On Your Own

First off, an apology.  We hear that there were some formatting issues which prevented the Venn diagram in last month’s newsletter from showing up for anybody.  That’s a shame, because it was pretty hilarious.  But, lesson learned.  No more Venn diagram jokes.  We'll stick to .jpg based humor.

The Fed met again this month, in a quarterly show that has become increasingly Rocky Horror-esque.  No rate hike at the moment, though they expect to hike again in December and 3-4 times next year as well (I’ll take the under on that one if anybody’s interested…).  The bigger news out of the meeting was that they are (finally!) starting to reduce the size of their balance sheet.

In response to the Financial Crisis, in 2009 the Fed launched their Quantitative Easing “QE” program, whereby they bought US bonds with money they created out of thin air.  About $3.5 trillion (that’s trillion with a “t”), to be exact.  The thought was that you could avoid a repeat of the 1929 depression by expanding the amount of money in circulation.  And, yay, no depression as of yet, but also no sign of the inflation the Fed has been trying to ignite.  Why?  Because most signals point to QE not working at all, and in actuality perhaps even hampering the recovery of the last 8 years.  All that $3.5 trillion ended up...where exactly?  Not circulating in the general economy you say?  Ah yes, that’s right, it’s pretty much all held as “excess reserves” at the banks.  Fun fact - the Fed pays banks interest on these excess reserves.  So, to recap, the Fed creates $3.5 trillion dollars and gives it to the banks.  The banks don’t lend it out, they hold on to it.  And by “hold on to it”, they say, “Oh hey Fed, we have more cash than we need to at the moment, why don’t you keep some of it safe for us and pay us interest on it”.  Brilliant.

All that to say the biggest news of the Fed meeting was probably Janet Yellen herself saying it was a “mystery” why inflation hadn’t been picking up.  Yes, that was her exact word.  That means that either 1) nobody at the Fed has any clue how the experimental monetary policies they’ve been engaging in actually transmit through the economy, or 2) they know it doesn’t work but can’t actually come out and admit that, so it gets explained away as a “mystery”.  Dammit Janet indeed.

Sigh.  Now, after that inordinately long introduction (we can be a little prone to ranting about Fed policies), here is what we actually wanted to talk about this month: what to do when you’re on your own.  Fitting, perhaps, for the back-to-school season, but this really came about through conversations with multiple clients and prospects in the last couple months.  If your employer doesn’t offer a 401(k) plan of any type or you are perfectly at home in the “gig economy”, what should you be doing for yourself and your future?

1) Take Care of the Right Now

Keep 3-6 months of expenses in cash in a savings account that you don’t touch.  Preferably an account with an online bank that pays around 1% or so at the moment.

2) Take Care of the Future

Once your emergency fund is built up, open an IRA. The maximum you can contribute to an IRA (Roth or Traditional) this year is $5,500 ($6,500 if you’re over 50 - isn’t the IRS nice for letting you “catch up” by an extra thousand dollars if you’re nearer to retirement?), so start by maxing that out.  If you can put aside more than that in the course of a year, it will have to go into some sort of other savings account or taxable investment account.  (An additional benefit to having a work-sponsored 401(k) plan (besides the employer match) is that the contribution limits are higher - $18,000 or $24,000 if you’re over 50).

If you’re a contractor at your job or a self employed, you might be in luck.  You might be able to open what’s called a Solo 401(k) and contribute up to $54,000 for yourself this year.  There are a few more hoops to jump through in trying to open a Solo 401(k) relative to an IRA, but feel free to give us a call if you think it might be right for you and want to discuss the possibilities.

3) Take Care of Yourself

We read an interesting article recently about how your most valuable asset is….yourself, and your future earning potential.

But seriously.  Think about this for a second: say you have $250k in your retirement portfolio.  Let’s invest it conservatively - 10-yr US government bonds paying 2.3%.  That means your portfolio is generating $5,750 in income.  If you make $60,000 at your job, that’s the equivalent of having a portfolio of $2.6 million.  That’s million, with an “m”.

And sure, we understand that there’s a lot of stuff that gets swept under the rug and simplified in that theoretical.  But it is an interesting take on making yourself the center of your financial plan, rather than your retirement account.

In that vein, another thing you can do for yourself is open up an HSA (Health Savings Account).  If your employer offers health insurance, chances are it will be a so-called “high deductible plan” and come with an HSA.  These things are great!  And you should definitely be contributing to them.  On an employer plan, money goes into the HSA pre-tax, and it can be used tax-free on a wide range of medical items (fairly comprehensive list here) including glasses, contacts, dentists, chiropractic work, acupuncture, band-aids, obviously any bill from a doctor...it’s pretty inclusive.  And!  The best part is that any unused amounts get rolled over to the next year (unlike an FSA - Flex Spending Account - where you just lose any unused money at the end of the year), so by contributing regularly you can really offset the out-of-pocket costs of healthcare expenses down the road.

If you don’t have employer-sponsored insurance and have to buy individual coverage, it’s still pretty straightforward to open an HSA.  The IRS considers any individual health insurance plan with a deductible over $1,300 ($2,600 for family plans) to be a “high deductible” and therefore eligible for an HSA.  If this is you, look into opening an HSA with your bank (Bank of America provides them, for example), or something like HSA Bank which, as the name implies, is...a bank that handles HSA accounts. Contributions to the account are tax deductible, and any unused amounts just get carried forward to be used in the future.  

Now, of course there is a limit to these contributions as well.  This year it's $3,400 for an individual, $6,750 for family plan coverage, and an additional $1,000 if you’re 55 or over.  And if you use that money for non-medical expenses, you have to pay tax on it plus a 10% penalty if you're under 59 and a half (just like with your IRA).

So if you’re on your own, there you go.  $5,500 into an IRA and $3,400 into an HSA gives you $8,900 of tax-advantaged money you’re putting aside every year.  If your only goal at the moment is to maximize your retirement savings, that’s how you should do it, with any excess going into a taxable savings or investment account.

But we understand that maxing out tax-advantaged retirement savings is not necessarily the best thing for everyone to do, since it sometimes can come at the expense of saving for pre-retirement goals, such as buying a house or helping your kid through college.  Maxing out an HSA does nothing for you if you need the money for something non-medical next year and have to pay that 10% penalty.  

If you find yourself wondering how to best balance your short- and long-term goals among all the different options out there, that’s where we come in.  Give us a call, we’d be happy to talk it through with you.