Friend of the blog Matt sent in a great question this week:
Hi Jesse – do you have any recommendations when it comes to life insurance? I know Term is the way to go, but that’s about all I got…
I scanned your blog posts and didn’t see anything too specific with it but if you have any guidelines for pricing or coverage recommendations, please let me know!
Matt
Matt’s Right. We Want Term!
Matt’s right. Term life insurance is the best option in 99.99% of cases.
Other types of life insurance (Whole, Variable, Universal, etc.) are bloated products that are “pushed” and “sold” far more often than they’re genuinely sought after. These products try to combine investing with insurance and end up being overpriced versions of each.
Some things aren’t worth combining!
The smarter option is to buy insurance that only acts as insurance and then use your remaining money to invest in pure investments. Term life insurance is just that life insurance product. All it does is provide money to your beneficiaries if you die. If you don’t die, it doesn’t pay. It’s simple.
But Do We Need Life Insurance?
How do we determine if someone needs life insurance?
I use the same framework I would use for anyinsurance question (home, boat, pet llama insurance, etc.).
Are you exposed to a financial risk that you could not comfortably recover from using your current asset base?
Let’s say your house burns down. Does that present a financial risk you could recover from using your current assets (cash, investments, etc)? If you answer no, then you need home insurance. (If you have a mortgage, your lender likely mandates you have insurance so they’recovered should the house burn down).
If your wedding ring got stolen, does it present a financial risk you could recover from? Personally, I wear a ~$200 tungsten carbide wedding ring. If my finger got stuck in a tragic 3-ring binder accident while compiling someone’s financial plan, I could replace that $200 ring without issue. I do not need ring insurance. Granted, the cosmetic costs of finger reconstruction might make me wish I had better health insurance…
Back to the point: that’s the framework to use! Does the downside risk present an insurmountable financial burden to you (or your beneficiaries?)
The answer for many younger readers with dependents (spouses, children) is a screaming YES. As in, “If I died and the family lost my income, it would be very financially uncomfortable for many years!”
But how much coverage do you need?
My Preferred Methods: Income Replacement and “DIME”
The two methods I prefer (and suggested to reader Matt) are the Income Replacement method and the DIME method.
Income replacement suggests you replace your income for a certain number of years, typically until your children reach a particular age or until your spouse reaches retirement age.
In my personal case, I wanted to replace my income until my youngest child (who is still technically hypothetical) is out of the house. I chose a 30-year term policy equivalent to ~20 years of my income (with a small discount rate for future years). No matter when I get hit by that proverbial bus, 20 years of income should cover my youngest child until they’re out of the house.
The DIME method adds up any outstanding debts, add in your income for a certain number of years, then adds your remaining mortgage, and finally adds on future expected education costs. Debts, income, mortgage, education.
The DIME method double-counts a few things. For example, I’m using my income to pay my debts and mortgage. I shouldn’t need to double-count them. Nevertheless, I like the idea of itemizing the biggest future expenses (college costs, mortgage payoff, etc.) and ensuring your life insurance policy can cover them.
The Best of the Rest
Other strategies I’ve seen for sizing life insurance policies include:
The Human Life Value (HLV) method. It asks an individual to consider their annual income for each year until their retirement, add in other benefits and bonuses, subtract the income used for their personal consumption, and then discount future income to today’s value.
Done correctly, this method should provide the beneficiaries with a lump sum of the resources you would have expected to provide to them over the remainder of your working life. It’s just a bit too complicated and mathematical for most people to get right.
The Budget-Based method simply multiplies your household’s monthly expenses by the number of months you expect those expenses to be maintained. It’s similar to Income Replacement, but looks at expenses rather than income.
Lastly, the “Rule of Thumb” (which I think is a poor name!) suggests you multiply your income by 10. Very much “one size fits all,” which is why I don’t like it.
Granted, one detail to note is that most life insurance sizing strategies are intentionally conservative, leading to policy sizes that are large enough during the highest-risk years but end up being too large as time goes on.
For example: a young family might need a $2M, 25-year policy on each parents. But by the time the kids are in college, that $4M of total coverage is surely too much.
Thanks for the question, Matt!
And to all of you: term life insurance is a smart financial planning move. But I hope none of you ever need to collect!
Thank you for reading! If you enjoyed this article, join 8500+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week. You can read past newsletters before signing up.
-Jesse
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It’s breakfast time, you’re hungry, and I’m offering you two options:
A healthy, adult hen
Two dozen eggs
Your first thought is probably: “Seriously? It’s just breakfast. I don’t want a live chicken running around my house.”
Forget that thought for now.
If you’re like me, your mind next asks, “If I do choose thechicken, how many eggs can I expect over time? What’s the risk the chicken doesn’t get to two dozen eggs? Am I willing to wait for two dozen – or hopefully more – eggs to arrive?”
When we know those answers, we can make a smart decision. It’s a time value of chicken question. It’s why Warren Buffett recites Aesop’s fables.
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A similar mathematical question lies at the heart of financial planning: how do we compare lump sum savings against a stream of income?
The question might sound simple. But people get it wrong all the time, and their financial lives are at stake.
Savings vs. Income: Would You Rather?
Would you rather have $140,000 today or $10,000 yearly for life? David Blanchett and Michael Finke posed that question in a study published by an annuity industry group.
Yes – we should exercise caution. It’s natural for an annuity industry group to publish pro-annuity media, and this study is certainly pro-annuity, as we’ll see. In general, I’m not a fan of annuities. Nevertheless, I think the study’s results are directionally accurate.
This is a hen vs. eggs question! $10,000 per year is like our hen: a steady income stream. The $140,000 is like our eggs: a big lump sum all at once., The study points out that person could use their $140,000 to buy an income annuity and guarantee themselves $10,000 per year for life. In other words, the two options are functionally identical.
However, study respondents don’t see the options as identical. Instead, most respondents prefer the $10,000 per year for life. It’s viewed as safer and more accessible to spend. The logic is:
If someone knows another $10,000 is coming next year, they’re willing to spend the $10,000 they receive this year.
But the lump sum doesn’t inspire that same confidence because it all depends on if or how you invest it. What if I spend down the $140,000 to nothing?! I’d much rather have the $10,000 per year at that point.
This is Loss Aversion 101. If you can guarantee a person won’t lose – just as the stream of income guarantees – that person is biologically biased to see that option as more appealing. Even if it isn’t!
The Big Problem
The problem with this “income vs. savings” logic becomes evident if we tweak our numbers.
What if I offer you a $200,000 lump sum vs. $10,000 yearly?
The pure math tells us it’s a no-brainer. Choose the lump sum! You could use that lump sum to produce an income stream greater than $10,000 annually.
But some would ask, “Can you guarantee that income? Or are you making a bet that you likely can produce more than $10K per year? What if you’re wrong?” And because of that risk of being wrong, they would still choose the $10K per year.
How does someone overcome this bias?
According to the study mentioned above, a simple income annuity would help by converting the $200,000 lump sum into a $14,000 per year guaranteed income stream, crushing the $10,000 per year option.
Note: the study’s ratio of $140,000 lump sum to $10,000 annual income stream suggests internal rates of return of: 0% over 14 years, 3.7% over 20 years, 5.8% over 30 years, and 6.6% over 40 years. This alignswell with Schwab’s guaranteed annuity payouts, as of this writing.
But as I’veexplained here before on The Best Interest: do you want to run the risk of a 0% return for 14 yearssimply to achieve the “nirvana” of 6.6% annually for 40 years?
That doesn’t work for me.
Quick Aside: Dividend Stocks!
The same faulty logic of “income >> lump sum” exists in the world of dividend stocks.
One of the greatest myths about dividend stocks is that they’re inherently superior to other stocks because they produce a dividend income stream. (Here’s a complete breakdown of all the faulty dividend stock logic.)
The income allure of dividend stocks convinces many retirees to stock their portfolios full of them. “You can get a 6% per year dividend AND still own your stock at the end of the day!”
A more diversified stock portfolio might “only” pay a 2% dividend while its price increases 8% a year (over the long run). If a retiree wanted to live off this second portfolio, they would have to sell some of their shares. That selling begs a scary question: What if we sell and sell again and again until we run out of stocks?!
The same question scares people looking at the $140,000 lump sum: what if we spend and spend again and again until we run out of money?! They opt for a steady income stream. They opt for dividend stocks.
Their normal, understandable monkey brains overvalue the income stream and undervalue the lump sum. Don’t be that monkey!
What To Do Instead?
One of my goals here at The Best Interest is to instill confidence. Specifically, the confidence that a diversified portfolio can achieve particular performance goals over sufficiently long periods.
Not without risk, mind you. That’s important. To achieve investment reward, we must assume investment risk. But I want to instill confidence that you can assume some risk (however much is appropriate for you) and good things will happen over long periods of time.
Such a portfolio can translate a lump sum into an income stream or an income stream into a lump sum. We need to fight the urge to overvalue one over the other.
