress through them are worth noticing. They will often tell you more about your financial progress than your best day metrics, AND without all the unrealistic expectations that best day metrics create.

Let’s go back to the scenario where your water heater and your transmission go out in the same month and that emergency savings account you had worked so hard to accumulate is back down to $0.

If you stop comparing that scenario to your recent best-day stretch, and instead think back to 2 years ago, when the only option you would have had to cover $10,000 of unexpected expenses would have been to put it on a credit card, you can suddenly see that you have made a substantial amount of progress in this area.  At one time this scenario would have been a financial crisis, whereas now, while it feels like a really crappy punch in the gut, it is actually an incredible marker of the progress you’ve made.  

If you’re having a hard time managing cash flow this month because of bad circumstances or impulsive decisions, but that just means you didn’t make a contribution to your savings, and 2 years ago it would have meant dollars onto credit cards, that’s a big deal.

And the truth is, we don’t generally need a reason to carry on and keep up the good habits we’ve worked so hard to develop on our best days. The best days are, in and of themselves, quite rewarding and motivate us to keep going. But for most of us, to keep from dropping into the depths of despair, we need a way to measure progress on our worst days, to put them into perspective, to remind ourselves of how far we’ve come, and the only way to do that is to compare our worst days to your previous worst days. Our worst day metrics can tell us a lot about our progress at a time when we need to hear it the most.

Setting Realistic Expectations for Good Day Metrics:

I want to be clear, I think there’s a place for best day metrics, they tell us something about our highest potential to achieve (in a given moment), but we over assign value to them, often to the detriment of our progress. It’s not actually motivating to most people to feel defeated or less than what we are capable of being (I do want to acknowledge that for a small, fairly vocal, group of people this actually can feel motivating, but for many, it’s actually highly demotivating).

So, if we take our best day metrics, and overgeneralize them to our average and worst days, for many people, it ends up creating a sort of self-defeating space, where a bad day tested against a good day metric takes us into the headspace that looks something like:

Well, I guess I’m not any good at this after all. It was too good to be true to think I could stay on budget and have an emergency fund. This is always just going to be a struggle and I’m never going to be any good with my money, and I guess I’ll go back to my old financial ways because at least I was having more fun then.

So, it is important to have some bad day metrics to compare those inevitable bad days against to avoid this type of spiraling.

But, for those of us who are reasonably average at many things (and most of us are) with effort and time, good day metrics can and often do become average day and sometimes even bad day metrics, we just can’t expect them to be right way.

The first time I broke 100 on the golf course, the problem wasn’t in thinking that I was a golfer who could break 100, the problem was in thinking I was a golfer who was going to break 100 all the time from there on out. The truth is it took me almost a year to get back to that score – A YEAR. And it was one of the most frustrating and least fun years of golf that I have ever played, because every time I went out thinking I could break 100, and every time it didn’t quite happen, and I left quite discouraged. But now, 100 is a “worse than average” day metric for me on the golf course (and yes, for those of you who play a lot of golf with a high level of skill, you’re correct in thinking I’m still not that good of a golfer). And the fact that 100 is a bad day metric but it used to be a good day metric is a useful thing to remind myself of when I’m starting to feel frustrated.

Good day metrics have their place, and it’s fun to historically compare their peaks, but if you put them into the wrong place, you really risk a level of discouragement that can be crippling to progress. And your money trajectory is too important to let it fail because you used the wrong benchmark to compare yourself to on a bad day.

So go back and make yourself a list of those financial low points in life and remember to pull it out when you’re having a bad financial stretch. Maybe 5 years ago it was credit card debt you used to bail yourself out of a jam, then 3 years ago you had to spend down every last dollar of your savings account, and today, when a major unexpected expense came up, you still had $1000 dollars left over, and that’s substantial progress, even if no one is giving out trophies for incremental improvements on our worst days.

It’s natural for all of us to want to live up to our peaks all the time, but it’s important to realize when that’s actually getting in the way of our progress rather than propelling us forward to new heights. In those times, it’s critical to find a piece of information, a realistic metric, that allows us to take the next smallest step forward when we’re feeling discouraged, unmotivated, or disappointed.

You Should Love Your Financial Advisor

You Should Love Your Financial Advisor

(or find a new one)

Look. 

We know financial advisors don’t have a great reputation. 

We got into the financial advice industry to be disruptors of what we consider, at worst, unethical financial advising practices, and more often just apathetic and uninspiring ones.

We know this, but it still disappoints us every time we hear someone refer to their financial advisor as someone they don’t trust, aren’t happy with, or just a person who takes a lot of their money but isn’t really doing much for their financial situation. 

Whenever we hear a blasé review of a person’s current financial advisor, we just want to say “Stop! You pay financial advisors a lot of money to provide a service to you, a service related to an extraordinarily important component of your whole life. You need to go find yourself a financial advisor that you love.” 

Yes. Love!

There is someone better out there for you. And, in exactly the same way you would nudge a friend to break it off with a significant other after they complained about them for the zillionth time, we want to nudge you to go find yourself a better financial advisor. If someone gave you a terrible haircut, we’re hoping you wouldn’t go back for round two. So why is it so normal to stick with a financial advisor who is not living up to your expectations?

The only thing we dislike less than hearing that a dissatisfied client of an advisor is staying with them, is an advisor who fondly refers to the blessing of inertia in our industry. As in, “it’s just such a blessing that unhappy clients stick around because they’re too intimidated by or can’t be bothered with the process of moving their money to another financial advisor.”

(Yes, you heard that right. They are self-aware and they’re not even ashamed to talk about it with other financial advisors.)

This rhetoric is surprisingly common behind closed doors at financial advisory firms and conferences. At companies that prioritize the addition of new clients or new accounts at an unsustainable pace, reliance on client inertia leads to waning services after clients initially onboard because it’s more important to add new clients than to keep the existing ones happy (since they are, after all, likely to stay whether they are happy or not). And it’s a ridiculous thing for any advisor to be proud of or thankful for, and yet we hear it so often.

With talk like that, it’s no wonder people have such a hard time trusting financial advisors, seeing their value, or believing they could ever find a financial advisor that they love. 

And while it may be some work to find yourself a new financial advisor, it may not be as hard as you think. Typically, the hardest part for you will be finding people to interview, taking the time to talk to them, to assess their practice/processes, and decide whether they’re a good fit for you. So many people get intimidated by the prospect of moving their accounts and doing a bunch of paperwork, but in reality, a good financial advisor is likely going to make that part of the process pretty easy (and if you’re a DIY investor not wanting to move accounts at all, in this day and age, it’s also quite possible to work with an advisor who can just advise you on what to do with the accounts you have, with no transfer or takeover of assets required.)

What are some signs you might be ready for a new financial advisor? 

Beyond just outright complaining, here are some other questions to consider when assessing your current relationship with your financial advisor:

Do you consider this person a trusted financial ally for ALL of your financial questions?

Would you, for example, reach out to them if you had to unexpectedly make a big purchase, or were having some trouble figuring out how to best manage your budget, or considering making a significant job change. A good financial advisor should be your go-to for all financial questions, not just questions about your investments

Do you look at the fees they charge you each month or quarter and think to yourself, this person is absolutely worth what I pay them?

