Retirement - The Finance Gourmet

What To Do If You Win $400 Million Powerball

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There are Powerball jackpots, and then there are POWERBALL JACKPOTS. Tonight’s Powerball jackpot is at $403 million (annuity), and $243.9 million (cash), which according to news reports is the 10th largest jackpot of all time.

Every wonder what you should do if you win Powerball? The truth is that with a jackpot this large, you’d have to mess up pretty bad for it to be much of an issue. Smaller jackpots can be trickier, if you are trying to live the rest of your life without ever having to work again, AND live a larger than life lifestyle.

Choose Annuity or Cash

There are two options to choose from if you win the Powerball jackpot. Contrary to popular belief, the value of both choices is the same. The actual jackpot is $243.9 million in both cases. However, if you choose the annuity, the lottery invests that $243.9 million on your behalf, and then sends you 30 checks over the next 29 years. The difference between the announced annuity amount is nothing more than the interest that builds up over those 29 years of payouts. Hypothetically speaking, if you were able to invest the money in the same way that the lottery does, you would get the same payments from choosing cash as you would from choosing annuity.

Why do you get payments for 29 years for Powerball annuity? Because, you get the first payment right away. For example, if you won in March of 2017, you would get a check for $8.13 million in March or April. That leaves 29 more payments, one each year for 29 years.

So, should you choose annuity or cash?

Most financial planners would recommend you take the cash prize. This is for two reasons. First, is that then they get 1% (or so) of $243.9 million each year for managing your money. Second, is that you can actually control how the money is invested, and theoretically tailor such an investment to your needs.

The reality is that if you take the annuity of an amount this large, you are going to end up investing a lot of it anyway. Most people don’t spend $8 million per year. I suppose you could, but even if you went big that first year and bought houses, cars, vacations and stuff that totaled $8 million, you wouldn’t necessarily need another house and other stuff in the following years. Eventually, you might be investing at least a few million each year.

The main reason to take the annuity is to remove any stress around the money. One of the difficulties of winning the lottery is that it is a one-time event. This means you have to manage against spending too much money for the rest of your life. This is very different than having a large income, in which case, there is always more money coming should you overspend or make a bad investment, or other mistake. It is that ongoing income that let’s people “learn” how to be rich even if they make some mistakes early on.

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Even if you do everything right, the stress of worrying about your money and wondering if you are still doing it right, can be difficult to deal with.

That isn’t to say that you shouldn’t take the cash, if you are willing and able to take on the management of it. You’ll lose a lot to taxes right up front, but then, with some careful investing, it shouldn’t be difficult to generate something like $2 or $3 million per year, without even touching the principal. Unlike with an annuity, you could manage the taxes by choosing tax-advantaged investments. Of course, you could do the same thing in reverse with the annuity. Use just $2 or $3 million per year and the rest gets invested where it grow. By the time you need to sell anything, you would be paying the much more forgiving long-term capital gains tax rate of just 15%.

In the end, with a major size lottery jackpot, either choice would end up being just fine. Smaller amounts can be trickier. A $20 million annuity for example would be less than $1 million per year. That’s great, but if you are younger, you’ll need to think about what happens after the 29 years are up. In that case, the smartest thing you can do is treat the payments like income from a job, complete with retirement savings.

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Or, take the lump sum and take a look at whether you really can quit and never work again on a $5 million nest egg (50% as cash value, then 50% to taxes). If you’re 50 or 60, that really shouldn’t be a problem if you keep a modest lifestyle. If you are in your 30’s you can make it if you invest smart, and stick to something like $200,000 per year in withdrawals.

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Don’t worry too much, though. Your odds of winning are not good. But, if the universe smiles on you, carefully evaluate your options.

2017 Finances and Money Issues

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Welcome to 2017!

Relax. Take a deep breath.

There. Feel better? Good. Then let’s jump in.

Finances Updated in 2017

With a new year, come some new numbers. There will be updates to the maximum 401k contributions, income limits for Roth IRAs, and others. Plus, there will be adjustments to the 2017 income tax brackets, the 2017 standard tax deduction, and more. And, of course, there is a new IRS mileage rate for 2017 as well.