Specifically, we need to have enough confidence in math to overcome our monkey loss aversion that overvalues income and undervalues a lump sum of money.
I’m not sure that confidence can be spoken into existence – at least not in the short-term. But with enough smart evidence and time, confidence builds.
Maybe even enough confidence to choose that chicken over the eggs.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
Want to learn more about The Best Interest’s back story? Read here.
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Imagine you’re a gardener. You spend a weekend building a few raised beds, planting sunflowers and corn, etc. It’s a nice little hobby. Your first summer gardening ends up successful and fulfilling.
You come back for Year 2 with vigor! You want to expand. You spend a month preparing your beds and double the size of your garden. You plant new veggies and a few flowers, and all goes well.
You rinse and repeat for a few more years. Not only is your garden blooming, but its size is blooming. After years of doubling in size, it occupies a couple acres in your side field (we’re putting you in the countryside).
Eventually, you grow so big that an annual doubling size is no longer feasible. You don’t have the time or equipment to build twice as many new beds. You don’t have the resources to water and fertilize the full area. You don’t have the patience to weed the weeds and scare away the hungry deer and rabbits.
Growth, in other words, cannot be exponential forever.Eventually, size becomes the enemy of growth. Growth is easy when you’re small. It’s much harder when you’re big.
We see similar “rules” all over the natural world. Small children grow and learn unbelievably quickly in their early years. They “grow like a weed” – how punny. But eventually, that child becomes a “full-grown” adult who, if they’re learning at all, certainly is no longer learning at an exponential pace.
While the governing rules might differ (Mother Nature vs. something economic), a similar phenomenon applies to the business world and thus to the stock market: growth can’t be exponential forever, and growth becomes harder the bigger you are.
Forward Growth, Backward Growth
Let’s go back to the garden.
Imagine I have a bed of fully grown sunflowers —10 feet tall, giant heads, full of seeds.
Next to that, I have a bed of corn. The corn is only halfway grown—3 feet tall, barely a sign of any “ears” yet.
If I wanted to see which crop has the bestgrowing potential, how should I measure it?
The natural tact to measure backward and say, “It’s the sunflowers – look, they’re huge! They’ve grown like crazy this past month!”
But I could also measure forward and say, “The sunflowers are ‘exhausted’ – fully grown! The corn, though, still has a huge potential in front of it.”
The same idea applies to the stock market.
If we measure backward, the best-performing stocks of the past 5 years are the biggest stocks right now (kind of like our sunflowers). Ben Carlson shared this idea and data in a recent post. The right-most columns below show that today’s largest stocks are also the best performers of the past 5 years:
The biggest stocks (on the right) have also had the best recent performance.
But as investors, is it good for us to “measure the sunflowers” after they’re fully grown?!
The wise skeptic would retort, “Jesse – you don’t know if those large stocks are fully grown or not.” It’s true. For all we know, those “sunflowers” could double in size again. We’ll come back to this idea later.
Still, I think it makes more sense to measure from the beginning and ask, “Which stocks will grow most in the future?” The problem is that we don’t have crystal balls. We don’t know what the future will hold.
The middle ground, then, is to combine the past and the present. For example: what if we took the stock market’s values from 2019, ranked the size of those companies at that time, and then tracked their performance from 2019 until today?
That’s exactly what this chart shows:
If we measure forward instead of backward, we see that smaller companies have been the best performers of the past five years (not that large companies performed all that poorly).
Here’s another terrific way of visualizing that idea. I’ve been using the following chart with some clients recently, especially when they ask questions about Apple, Microsoft, or NVIDIA, etc.
The data examines companies when they reach the Top 10 largest companies in the U.S. stock market. The left side of the graphic shows companies before they reach the Top 10, and the right side shows companies after they reach the Top 10. The left shows “future world-record sunflowers as they’re growing” and the right shows “world-record sunflowers once they’ve set those records.”
The chart pulls together our various ideas today.
It’s hard to grow forever. Instead, growth has an upper limit. Once a company has become “one of the largest companies in the US, or even the world,” odds are that its growth is tapped out.
While investing in “full-grownsunflowers” might be appealing – after all, look how tall they are! – the smart money knows investors don’t make money on past growth. They make it on future growth.
I’m not guaranteeing it. The future might be different than the past. Maybe NVIDIA will continue taking over the world. But get this:
In the five years from July 2019 to July 2024, NVIDIA’s market cap grew from $100 billion to $3 trillion, a 30x increase.
If NVIDIA did the same thing from now until July 2029, its then-$90 trillion market cap would be:
as large as every other publically traded company in the world, all combined.
about 2x the rest of the entire U.S. stock market, combined.
about 3x the annual GDP of the U.S.
and roughly ~$90 trillion more than my personal net worth. Ouch.
Uncle Warren, Cousin Rubin
In 1995, Uncle Warren Buffett wrote to his investors:
The giant disadvantage we face is size: In the early years, we needed only good ideas, but now we need good bigideas. Unfortunately, the difficulty of finding these grows in direct proportion to our financial success, a problem that increasingly erodes our strengths.
When you have one garden bed, it’s easy to double in size. Just build one more bed. It’s not so easy when you’re running an entire farm.
Buffett’s company, Berkshire Hathaway, is in the business of buying other companies – great companies, ideally, at fair prices.
But Berkshire is worth $900 billion dollars. They can’t afford to buy a $1 million company that they think will double to $2 million – it’s a tiny drop compared to their $900 billion value. Instead, Berkshire is looking to acquire multi-billion dollar companies. But those companies aren’t flying under the radar. They’re well-known and accurately priced. The opportunity for large investment gains simply isn’t there.
A similar idea comes from Rubin Miller, writing about Nvidia. Rubin said:
The stock market has averaged ~ 10%/year over the last 100 years, so if that continued while NVIDIA averaged 32% (which it has since its IPO in 1999)….
In 10 years, NVIDIA would be ~ 27% of the U.S. stock market.
In 15 years, NVIDIA would be ~ 68% of the U.S. stock market.
In 25 years, NVIDIA would be ~ 420% of the U.S. stock market.
But nothing can be more than 100% of something that it’s a part of.
That’s the impossibility (meaning if anything like this remotely occurred in reality, the entire market’s return would of course be pulled higher than 10%, simply by NVIDIA’s weight and return).
But this is the rub. You cannot compound returns at high rates forever.
On an infinite timeline, anything compounding at a higher rate than something else will eventually completely subsume it.
Rubin Miller
Eventually, in other words, NVIDIA would be so big and the rest of the market so small (comparatively) that “market returns” wouldn’t tell us anything about “the market” – they would only tell us about NVIDIA!
This is not poo-poo’ing on NVIDIA. It can still be a great company. But that’s different than being a great investment. You can be a good company, but a bad stock..
Or, back to our sunflower analogy, here’s a fact: a sunflower grows 100x in height over ~70 days. Then it withers and dies. But if it didn’tdieand instead continued 100x’ing its height every 70 days, that sunflower would reach the Moon in just over 1 year.
You tell me. Maybe we’ll soon see a sunflower reach the moon.
But I’m not betting the farm on it.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
Want to learn more about The Best Interest’s back story? Read here.
Looking for a great personal finance book, podcast, or other recommendation? Check out my favorites.
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Bonds are a cornerstone of smart investing, providing a dependable way to balance the ups and downs of the stock market. These financial instruments, though not entirely risk-free, offer a steadier income stream and a sense of financial security that can be particularly appealing during uncertain times.
By understanding how bonds work and their potential benefits, investors can make more confident and informed decisions. Whether you’re a seasoned investor or just starting out, incorporating bonds into your portfolio can help achieve a more stable and balanced investment strategy.
Definition of a Bond
A bond is a loan between a borrower and a lender. As the investor, you would essentially buy an I.O.U. note from a borrower. The note will include the term of the loan, the payment schedule, and any other relevant details.
The bond boils down to a promise from the borrower to the lender to pay you back in full, plus interest.
Who issues bonds?
Any organization can issue them. The typical institutions that issue bonds are large companies, the federal government, cities, and states.
The issuer of the bond will often explain why they need the money. For example, the government may need it to build new roads, or a company may need it to fund new research. The reason behind the issuance of bonds varies, but for one reason or another, the organization needs money.
Types of Bonds
There are several types of bonds, including:
Corporate bonds: These are issued by companies and can be traded on public markets. They are used to raise capital for business operations, expansion, or to refinance debt.
Municipal bonds: These are issued by cities, states, and other local governments to finance public projects such as schools, highways, and utilities. They are tax-exempt, which means the interest paid to investors is not subject to federal income tax.
Treasury bonds: These are issued by the federal government and are considered to be among the safest investments because they are backed by the full faith and credit of the U.S. government.
High-yield bonds: Also known as “junk bonds,” these are issued by companies with lower credit ratings and therefore carry a higher risk of default. They offer higher interest rates to compensate for this risk.