You should. Period. Financial advisors have a lot of value to offer if they are educated, proactive, and involved in your situation. If you’re paying hundreds or thousands of dollars a month to someone, you shouldn’t have any doubt that they are worth what you pay them. 

Do you trust the advice they give you?

We’ll talk about fiduciaries a little bit farther down, but a good financial advisor should give you options and financial advice that are in your best interest, always – we refer to this as the 100% fiduciary standard. And although studies show that 50-65% of Americans believe their financial advisor is a fiduciary, in reality, only about 11% of financial advisors work in a 100% fiduciary capacity.

Where should you look for a new financial advisor? 

There are fortunately good resources for finding financial advisors out there, but it’s never a bad idea to start with folks you know and trust, and to ask for recommendations. But be thoughtful about who and how you ask, and how you interpret the responses.

Good financial advisors tend to specialize in the types of work they do, so the best financial advisor for your parents might not be the best financial advisor for you. Asking people whose financial and life situations are similar to yours makes it more likely that the recommendation will be a good fit for you. And try to make it clear when you ask, you don’t just want to know if someone knows of a financial advisor, you want to know if they have a financial advisor that they love. 

That being said, we’d also highly recommend that you do some independent research of all the options out there. These two sites are a great place to start: 

Both of the sites above vet their advisors for: 

  • Education – advisors have to have completed the Certified Financial Planner™ (CFP®) certification, which is the minimum level of planning education you should be looking for in a financial professional. 
  • Fee-Only – advisors can’t make commissions on sales of mutual funds or insurance products. (Note that ‘fee-only’ is distinctly different from ‘fee-based,’ and ‘fee-only’ is what you want)
  • 100% Fiduciary – advisors must act in their clients’ best interest 100% of the time. (Similar to the language around fee-only vs. fee-based, advisors can claim to be a fiduciary even if they only have to act as one some of the time, so it’s important that you ask your financial advisor if they are required to act as a fiduciary 100% of the time), or use one of the sites above as a way to screen for that before you start interviewing.

How many people should you talk to before making my decision? 

As many as it takes to find a financial advisor that you are enthusiastic about working with. But typically, we’d recommend chatting with at least three financial advisors so you can see what the options are like and the range of services available. 

It’s a little bit like buying a house though. You might know very quickly that you’ve found a great fit for you, or it may take months of looking at what’s out there to find just the right fit. So, there’s no rule that says you need to stop interviewing after three, nor is there anything saying that the first person you talk to won’t be a great fit (though even if they are, what’s the harm in talking to a couple more?)

What should you look for in a potential financial advisor? 

The three key components mentioned above – 100% fiduciary, fee-only, and some level of education that shows an interest in proactive financial planning (preferably a CFP® certification), are essential. But in addition to these, take the following under consideration: 

Fit – personality, trust, expertise. You want a financial advisor you feel like you can connect with, be honest with, and trust. Fit is critical to a successful working relationship. Beyond just a connection, look for someone who specializes in working with folks who are similar to you in terms of career stage and even industry. They’ll have far more to offer in terms of proactive financial advice for your situation. 

Business Model – It’s also important to consider the environment under which advisors work. We’ve met good financial advisors who work for major brokerages, but the reality can’t be ignored that the bigger the firm (like running ads on Superbowl Sunday big), the more likely the advisors’ top priority, whether they want it to be or not, will be adding as many new, big clients as they can. The problem with that is that even a good financial advisor has to put their focus somewhere, and if the focus is always on more and new, it’s unlikely that your financial situation will get the sustained, continued, and long-term attention that it deserves. I actually think great, underutilized questions to ask a financial advisor are: “Do you limit the number of new clients you take on?” and, “Does your firm expect that you add more clients constantly?”

Background Check – Did you know you can background check any financial advisor that you talk to? Want to see if someone has filed a complaint, what the verdict of that complaint was, etc? You can use the FINRA Broker Check tool to do that for any financial advisor that you interview. So in a world where it’s important to trust but verify, we also highly recommend doing your homework on the advisor’s history before making the decision to hire. 

Is it better just to do it yourself? 

There’s no right or wrong answer to this question, and we’d be highly skeptical of anyone who considers this to be a yes or no question. Financial advice is a service, just like any other. And for some people, it makes sense to pay for that service, while for others, it makes sense to do it themselves. And for some, there will even be times in life that it may make sense to have a financial advisor, and other times where they are perfectly comfortable and capable of going it alone. The truth is that any one of those choices is not universally better than the other. 

Think about this like paying for car or home repairs or maintenance. There are multiple factors to consider when deciding if you want to work on your own vehicle or remodel your own kitchen. 

  1. Do you have the expertise to do this?
  2. If not, do you have the time and willingness to learn how to do this?
  3. If you do have the expertise, is this the way you want to spend your time and energy?

This is no different than assessing whether you want to pay someone to do your taxes, work on your vehicle, cut your hair, or clean your house. But we’d have the same advice for you in those situations as we did in this one. If you’re going to pay someone for a service, don’t settle for something that’s unsatisfactory. 

Take a moment to think about someone you hire that you are truly thankful for, someone you enthusiastically recommend to your friends and/or family, someone you feel is well worth the money you pay them. Now imagine that you could feel that way about your financial advisor. Imagine you hop off a call with your advisor and feel a sense of peace and clarity about your finances. Imagine bursting with excitement about your financial advisor and wishing you could immediately tell your friends or family what a great experience you’ve just had. 

Is it possible? Yes. It is possible to love your financial advisor, and you should, because you are investing your hard-earned money to hire one! 

So, if you are going to work with a financial advisor, take the time to find one you can be enthusiastic about, and don’t be afraid to change if you are not. 

Image sources: Laptop photo by Nick Morrison on Unsplash , Magnifying glass photo by Ahmed Zayan on Unsplash

Annual Financial Hygiene Checklist

Annual Financial Hygiene Checklist

Financial planning can be a lot of things… fun, stressful, exciting, overwhelming. But in reality, a lot of the time, like many types of self-care, it can actually just be boring. So, while this can be an exciting time of year to think about aspirations, it’s also a good time of year to think about one of the most important and boring parts of your financial equation: basic maintenance.

That’s why, this year, in celebration of the new year, we’re putting out an annual financial hygiene checklist. Whether you’ve got big financial resolutions for the new year or plan to just stay the course, there are a few things we should all make sure to do at least once a year to ensure basic, ongoing financial health.

1. Log In to Your Accounts

That means bank accounts, investments, and credit accounts. I know, it’s hard to imagine you could lose track of your money, but we’ve helped more than one client track down accounts they have lost over time. That’s why it’s a good idea to make sure you know where your accounts are located, and to log into each of them at least once per year.

While you’re logged in, we recommend:
  • Changing your passwords – a task that should be done at least annually.
  • Updating your directions or guide for your Power of Attorney and Estate Executor.
    (Don’t have a guide set up? Check out Erik Dewey’s Big Book of Everything for a great place to start.)
  • Getting the information you need for an updated balance sheet and net worth statement.

2. Update Your Balance Sheet and Net Worth Statement

In a nutshell, your balance sheet is a list of what you own and what you owe, and your net worth statement is simply a calculation of the value of everything that you own minus everything that you owe.

Sounds pretty boring, right? But, we firmly believe that the only appropriate way to assess your financial progress and status is to use your past self (rather than anyone else or any random societal standard) as a benchmark, and the easiest way to do this is to build a net worth statement and update it at least once per year.

