investing

  • Increased Retirement Account Contribution Limits for 2024

    The IRS announced new contribution limits to employer retirement accounts (401(k)s, 403(b)s, most 457(b) plans, and the Thrift Savings Plan) and individual retirement accounts (IRAs, Roth IRAs). Along with increased contribution limits, the income limits to be able to contribute to a Roth IRA and to deduct contributions to a traditional IRA are receiving a bump for 2024 as well.

    Key Points

    • 401(k)/403(b) employee contribution limits increased to $23,000 for 2024.
    • IRA and Roth IRA contribution limits also increased and are up to $7,000.
    • The income limit to be able to directly contribute to a Roth IRA ranges from $146k – $161k for single filers and  $230,000 – $240,000 for married filing jointly.
    • The total contribution limit for employer retirement accounts also grew to $69,000. This is the limit for all employee, employer, and after-tax contributions.

    2024 Employer Retirement Account Contribution Limits

    The employee contribution limit for employer retirement accounts, think 401(k)s, 403(b)s, the Thrift Savings Plan and most 457(b) plans is increasing to $23,000. A $500 bump from 2023. The total limit which includes employee and employer contributions rises to $69,000, a $3,000 boost from last year.

    The catch-up contributions available to employees who are 50 or older remains unchanged for the new year at $7,500.

    After-tax 401(k) Contribution Limits

    Once you hit the limit to what you can contribute as an employee, $23,000 for 2024, you may be able to save more in your 401(k) through after-tax contributions. That’s where the combined limit of $69,000 comes into play. If your 401(k) plan allows you can make additional after-tax contributions up to the $69,000 limit.

    Consider an example where your employer makes a flat $5,000 401(k) match and your 401(k) plan allows after-tax contributions. Once you’ve made your $23,000 contribution you can contribute an additional $41,000 of after-tax contributions.

    $23k employee contribution + $5k employer match + $41k after-tax contribution = $69k

    Your after-tax contributions will continue to grow tax-free and you will owe taxes on their withdrawal in retirement similar to traditional 401(k) contributions.

    After-tax 401(k) -> Mega Backdoor Roth

    An even better option if your 401(k) plan allows it is to do an immediate Roth conversion on your after-tax contributions. Since the contribution is made with after-tax dollars there will be no tax owed on the Roth conversion, and your converted funds will grow tax-free and can be withdrawn tax-free in retirement. You can learn more about the Mega Backdoor Roth at this link.

    2024 IRA (Individual Retirement Account) Contribution Limits

    The contribution limit on IRAs is getting a $500 increase for 2024 as well. Individuals can contribute up to $7,000 to Roth and Traditional IRAs, up from $6,500 last year. The 50 and over catch-up contribution will remain at $1,000.

    The income limits to contribute to a Roth IRA or to make a tax-deductible traditional IRA contribution are increasing as well. These limits can be a little confusing because the amount you can contribute or deduct decreases once you earn above a certain amount, and if you are married the limits also vary based on whether you or your spouse have access to an employer retirement plan like a 401(k).

    2024 Roth IRA Income Limits

    The income limits for a Roth IRA are relatively straightforward compared to the rules around the traditional IRA. For a Roth IRA in 2024 single taxpayers can make the full contribution if your income is $146,000 or less. Above $146k as you make more income the amount you can contribute is reduced until you make $161,000 at which point you can no longer directly contribute to a Roth IRA.

    Although, if your income is too high to contribute to a Roth IRA directly you can still make a backdoor Roth IRA contribution.

    The phaseout limits for married couples filing jointly contributing to a Roth IRA go from $230,000 to $240,000. Both of these limits increased $12,000 from last year, so more folks should be eligible to contribute to a Roth IRA directly in 2024.

    2024 Traditional IRA Income Limits

    Income limits to deduct contributions to a traditional IRA follow a similar pattern. There’s a range of income where your ability to deduct contributions is phased out and the actual limit depends on your tax filing status and on whether you or your spouse have access to a workplace retirement plan.

    If you are a single filer and you don’t have a workplace retirement plan, or if you are married filing jointly and neither you nor your spouse have a workplace retirement plan then there aren’t any income limits and your traditional IRA contribution will be deductible.