Convertible bonds: These are bonds that can be converted into a predetermined number of shares of the issuing company’s stock. They offer the potential for capital appreciation in addition to the interest paid to bondholders.
Zero-coupon bonds: These are bonds that do not pay periodic interest to bondholders. Instead, they are issued at a discount to their face value and the bondholder receives the full face value at maturity.
Floating-rate bonds: These are bonds whose interest rate is tied to a benchmark rate, such as the London Interbank Offered Rate (LIBOR). The interest rate on floating-rate bonds adjusts periodically based on changes in the benchmark rate.
Are all bond issuers the same?
No. It may be obvious, but some issuers are more trustworthy than others.
Generally, U.S. government bonds are considered the safest possible bond. Many deem these bonds as practically risk-free. Of course, there is always risk involved, but it is rather unlikely that the U.S. government would default on its loan to you. Less trustworthy issuers are shady companies that you don’t trust.
A risky bond issuer will be forced to offer a higher interest rate than a stable issuer. That is because it is less likely that they will be able to repay the loan of the investor. If that happens, then the investor will lose their money. Bonds that offer high interest rates are considered junk bonds. That is because it is likely that the issuer will be unable to repay their investor.
The U.S. government offers the lowest interest rate on its bonds. That is due to the fact that they are most likely to repay the investor. Stable private companies will fall somewhere in between. Bonds that offer lower interest rates are considered investment-grade bonds.
How does a bond work?
When an organization needs money, it will issue bonds with the terms already set. As an investor, you will need to accept the terms or pass on the bond. The details of the bond will include the exact terms of the bond. Let’s look at what will be included in each bond offering.
Issue price – The issue price is the price that the investor will have to pay for the bond.
Face value – Typically, the face value of a bond is a nice whole number like $100 or $10000. It is unlikely that you would find a bond available for $99.47.
Coupon rate – A coupon rate is equivalent to the interest rate that is on the bond. The issuer of the bond will pay this rate of interest to the investor.
Coupon date(s) – Throughout the lifetime of the bond, the issuer may be required to make payments to the investor. The coupon dates will outline the amount of these payments and when they need to be made.
Maturity date – A maturity date is basically the end of the bond. On this date, the issuer of the bond must pay the face value of the bond to the investor.
When you have all the information, you will be able to make an informed decision about a bond purchase.
What impacts bond prices?
Many things go into the price of a bond, but these are the most common.
Issuer’s credibility. If a shady company is offering a high yield bond, it will likely be classified as a junk bond. The risk will be reflected in the price of the bond.
Maturity date. The longer you have to commit your money to the bond, the higher the yield you will receive. The bond issuer is paying for the long-term use of your money.
Interest rates. Interest rates have the largest impact on bond prices. Higher interest rates will lead to lower bond prices.
Are bonds a risk-free investment?
No. Some bonds are significantly riskier than others. If a bond offers a high yield, then it is likely a risky investment.
Some people associate bonds with guaranteed returns. That is just not the case. You can lose money through bond investment. However, if you choose your bonds carefully, then this may be less of a worry. For example, if you choose to stick with U.S. Treasury bonds, then it is likely that your money will stay safe.
How does an investor make money with bonds?
When you purchase a bond, you can make money in a couple of ways.
First, you will receive interest payments regularly based on the coupon rate of the bond.
Second, you can sell the bond for more than you paid for it. If interest rates go down, then bond prices will rise. At that point, you will have the option to sell your bond for a profit before maturity.
How to Buy Bonds
There are several ways to buy bonds:
Directly from the issuer: Some bonds, particularly municipal and Treasury bonds, can be purchased directly from the issuer. This may be a suitable option for investors who want to hold the bonds until maturity and receive the full face value.
Through a broker: Investors can also purchase bonds through a brokerage firm. Brokers can help investors find the bonds that best match their investment goals and risk tolerance, and handle the transaction on their behalf.
On a bond exchange: Some bonds, such as corporate bonds, are traded on public exchanges, similar to stocks. Investors can buy and sell these bonds through a brokerage account or through a bond exchange-traded fund (ETF).
Through a mutual fund or ETF: Investors can also invest in bond mutual funds or bond ETFs that holds a diverse portfolio of bonds. This can be a convenient way to gain exposure to a variety of bonds without having to purchase them individually.
Before buying any bonds, carefully consider the issuer’s creditworthiness, as well as the terms and conditions of the bond. It’s also a good idea to diversify your bond holdings to reduce risk.
Final Thoughts
Investing in bonds is one way to diversify your portfolio.
Remember, bonds are not entirely risk-free. Do not assume that you will make money on a bond investment. It is entirely possible to lose money by investing in bonds.
Before you make any decisions about investing in bonds, research your options. It is important to understand all the risks involved before you choose to invest your hard-earned money.
Empower, formerly Personal Capital, is a client-centric robo-advisor offering investment and wealth management services. The company distinguishes itself from the competition by combining automation with personal service. With over 2.7 million users, Empower currently holds $16 billion in assets under management.
Unlike many financial apps designed to make investing more accessible, Empower is a robo-advisor for those who already have some established wealth. They’ve gone back and forth on the minimum investment required, which is now set at $100,000.
Get started with Empower
on Empower’s secure website
Its goal is to provide a more transparent and affordable investment platform. However, its wealth management service does target clients with larger assets, with higher fees being assessed with the fewer assets you let the company manage.
In this Empower review, we’ll get into the specifics shortly, but the upside to potentially paying higher fees is the access you get to financial advisors to help with your investment strategy.
The company utilizes five principles for investing:
the modern portfolio theory
personalized asset allocation
tax optimization
equal sector and style weighting
disciplined rebalancing
No matter how much in assets you’re looking to invest, consider Empower if you prefer a hands-on experience or if you have a large portfolio to open or transfer. Either way, we’ll take you step-by-step through the different types of accounts you can have with Empower, as well as the fees you’ll pay at different asset levels.
You’ll also learn about the special features that make Empower unique, including financial tools and expertise. If you’re looking for an online advisor for any or all of your wealth management, see if Empower is right for you.
Available Plans at Empower
There are three different plans available at Empower, which are divided up based on the amount of investable assets you have. If you know how much you’d like to invest, find the correct category to learn about the benefits and services you’d receive from Empower. Then keep reading to learn more about the fee structure.
Investment Service Plan
The first plan is targeted for those with up to $200,000 in assets to be invested. Services include access to a financial advisory team, a tax-efficient ETF portfolio, dynamic tactical weighting, 401k advice, and cash flow & spending insights.
You’ll also get to use Empower’s free wealth management tools. You do, however, need a minimum of $100,000 to get started investing with Empower.
Wealth Management Plan
The next option is the Wealth Management plan, for those with investable assets between $200,000 and $1 million. You get access to all the benefits from the Investment Service plan, plus several others.
The Wealth Management service includes two dedicated financial advisors, customizable stocks and ETFs, a full financial and retirement plan, college savings and 529 planning, tax-loss harvesting and tax location, and financial decisions support.
The financial decisions support refers to help with insurance, home financing, stock options, and compensation. Also, note while your financial advisors can help you plan for investment accounts like a 401k for retirement or a 529 for college savings, Empower doesn’t actually offer these accounts.
Private Client Plan
If you invest more than $1 million, you qualify for the Private Client Plan. Again, you receive all the perks of the previous two plans, in addition to several more.
To begin, you’ll get priority access to CFP, financial advisors, investment committee, and support, plus an investment portfolio mix of ETFs, individual stocks, and individual bonds (in certain situations).
You also receive family tiered billing; private banking services; estate, tax, and legacy portfolio construction; and donor-advised funds. Empower also offers private clients a private equity and hedge fund review, deferred compensation strategy, as well as estate attorney and CPA collaboration.
Get started with Empower
on Empower’s secure website
Fee Structure and Accounts
The more money you invest through Empower, the more money you’ll save in fees. If you invest up to $1 million, your fee comes to 0.89% of the assets being managed. If you invest more than $1 million, your first $3 million in assets are only charged a 0.79% fee. Then, your next $2 million is charged 0.69%.
The $5 million after that are charged 0.59% and the next $10 million are charged 0.49%. However, there aren’t any charged beyond the account management fees, so you don’t have to worry about annual, transfer, or closing fees.
So what types of investment accounts are supported through Empower? There are many: both individual and joint non-retirement counts; Roth, traditional, SEP, and rollover IRAs; and trusts.
Through your Empower investments, you can expect a healthy range in your portfolio. For example, when buying U.S. equities, they buy a diversified sample of at least 70 individual stocks that epitomize their tactical weighting approach and optimize your account for tax purposes.
Empower also only purchases liquid securities, so that if you ever need to access cash quickly, you can receive funds within a settlement period of just one to three days.
Funds are held by Pershing Advisor Solutions, a Bank of New York Mellon Company. It is one of the largest U.S. custodians and currently holds more than a trillion dollars in global client assets.