Not sure where to start? Check out Gabbi’s incredibly helpful video on this topic.

3. Check the balance of your Flexible Spending Account (FSA)

This one is a bit time sensitive. Many employers allow an FSA grace period where funds contributed last year can be spent this year as long as they are spent before March 15th. So, if you didn’t check the balance of your FSA and spend it down at the end of last year, there may still be time before the “use it or lose it” deadline.

4. Revisit your Roth and Traditional IRA Contributions

You have until the tax filing deadline to max out your personal Traditional IRA or Roth IRA for the previous year, so if you’d like to make a contribution for last year, there’s still time.

That being said, it’s also important to remember that IRAs and Roth IRA’s have income limits and rules to abide by. So, to make sure you’re staying on the right side of the IRS when it comes to if and how much you contribute, it’s good to revisit those rules and income limits annually.

To stay out of a situation where you may have to do a complex reversal or recharacterization, it’s a great idea to work with your tax professional and/or financial advisor to best determine if and how you can take advantage of traditional or Roth IRA contributions each year.

5. Establish or Re-Establish a Fraud Alert on your Credit if it’s not Frozen

If you’re not in a place where it makes sense to freeze your credit entirely, the bare minimum recommendation to protect your credit is to set a fraud alert on it annually. This will make sure no one can open a line of credit in your name without you receiving a phone call first.

And, it’s super easy to set up. For step-by-step instructions, check out this blog post we published on the topic a few months ago.

6. Check Your Social Security Earnings Record

If you haven’t heard my cautionary tale of how it’s not just a given that your employer accurately reports your W2 earnings to the Social Security Administration each year, you can read about it here.

But, the moral of the story is, it’s a really good idea to regularly review the earnings the Social Security Administration receives for you each year from your employer, because mistakes get hard to fix the longer they go unnoticed. And, it’s much easier to check your approximate earnings and spot a mistake when it’s only 2-3 years old, rather than having to rely on your memory to notice a mistake from 10 or 20 years ago.

7. Review Your Insurance Policies

We hope you have a good insurance agent or broker (or at least a good financial planner) that you’re working with to review your insurance coverage regularly, but we also know that insurance is kind of boring, and even though your agent calls you every year, you may not always respond. Coverage needs for life, disability, renter’s, homeowner’s, auto, and umbrella liability insurance all change throughout the course of your lifetime, so you can’t just set them and forget them. It’s a good idea to sit down and review your coverage annually and make sure it’s adequately protecting you and your family.

8. Check Your Tax Withholding

Did you know the IRS provides a free calculator that will allow you to check your tax withholding at any point during the year to see if you can expect a refund (or will owe money)? Checking this 2-3 months into the year can give you plenty of time to make adjustments to withholding so that you don’t end up with a big, unexpected tax bill next year.

It’s also a good idea to revisit this if you receive a major change in pay or take on a new or additional job in the middle of the year.

Even if you don’t have major financial aspirations or goals for 2024, think of this list like an oil change for your car – you may not need a new car or a new transmission, but there’s some basic maintenance that we all need to do to keep our financial picture looking healthy on a regular basis, and this list is a good place to start.

Header image source: StockSnap on Pixabay

Rethinking our Response to Holiday Overspending

Rethinking our Response to Holiday Overspending

Did you overspend for the holidays again?

Whether it’s travel, gifts, decorations, going out, or hosting parties or dinners for friends and family, December is one of the most common months for budget-breaking in American households. And, with New Year’s resolutions right around the corner, it also prompts one of the most common overspending responses: the desire to quickly forget it and “start fresh” tomorrow, where you will, by some magical power that has let you down a million times in the past, be better able to get a handle on your spending.

Consider just how many years you have repeated this pattern, only to end up back here again, overspent in December and overly optimistic about your ability to start fresh on January 1.

This year, instead of pushing those crappy feelings about overspending out the door as quickly as you possibly can, what if you tried a different approach to thinking about your holiday overspending that included just a little bit more time and attention to the present, tuning in to both the emotional and financial data you have in front of you?

If you’re willing to give something new a try, here’s what I recommend:
Close up shot of a pen resting on a journal

1) Sit with the discomfort and the consequences of your overspending.

This is not meant to be a shame-inducing exercise. We all need to practice holding discomfort and disappointment around choices we’ve made without shame or guilt. Imperfect choices don’t make us bad people, they make us human. But, to learn from them we must be willing to let ourselves acknowledge how they make us feel.

You shouldn’t shy away from the bad feeling overspending is giving you. You need to spend enough time with it to know it and to be able to bring it up again in the future. Try writing it down or recording a voice memo of it – something that you’ll be able to look at next November to help you remember this feeling as you head into the holiday spending season again.  

If you’re having trouble accessing the feelings directly, consider some of the following:

  • How has this choice made it harder for your future self? (For example, by creating debt that will have to be paid off or diminishing savings that was meant for something else.)
  • What are you giving up in exchange for the spending you just did? Was it worth it?
  • Did your spending provide you with any level of enduring satisfaction?

Our brains love to get rid of bad feelings and bad memories as quickly as possible. They are trying to protect us. But having a strong, aversive memory related to the feeling created by overspending at the holidays when the holiday season starts next year is one way to help combat the pressure to overspend for a dopamine hit. If your brain is trying to tell you that all this overspending is going to make you feel great, because “tis the season,” you need to have a stronger memory of how it actually makes you feel when you overspend. And then, you need to pause before you start up with the pattern again. Just take 5 minutes and sit with that feeling before you purchase a single thing for the holidays next year. Look back at your notes and journaling. If it’s uncomfortable to spend 5 minutes thinking about that memory, then do you really want to recreate that scenario all over again?

Calendar flipping pages

2) Plan for the financial ask of the holidays.

Pay attention to the details. It’s true, the holidays, for most of us, will likely always ask a bit more from our budget. And while we can pay attention to where and how much we indulge in that ask to keep that overspending to a minimum, we can also plan for that ask where it may feel like an inescapable reality.

For many, it’s probably unrealistic to think that December spending and February spending are going to be identical. But if you sit down and look at the numbers right now, you could just plan to save a little extra for December all throughout the year. If December is running you $1200 more than a normal month for gifts and food, maybe you just need to create a savings bucket for December and put $100 into it each month. The key here is – you have the data right here and now in front of you to look at, and an entire year to save for it. There’s literally no time like the present to see how much holiday spending is costing you and to put a plan in place to save for it ahead of time. And I’d emphasize again, if that’s uncomfortable, that’s all the more reason to do it.

What if that was your only New Year’s money resolution: to save enough through the year to make December not a financially stressful month, and you kept at it all year and were able to get through December without creating that financial bust feeling that it always brings. Think about how much more you might trust yourself to actually see another small financial goal through the next year, feeling good and well prepared for a month whose spending normally has the opposite impact on your feelings about money.

The consequences of overspending on anything that takes you farther away from the financial life you want to be living should be uncomfortable because it is a form of self-harm. If these feelings are not uncomfortable, you’re probably not spending enough time with them. If you don’t take some time to sit with the feelings and the data, you risk heading into the New Year with idealistic planning euphoria that will likely let you down again. To find the lesson in the choices that got you here, you need to spend some time with how they make you feel, and plan for the reality of what predictable and repeatable annual spending, like the holidays, asks of your budget.

