This is the third episode of the Investing By Age series.
As you move into your peak earning years, it’s all about making smart decisions right now.
Listen now and learn:
- How to optimize your retirement savings
- Ideas for strategically investing for education costs
- 5 estate planning documents you need to get
Play the episode below or read the detailed show notes.
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Show Notes
By the time you’re in your 40s, you are probably full-on adulting. You hopefully have established some financial goals, invested in your workplace retirement accounts, and set aside money for a rainy day.
It’s also more likely you have gotten married, bought a home, and had a few kids.
Next comes the question of whether you’ve done everything you can for retirement.
As you move into your peak earning years, it’s all about making smart decisions right now.
Here are the top strategies to put in place in your 40s to plan for your future:
1. Test the Viability of Your Retirement Plan
It’s important to check on the viability of your retirement plan throughout your accumulation years, especially if you haven’t hired a financial advisor yet.
How much money you need to retire is something I focused on in Episode 54, which has been a wildly popular episode; and it’s only 14 minutes long, so I’d encourage you to go back and listen. You can also see some fairly comprehensive retirement readiness benchmark data from that episode in the show notes.
Savings benchmarks like those discussed in the episode can be a useful starting point for testing the viability of your retirement plan.
The reason it’s important to get a good grip on your retirement readiness in your 40s is that any necessary course corrections are going to be far less painful now than they will be later on.
In addition to explaining those benchmarks, I also explain the more sophisticated process we use with new clients; because whether you can afford to retire and what kind of spending you can sustain is such an important question that it’s important to understand the additional capabilities a financial advisor brings to the table.
2. Optimize Your Retirement Savings
The first step to optimizing your retirement savings in your 40s is consolidating your investment accounts.
It’s not uncommon to have investments scattered across old employer 401(k)s, robo-advisors, and brokerage accounts. Now is a good time to do a little house keeping.
By consolidating your accounts allows for a more holistic understanding of your full financial picture, which in turn makes it easier to have all your assets working together towards your goals. Consolidation also offers real potential for reduced fees and taxes – which I personally think is the biggest benefit of consolidation – however, most people I work with seem to most appreciate consolidation because it means having fewer accounts to juggle, which makes things easier to manage and keep track of.
Once you consolidate assets, the next step in optimizing them is aligning your long-term asset allocation with your retirement plan.
In your 40s, you likely still have multiple decades before you’ll need to live off those assets, so you theoretically have a fairly high ability to have an aggressive mix of stocks and bonds. Of course, it’s not uncommon for some people to have a lower willingness to live with the volatility of a more aggressive portfolio, but again, consolidating assets allows you to align your investments accordingly.
Finding the appropriate mix of stocks and bonds to meet your retirement goal while also funding the life you want along the way is probably the most important investment optimizing you can make.
Beyond that, assuming you consolidate your investment accounts as I suggested, there are probably some opportunities for tax efficiencie within your portfolio using asset location, which is the process of keeping less tax-efficient investments in tax-deferred accounts and more tax-efficient assets in taxable accounts.
And once all your accounts are under one umbrella, it will also be easier to make sure that you are using the lowest cost options in place.
Finally, if you have several investment accounts spread out across different providers, there is a decent chance that you have some duplicative exposures and opportunities for enhancing your overall diversification.
Once you have the right mix of stocks and bonds, along with the ideal mix of assets in your taxable and tax-deferred accounts, it’s important to address any diversification deficiencies whether that’s (for example) having too much US Large cap, not enough international stocks, or a lack of global bonds. You may also uncover opportunities to leverage strategies for offsetting the risk of any concentrated positions you’ve accumulated in individual stocks.
Once you have your existing retirement investments optimized, the next step is to optimize your future retirement savings.
When you have the opportunity to earn compound returns while also enjoying a tax benefit, you should definitely take advantage. This involves IRAs, HSAs, and your employer-sponsored plan.
The type of IRA you choose will depend largely on your projected tax bracket in retirement. Those on the lower end often go with a Roth IRA, but traditional IRAs still provide tax-deferred growth and may be tax deductible depending on you—or your spouse’s—workplace retirement plan.
Speaking of workplace retirement plans, at some point in your 40s, you might find that it makes sense to shift your contributions to or away from a Roth. These days, most people have Traditional and Roth options in their 401(k) plans or their 403(b) or 457 plans.
While a Roth account in your employer’s plan is generally favorable earlier in your career, you are likely approaching (if not already past) the point of that bucket making sense for you. Unfortunately, there isn’t a simple formula for making this determination, but it mostly comes down to whether your tax rate will be higher or lower in retirement than it is today.
It’s important to, as best you can, understand the potential tax impact of different outcomes through the lens of both tax savings today as well as tax savings in the future. I’ve always found a lifetime tax analysis to be useful in making this decision.
3. Get Strategic With Education Savings
Aside from planning for retirement, the most common goal for investors with children is saving for education. There are several vehicles for education savings, but the best is a 529 savings plan.
Contributions to a 529 plan grow tax-deferred, and withdrawals are tax-free when used for qualified education costs. Many states even offer state income tax deductions on contributions to a state-sponsored plan.
In your 40s, you should consider setting up automatic contributions to a 529 plan for investment in an age-based investment model, but it’s important to remember that you shouldn’t prioritize your children’s education over your own financial well-being.