Tax Optimization Strategies
Empower uses several techniques and strategies to ensure clients are optimizing their taxes on investments. First, they entirely avoid mutual funds, which they regard as inefficient for tax purposes. Their asset location is personalized whether you have taxable accounts or retirement accounts.
For example, Empower typically places high-yielding accounts and fixed income into a tax-deferred or exempt account. REITs are also generally placed in a retirement account because they pay nonqualified dividends.
Finally, Empower utilizes tax-loss harvesting, meaning they use individual securities that realize losses and can, therefore, offset gains or provide a tax deduction.
Special Features
You can take advantage of some of Empower’s online resources without even becoming a client. Just by creating a Empower account, you can link all of your financial accounts for an investment checkup.
The program analyzes your bank accounts, credit cards, and investments to create recommendations on your asset allocations. You can then choose whether to make those adjustments to your investments.
Additionally, you can check holistically on how your investments are performing by considering how much you’re charged in fees. You can do this in one of two ways.
The first is through the Mutual Fund Analyzer, which you can compare performance (with fees) against the broader markets. Then you can use the general Fee Analyzer to see what you’re being charged on your non-taxable retirement accounts.
You can also use Empower for a budget check-up that analyzes your saving and spending. You can even incorporate their Retirement Planner for long-term savings projections.
You’ll be provided with several scenarios, including best-case, worst-case, and most likely. It gives you a good idea of what you could potentially expect when you’re finally ready to retire.
All of these features run through the Empower financial dashboard, so you can get a holistic view of your entire financial picture. You can use them on their mobile app or website.
Some of their investment management tools include a 401(k) Analyzer, Retirement Planner, Investment Checkup, Net Worth Calculator. Moreover, you still have the ability to contact a personal financial advisor.
As we mentioned earlier, Empower implements five distinct strategies for investing. Learn a bit more about each one to get a better grasp of how your money would be managed by this advisor.
Modern Portfolio Theory
The prime directive here is to create an efficient portfolio for clients while yielding the highest possible return for the lowest possible risk.
Empower works with six asset classes to provide this equilibrium, which are all meant to be liquid and broadly investible. These asset classes are U.S. stocks and bonds, international stocks and bonds, alternatives (including ETFs and commodities), and cash for liquidity.
Personalized Asset Allocation
There’s a reason the company is called Empower: they understand that no two investors are exactly alike. That’s why they look at your individual data and financial goals to balance your portfolio’s risk and growth.
They use a proprietary Retirement Planner software that analyzes your spending and savings habits in addition to your projected income. This helps you determine what your financial future looks like and what you may need to change to reach your future goals.
Tax Optimization
We mentioned earlier that Empower optimizes your taxes by using tax-loss harvesting and asset location, as well as avoiding mutual funds.
In fact, these steps could boost your annual returns by as much as 1%. While many financial advisors use one or two of these tactics, Empower offers a truly robust strategy to make your portfolio more tax efficient.
Equal Sector and Style Weighting
Empower’s strategy for diversification involves equalizing the composition of your portfolio by sector, size, and style.
The goal is to prevent bubbles and other volatile conditions from adversely affecting your investments too much. Likewise, they don’t rely on a few large companies, but instead spread out U.S. stock investments between 70 and 100 different stocks.
Disciplined Rebalancing
Your portfolio receives a daily review for any potential rebalancing needs. For high-level assets, they’re typically rebalanced when they deviate more than a few percentage points from the target.
Specific securities receive a smaller margin and are reviewed after just a 0.5% move from the target. Having a systematic review allows you to maximize your ability to buy low and sell high.
Who is Empower best for?
Empower offers truly extensive services for high net worth investors, particularly considering the low percentage of fees charged. This is especially true if you’re an investor with several million dollars in assets and who likes to have easy access to a dedicated financial advisory.
After all, in the Private Client tier of $1 million+, you can get advice on just about anything related to your finances, whether it’s about retirement, real estate, or anything in between.
That’s on top of the personalized asset management, so you have a one-stop-shop of both automated algorithms and a human point of contact who understands the larger picture concerning your finances.
Empower also makes it easy for this type of investor to remain passive. If you appreciate their investment management and like how the allocation and review processes, then you don’t have to do much on your own.
Who knew a lack of proper estate planning would throw the entire realm into war? That’s the lesson I garner from HBO’s House of the Dragon. If you’re unfamiliar (as I was) with the series, here’s an uber-quick primer to catch you up.
[SPOILER ALERT!]
It takes place in the same universe as Game of Thrones. Semi-medieval, very political, heavy on violence and sex. House of the Dragon is set roughly ~200 years before the Game of Thrones timeline
The show chronicles the early history of House Targaryen, focusing on the events leading up to and during the Targaryen Civil War (a.k.a. “the Dance of the Dragons”). The series delves into the Targaryen dynasty’s political intrigue, family dynamics, and power struggles.
Turns out, the entire civil war results from poor estate planning. I doubt my or your estate plans would ever be so consequential, but it’s worth learning our lessons (even if they come from a dragon-y fantasy world).
Where the Problem Starts…
Throughout most of Season 1 of the show, a clear precedent is set:
The King, Viserys, is generally liked and respected. He’s sick, though, and growing sicker as he ages. He has no male heirs – a big deal in hereditary monarchy. His wife dies in childbirth.
So, before all the important lords and ladies of the realm, Viserys names his one and only daughter – Rhaenyra – as his heir. An unusual choice, but clearly made.
Time marches on. Viserys remarries. He has more children – two boys and a girl. In most monarchies, the eldest son is heir to the throne. But Viserys maintains his previous decree: despite having a son, his eldest daughter, Rhaenyra, will remain heir to the throne.
More time – 15+ years – goes by. King Viserys…very, very sick…is finally on his deathbed. And thus, the stage is set for drama…
The Drama
As King Viserys lies dying and drinking “milk of the poppy” (a creative naming of what we’re to believe is an opiate pain reliever), he speaks with his wife, the Queen. Remember, this is his second wife; she is stepmother to Rhaenyra and mother to the King’s sons (who some would argue are the “rightful” heirs to the throne).
Only the Queen is present. The King is high on drugs and in terrible pain.
He manages to speak a few sentences about “the prince that was promised” and “Aegon” and a cryptic suggestion, “…to unite the realm against the cold and the dark. It is you. You are the one. You must do this. You must do this.”
And then he dies. What the heck did that all mean? “Aegon” is a boy’s name. And you guessed it: the King’s eldest son (the Prince who is not the named heir) is named Aegon.
Whoa. Those are some scary special effects…
Was the King speaking of his son, Aegon? Is young Aegon “the Prince that was promised…to unite the realm?” The Queen certainly thinks so. After all, she’s biased toward wanting her son (not her stepdaughter) to gain the throne.
As viewers, though, we know the King—high as a kite—was, in fact, referencing a centuries-old tale of “Aegon the Conquerer,” a long-dead Targaryen king who prophesied a future cataclysmic war pitting the living (and their dragons) against some undead ice zombies.
Ice Zombies. Cool.
The Queen doesn’t know this backstory, though. You can’t blame her for thinking, “Prince? Aegon? Unite the realm? Oh – he’s telling me he’s changed his mind! He wants our son, Aegon, to take the throne.” Classic mixup! Could happen to any of us.
The Queen returns to all the courtly leaders with this news: the King, on his deathbed, made clear to me that he wants our son, Aegon, to ascend the throne. Rhaenyra, despite the past ~15-20 years of clearly communicated precedent, is out.
What’s Rhaenyra to think?! She has lived most of her life as the heir to the throne. And then, at the 11th hour, with only one biased witness present, as the King lay high and dying, supposedly he changed his mind? It seems suspicious, no? One could even say it’s a clear foul play.
Thus starts the Targaryen Civil War. Rhaenyra (and her followers) vs. her half-siblings (and theirs).
Lessons for Us
Financial planning is more than investing and taxes. Estate planning is another major component. In short, estate planning answers, “What happens to your assets after you die?”
I doubt any of us have a kingdom to bequeath. Nevertheless, what did the Targaryens get wrong that we should strive to get right?
Put it in writing. A clear, legally valid will is essential. It outlines your wishes regarding the distribution of your assets. It can prevent misunderstandings or disputes among your heirs.
Designate beneficiaries. Ensure that you have designated beneficiaries for all applicable accounts (like retirement accounts and insurance policies) and that these designations are up-to-date.
Use Clear Language. Be explicit and precise in all estate planning documents to avoid ambiguity. Clearly state who gets what and under what conditions, and consider using legal terms correctly to ensure your wishes are interpreted as you mean them. Work with an attorney to get it right.
This article outlines a further 11-step process to begin your estate plan.
One more vital tip: create a Life File. Your loved ones will thank you.
How Estate Planning Can Go Wrong
“House of the Dragon” shows us how estate planning can go wrong.