Is It Time to Cash Out Your I-Bonds?

Is It Time to Cash Out Your I-Bonds?

It seems like only a year ago we were dealing with such an intense rush to buy Treasury Series I Savings Bonds (now affectionately known to the general public as I Bonds) at their historically high 9.62% interest rate, that as the October 31st purchase deadline approached, the Treasury Department’s website could not keep up with purchaser demand. As many rushed to get their purchases in, they found themselves unable to access the site needed to do so.

Since that time, inflation rates have settled, and the one-year mandatory holding period has now passed on I-bonds purchased prior to November 1, 2022. This has led some to wonder if it’s time to bail on their I Bonds in search of better yielding pastures. Current I Bond rates for bonds purchased during that 2022 frenzy are now just under 4%, which means a one year CD would produce a higher yield than your I Bonds.

(To clarify – though the posted rate on the Treasury Direct site is 5.27% as of November 1, 2023, that also includes a fixed percentage rate of 1.3%, which only applies to newly purchased bonds. Unfortunately for those who purchased at the 9.62% rate, that fixed rate is set at 0%, so any I Bonds purchased from May-October 2022 are currently making 3.97%).

So, is it time to looks for a better yield on your safe money? It depends a lot on why you bought I bonds in the first place, and how you think about that money in terms of your overall financial picture.

I have a ton of clients who bought I bonds during that time, and most of them fall into 2 categories, and my advice for them would be different, depending on their situation.

1

Those who were holding a relatively short-term pile of cash for something like a home purchase or home-improvement project that was 2-5 years out.

2

Those who just generally had a chunk of money around that wasn’t earning much, that they didn’t have an immediate need for, and in many cases, still don’t.

If you’re in category 1, and you bought I bonds because you were looking for a short-term place to stash some cash safely and your 1 year holding period on I Bonds has now passed, I think it’s worth considering whether your short term needs can be better met elsewhere. With it currently being possible to find CDs in the 1-2 year time-frame that are yielding 5-5.5%, I bonds may no longer be giving you the best return on this money for the time frame you’re considering. And there may be better ways to earn a higher guaranteed interest rate in the short-term.

If you’re in category 2, and you still have no real foreseeable need for those funds, consider making I Bonds part of your new emergency savings fund and just letting these bonds ride the ups and downs of inflation. Prior to the one-year holding period, I Bonds can’t really act as an emergency fund because you can’t access the money. But once the holding period has passed, for I Bonds purchased electronically, it’s typically about a 2-business day wait to get those funds transferred back into your contributing account. (For paper-bond holders, the cash out process is a bit more involved, so paper I Bonds may not actually make the best emergency fund.)

If you’re working with an appropriate buffer savings account, with the idea that your emergency fund is really just there for the 2-3 times in your life that you might REALLY need a sizeable amount of money for a truly unexpected event, then I Bonds are sort of the perfect place for them because they are:

1

Out of sight, out of mind.

They’re just difficult enough to get to that you don’t really think of them as readily accessible money. That’s exactly what you want for an emergency fund, something you basically forget about.

2

Not going to lose value to inflation, which to me, is the most I’m really hoping to get out of “earning power” from my emergency fund.

I don’t want it to be worth less because inflation has eroded its value, but I don’t need it to be kicking inflation’s butt in terms of returns either. I bonds are the perfect vehicle for this. You can rest assured that inflation is not eroding their value without having to actively be involved in their management.

3

Flexible in terms of cash out amount; You don’t have to cash out the amount you put in.

You can pull out any amount above $25 and leave the rest to continue working for you (and preserve its holding period), and I Bonds can be rebuilt in smaller and more regular increments as well if you ever do need to draw on these funds.

Remember, the goal of emergency-fund safe money is not to make as much money as possible with it, it’s to keep you from having to borrow money at high interest rates in the event of some sort of unexpected financial catastrophe. And while chasing short-term returns on things like CDs may feel like the smart money move now, it doesn’t take too long of a look back into history to remember when CDs and high-yield savings accounts were returning 0.5%.

Whether you decide to cash out your I Bonds or not, there are a few additional considerations and risks to note.

If Cash Out is in Your Near Future

1

Be aware that cashing in an I bond any time before the full 5 year holding period results in a penalty equivalent to the last 3 months-worth of interest earned.The good news is you don’t have to factor this into your calculations of what your I Bonds are worth. If you log into your Treasury Direct Account and look at the value of your bonds, any bonds held for less than 5 years are showing the current value minus the most recent three months of interest, since that’s what you can cash out for today.

2

If inflation picks back up again in the next 2-3 years, and you decide you want to purchase I Bonds again, you’ll restart with a new holding period on new bonds purchased, and you’ll be subject to the one-year purchase limitation (which, in most cases, unless you’re out there working the loopholes, is $10,000 per person per year).

3

Interest on I Bonds is taxable, so if you cash out, you’ll owe income taxes on the interest that you’ve earned thus far.

If You’re Holding for the Long-Term

1

There are times/years when your I Bonds may not return anything. In years where the inflation rate drops to 0% or below, I Bonds that have a 0% fixed rate will be making 0%. In times like these, it’s good to remember that your I bonds are keeping up with inflation just fine, there just happens to be no inflation to keep up with.

2

Interest on I Bonds is taxable, and you have the choice to pay those taxes along the way or wait until you cash out (or when the bonds mature in 30 years, if you hold them to their full term). Either way you choose, make sure you’re keeping clear records and discussing with your tax professional. Since cash out or maturity is the only time Treasury Direct actually issues a 1099-Int, if you want to pay each year as interest accumulates, it will take some effort on your part to get into your account and see how much you’ve earned, and to keep track of the interest you’ve already paid on your earnings.

3

For people at some income levels, who meet certain conditions, I bonds (And Series EE Savings Bonds) have a similar tax advantage to 529 plans, which is to say, if you use them for higher education expenses for your children, you may not have to pay any taxes on the interest earned.

Is There Any Reason to Buy I Bonds Right Now?

I think if you like the idea of using I Bonds as a long-term emergency savings fund, but you didn’t quite get enough into them last year to fully fund your emergency savings need, a more steady approach to I Bonds purchases until you meet that goal could make sense for you.

Though most people were frantically attempting to put the max ($10,000) into I Bonds before the deadline last year, they don’t have to be purchased like that.

So, if you put $10,000 into I Bonds last year, but would really like to have your emergency fund up at around $20,000 or $30,000, you could set up a more gradual purchase plan (you can buy I Bonds in increments as small as $25, and it’s possible to set up a regular contribution/purchase on the Treasury Direct site, so that this can happen passively in the background of your accounts each month). An advantage to doing this is that bonds purchased at different times have different fixed rates, so for example, an I Bond purchased today has a 1.3% fixed rate that stays with it over the course of its lifetime, so that even if the inflation rate drops to 0% or below, that bond will still be returning 1.3% for you even in times of negative or no inflation. So while the current posted 5.27% rate isn’t quite as flashy as that 9.62% rate, there’s an argument to be made for a bond purchased today as a better “long-term” savings vehicle, since its overall interest rate will never actually drop to 0.