    Single filers with a workplace retirement plan have an income limit phaseout range from $77,000 to $87,000.

    For married filers where the spouse making the contribution has a workplace retirement plan the income limit phaseout range is $123,000 to $143,000.

    For married filers where the spouse making the contribution does not have a workplace retirement plan, but the other spouse does, the income limit phaseout range is $230,000 to $240,000.

    These limits are also increases from last year.

    Qualified Charitable Contributions

    Along with increases to retirement contributions, the amount that you can contribute from your retirement account to charity also increased. A QCD (Qualified Charitable Distribution) allows you to roll funds directly from your IRA to a qualified charity. QCDs satisfy RMD rules and you can exclude the amount donated from your taxable income. The QCD increases by $5,000 for 2024 up to $105,000.

    Should you make any changes based on these increases?

    If you’re maxxing your 401(k) contribution you’ll want to review your planned contributions for 2024. For IRAs and Roth IRAs, compare your expected income for 2024 to the new limits and adjust any automatic contributions you already have set up.

    If you are unsure where your income will fall or if you’ll have the cash to contribute to your Roth or traditional IRA you can always wait until you file your taxes the next year to make your contributions. So, you could make 2023 IRA contributions up to tax-day 2024.

    Wrap Up

    While it doesn’t quite make up for the spike in inflation we’ve seen the past few years, it is nice to be able to stash away a few more dollars tax-free for retirement. Make sure to review your income and planned contributions for next year to take advantage of additional contribution limits especially if you’ve turned 50 and can start making catch-up contributions.

  • What is an Index Fund?

    Depending where you are on your financial journey the information in today’s post might seem obvious. But for every individual who knows the ins and outs of mutual funds and ETFs along with what the letters VTSAX stand for, there are just as many who are just getting started and are eager to learn. So, what is an index fund?

    Key Points

    • Mutual Funds and Exchange Traded Funds (ETFs) can be thought of as a basket that holds pieces of other assets like stocks, bonds, and even other mutual funds or ETFs.
    • Mutual Funds and ETFs make it much easier for investors to create a diversified portfolio.
    • The best stock pickers and mutual fund managers often fail to do better than the overall stock market, and that’s their job. If they can’t beat the market, why do so many individual investors think that they can?
    • Investing in Index Funds is a way of acknowledging that it’s extremely difficult to outperform the stock market and you are better off matching it’s performance instead.

    What Goes in Your 401k?

    When you got your first job with a 401k or 403b and made the choice to contribute a percentage of your paycheck you might have been confused when you next had to pick your investment allocation.

    We don’t do a great job with financial education in the U.S. so thinking you were done after choosing to put money in your 401k is understandable. But the 401k is the just the account that holds your investments. Contributing is great, but choosing what investments to hold in your 401k is extremely important.

    Nowadays some 401k/403b plans will auto invest individuals into a target date retirement fund, which is great. But what if this doesn’t apply to you? What types of investments should you hold in your 401k/403b or your IRA, Roth IRA or 457b for that matter? The answer to that varies based on your age and goals, but it should generally be a mix of stock and bond index funds. So what exactly are index funds?

    An index fund is simply a type of mutual fund or Exchange Traded Fund (ETF) that tracks the movement of a particular index. In plain English that means it’s like a stock whose price goes up and down the same as the index it follows. Most index funds follow a specific stock or bond index.

    So, if an index is just a basket of companies what makes an index fund so special and why should you choose to invest in them versus other funds, or individual stocks and bonds?

    The Stock Market Generally Trends Up

    Investing in stocks is one of the best ways to earn the higher returns needed for your portfolio to grow and provide for your future goals, such as retirement. Keeping your money in cash, which is attractive right now in October 2023 with savings accounts offering interest of 4% or more often fails to beat out inflation over the long haul.

    Money invested in bonds will grow slowly, generally in the range of 3% – 5%. While the returns on the US stock market have generally been around 8% annually, depending on the date range you look at.

    So, if we believe that the value of the stock market will continue to increase and investing in stocks is the best way to grow our wealth to prepare for the future, why are index funds the best way to do that? Shouldn’t we just find the next Amazon or Google and buy their stock instead?

    Picking the Hot Stock

    The problem with finding the next hot stock is finding the next hot stock. There are many very smart people who spend a ton of time and money trying to find the next Apple or guess when the next recession will hit.