The King’s transition plan was never written down. It was only spoken. If the King can speak it into existence, why can’t he simply speak it away?
When creating estate documents (like a will), a person must be “of sound mind.” This is a legal term, and like many legal terms, it exists on a spectrum. But surely most U.S. jurisdictions would maintain that being high on opiates is not “of sound mind.”
You should discuss your estate plan (and any changes) with the included (and excluded) parties. Some people might push back on me here, but I think it’s important. When people are included or excluded from your estate, they should know about it while you are still living. Otherwise, it creates a problem after your death, when, by definition, you’re no longer around to solve it. Ideally, the King would have gotten all interested parties – Rhaenyra, the Queen, his second batch of children, etc. – on the same page from Day 1. His drug-addled ramblings would have been more easily dismissed as just that.
Forget the Seven Kingdoms. Our world is riddled with famous stories of contested estates. You don’t want to add your family to that list.
We’ll see how “The Dance of the Dragons” concludes. What a nice euphemism for a firestorm slaughter!
In the meantime, though, let’s get our own kingdoms in order.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
Want to learn more about The Best Interest’s back story? Read here.
Looking for a great personal finance book, podcast, or other recommendation? Check out my favorites.
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In regards to your recent “When to Take Social Security” article, you left something out. You can take Social Security early (say, age 62), then invest that money, and your investment will end up better than if you had waited on Social Security until age 67 or age 70.
Interesting! But does the math work? Let’s dive in. Should you take Social Security early and invest it?
What Kind of “Returns” Do You Get For Waiting on Social Security?
Let’s start by looking at Social Security. What kind of “return on investment” do you receive by delaying your Social Security decision?
There’s no easy way to do this today without a spreadsheet, so we will use this Google Sheet to show you some math. (I keep the original file pristine so all readers see the same numbers, but you can go to File –> Make a Copy to create your own copy of the file to play around with.)
For starters, we need to understand how retirees’ benefits change as they age. Depending on their birth year, today’s retirees reach their “Full Retirement Age” (FRA) at 66 or 67 years old. Depending on the age at which they apply for Social Security, they’ll receive a certain percentage of their full benefits, described in the table below.
To make the math easy, we will assume our retiree’s Primary Insurance Amount (PIA)…aka the amount you receive if you wait until FRA…is $1000 per month. So “100%” on the table above equals $1000 per mont
The longer our retiree waits, the higher their monthly payments will be. But what does that look like as an “investment?” And how does inflation factor in?
What About Inflation?
The Social Security Administration adjusts everybody’s Social Security payments yearly to account for inflation. This “cost of living adjustment” is often shortened to “COLA.”
The average COLA adjustment since 1975 has been 3.66%. We need to include that in our spreadsheet too.
Baseline Analysis – No Investments Yet
Let’s start with a baseline analysis. We’ll examine a series of retirees who collect their Social Security monthly, and immediately spend it. They make no investments with their Social Security cash flow. We could conceptualize this as hiding those dollars underneath their mattresses.
We’ll compare results by looking at the total dollar amounts collected over time. This will be our baseline analysis. You can follow along on the spreadsheet tab labeled “No Investment Return (Yet) – Nominal Dollars Only”
The results: in this scenario, early collection only makes sense for a retiree who dies before age 74. This should make sense. We know that delaying Social Security makes more and more sense the longer someone lives.
Let’s add in investment returns.
Analysis 1: Investing in a 4.7% Savings Account
Let’s consider a retiree who takes all of their Social Security income and deposits it into a savings account bearing 4.7% annual interest.
Why 4.7%? That’s the average overnight Federal Funds rate since 1960, and modern-day high-yield savings accounts tend to offer interest rates that are closely correlated to the Fed Funds rate.
Note: if your personal pile of cash isn’t in a high-yield savings account, you should ask yourself why that is…
The results: if you pass away at age 77 or earlier, collecting earlier makes sense. Otherwise, waiting until FRA or later likely makes sense. This is no different than “traditional” Social Security advice.
Analysis 2: Investing in a “Standard” 60/40 Portfolio
What if our retirees put their money in a tried-and-true 60/40 portfolio?
From 1950 until today, that kind of diversified 60/40 portfolio has returned an average of 9.3% per year.
The results: Whoa! As shown on the “A2” tab, collecting as early as possible makes sense for anyone who would pass away before age 88.
We know, on average, most 62 years olds are going to pass away well before age 88. The smart, probabilistic thing to do then, is collect Social Security as early as possible and invest it in something like a 60/40 portfolio (or, something with greater returns).
But wait…because I’ve only showed you half the story. And that’s a major problem.
Big Problem: What’s the Risk?
If we zoom out on reader DT’s idea as originally stated, we should confidently conclude: OF COURSE it makes sense! If you have sufficiently high investment returns, you should always start as early as possible.
Even if the benefit of delaying Social Security was 20% per year, but I had an investment that paid me 40% per year, I’d rather start collecting as soon as possible and get the money invested. Given sufficiently high returns, you always want to get the compound growth started.
But we must return, once again, to a foundational pillar of investing and oft-repeated maxim of The Best Interest: Risk and return are intrinsically connected.Returns are not “free.” They are compensation for taking on investment risk.
Whenever an investor compares returns alone, without also comparing the risks involved, they’re making an incomplete analysis. DT’s original question only considers return. It doesn’t consider risk.
What Comparison Makes Sense?
The benefits of delaying Social Security are guaranteed by the U.S. government. That’s very low risk. What kind of investment risk should we compare that to?
I see two viable options.
First, why does Warren Buffett invest all of Berkshire Hathaway’s extra cash into U.S. Treasuries, instead of an S&P 500 index fund? Doesn’t he know the S&P 500 has much better long-term returns?!
Answer: U.S. Treasuries are as risk-free as anything in the investing universe, backed by the full faith and credit of the U.S. government. As long as Uncle Sam pays debts, U.S. treasuries are risk-free. The S&P 500 is far from risk-free, and Buffett knows it. He wants his cash to be safe and ready for deployment at a moment’s notice. The S&P 500 cannot fulfill that need.
The first logical comparison today, then, is to use a true “risk-free” rate as our investment return. Something like a high-yield bank account (FDIC insured) or short-term U.S. Treasury is appropriate. Conveniently, we already did that in Analysis #1, where our conclusion is no different than traditional Social Security advice: the “break even” point occurs in the late 70s.
Note: this is reason for the concept of “risk-adjusted returns.”To compare only the returns of two investments is not an apples-to-apples comparison.
The second option is to show the downsides of Analysis #2. That is, to show how 9.3% per year from a 60/40 portfolio is far from a guarantee. More specifically, I’d like to show how the downside risk of a 60/40 portfolio could turn our result on its head. What happens if we suffer some bad markets during our early Social Security period?
Looking at historical returns, a 60/40 portfolio has had 10-year periods with returns below 2% per year. What if we started our Social Security timeline with that kind of low return, and then made up for it at the end of the analysis? That’s what I show on our spreadsheet on the A3 tab.
The results? The 60/40 “solution” comes with risks! In this scenario, “taking Social Security early and investing it” only worked out if our retiree died before age 75. That’s not a good outcome. Doubly so if Social Security is a safety net or backstop in your financial plan.
To Apply or Not Apply
If your Social Security is “play money” in your financial plan, and you’re ok with risking a loss, then I can see the merit and appeal of DT’s proposal. You can apply for Social Security early, invest it (reasonably), and the odds are in your favor that you’ll end up in a good spot.
But it’s no guarantee.
And the entire point of the Social Security system is to provide a guaranteed benefit to retirees. If Social Security plays even a minor role in your financial plan, I would strongly discourage putting that money at investment risk to eek out extra returns.
When we make a level comparison by using a risk-free rate, like in Analysis #1, we see there is no net benefit to taking Social Security early to invest it.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
Want to learn more about The Best Interest’s back story? Read here.
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I’m now 30 months into my new career, and I’m loving every single day.
As a lifelong learner, I find the nuanced topics of financial planning and investment management to be a limitless sandbox, or perhaps more like an underground cave system. Where’s the bottom?! Nobody knows!
Despite that complexity, my colleagues and I help clients with many common issues that are not the strict domain of experts. These are topics you don’t need CFPs, CPAs, or attorneys to help you with. And that fact – that even experts focus on getting the basics correct – is an important lesson.
Let’s dive into some examples.
Cash Flow Management
Cash flow management is the single biggest financial fundamental that most people overlook. I see examples of this daily, both good and bad.
I’ve seen people earning $600,000 and spending $625,000 yearly. They’re drowning (though usually unaware of it).
I’ve seen people earn $300,000 and spend $200,000, or earn $120,000 and spend $80,000. They are thriving. If you’re saving 20%+, you’re killing it. Great work.
Yes, it is so simple: Spend less than you earn and, ideally, measure it. Despite its simplicity, this idea is the foundation upon which the rest of our finances are built. Cash flow management is a vital part of every financial planning conversation.