Attribution: Header image by TheKarenD on Flickr

Rethinking Default Inheritance Assumptions

Rethinking Default Inheritance Assumptions

When having estate planning conversations with clients, one of the common questions or discussions that comes up is, for lack of a better word, who could be their “logical” inheritors. For some, there’s no question about who they want to inherit the bulk of their assets and estate. But the conversation, particularly when clients don’t have a significant other or children, often becomes a process of listing extended family that would be the next logical familial inheritors. Sometimes, these relatives are distant and hardly known to the client, other times they are siblings whose age is such that it’s unlikely that they’ll even be alive when the client passes away. Even though my clients are generally the type of people who tend to make their decisions through a lens of high social responsibility, it makes me wonder if we may all be sleepwalking a bit when we think about aligning our estate planning wishes with our values-based lifestyles and financial decisions.

Now, I want to be clear that I am not objecting to a choice someone makes to leave the bulk of their accumulated lifetime savings to their children or even a long-lost relative. It’s really none of my business who your choice ends up being. It’s just that this choice, for many, represents the largest bequest of assets they’ll ever bestow upon any recipient – so I believe it deserves as much thoughtfulness and intentionality as the other financial decisions clients make.

I have a suspicion that part this “pick the next logical family member” attitude comes from a general discomfort with the estate planning process. At any age, it’s uncomfortable for many of us to sit down and think about what happens to our stuff and our money when we die. Uncomfortable to think too much about someone else living in our home or selling it. Uncomfortable to think about a lifetime of things we consider ours just being given away, especially if we don’t have that perfect someone in mind to give it to.

Since I’ve recently been working on re-drafting my own estate planning documents with my attorney, and I, as a single, childless person, am in a very similar situation to the one described above, it’s given me an opportunity to think through this process of intentionally designating heirs. And through this thinking I’ve tried to develop a series of questions to work through with my clients when a situation arises where they may feel uncertain about who the recipient of their bequests should “logically” be.

Question 1:

What do you value and how can this decision reflect that? 

It’s important to set up this conversation as we would any financial decision – against the backdrop of your values.

If you haven’t yet tackled the “what’s most important to you” question as a part of your broader financial-decision making process, it’s worth it to do that before sitting down to make decisions about your estate plans. Because it seems like trying to answer the question of who you want to benefit from what you’ve accumulated over the course of your entire hardworking lifetime must first be a question of what you think is important.

Question 2:

Realistically, what is the need and the extent to which your family, extended family, or long lost third cousin will benefit from your bequest?

This is obviously a complex question, because we don’t always know that much about the financial situations of others. And, realistically, for most middle and even upper-middle class folks, there are very few people who wouldn’t generally feel a bit more comfort after receiving an inheritance. That being said, it’s also true that many people don’t inherit from their parents or older relatives until they are well along their own path to financial stability. And while it may be important to leave your family something to improve the quality of their lives with, by the time they receive it, it may be more like icing on the cake. And if that’s the case, it worth considering whether there might be other people or causes whom you feel may benefit more significantly from at least a partial bequest of your estate.

Question 3:

Are there organizations who might benefit from a donation, or even a specific asset in your estate?

Many clients I work with place a high value on philanthropy throughout their lifetimes, and often lament the fact that they cannot do more, and yet it’s quite common for them to never bring up charitable bequests within their estate planning wishes. If charitable giving is important to your lifetime financial decision-making though, I think it’s at least worth a consideration in your legacy.

Another way to think of this might be around what parts of your estate may actually really benefit certain organizations that you value and would like to support. For example, the bequest of a house could be hugely impactful to something like a housing and land trust whose mission is focused on the creation of affordable housing opportunities, or the bequest of your vehicle might have a bigger impact to a charitable organization that could put your vehicle to use than its resale value would represent to your estate. Similarly, heirlooms or collectibles that your family has expressed little or no interest in might be extremely valuable to a historical museum. So, it’s also worth considering whether you may have specific assets that would benefit a charitable organization in a way that far exceeds what the sale of that asset would bring.

Question 4:

Are there ways for heirs to benefit from your accumulated assets even before your death?

This one doesn’t apply to everyone, and I’d always recommend working with a good financial advisor to help with these types of decisions. But very often, retirees do hit a point where it becomes clear that they have more than they need to see their retirement through, even if they live to be 105, and need a fair amount of long-term care.

If you are fortunate enough to be in this position, it might also be worth considering upping your lifetime giving to future heirs (whether they are your kids, your community, or organizations whose mission is important to you). Not only is this a good way to put your legacy wishes into action when you can still see their impact, it also may have some underlying tax-advantages as well if structured correctly.

Not everyone is fortunate enough to have this opportunity, and again, I wouldn’t start giving things away during your life too freely without the advice of a financial advisor. But if you are in this position, lifetime giving may be another strategy to explore as complementary to your estate planning wishes.

A few additional notes to consider as you embark on this journey…

1

It’s not really comfortable to do this type of thinking.

No other financial decision brings out more of a “just want to get it over with” attitude in my clients than estate planning.

I think this is why it’s so tempting to just say – leave it all to the kids, or my brother, or this third cousin I don’t even know. The less they have to think about it, the less time they have to spend in that discomfort.

As I mentioned, I recently went through the process of making some of these changes to my own estate planning documents, and it IS uncomfortable. But what I ended up with is a set of documents that I feel represent what I would want to leave behind in this world even if I was no longer around to make a daily impact on it. A set of documents that are far better aligned with how I make my other financial decisions than my previous ones were. But it’s still uncomfortable to think about. I don’t know if that will ever go away.

2

It’s not an all or nothing decision.

Your desire to leave something to charity, or a long-term caregiver, or a good friend or mentee doesn’t mean you can’t leave anything to your family. The great thing about a will is that it allows you to make specific bequests, and it also allows you to portion out your estate. Maybe your comfort level right now is with leaving 5% of your estate to a charitable organization, but maybe in 20 years, when you’re confident that your kids are on their way to being financially stable, or your estate has grown some, you’ll feel like you can increase that percentage or dollar amount.

Portioning off your legacy by percentages, dollar amounts, or even specific assets is something any good estate planning attorney should have no problem completing for you.

The point here is not to cut your kids and loved ones out of your will, the point is to make sure your last big financial transaction is well aligned with what you value, and how you make your other financial decisions. That you’re not just doing it on autopilot.

3

It might be worth having a conversation with your default heirs about your plans.

I have a lot of conversations with clients who are likely to inherit something from their families someday about the importance of not counting on or relying on this inheritance as part of their financial plan. But not everyone has a financial advisor to give them the same advice.

And, even with that, there’s no question that in our society, it’s easy to get gifts (particularly financial gifts) and who receives them tied up with questions about who is favored or loved. So, if you are making changes to your will to include heirs that may not be your children, I think it’s worth considering whether you can reasonably have a conversation with your kids about your intentions and why you are making the choices that you are, so that they’re not left to interpret these decisions as a lack of love for them after you’ve passed.

This is not universal advice – the dynamics of all families are different and I realize in some families, this is simply not possible to do. But often, one of the major complaints I hear from my clients as it relates to inheritance has nothing to do with if they’ll inherit or even how much. It has to do with the lack of transparency and communication their parents have had with them about this particular topic. Their bigger concerns are often just whether there are appropriate estate planning documents in place at all, and what their responsibilities will be when the time comes to enact them.