What about 529 plans? There aren’t a lot of updates to those numbers each year, primarily because most facets of 529 college savings plans are administered through the states, who aren’t always as keen on changing and updating everything.

You’ll want to re-evaluate your financial plan for the new year, and you’ll want to review how your financial plan did in 2016. Plus, you’ll want to rebalance your portfolio, if you didn’t do it at the end of 2016.

Retirement Plans 2017

A big part of most retirement plans are tax-advantaged savings accounts like your 401k plan, IRA accounts, and, for some of you, 457 plans, 403(b) plans, and various differed compensation plans. All of those need adjusted and reviewed for 2017 as well.

2017 Income Taxes

A big focus for many people’s finances at the start of 2017 is the looming prospect of income taxes. Start collecting and saving your W2 forms, 1099 forms, and all those other tax forms you get in the mail. However, keep in mind that an increasing number of financial institutions, and even employers are distributing tax forms electronically. Be sure to log into all of your accounts and see if your tax forms are there to download, especially if you have signed up for paperless accounts with anyone.

Set a box, or file folder where you go through your mail so that you can put tax documents in it right away and not lose any. For electronic ones, print and download them so you have them to enter into TurboTax, or give your accountant or tax preparer.

Remember most tax forms are due to be mailed by January 31st.

Also, start thinking about whether you need (or want) to make any retirement plan contributions for 2016 still. You get until April 15th to make the contributions and still count them as a 2016 tax deduction.

Don’t Panic About Money in 2017

Does that sound like a lot?

We haven’t even scratched the surface of making smart money decisions in 2017, but don’t worry. Finance Gourmet will be bigger and better than ever in 2017 to help guide you through with financial recipes for success, and more.

It’s going to be a great 2017.

401k Contribution Limits 2016 and 2017

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401k contribution limits prevent higher income taxpayers from stuffing too much money into their 401k plans.

Each year, the IRS adjusts tax numbers due to either tax law changes, or statutorily mandated adjustments. However, in some cases, the tax amounts are tied to inflation so that they automatically adjust. In many cases, numbers are only modified for the current tax year when a certain limit or threshold is met. Limits for 401k contributions are indexed to inflation and adjusted every year in this manner, provided there is enough change caused by inflation to modify the numbers.

2016 401k Contribution Limits

The current 401k contribution limits for 2016 were set by the IRS in late 2015. These limits are tied to an economic index that measures the overall cost of living. The index is designed to rise with inflation. By tying 401k contributions to the index, Congress doesn’t have to pass a law to change the 401k income limits or maximum annual 401k contribution amounts for 2016.

The 2016 maximum 401k contributions limits are unchanged from 2015 because there wasn’t enough inflation during the year to cause an increase.

The 401k contribution limit for 2016 is $18,000 for an employee’s elective deferrals. As always, there is a 2016 catch-up contribution amount allowed for taxpayers over the age of 50. For 2016, the catch-up contribution limit is $6,000, also unchanged from 2015. So, for an employee over 50 years of age, the maximum 2016 401k contribution amount is $24,000.

Unlike traditional IRA deductions, there are no income limits for 401k contributions. However, certain businesses may restrict contributions for high-income employees, or business owners, if the plan is considered top-heavy, or otherwise fails to meet certain IRS 401k plan rules. As always, 401k contributions can only be made by salary deferral. Individual 401k plan rules vary from company to company and a maximum salary contribution is often one of those rules.

401K Contribution Limits 2017

The maximum contribution you can make to your 401k in 2017 will remain unchanged at $18,000 per year. The contribution limit for 401(k) plans are adjusted for inflation. Since there was no inflation in 2016, the numbers did not increase, similar to the non-increase in the cost of living for Social Security recipients.

Too High 401k Contributions

If your contribution percentage to a 401k plan is set too high, your plan has rules to deal with that. Typically, the plan accepts contributions from employees at their own set contribution percentage until the maximum amount is reached. At that point, no further contributions or salary reductions are made until the new tax year.