Portfolio Complexity
Prospective clients or new clients typically prioritize portfolio reconstruction. I get to see the peculiar, the zany, the intriguing…somebody call P.T. Barnum!
The most common theme, though, is that many outside portfolios have come to me far more complex than they needed to be.
The most frequent complexity is to see 4 or 8 or 15 mutual funds in a single portfolio that are performing the same exact role. Who needs 15 mutual funds that are all 60% stocks, 40% bonds, and actively managed? The answer, of course, is nobody. But why, then? Why do investors get in this situation in the first place?
The reason is what I call “flavor of the month.”
With about 97% accuracy, I can tell these portfolios were built by a financial advisor who was financially incentivized to buy specific funds for their clients. The “mothership” will tell such advisors, “Our NBNHX mutual fund is undercapitalized. If you put your clients in NBNHX this quarter, we’ll double your commission on it.”
That’s a flavor of the month. Not for the client, mind you. But for the advisor. It’s a conflict of interest, for sure, but not all advisors are required to act as fiduciaries. We call on Uncle Charlie to remind us, “Show me the incentives, I’ll show you the outcomes.” Next thing you know, NBBHX has entered the portfolio.
The portfolio fills up with these various flavors of the month until – voila! – you have a Baskin Robbins. But despite the “flavors” having different ticker symbols, they all taste the same. Imagine if Baskin Robbins sold 31 flavors of vanilla! That’s what these portfolios look like. “Could I get a scoop of vanilla, a scoop of French Vanilla, and one of Vanilla Bean? Sprinkles? Never…”
Instead, we should make specific investment choices to answer specific portfolio problems—in layman’s terms, put the “right tools for the jobs” into your portfolio.
Each “job” might require its own specialty “tool.” We each have many tools in our garages and toolboxes. There’s nothing wrong with having multiple funds in a portfolio. But you don’t want or need redundant assets, just like a homeowner doesn’t need nine shovels.
You should be able to point to each fund or asset in your portfolio and describe the unique reason it’s there or the specific portfolio problem the asset is solving.
It’s hard to find a picture that combines “ice cream” and “tools,” so I asked A.I. to help me out. I’ve seen plenty of weird A.I. images at this point, but it’s still disorienting to see such real-looking objects (that ice cream isn’t real?!) juxtaposed with a computer’s misguided interpretations (what kind of dental torture device is that in the lower right? and why do the screwdrivers all have wooden popsicle sticks?).
Too Much Cash
Nobody should complain about 5% risk-free rates. However, cash is not a long-term investing strategy. Risk-free rates cannot, and should not, outperform inflation over the long run. You need to take some risk.
While cash is an important buffer to ensure short-term liquidity and an emergency fund safety net, your long-term assets should be in a risk-bearing, higher-growth asset class.
Stocks and bonds are wonderful.
Further reading: How Much Time Does It Take for Stocks to Outperform Bonds?
Goal Setting
Whether you realize it or not, your financial plan has specific branches and pitstops and end-points. My financial plan does too. But mine are much different than yours.
The reason is because each of those branches and pitstops and end-points are related to specific goals. My goals for my plan, your goals for your plan.
You don’t need a professional’s intervention to ask yourself, “What are our financial goals? What do we want life to look like, and by when, and how much might that particular life cost us?”
Consolidation
A common financial stress I hear rhymes with, “We have money all over the place. Too many accounts, too many statements, we need help!”
There’s not always a financial impact from consolidation (though sometimes it will save you annual or monthly account charges). But a significant mental burden lifts when you go from 24 disparate accounts down to 5.
Scary Stuff
People out there have scary stuff in their financial lives. The more stones I overturn, the more interesting scenarios I find. Some examples include:
Keeping large amounts of credit card debt to “improve our credit scores.” Credit scores don’t work that way.
Saving large sums ($25,000+ per year) while carrying huge credit card debt ($50,000+). Bad priorities. No investment is going to outperform paying down a 25% debt.
Tapping into a 401(k) prematurely (though quite intentionally) without awareness of the extremely stiff penalty. There’s a 10% early withdrawal penalty plus your marginal Federal tax rate (22% to 37% for most of you) plus your marginal state tax rate (6-8% here in NY). For hire earners, it sums to north of 50%. That $50,000 withdrawal? You keep $24,000 of it. The rest goes to the IRS.
Unrealistic spending plans. Both irrationally optimistic and irrationally pessimistic. Two families each want to spend $100,000 a year throughout their retirement. The first family has a $500,000 nest egg, which works out to a 20% withdrawal rate. The 4% rule is squealing. The second family has $15 million, or a 0.67% withdrawal rate. They are crippled with anxiety over running out of money. Neither family is living in reality.
No communication. Family finances are a deeply personal topic. There are many ways to skin the cat. But there aren’t infinite ways to skin a cat. Some methods are plain stupid. It shouldn’t take a meeting with a CFP for one spouse to tell the other spouse they still have $120,000 of student loans. Communication, communication, communication.
Ok, you spelunkers. It’s fun to dive deep into the financial planning cave, where the Social Security salamanders and the Roth conversion crayfish lurk. But the professionals care deeply about the “surface-level” stuff too, and it’s perhaps more important to get those simple ideas right.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
Want to learn more about The Best Interest’s back story? Read here.
Looking for a great personal finance book, podcast, or other recommendation? Check out my favorites.
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One of the best things you can do for your future self is to save for retirement. Unfortunately, recent research indicates that a significant portion of Americans are falling short in this area. According to a 2023 survey, about 22% of Americans have less than $5,000 in retirement savings.
This highlights the importance of early and consistent financial planning for your post-working years. It’s never too early to start thinking about your financial future, and actively contributing to your retirement savings is essential.
If you’re looking for a way to sock money away for retirement, your 403(b) plan could be just what you need. These retirement plans are offered by employers in the nonprofit sector and some other careers, like public education and healthcare. If your employer offers a 403(b) plan, here’s what to expect.
Key Takeaways
A 403(b) plan is a retirement savings plan available to employees of tax-exempt organizations, public schools, and certain other employers. It functions similarly to a 401(k) but is specifically designed for the nonprofit sector.
Contributions to a 403(b) are automatically deducted from your paycheck, can be made pre-tax (traditional) or after-tax (Roth), and may be matched by your employer, providing significant potential for growth through compounding returns and employer contributions.
While 403(b) plans offer advantages like tax benefits and employer matching, they have contribution limits and penalties for early withdrawals, and the investment options are usually limited to mutual funds and annuities, which may carry higher fees.
403(b) Plan
A 403(b) is sometimes called a Tax-Sheltered Annuity (TSA) plan. For practical purposes, it’s basically a 401(k) plan for people who work for qualifying tax-exempt organizations, certain hospital organizations, or employees of public schools. Government employees, church workers, and even librarians might also have access to a 403(b) plan.
See also: What’s the Difference Between a 401(k) and 403(b)?
Your employer chooses what type of plan they are willing to offer, so you can’t choose to participate in a 401(k) instead. Your 403(b) plan will come with different investment options, usually in the form of mutual funds that allow you to create a portfolio that matches your risk tolerance.
However, it’s important to understand that the annuity agreement involved makes for a couple of tricky situations that might not apply to other retirement plans:
Withdrawals are subject to a 20% federal income tax withholding, except in specific circumstances.
To dissolve the annuity investment aspect of a 403(b), there might be a surrender charge of up to 8%.
Speaking with a professional to help you with these situations can help you understand some of the quirks involved.
How does a 403(b) work?
Your employer will automatically deduct your contributions to the 403(b) from your paycheck in many cases. This deduction is usually expressed as a percentage. For example, if you make $2,500 each paycheck and want your employer to withhold 4% of your income, $100 will be diverted to your retirement account each payday.
If you choose a traditional 403(b) arrangement, your employer will deduct your contribution from your pay before taxes are figured. This reduces your tax bill today, but you’ll still have to pay income taxes when you withdraw money later. On the other hand, your employer might offer a Roth option, which doesn’t result in a tax benefit today. Instead, your money grows tax-free, and you won’t have to pay taxes when you withdraw.
Some employers also match your contributions. For example, they may match a certain percentage of your income or offer a dollar-for-dollar match up to a cap. Either way, an employer match on your plan is free money that you can put toward your retirement.
Thanks to compounding returns, the money grows over time, and you have a chance to build wealth, so you have financial resources when you quit working. It’s possible to adjust how much you save by letting your human resources representative know, or by managing your contributions through your employer’s online benefits portal.
403(b) Contribution Limits
The government wants to encourage retirement saving, so they offer tax advantages when you contribute to a 403(b) plan. However, you can’t just put everything into a tax-advantaged plan. Your 403(b) comes with limits.
For 2024, you can contribute up to 23,000 a year, which is a $500 increase over the 2023 limit. If you’re age 50 or over, you can make extra contributions totaling $7,500 a year in 2024. The combined employer and employee contributions can be a maximum of either $69,000 or 100% of your most recent yearly salary, whichever amount is lower.