    You’ve likely heard of famous investors like Warren Buffett. That’s because it is incredible hard to pick successful stocks, or “beat the market” year in and year out. The people that can do this are justifiable famous.

    If you have the skill to pick the best performing stocks and only buy those, that is definitely the way to go. The problem is that the vast majority of us are just as likely to pick the next pets.com as we are to find the next Amazon.

    The Benefits of Diversification

    If we acknowledge that we it’s hard to pick winners in the stock market what are our options? The solution is to purchase a variety of different stocks. Some stocks will do well and grow in value, and others will do poorly. By diversifying among a large number of stocks we decrease the chance that we’ll go bust and lose our entire investment. We choose to own the entire market, rather than trying to beat it.

    With a diversified portfolio we settle for the opportunity for decent return, rather than risk an all or nothing bet on one single stock.

    That’s where mutual funds and ETFs come in. These are single securities that act like a basket holding a slice of many different stocks. Instant diversification!

    How About Paying Someone to Pick the Best Stocks?

    Since there are smart people out there who know how to beat the market why don’t we pay them to pick the best stocks and beat the market for us? It turns out you can try to do this by buying “active” funds.

    Active funds are mutual funds or ETFs made up of stocks or bonds that the fund manager chooses because they think they will do well and outperform the market. The problem is that just as with picking a quality individual stock, it is very hard to pick a quality active fund.

    Maybe an active fund will outperform its benchmark for one year, but it’s very difficult for it to do better year after year. The S&P Dow Jones Indices releases their SPIVA® (S&P Indices Versus Active) reports each year. During the first half of 2023 59.7% of U.S. large-cap equity fund managers underperformed the S&P 500. If you look over a three-year period 79.8% underperformed.

    It is just as hard for someone to select which active funds will outperform in a certain year as it is to select which stocks will do the same. So, if we can’t really pick which of the active funds will do well, why do we choose index funds instead? Reason 1: an index fund won’t outperform the market but it shouldn’t underperform either. Reason 2: index funds cost much less than active funds.

    Index Funds are Cheaper Too

    We’ve learned that the majority of active funds don’t do any better than their index, so they must cost less than an index fund that “just” tracks the index right? Nope!

    The average expense ratio for an active equity fund in 2018 was 0.76% and the average for an index equity fund was 0.20%.

    That 0.56% difference in fees between an index fund and active fund may not seem like a lot. After all, 0.56% of a $10,000 is only $56 but it adds up over time. For a $500,000 portfolio growing at 6% per year, paying an extra 0.56% in fees would cost you $421,938 over a period of 30 years. That’s quite an impact!

    The Best, Most Cost-Effective Option

    All of these reasons: diversification, lower fees, the difficulty of picking winners are why index funds are the right choice for most investors. These benefits have led to a rise in popularity of index funds. Where before you could only find funds that tracked the largest stock markets, today you can find an index fund for almost anything.

    Wrap Up

    Index funds are the best investment options for most investors for their workplace retirement accounts, IRAs and Roth IRAs, and taxable brokerage accounts.  They provide a low cost way to track the stock market and diversify your portfolio versus trying to pick individual stocks or active mutual funds that you think will beat the market.

  • WHICH TYPE OF LIFE INSURANCE IS RIGHT FOR ME?

    Concept of insurance with hands over a house, a car and a family

    Insurance can be a very complicated topic, and life insurance especially so. One of the reasons is that people don’t like to think about dying and especially not dying younger than they’d like. But another reason has to do with the complicated nature of life insurance and all of the various types available.  

    There are many different types of life insurance policies and two similar policies can offer wildly different benefits based on the addition or subtraction of just a few words. I can think of almost nothing worse than being caught in a situation where I don’t receive the benefits that I desperately need, all because I misunderstood the type or terms of the insurance that I paid for.

    The response by most people when confronted with a complicated situation like this is to ignore the issue and hope for the best. But most of us do need some type of life insurance, so it’s best to understand the differences between the main types of policies.

    This post contains a very brief overview of the main types of life insurance available today. Having a basic understanding of the different types of insurance available can help you narrow down the multitude of options available. That way you can start to find the policy type that will serve best to protect yourself, your family and your assets.