Remember, the point here is not to cut your kids and loved ones out of your will, the point is to make sure that this decision is simply as well aligned with what you value as all of the other financial decisions you make over your lifetime. That you’re not just doing it on autopilot because you don’t really want to think about it.

Is Washington’s New Roth Deferred Comp Option Right for You?

Is Washington’s New Roth Deferred Comp Option Right for You?

This fall, WA State Department of Retirement systems will be rolling out an option to make elective deferrals to retirement savings accounts (aka Deferred Comp, DCP, or 457(b) accounts) as after-tax, Roth contributions.

Prior to this, state employees and others served by the DRS Deferred Compensation Retirement plan have been limited to pre-tax (aka as traditional or tax-deferred) contributions to their retirement plans, and the change has many asking if they should utilize the Roth option or continue with their traditional contributions.

For a brief review of account types: traditional contributions are made pre-tax (so you don’t pay income taxes now). They are invested and are only taxed when you take account distributions in retirement. But when you do take distributions, you’ll pay income tax on both the original contribution amounts as well as the investment earnings. Traditional contributions are a great way to lower your current taxable income, but they aren’t tax free. They just defer your taxes to a later point in time.

Roth Contributions are made after tax, which means they don’t lower your current taxable income. But once the contributions are made, they are allowed to grow tax free from that point on until you access them in retirement. When distributions are taken from a Roth account, you don’t have to pay taxes on the distribution, so the investment growth is essentially yours, tax-free.

While there is no single right answer to the Roth vs. Traditional contribution question, there are steps to work through when trying to decide if the new Roth Deferred Comp option is right for you:

1

Establish a rough estimate of your post-retirement income and determine whether it will represent a change in tax-brackets.

1

Establish a rough estimate of your post-retirement income and determine whether it will represent a change in tax-brackets.

Most people served by the state administered DCP program will also receive a Plan 2 or 3 Pension, Social Security (with the exception of those served by the LEOFF program, many of whom are exempt from Social Security), and possibly funds from a Plan 3 TAP Annuity. The combination of these funds means that you will likely have a fairly steady source of taxable income in retirement. It’s a good idea to start by trying to anticipate how much, and if it will adjust/change your tax bracket at all.

A tax-rate calculator can help you get a sense of what income tax bracket you might be in at retirement so that you can compare it to your current tax bracket. If you’re not sure what your current tax bracket is, these days, when you finish preparing your taxes (or get them back from your tax preparer), they typically come with a summary comparison sheet for the last 3 years at the front of the document. At the bottom of that comparison sheet, you’ll be able to find your marginal tax rate to compare it to the projected marginal tax rate shown on the calculator above.

If your tax bracket looks like it will be drastically lower in retirement – that bodes well for favoring traditional, pre-tax contributions, when possible. But for many teachers, state workers, and other public servants who are also good retirement savers, it’s quite possible that your tax bracket may be equivalent to, or in some cases even higher, in retirement. And if it looks equivalent (and none of the other considerations below apply) it’s a good idea to consider using a Roth contribution method for at least half of your ongoing retirement savings. That being said, item 2 below might point you in the direction of directing an even higher percentage to Roth contributions, while item 3 might actually suggest it’s a good idea to wait a few years before starting to make retirement contributions as Roth contributions.

2

Determine how much tax-deferred savings you already have, and how that will impact your future, taxable income.

2

Determine how much tax-deferred savings you already have, and how that will impact your future, taxable income.

As I mentioned in this article on teachers who may have too much tax-deferred savings, it’s a real possibility for someone who has worked in a state or teaching job and who has saved aggressively for retirement to create a situation where, once Required Minimum Distributions begin, they are catapulted into a significantly higher tax bracket in retirement than they’ve ever been in before.

At that time, for teachers, I recommended considering a Roth 403(b) as a potential alternative savings method, but there really wasn’t a good alternative for state employees. The good news is that with the state’s adoption of the Roth DCP plan, teachers and all others served by DRS and the state DCP plan will now have the option to make some or all of their retirement savings Roth contributions, for many, eliminating the need to go the 403(b) route at all.

A great way to determine how impacted you might be by this phenomenon is to use an RMD Projection Calculator. This will allow you to see how much you will be required to start taking in Required Minimum Distributions in your early to mid-70s. You can add this to the taxable income you’ve calculated above in the tax bracket calculator and see how it impacts your tax bracket. If it looks like the existing savings you have is going to produce substantially more in RMDs than you need, and will drive your tax bracket up even farther, it’s worth considering a full switch to Roth contributions as soon as possible (provided you won’t be significantly impacted by the issues in point 3).

3

Determine whether increasing your taxable income now will have any unintended, drastic consequences on your tax deductions or credits.

3

Determine whether increasing your taxable income now will have any unintended, drastic consequences on your tax deductions or credits.

All other things being equal, I tend to favor Roth Contributions as at least an equal portion of retirement savings for most people, unless they are in a marginal tax-bracket higher than 30% currently, or they have a good reason to believe they’ll be in something like the 10-12% tax bracket through most of their retirement. If we pull financial planning out of the hypothetical spreadsheet world and look at it in real terms of real people retiring, I’ve rarely met a retiree who regretted the amount of Roth contributions they made along the way, while many are overwhelmed by the tax implications of large tax-deferred retirement accounts. The truth is, when you’re making money, paying taxes is a pain, but it’s not a source of great anguish for most people. But in retirement, when income is fixed and you’re no longer adding to your investments, bigger than normal tax bills can actually be a source of great mental stress for many retirees because they see the taxes they have to pay pulling from a fixed pot of income that they are not replenishing each year with a salary.

That being said, there are certain situations where your Taxable or Adjusted Gross Income may be just barely qualifying you for a lot of tax breaks (in addition to a generally lower tax rate) that you wouldn’t get if you suddenly started to show even a little bit higher Adjusted Gross or Taxable Income. This is a particularly relevant consideration when you’re getting big tax breaks related to your kids (for childcare, higher education expenses, etc.).

While the details of each of these are too much to get into here (these types of tax breaks phase out at all different income levels, so unfortunately there is no succinct way to explore them all), suffice it to say that it’s worth discussing with your tax-preparer or financial planner the consequences (and potential lost tax-advantages) if you’ve been making fairly substantial pre-tax contributions and suddenly start making those as Roth contributions. Besides just paying taxes on more income, are there other major advantages you might be missing out on if you make this switch from traditional to Roth contributions?

What Else Do You Need to Think About when Switching to Roth Contributions?

Once you’ve decided to make the switch, there are a few things that you may have questions about, or that you’ll want to keep in mind going forward.

1

If you’re switching from pre-tax to Roth contributions, but plan to contribute the same percentage or dollar amount as before, you’ll see a smaller paycheck due to the taxes taken out.

1

If you’re switching from pre-tax to Roth contributions, but plan to contribute the same percentage or dollar amount as before, you’ll see a smaller paycheck due to the taxes taken out.

For example, if you were making a $1000 per month contribution to a traditional DCP account before, and you decide to make that $1000 contribution to a Roth DCP account going forward, they’ll still only take out $1000 for the contribution, but they’ll have to withhold taxes on the contribution amount, since taxes will be owed this year. Depending on your tax bracket, you could anticipate that your monthly take-home pay on a $1000 contribution might be $100-$300 lower to account for this additional amount you have to pay in taxes now.