The IRS also allows for additional catch-up contributions if you’ve given 15 years of service with an employer. Pay attention to the contribution limits and your employer’s plan so you can take advantage of what’s available to you.
When can you withdraw money from your 403(b)?
Because your 403(b) is a retirement plan, you can’t just take money out when you want — at least not without paying a penalty. If you withdraw money before reaching age 59 ½, you’ll have to pay taxes, and the IRS will charge you an extra 10% penalty. The only exception is if you have a Roth account. At that point, as long as the account is at least five years old, you can withdraw your contributions without penalty.
Be aware, too, that when you reach age 70 ½, you’ll have to start taking Required Minimum Distributions (RMDs) from your non-Roth 403(b). The government uses a formula to determine how much you should be taking each year in RMDs. You’ll have to pay taxes on the amount, as with any other tax-deferred retirement plan withdrawal.
As you approach retirement and begin figuring out how much money to withdraw and which accounts to start with, consult a retirement professional. A knowledgeable professional can help you manage your different accounts and figure out how withdrawals interact with Social Security benefits.
What happens if you leave your job?
You might have a vesting requirement with your 403(b). Vesting requires you to be with an employer for a set amount of time before you get to keep all the money from the match. However, the money you contribute on your own is not subject to vesting.
In some cases, you might be able to keep your money in the 403(b) account, even after you leave. However, you can’t make new contributions. As a result, it might make sense to roll your money into an IRA. That will allow you to keep growing the account and control where the money is invested.
How much should you contribute to your 403(b) plan?
Putting money into an employer-sponsored retirement plan is one of the easiest ways to save. It comes out of your paycheck, so you don’t have to think about it. However, you might be concerned about how much you can afford to divert from other goals.
A good place to start is to maximize your employer match. If your employer will match your contributions up to 3% of your income, consider saving 3% of your income. That way, you at least get some additional free money going toward your financial future.
If your employer doesn’t offer matching contributions, your 403(b) is not required to meet the burdensome oversight rules of the Employee Retirement Income Security Act (ERISA). This means you could have lower administrative fees than you would with 401(k)s or other funds subject to greater oversight.
Factors to Consider
Next, you need to consider different factors related to your current situation. Some things to keep in mind as you determine how much to put into your 403(b) include:
Debt: High-interest debt can weigh you down. It’s ok to save a little less for retirement in the name of paying down debt faster. You can work toward both goals, but just know where the bulk of your focus should be, based on your goals.
Emergency fund: Once you have a baseline established for retirement saving, you might want to focus on another goal. Consider building at least three to six months’ worth of expenses in an emergency fund.
Other savings goals: Maybe you have goals like buying a home or starting a college fund. You don’t want to put your own retirement at risk to pay for your child’s college, though. Think about what you want your money to accomplish, and then go from there.
Once your goals are met, return to the 403(b) and considerably boost your retirement savings. It’s a good idea to increase your retirement savings each time your finances improve, or you get a raise.
How to Invest in a 403(b)
The investment options available in a 403(b) plan are generally more limited compared to other tax-advantaged retirement plans. These options typically include mutual funds and annuities.
Unlike 401(k) plans, it is not typically possible to invest in individual stocks, exchange-traded funds (ETFs), or real estate investment trusts (REITs) through a 403(b) plan. However, many 403(b) plans do offer low-cost bond and stock index funds, which are often recommended by financial experts for retirement investing.
To determine the right mix of stock and bond funds, you should consider your age, risk tolerance, and the amount of time you have before retirement. As you get closer to retirement, it may be appropriate to increase the proportion of bond funds in your portfolio.
Target-date funds, which are mutual funds that automatically adjust their holdings to suit your target retirement date, can be a good choice if they are offered by your 403(b) plan. Alternatively, you can consider investing in an annuity through your 403(b).
However, it is important to be aware that annuities can be complex financial instruments with high fees and potentially lower returns than other options. It is a good idea to speak with a financial advisor before deciding to invest in an annuity.
If your 403(b) plan does not offer the investment options you want, consider using an individual retirement account (IRA) to supplement your portfolio. If your employer offers a matching contribution to your 403(b) plan, ensure that you are contributing enough to take advantage of this benefit before investing in an IRA.
Are there other ways to prepare for retirement?
A 403(b) is not the only way to save for retirement. In fact, you should consider retirement planning holistically, working it into your other short-term and long-term money goals.
In addition to using a 403(b), you can also open an IRA to set aside money in an account that you have more control over. If you qualify, you might also be able to use a Health Savings Account to begin saving up for healthcare costs in retirement.
Please keep in mind that you might have other accounts from previous jobs. Rolling them all into one IRA can help you consolidate the money to more effectively plan for the future. Make sure you consider taxable investment accounts, savings accounts, pensions, and even Social Security benefits in your planning.
For the most part, though, the first step is getting in the habit of saving money. You might not feel like you have “enough” money to invest for retirement. This isn’t true. Even if you only set aside 1% of your income, it’s still better than nothing.
Here are some tips for managing your retirement portfolio:
Work toward increasing your contribution a bit each year.
Review your accounts once a year and rebalance as needed.
Consolidate accounts to reduce fees and improve management.
Be realistic about your retirement needs and plan accordingly.
Incorporate other financial goals and prioritize retirement.
Use windfalls, bonuses, and other unexpected income sources to pad your account.
Bottom Line
The earlier you start saving for retirement, the less you have to contribute each month to meet your goals. However, it’s better to start late than never. Put as much as you can into your 403(b) from the get-go, taking special advantage of any employer match. As you develop the habit of setting goals and saving for them, you’ll position yourself for financial success.
Thanks to reader Lynn, who wrote in this week with some specifics about her household’s situation and an overarching question: When should we start taking Social Security?
I’ll provide background information below, and then we’ll discuss a few common “if –> then” heuristics to help you with your Social Security planning.
Background – The Pros and Cons of Taking Social Security Early
Social Security is a government program that provides financial support to individuals who are retired, disabled, or survivors of deceased workers, funded primarily through payroll taxes. It aims to ensure economic stability and security for eligible participants by offering benefits to mitigate income loss due to retirement, disability, or death.
Today, we’re talking about retirees.
American retirees each have an “eligible benefit” from Social Security, which is based on the following factors.
They must be 62 years old or older
They’ve worked and paid into Social Security for at least 10 years (measured quarterly, for a total of 40 or more quarterly credits)
They could be eligible for additional credits based on their spouse’s work history, too.
Your eligible benefit is determined by your highest 35 years of earnings, with each year’s earnings adjusted for inflation (aka “indexed”). The higher your overall earnings, the greater your Social Security benefit will be.
Quick Example: AIME and PIA
Here’s a quick example:
Bob worked the same job from age 22 to age 62. His salary in 1984 was $25,000, and he’s received a 4% raise every year since; he’s earning $120,000 now in 2024 (his final working year).
We’d use the Social Security indexing factors to adjust each of his prior years’ earnings by rates of inflation. We’d then pick the highest 35 years, find the average, and divide by 12 to get Bob’s average indexed monthly earnings, or AIME.
Bob’s AIME is $8717. Here’s the Google sheet with the math. Feel free to make a copy.
Note 1: because only a certain percentage of income is subject to Social Security taxes, only that portion of earnings is considered for AIME. In 2024, the FICA income limit is $168,800. Even if someone earned millions every year for their entire career, their AIME would only include that smaller portion of income that was taxed by FICA. That logic is why the maximum AIME in 2024 is ~$13,100.
Note 2: if you don’t work a full 35 years, you’ll have some “zeroes” in your AIME math. This isn’t ideal. But depending on the rest of your work history, these zeroes could have a major effect or a minor effect. The PIA section below will shed more light.
Next comes PIA, or the Primary Insurance Amounts, aka what you actually receive from Social Security if you retire at “full retirement age,” or FRA. PIA is the real deal. An individual’s Social Security benefits (or PIA) are based on specific percentages of that individual’s AIME. For 2024, the PIA math is:
Take 90% of AIME below $1174
Plus 32% of AIME between $1174 and $7078
Plus 15% of AIME above $7078
If we run that math for Bob, whose AIME was $8717…
90% of his first $1174 = $1056.60
plus 32% of ($7078 – $1174) = $1889.28
plus 15% of ($8717 – $7078) = $245.85
For a grand total PIA of $3191.73per month.
You see – not all your AIME dollars count the same! The first dollars matter a lot – they’re counted at 90%! The latter dollars are only counted at 15%. And since high-earners’ latter dollars aren’t factored into AIME at all, we can think of those dollars as being counted at 0%. This concept is dubbed the “Social Security bends” or “bend points” because of how it looks when graphed out.
If you have a “zero year” in your 35 years of earnings, your AIME will certainly decrease. But if you’re already in the 0% or 15% section of the PIA graph, it might have only a tiny effect on your PIA. It’ll have a huge effect if you’re in the 90% section.