Kids can always take out student loans, but you can’t really take out a loan to fund your retirement. Plus, if you don’t have a sufficient cash reserve or emergency fund in place, then you might find yourself needing to tap the 529 funds for a non qualified purpose, in which case there is a 10% penalty—plus earnings are taxed as ordinary income in the year you withdraw them.
But if you are hitting your retirement savings goals and you have some sort of an emergency fund in place, then the overall costs of 529 plans along with the tax benefits make them a great vehicle to save for education costs.
Like everything else in personal financial planning, there are personal circumstances that result in different 529 strategies for optimizing your education planning. I think the most interesting strategies come into play if you send your kids to private school for elementary, middle, or high school. I talk a little bit about this in Episode 52 if you want to check that out.
Other opportunities arise when someone has the capacity after fulfilling all their other savings goals to max out their 529, or they have already accumulated such a sizable balance that they are on pace to fund more than 70% of their kids’ college expenses.
In both of these instances, optimizing your 529 plan is a matter of capital allocation and tax minimization strategies that are probably a bit beyond this scope, but shoot me an email if this sounds like you and you want to dive into the specifics.
4. Complete Your Estate Plan
This is an item I almost put in your 30s because I generally feel like anyone who is married or has children ought to have an estate plan in place. But even if you don’t plan to get married or have children, you will likely have accumulated enough assets by your 40s that you ought to get an estate plan in place.
There are five documents you’ll need:
- 1. Will: The crux of any estate plan, a will distributes your property as you wish after death. Without a will, disbursements are made according to state law, which might not align with your priorities. In addition, a will names an executor to manage and settle your estate as well as a legal guardian for any dependents.
Since this is a legal document, it is crucial that your will be well written and articulated so that it is properly executed under your state’s laws.
- 2. Living Trust: Also known as a revocable or inter vivos trust, a living trust creates a separate legal entity to own property.
The primary benefit of a living trust is that your assets avoid probate, which can be costly and time consuming. Until the probate process is completed, your assets can’t be distributed to your surviving heirs.
In addition, probate can interfere with the management of a closely held business or stock portfolio. If you are concerned about probate documents such as your will and statements of assets/property become public record, having a trust in place generally prevents public knowledge of your estate.
- 3. Durable Power of Attorney (DPOA): This authorizes someone to act on your behalf should you become physically or mentally incompetent to handle financial matters. The person you designate in the DPOA can pay bills, file taxes, direct investments, etc. on your behalf.
- 4. Advanced Medical Directives: allows you to specify the medical treatments you desire in the event you can’t express your wishes and appoint someone to make decisions for you.
Without this document, medical care providers must prolong your life using artificial means, if necessary. The three types of advanced medical directives are a living will, a durable power of attorney for health care, and a Do Not Resuscitate order.
- 5. Letter of Instruction: a non-legal document that may accompany your will to express personal thoughts and directions. Unlike a will, the letter of instruction remains private and its directions are not binding.
Learn More: What You Need to Know About Estate Planning
Estate planning is a little different for everyone, but getting these five documents in place covers the essentials.
5. Hire An Advisor
You don’t need to overcomplicate your journey to financial success, particularly when you already have a mountain of responsibilities. High-pressure jobs, family obligations, managing the day-to-day errands and chores required to be a functioning adult, trying to maintain a social life, and hobbies outside of work—they all add up.
It’s OK to feel overwhelmed by your finances, but it’s not OK to let that stop you from making progress toward your financial goal.
Thankfully, you don’t have to do this alone. Working with a financial professional can help you make smart choices about money so that you achieve your goals and fulfill your values. Even better, a financial professional frees up valuable time for you to spend elsewhere.
Of course, not all advisors will put your interests first, so it’s important to find someone that always acts as a fiduciary. The most fail-safe way to ensure you work with a fiduciary is to ask your advisor to put that fiduciary commitment in writing. If your advisor isn’t willing to do that, then you should seek help elsewhere.
For all the action items in this episode, using a financial advisor can help minimize mistakes and optimize opportunities. I’d suggested getting financial advice of some sort in your 30s, whether that’s a robo-advisor, a human advisor, or a hybrid advisor.
But these items in your 40s are complex enough that a human advisor is more likely the right fit. And that will become true as you continue to age. The decisions become more complex and the stakes are higher – so hiring an advisor is an investment in yourself that can ensure you stay on the right path.
Resources
- What You Need to Know About Estate Planning
- Should You Use a Traditional IRA or Roth IRA For Retirement Savings?
- EP 54: How Much Money Do You Need to Retire?
- Do It Yourself or Hire an Advisor?
- 5 Key Questions About 529 College Savings Plans (Plancorp)
- EP 52: How to Manage a 529 Plan During a Market Downturn
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Long-term investing made simple. Most people enter the markets without understanding how to grow their wealth over the long term or clearly hit their financial goals. The Long Term Investor shows you how to proactively minimize taxes, hedge against rising inflation, and ride the waves of volatility with confidence.
Hosted by the advisor, Chief Investment Officer of Plancorp, and author of “Making Money Simple,” Peter Lazaroff shares practical advice on how to make smart investment decisions your future self with thank you for. A go-to source for top media outlets like CNBC, the Wall Street Journal, and CNN Money, Peter unpacks the clear, strategic, and calculated approach he uses to decisively manage over 5.5 billion in investments for clients at Plancorp.
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