2

The total contribution limit hasn’t changed.

3

There is no income limit for Roth DCP contributions like there is for Roth IRA contributions.

2

The total contribution limit hasn’t changed.

In 2023, you can still make a total DCP Contribution of $22,500 (or $30,000 if you are 50 and older). Whether it’s all Traditional, all Roth, or a combination of both, this is still the maximum total amount you are allowed to contribute to DCP per year.

3

There is no income limit for Roth DCP contributions like there is for Roth IRA contributions.

This is a question I receive a lot, and it’s a great point to be aware of. For many folks who have been phased out of their ability to make traditional Roth IRA contributions due to the income limitations, it’s important to realize that these income limitations do not apply to Roth DCP contributions. So, income levels are worth considering because they impact tax brackets, but there’s no point at which you won’t be allowed to make Roth contributions to your Deferred Comp account should you want to do so.

Without knowing exactly what the future brings in terms of income, tax-brackets, and investment growth, it’s hard to know with 100% precision whether Roth Contributions will be the right call for you going forward. That being said, by considering all of the factors above, and working with your financial planning or tax professional, you’ll be able to make a reasonably educated guess about whether you want to take advantage of this new Roth Contribution option being offered by WA State Department of Retirement Systems.

Have more questions?

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Image attribution: Header image by Sean Oneill via Flicker. Some rights reserved.

Accessing and Interpreting Your Social Security Estimates and Earnings Record

Accessing and Interpreting Your Social Security Estimates and Earnings Record

And why you should make this part of your Annual Financial Routine  

Social Security. If you’re under the age of 40, there’s a temptation to question whether you’ll even receive it. In fact, the most common pushback I receive from young to middle aged financial planning clients when I ask them to log on and get a Social Security benefit estimate is that they don’t want to count on Social Security as part of their retirement plan. And that makes sense, given that for most of us, our adult lives have been filled with headlines about how Social Security is running out of money and won’t be there for us in retirement.

But hear me out.

You need to log in to your Social Security Account once a year anyways, even if you don’t have the ten years of work experience you need for a benefit estimate, and even if you don’t want to count on Social Security as part of your retirement income. It’s still a good idea to make this part of your annual financial routine.

First, it gives you an idea of what Social Security might pay you in retirement. There are obviously no guarantees here. As we stare down some major financial hurdles that Social Security will have to face in the next 10-15 years and combine those with some assumptions the system’s algorithm is making about your earnings record (more on this later), you can’t take that estimate and consider it money in the bank just yet. But I still fall on the side of Social Security being a system that is likely too big and too heavily relied upon, to fail entirely. And while some people may want to plan to do without it, for many, the Social Security estimate is a good starting point for a realistic retirement savings goal for both the very motivated, and the very unmotivated retirement saver.

By that I mean, I’ve worked with plenty of middle-income clients whose interest in saving for a retirement where they don’t count on Social Security is subject to a bit of sticker shock when they see what savings that would require. But rather than give up hope entirely, a good way to approach this is to create a plan that includes Social Security as a first step to a retirement savings goal, with the option to flex up later as more income becomes available.

On the opposite end of the spectrum, Social Security estimates are also a useful tool for someone who may assume Social Security will cover a lot more than it actually will. And this can be motivating in terms of establishing an understanding that even if it is still around, it’s not going to pay for everything. So, you need to start saving and investing to make up the difference.

Either way, the number is just information in your financial forecast, but it’s useful information to have, and it’s worth logging on just to get a sense of it and what part in your financial future it might play. But, there’s an even more important reason to do an annual check on your Social Security account regardless of your age, and that is to check the accuracy of your earnings record.

What is Your Earnings Record and Why Do You Need to Check It?

Your earnings record is simply a record of earnings from every year that you’ve worked where Social Security Tax was taken out of your paycheck and paid on your behalf. When it comes time to receive a benefit, your benefit calculation will be based on the highest 35 years of your earnings record.

And while, in a perfect world, all Social Security taxes you’ve paid would show up here, in the real world it’s not a given. Whether it be typos or egregious errors made by incompetent payroll departments, mistakes in reporting happen.

Seriously – take it from me. The first time I did this I found a mistake from 11 years back where an employer had simply not reported my earnings to Social Security for the entire year. And fortunately – I had a good enough memory of that year to recognize right away that there was a misreport. But even then, resolving it involved contacting the former employer (who I hadn’t worked for in 11 years) and requesting a reprint of my W2. I’m not sure if I’d been looking at that record for the first time at 50 or 60 if I’d have been able to both recognize the error that quickly and get the documentation from the employer that I needed to fix it.

The Social Security website is remarkably specific these days when you look at your earning record. It tells you not just the dollar amount of earnings reported, but also who reported them. So, in a case like mine where I had worked for two employers in the year of the misreport, it was easy to spot who had made the error, and where I needed to start in my quest to fix it.

If you’re in the habit of routinely shredding tax returns after a certain number of years, then checking this record each year before you do this is a really good idea. That way you’re not getting rid of the evidence you may need (like a W2) to refute the misreported earnings.

How Do You Access Your Social Security Benefit Estimate and Earnings Record?

The Social Security Website is where you’ll want to start: https://www.ssa.gov/

If you’ve been here before and already set up your log in credentials, you can simply log in using those. If you’ve never logged in, you’ll need to create an account. The new id.me account setup has made this a relatively easy process for anyone with a smartphone and a drivers’ license or other state-issued photo ID. By leveraging the power of AI, they’ll have you upload a photo of your ID, and then use your camera to take a photo of yourself to verify that it matches. Once your identity has been verified, you’ll be able to log in with the credentials you’ve set up and download both a benefit estimate and review your earnings record in detail.

Keep in mind that the earnings record can take 1-2 years to update, so when you’re reviewing your record for accuracy, don’t fret too much if the most recent years are incomplete. Just make a note to check them again when you login next year.

What Does Your Benefit Estimate Actually Tell You?

Once you’ve checked your earnings record, you may start to wonder what the number on your benefit estimate means, and how accurately it will reflect what you are projected to receive in retirement. To really understand it, you need to know what assumptions it’s making behind the scenes.

As I mentioned, Social Security benefits are based on your high 35 years of earning, so for a young to middle aged person, the system is obviously making significant assumptions to create projections. The first one to be aware of is that your Social Security Benefit Estimate is based on the assumption that whatever you earned last year, you will continue to earn this amount annually (adjusted for inflation) through your retirement date. If you didn’t work last year, or your earnings have yet to be reported, then it will use your earnings from two years ago as your assumed annual earnings until retirement.

That’s something to be cautious about if your earnings are variable, or last year represented a particularly high or low earnings year for you.

Another factor to keep in mind is that the benefit estimate at any given retirement age is also using an assumption that you are working until that age. Though this may be the case, it’s not uncommon for folks to retire at an earlier age than 67 or 70, but delay taking their Social Security benefit until their Social Security Full Retirement Age or later. In this case, the system may be slightly over-projecting what your estimate will be.

The flip side of the potential for over-projection using a particularly high earning year, is that if you have no reported earnings for the last two years, Social Security estimates assume that you will not have any earnings between now and retirement. Which could obviously create a very skewed estimate if you, say, have taken a couple of years off to raise young children or travel the world, but plan to go back to work before you retire.