Bob had his final ~$1700 of AIME in the 15% section of the PIA graph. I ran a quick test and turned his 35th year into a zero. His AIME dropped from $8717 to $8487 – a $230 drop. His PIA dropped from $3192 per month to $3157 – a $35 drop. $35, you might guess, is 15% of $230.
PIA is Bob’s benefit if collects at “full retirement age.” But what if he collects early?
What About the Age You Start Collecting?
Social Security uses a concept called “full retirement age” (FRA) to determine how much of your eligible benefit you get to collect. Your personal FRA depends on the year you were born. The chart below shows the details:
FRA is either 66 or 67 years old for today’s new retirees. You can start collecting Social Security benefits before your FRA, but there’s a price to pay. Your benefits will be permanently reduced. But by postponing your benefits until after your FRA, your benefits will be permanently increased. The two charts below show both sides of that coin for both age 67 FRA retirees and age 66 FRA retirees.
Let’s do a quick decoder to make sure you understand how this all fits together.
If Bob was born in 1962 (and therefore is 62 years old today), he could start collecting Social Security right now. His FRA (based on his birth year) is 67, so we’ll consult the blue section of the table above. By collecting at age 62, Bob will only receive 70% of his full benefit. His PIA was $3192 per month; Bob would only collect 70% of that, or $2234 per month.
If Bob waits to collect, a few things will happen.
First, the AIME math and the PIA bends will likely change to account for inflation and other factors. On net, this will increase Bob’s PIA.
Second, Bob’s postponed filing age will increase his benefit amount, per the blue table above. If Bob waits until age 70, he’ll receive 124% of his PIA.
This begs a question: should Bob collect early to get those extra years of income, though at a discounted benefit? Or collect later, for fewer years, but at a much higher rate? When is the breakeven point?
The Breakeven Point for Collecting Social Security
When is the breakeven point for collecting Social Security? I looked at retirees with FRA = 67 years old. Here’s my Google sheet if you want to play around with it yourself.
With the bare eye, you can see the breakevens occur in the upper 70s. The joke in financial planning is, “Tell me when you’ll die, and I’ll tell you when to start collecting Social Security.” But the rough outline is:
If you die before age 77, collecting as early as possible would have been best.
If you die between ages 78-80, then all scenarios are roughly equal (all within ~6% of one another)
If you die after age 80, then waiting until at least “full retirement age” of 67 has distinct advantages
If you die after age 84, then waiting until the maximum collection age of 70 becomes optimal, and it only gets better the longer you live.
But there’s much more to consider than “how long will you live?”
So let’s get to the real meat of the article: what are some applicable thought processes, strategies, and if –> then scenarios to guide you and your family in Social Security decisions?
This is Hard to Get Right
As Annie Duke says (and I love to repeat), two things determine outcomes in our life:
the quality of our decisions, and
luck.
Or, put another way, there are things in your control and things out of your control.
Whatever decision you make regarding Social Security, you must accept that luck might strike, and your decision won’t have been the optimum one. It’s not because of the quality of your decisions. It’s because of luck. (This is “results-oriented thinking,” a bias worth breaking.)
You Want to Get This Right
This is close to a one-way gate.
Once you start collecting Social Security, you do have up to 12 months to 1) change your mind and 2) repay any benefits you’ve received so far. You get one of these “withdrawals” in your lifetime.
Once you delay collecting, though, you can’t go back in time and reclaim those missed benefits.
Ideally, you want to get this decision right.
Health, Illness, Family History, and Social Security
The most common questions surrounding Social Security revolve around your personal health and family history. We’ve determined that ages in the late 70s to early 80s are the “break even” point. You should ask: does anything in your personal or family history point you toward an early or late death?
If you’re healthy and all your relatives live to 100, it’s reasonable to assume you could have a similar fate. Postponing Social Security as long as possible (age 70) makes sense.
If you’re chronically ill, your relatives have all passed away early, etc., again, you can reasonably assume you could have a similar fate. Collecting Social Security as early as possible would make sense.
Granted, I’m not a doctor. One health phrase worth remembering is, “Genetics loads the gun, environment pulls the trigger.” In other words, you aren’t condemned to your family history. You have dials to control. Don’t forget that.
Do You Need It? It’s Longevity Insurance.
Do you need to take Social Security early? Will that extra income bridge the gap between cat food and a normal human diet? Because if you don’t need Social Security, why take it early?
Delaying your Social Security will act as “longevity insurance,” protecting against the risk that you will live to 90, 95, or beyond. The longer you wait, the higher your benefit will be, and the better your long-term outcomes will be.
Are You Still Planning to Work?
Are you planning to work while also collecting Social Security? Tread carefully! Your work income will actively eat away at your Social Security benefits.
Bob, for example, who is age 62, can only earn $22,320 in ordinary income before he hits trouble. For every $2.00 he earns above that limit, $1.00 will be deducted from his annual Social Security benefit. If Bob earns $125,000 (like he did last year) while also collecting Social Security at age 62, he effectively receives $0.00 in Social Security benefits while being permanently hamstrung by his choice to collect early. Ouch.
“He collects no Social Security because of this one stupid trick.”
That specific income limit increases to $59,520 during the year someone reaches their FRA, and the penalty ratio “lessens” to 3-to-1. The penalty disappears altogether once the FRA has been reached.
There’s always a corner case, so making a concrete rule about working while collecting is hard. That said, it’s like going into credit card debt. You really want to avoid it if you can. You really want to avoid starting Social Security benefits before full retirement age if you plan on working.
Consider Spousal Benefits
Spousal benefits are one of the many rabbit holes in Social Security planning. There are many paths, they go deep, and it’s easy to get lost. Trust me, Alice.
The upshot for basic Social Security planning is that your decision to collect Social Security not only affects you, but could affect your current spouse, your ex-spouse, and/or your future spouse or future widow.
Remember Bob? His PIA is $3192 per month. Bob is married to Sharon. Her PIA is $1200 per month. Let’s say they both opt to start collecting at FRA, and thus collect exactly 100% of their PIA each.
Sharon also gets to collect a spousal benefit. If she applies for a spousal benefit when she hits her FRA, she is eligible for 50% of Bob’s PIA (or $1596 per month). She’ll collect her $1200 benefit and then an additional $396 per month.
But if Sharon had applied for the spousal benefit at age 62, she’d only be eligible for ~35% of Bob’s PIA, or $1117 per month. Since this number is lower than her own benefit of $1200, Sharon will get no extra spousal benefit.
Now, what if Bob dies?
Notably, Sharon would step into Bob’s benefit, receiving the full $3192 per month!
If Bob had started collecting at age 62, though, his benefit would have been $2234 per month. Sharon would step into that $2234 per month benefit when he died.
If Bob had started collecting at age 70, his benefit would be $3958 per month. Sharon would step into that $3958 per month benefit when he died.
Bob’s decision doesn’t only affect his benefits. It also affects Sharon, assuming she outlives him.
Some rules of thumb when it comes to spousal benefits:
The lesser-earning spouse can start collecting Social Security as early as possible, especially if they’ll become eligible for a larger spousal benefit at FRA (e.g. just like Sharon, who jumped from her own benefit up to the spousal benefit of $1596)
The higher-earning spouse should delay Social Security to age 70 because their decision not only has a 100% chance of affecting their own benefit but also has a ~50% chance of affecting their spouse’s eventual benefit (if we assume the “who dies first?” question is a coin flip).
What About the Overall Financial Plan, and Sequence of Returns Risk?
How does Social Security fit into your total financial plan? Especially in the early years of retirement, where you’re most at risk for a sequence of returns disaster?
“Sequence of returns risk” refers to the potential that a poor-performing portfolio early in your retirement will cascade into long-term pain. If your assets are worth less early on, you’ll be forced to sell more of them than you anticipated. This leaves fewer assets in your portfolio to grow for the long run.
One way to mitigate this risk is to find alternate sources of retirement income. Social Security, perhaps?! If early Social Security is a vital part of your overall plan’s success, the failure risk introduced from delaying Social Security could be too great to bear.
Taxability Concerns
Social Security is taxable (for many retirees). It’s worth considering if your decision to collect Social Security will have taxation impacts and what your net-of-tax benefits are.
What Do Your Trusted Advisors Have to Say?
While every retirement is a unique adventure, these adventures often rhyme. Your trusted advisor(s) might have seen dozens or hundreds of successful retirements before, all of which rhyme with your plan.
Their counsel might sway you in an optimal direction.
“I’m Ready Uncle Sam!”
Are you ready for Social Security? It’s not an easy question to answer.
Hopefully, I’ve answered more questions today than created new ones. Still, don’t hesitate to reach out with any questions or concerns.
Thank you for reading! If you enjoyed this article, join 8000+ subscribers who read my 2-minute weekly email, where I send you links to the smartest financial content I find online every week.
-Jesse
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