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Investing Blog Roundup: Schwab “Intelligent Portfolios” Suddenly Less Exciting

For several months now, Schwab has been promoting their upcoming “Intelligent Portfolios” platform, which will offer automated rebalancing and tax-loss harvesting of a portfolio of ETFs. The big selling point is that there is no fee for the service, aside from the cost of the funds held in the portfolio.

Frankly, an automatically rebalanced portfolio of Schwab’s super low-cost ETFs sounds pretty darned neat to me. For lazy investors such as myself, such a thing could even be preferable to a low-cost Target Retirement or LifeStrategy fund from Vanguard.

Unfortunately, now that Schwab has released additional information, we can see that the service isn’t going to be nearly as exciting as it could have been. You don’t get to choose the portfolio. Schwab assesses your risk tolerance and puts you into one of a few portfolios that they’ve created. And those portfolios have (what I consider to be) two drawbacks:

  1. They include some higher-cost ETFs, and
  2. They include a mandatory cash holding (which will earn almost nothing).

The Finance Buff has more information:

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What Is Estate Planning, and Do I Need to Worry About It?

When I recently asked for suggestions of specific estate-planning-related topics to write about, one thing that immediately became clear is that many people aren’t entirely sure what estate planning is — and whether it’s something they should be thinking about.

To put it bluntly, estate planning is planning for your incapacitation or death — choosing, for example, what will happen to your financial assets, your minor children, and your health care in such situations. As you can imagine, that’s a pretty broad field, and almost everybody has at least some degree of estate planning that they should be doing.

At the simplest level, estate planning would include making sure that the beneficiary designations on your retirement accounts and insurance policies are up-to-date. (Remember, it’s the beneficiary designation that controls where the money goes, regardless of what you say in your will.)

A very basic level of estate planning would also include making sure that you have a will that accurately reflects your wishes for any other assets (i.e., assets that do not pass directly to a named beneficiary outside of the will).

At a more advanced level of estate planning, some people will benefit from creating a trust to serve any of several different purposes. In short, a trust is a legal entity to which you would give some of your assets. Those assets are then managed by a person or entity whom you name (the “trustee”), for the benefit of some other person(s) or entity.

A trust can be helpful, for example, if there is somebody to whom you wish to leave assets, yet who you do not think should be put in charge of managing those assets (e.g., because of a disability or because of a well-established history of poor financial decisions).

Alternatively, trusts can be helpful for people on their second marriage. For example, imagine that you want to leave your assets to your new spouse, but you want to be sure that any assets remaining after that spouse dies go to your children from your first marriage (rather than to that spouse’s children from his/her first marriage). In such a case, you could put the assets in a trust, naming your spouse as a beneficiary to receive income from those assets for the duration of his/her life, and naming your children as beneficiaries who will receive those assets after your spouse’s death.

For some people, estate planning involves engaging in various activities to minimize the effect of estate taxes. This is, however, not a concern for most people these days, given the size of the federal estate tax exemption: $5.43 million in 2015, twice that for married couples.

Estate planning also includes several topics that are not strictly of a financial nature, such as choosing a guardian who will care for your children in the event of your death, or granting a medical power of attorney to a trusted family member or friend, so that he/she can make health care decisions on your behalf if you become incapacitated.

Investing Blog Roundup: Staying Flexible with Retirement Withdrawals

There are many personal finance rules of thumb that can be helpful when developing a rough-draft retirement plan. However, as Darrow Kirkpatrick and Christine Benz remind us this week, following a given rule of thumb may not be the best approach. Kirkpatrick addresses the question of how much to spend per year, while Benz looks at which account(s) to spend from each year.

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Don’t Change Tax Plans Based on Presidential Budgets

A reader writes in, asking:

“I heard on the radio recently that Obama will be changing IRA rules so that Roth IRAs will require RMDs and so there will be a limit on IRA account size. Do you think this has a big effect on the decision of which type of account to contribute to?”

To be clear, these are proposed changes that were included in the Obama Administration’s budget for the 2016 fiscal year. Every year, the President is required to submit a budget to Congress. And every year, the budget includes a list of tax changes — the nature of which naturally varies depending upon whether a Democrat or Republican is in office.

A key point, however, is that the President does not actually have the power to implement such changes to existing law.** For such a change to take effect, somebody would have to introduce a bill in the House of Representatives, where it would ultimately have to be passed. And the Senate would have to pass it as well. Then the President comes into play by signing the bill into law (or, in some cases, refusing to do so).

So, what ultimately ends up happening with most tax-related proposals in presidential budgets? Nothing. Most never even get introduced as bills. And, of those that do, many never get anywhere near becoming law. This is especially true in situations such as we have today in which the President is of one party and both houses of Congress are controlled by the other party. In fact, some ideas (the limit on retirement account sizes, for instance) have been proposed repeatedly without ever going anywhere.

From a civic duty perspective, it may be worth following such proposals so that you can contact your elected representatives to let them know whether (and why) you do or do not support various tax changes.

But from a financial planning perspective, if nobody has even introduced a bill yet, it’s far too early to start making any changes to your tax planning.

That said, you don’t want to bet everything on the idea that nothing will change. Tax law does change over time, which is why “tax diversification” — having some money in tax-deferred accounts and some money in Roth accounts — is generally considered to be a good idea.