All of this is to say, the benefits estimate is useful, but it’s important not to take it as a true reflection of what your Social Security amount will actually be, and to adjust accordingly if your situation is one that would result in a major over or underestimate.

The last big assumption to take into consideration is simply that Social Security Estimates are reported in today’s dollars, so inflation adjustments are not built into the number you are seeing on the benefit statement. As such, after checking the accuracy of the other assumptions stated above, I often encourage clients to make sense of the dollar amount as a percentage of their current spending. For example, if your Social Security estimate is $3000 at 67, and your current spending is $6000 per month, it would be good to have a savings goal and retirement plan that assumes you’ll need to offset at least half of your monthly spending with savings and investments. From there, you can start to work backwards to identify retirement savings goals.

For those of us still 30-40 years away from potentially claiming our benefit, it’s impossible to know what the Social Security landscape will look like when the time comes for us to retire, and it is wise to understand the lack of certainty in that space. That being said, it’s still a good idea to keep track of it (in the same way that it’s a good idea to make sure you log in to all of your accounts at least once annually), and to make sure the earnings reported for you are representative of the working career you’ve had so far. Because if Social Security stands the test of time (even at a reduced amount) you still want to make sure it’s working with an accurate earnings record on your behalf, so that you can claim as much of it as you have earned and are entitled to.

How much rent or house payment can you afford?

How Much Rent or House Payment Can You Afford?

This is a question I get frequently from clients, and there’s unfortunately no “one-size fits all” answer to this question. However, whether you’re considering rent or a mortgage payment, there are some key financial metrics and guidelines that can help you make this decision.

Conventional Rules of Thumb for Monthly Housing Costs

Most conventional recommendations advise limiting your total monthly cost of housing to 28% of your gross (before-tax) monthly income. So, for example, if your gross pay is $7000 per month, you’d be wise to shoot for a maximum housing allowance of about $1,960 per month for a rent or mortgage payment. And while this is a good rule of thumb to consider, there are other factors that may be at play in your personal financial situation that you want to take under advisement as well.

When considering the 28% recommendation for housing – look at how it factors into your other key financial ratios:

50/30/20 Ratio (For Renters and Home Buyers)

The 50/30/20 Ratio states that, as a general rule, 50% of your take-home income should be spent on non-negotiable needs (Rent or mortgage, utilities, groceries, insurance, and minimum debt payments), 30% on wants (Shopping, eating out, happy hour, concerts or sporting events), and 20% should go to savings, or to making additional debt payments if you are trying to get out of credit card or other non-secured debt. So, in the example above, if your $7000 monthly gross income results in $5,600 in monthly take-home pay, you would be wise to not exceed $2,800 per month in spending for necessities. And if the $1,960 per month that you’re spending on rent or a mortgage pushes you over that limit, you may want to reconsider whether it’s financially feasible for you to take on that payment or whether you need to look for a lower-cost housing option.

Overall Debt to Income Ratio (For Home Buyers)

Your total Debt to Income Ratio basically demonstrates to lenders what percentage of your total monthly income is going to pay off existing debts and is an important factor to consider if you are thinking of purchasing a home. Typically, a good or ideal debt to income ratio will have no more than 35% of your gross monthly income being spent on repaying debt (including the mortgage payment you’re intending to take on). So continuing with our example, if you were making a gross income of $7000 per month, ideally no more than $2,450 of that would be spent on paying down debt. That means that in order to afford your $1,960 per month mortgage payment, you’d need to have less that $490 in other monthly debt payments.

Don’t Neglect the Cost of Your Escrow Payment, Increased Utilities and HOA Fees

For first-time home purchasers, a major source of monthly-payment shock can come in the form of what you pay monthly to cover your escrow account payments. This amount essentially goes into an account that your property taxes and homeowner’s insurance are paid from. Because property taxes vary so widely, it’s hard to give an exact prediction of what this amount will be, but you can anticipate that it will typically be at least several hundred dollars, if not more in higher priced housing areas. When working with a lender on pre-approval, make sure they provide you with total monthly costs including escrow for different purchase amounts, and make sure to take that into consideration when evaluating the total cost of housing as part of your 50/30/20 Ratio. Utility costs often increase for homeowners as well because certain utility payments are factored into the cost of rent that will have to be paid separately when you own a home. And for condo purchasers, it’s also important to factor in the cost of monthly HOA dues.

Can You Cut Back Other Expenses to Commit to a Bigger House or Rent Payment?

If you were my client, I would advise against this as a plan without testing it first. If you were insistent and committed to it, I’d ask you to prove it to me. Prove to me that you can sustainably cut expenses elsewhere before you commit to a 30-year monthly payment on a home that exceeds recommended ratios. And the catch is, you can’t take it out of the 20% savings category. If you’re confident that you can reduce your “wants” spending to say, 15% so that you can afford more in the needs category, spend a year doing that before you commit to doing it for 30 years. And take that opportunity to save that extra 15%. After all, you’re about to embark on a purchase that will inevitably require a bigger buffer savings account than you needed when you were renting, so you might as well start now.

But if you’re already having a hard time meeting your 20% savings goal with your current monthly expenses or have already accumulated some credit card debt because you overspend monthly or when things come up, you are fooling yourself if you think that suddenly buying a home that increases both your monthly expenses AND your potential unexpected expenses for large-ticket items is going to fix this. It will not, no matter how alluring the idea of home-ownership is.

What If You Live in a Place with a Very High Cost of Living

This is very much a reality for many folks, and I’m not naïve to how variable housing costs are in different areas of the country. That being said, I think it’s important to have the conversation about the tradeoffs that come with being a lower-income earner in very high cost of living areas. Long-term, it is likely not going to be a sustainable way to live unless you are 1) actively pursuing a way to make more money, or 2) willing to explore alternative options for housing, like living with or renting to roommates, or possibly renting or purchasing a very small space. All of these are viable options, but otherwise, it just doesn’t compute. It’s not ever going to get easier to make ends meet living in an area where you can’t afford the cost of living unless you have a plan to either make more money or find creative ways to spend less. High cost of living areas are often filled with opportunities to make higher salaries, but if you are not pursuing those opportunities and are not willing to reconsider where you live, you may need to reconsider how you live and who you live with in order to make the available housing options affordable to you.

At the end of the day, there really is no one right way to do this. No exact rule that can answer this question for you. But ultimately, I’ve seen far too many people try and make high-cost housing options work that end in nothing but financial heartbreak and frustration. Keeping your housing choices within the realm of what you can afford is extremely important for your long-term financial health, and it also factors into preserving the life you want to live today (after all, for most people it’s a big tradeoff to let go of all their “wants” spending simply to buy the house they want… especially when considering how long the commitment to a mortgage is). But above all, I encourage you to avoid the trap of thinking you can make something work if you haven’t taken the time to prove to yourself that you can sustainably live on what’s left over after you’ve taken on the bigger mortgage or rent payment. That’s something to test before you make a life-changing financial decision, not after.

Have more questions?

Book a call with Lorri to discuss your situation, and to see what you can do to accomplish your goals.

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Disclosures & Policies

Sustain Financial Inc. is a Registered Investment Advisor in the State of Washington and California.

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