For example, someone earning $250,000 per year who sets their contribution amount at 15 percent will reach the maximum $17,500 contribution sometime during June. Once the 401k limit is reached, the plan will typically just stop taking any more contributions for the remainder of the year.

It is important for your own personal financial planning then, to decide how you want your contributions made. For example, if you want to contribute an equal amount each month over the course of the year for dollar-cost averaging, or other reasons you’ll want to set your maximum 401k contribution to $1458.33 per month. Most plans will allow you to set a specific dollar amount, or you can do the math to figure out what percentage of your salary will give you the right amount.

As always, ensure that your overall financial plan continues to make sense for you and your family. And, don’t forget to rebalance your 401k investment options according to your long-term plan as well.

Smart to Use Roth IRA For College

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Should I use my Roth IRA for college?

As a former financial planner, I would often get these questions from clients who read something somewhere. Much like patients asking doctors about drugs they heard about on TV, such questions rarely ended up being a good idea. Still, it is possible to use a Roth IRA to pay for college, but it only makes sense in very specific circumstances.

First, you probably know that a Roth IRA is designed for retirement savings, so that is what it is best used for. The corresponding vehicle for parents saving for college is a 529 college savings plan. In general, the best way to save for college is in a 529 plan versus a Roth IRA. That being said, a Roth IRA can be used, and may be clever in certain circumstances.

Can I Use Roth IRA for College

Let’s start with CAN you use a Roth IRA to pay for college. We’ll look at SHOULD you use a Roth IRA for college next.

As you may know, a Roth IRA offers tax-advantaged growth for investments within the account. This creates two kinds of money inside of a Roth IRA. The first kind of money is contributions. Contributions are the monies directly deposited into the account. They do not include any dividends, interest or gains on investments. If you put $5,000 in a Roth IRA for 10 years, then your contributions are $50,000, no matter what the account is actually worth. Any amount above $50,000 is earnings.

There are two features of a Roth IRA that allow for its use to fund college without paying penalties. First, all contributions can be withdrawn without penalty or taxes. In other words, in the case above, the taxpayer could use $50,000 to pay for college (or anything else for that matter) without taxes or penalties.

The second feature is that there is an exception allowing Roth IRA funds to be used to pay for qualified college expenses. Basically, if you are deliberately trying to stretch what “college expenses” means, it probably counts. Tuition, fees, books, supplies and equipment, at an institution with the word university or community college in the name are pretty much all covered. (Typically, non-degree programs like a coding bootcamp, or writers retreat don’t count.) You are allowed to pay such expenses for yourself, your spouse, your children, and their descendants (that means grandkids and great-grandkids are included).

However, this Roth IRA distribution exception only applies to the penalties that would ordinarily be due. The withdrawal does still count as taxable income. This can be a double whammy, because not only do you owe taxes on these funds, but it also increases your income for purposes of financial aid. Since financial aid takes into account your income, artificially inflating it by taking funds from your Roth IRA may not be a good strategy.

Is It Smart To Use Roth IRA for College?

Additionally, you are literally stealing from your retirement in order to pay for a child’s college. Not only is that money not available for your retirement, but that money is not able to grow while you are still working. At 8% growth over 20 years, that $50,000 withdrawal isn’t just $50,000 gone from your retirement, but $234,500 gone from your retirement.

One of the running themes on this blog is that despite what might be “best” mathematically isn’t necessarily what is right for each of us as unique humans with emotions. For parents who really want to help their kids with college, but who don’t have any other money saved up, a Roth IRA offers a tempting, if non-optimal, way to tap into some funds. That being said, keep it as minimal as possible, ideally, no more than the total amount of your contributions to avoid additional taxes.

Remember, as unappealing as student loans sound, there is no such thing as retirement loans. Consider if you are better off helping your child pay back students loans over time, rather than raiding your retirement savings to send them to college.

If you, or your child, is already looking to pay for school, the Roth IRA is an option, if not the best one. If, however, you are thinking of how, or where to save, consider setting up a 529 plan instead and save money specifically for college.