**The executive branch does have some power with regard to how existing law is applied. That is, in cases in which a particular provision in the tax law is ambiguous, the Treasury Department has some leeway in choosing how to administer the law. And then if taxpayers oppose the way in which the Treasury Department applies the law, the judicial branch (i.e., the courts) will ultimately get involved as well.

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Investing Blog Roundup: Nominating Jack Bogle for the Presidential Medal of Freedom

The Presidential Medal of Freedom is the highest civilian award given by the U.S. government. The idea is to recognize people who have made “especially meritorious contributions to the security or national interests of the United States, world peace, cultural or other significant public or private endeavors.” In the fields of economics/business, for instance, the award has been given to many people, including Warren Buffett, Daniel Kahneman, Sam Walton, and Milton Friedman.

This week, Phil DeMuth of Forbes made the case that John Bogle should be a candidate for such an award. Not only did Bogle create the first retail index fund, he created a financial services company that, by its structure, puts client interests first — because clients are essentially the shareholders.

Demuth writes:

“An American success story, Bogle inevitably became a millionaire. Here’s what his sacrifice meant he didn’t become: a multi-billionaire.  Bogle doesn’t own a private jet; he flies coach. It’s unlikely that you will read about future generations of Bogles becoming U.S. Senators or owning professional sports franchises. That money went into your pocket instead.”

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How Do Child’s Benefits Affect Social Security Claiming Strategies?

A reader writes in, asking:

“If I have a young child, how does that affect the age at which I should be filing for my Social Security?”

Before getting into how claiming strategies are different for people with qualifying children than for people without qualifying children, we must first discuss who is a qualifying child.

How Does Somebody Qualify for Child’s Benefits?

While you’re still alive, in order for your child to qualify for a Social Security benefit based on your work record, your child must be:

  • Under 18,
  • 18 or older and disabled (with the disability having begun before age 22), or
  • 18 or older and a full-time student in grade 12 or below.

In addition:

  • Your child must be “dependent” on you (though in the case of a natural child, that requirement is automatically considered to be met unless the child has been legally adopted by somebody else), and
  • You must have filed for your retirement benefit.

How Do Child’s Benefits Affect Claiming Strategies?

There are three key points to understand about the interaction of child’s benefits and Social Security claiming strategies.

First: Waiting to claim your retirement benefit does not increase your child’s benefit amount. While you are alive, your child’s benefit amount is simply 50% of your primary insurance amount — your PIA being the monthly retirement benefit you would receive if you claimed that benefit at your full retirement age. (After you die, your child’s benefit is 75% of your PIA.)

Second: Because you must have filed for your retirement benefit in order for your child to be able to qualify for a child’s benefit, the cost of each year that you wait to file is greater than it would be for a person without a qualifying child (because you’re giving up a year of child’s benefits as well as a year of retirement benefits).

Third: If you have a qualifying child, your spouse may be able to qualify for spousal benefits based on your work record, even if your spouse has not yet reached the normal qualifying age of 62.

As a result of these three facts, having a qualifying child is a point in favor of claiming early. It isn’t necessarily a conclusive reason that you should file early, but it’s certainly a point weighing in that direction.

For example, for an unmarried person, currently age 62, who is considering:

  1. Starting retirement benefits now at 62, as opposed to
  2. Starting at 70 (after filing and suspending at 66, in order to allow the child to start receiving benefits)

…having a qualifying child pushes the break-even point from age 80.5 to age 84.** That is, rather than having to live beyond age 80.5 in order for waiting to be advantageous, you’d have to live beyond age 84 (which is, of course, less likely).

For a married couple, there’s no way to give a generalized break-even point, because it depends on the difference in the spouses’ ages, as well as the difference in primary insurance amounts.

Possible Claiming Strategies

With the additional moving piece that comes into play when child’s benefits are involved, the complexity of assessing one strategy against another goes through the roof. As a result, while using a Social Security claiming calculator is likely a good idea for anybody, it’s even more likely to be beneficial for people who have a qualifying child. Unfortunately, to the best of my knowledge, only one of the online calculators (MaximizeMySocialSecurity.com) includes child’s benefits in the analysis.

Having said that, the following two strategies may serve as a (very rough) starting point for analysis.

Strategy one:

The low-PIA spouse claims retirement benefits as early as possible, thereby allowing the child to start taking benefits based on that spouse’s work record. Then, upon reaching FRA, the high-PIA spouse files a restricted application (thereby receiving spousal benefits based on the low-PIA spouse’s work record). Then, at 70, the high-PIA spouse files for his/her own retirement benefit, and the child begins receiving benefits based on the high-PIA spouse’s work record.

Strategy two (which may be preferable when the difference between the two spouses’ PIAs is quite large):

The low-PIA spouse still files for retirement benefits at 62, allowing the child to start receiving benefits. Then, at his/her FRA, the high-PIA spouse files and suspends, thereby allowing the low-PIA spouse to start receiving a spousal benefit, and thereby allowing the child to start receiving a higher child’s benefit. Then, at his/her age 70, the high-PIA spouse actually starts receiving retirement benefits by asking to have them unsuspended.

**We’re keeping things simple in this analysis by ignoring investment returns. If we assume that early-taken benefits are invested and outpace inflation, that would push the break-even point back even further.

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