    Two categories of life insurance: Term & Permanent

    There are two main categories of life insurance: Term and Permanent. A term policy lasts for a specified period of time (5, 10, 20 years, etc.), and a permanent policy lasts until the policy holder’s death as long as someone continues to pay the premiums.

    Term policies tend to be less expensive, because they have an end date and may not have to pay out a death benefit. Permanent policies tend to be more expensive because as long as someone continues to pay the premiums they will have to pay out a death benefit someday. Permanent policies also tend to be more expensive because the policies can include complicated provisions and options that you can adjust later on.

     A Term policy is almost always the best option

    Before going any further, I want to say that there are probably some people for whom each of these types of policies is a fit, but many people are sold permanent life insurance policies (whole, universal, variable) when a term policy would be much better – and less expensive – for them.

    The insurers tend to make more money from permanent policies, so the commissions (what the insurance salesperson earns when selling a policy) tend to be much, much larger for permanent policies than term policies. Since the salesperson is incentivized to sell permanent policies, more permanent policies are sold. This is another place where working with a fiduciary advisor, who is legally bound to look out for your best interest, can help you analyze your insurance needs and options and make sure you don’t end up paying more for insurance coverage you don’t need.

    For most people in their prime working years, life insurance is there to provide financial support for their spouse and/or children if they were to suddenly pass away. A term life insurance policy does this quite well. A 45-year-old can buy a 20-year term policy that expires at 65, by which time the need for the policy should be past if they have saved for their retirement and their children are grown and supporting themselves.

    A permanent policy will be more expensive and by the time you reach 65 or 70 you may not need coverage any more. At that point you might face the difficult decision of either continuing to pay the premiums or stopping and losing any future benefit.

    A term policy is as simple as it gets in the life insurance space. Proponents of permanent policies will argue that you can use their policies to build cash value and invest as well, but these options are more complex and expensive. You are almost always better off buying a term policy and investing in a separate IRA or brokerage account.

    Types of Life Insurance

    1. Whole Life Insurance: policy is permanent, premium is set, death benefit is set

    Whole life insurance, sometimes called “ordinary life” insurance is a type of life insurance which is guaranteed to remain in force for as long as the premium payments are made until death or until maturity if a maturity date is part of the contract (typically maturity dates can be 10, 20 years or to age 65). The premium for a whole life insurance policy is typically fixed (meaning the premiums will always be the same, also called a “level premium”) at the time the contract is purchased. Because the premium is fixed and there is no end date to the policy, a whole life policy is typically more expensive than a term life policy, which I will cover later. 

    Upon the insured’s death and payout of the policy, the payout is typically paid tax free. When discussing insurance, you will often hear the term “cash value”. This when talking about the whole, universal and variable life insurance variants. As the premiums are paid in a whole insurance policy, part of the premium pays for the death benefit and a portion goes into the cash value of the policy and builds over the whole life of the policy. In some cases a policy can be cashed out prior to the insured’s death (policies differ, but usually the premiums paid must be more than the value of the life insurance), in this case the dollar amount paid over the value of the insurance will be taxed as ordinary income.

    2. Universal Life Insurance: policy is permanent, builds cash value you can use to offset premiums, option to adjust death benefit

    Universal life is similar to whole life in that it provides a death benefit and remains in force as long as the premium payments are made. A main difference is that later on in the policy you can use a portion of the cash value of the policy to pay your premiums, lowering your out of pocket costs for the policy.  The interest rate is typically tied to a market rate, so as rates change your ability to tap into the cash value to adjust your premium fluctuates as well. Within most universal life policies there are also options to adjust the death benefit. Raising the death benefit amount will probably require additional underwriting, while lowering it will probably not. In either way you can expect to pay some additional fees to make the change to the policy. The ability to tap into the cash value and adjust the policy are benefits of a universal life policy, but the added complexity comes with an added cost versus a whole life policy. 

    3.Variable Life Insurance; policy is permanent, option to invest cash value in mutual funds, option to adjust death benefit (VUL)

    A variable life insurance policy, is similar to a universal life policy, but whereas with a universal policy the cash value grows within a savings account in the policy, with a variable life policy you can invest your cash value in mutual funds. But, rather than in a brokerage account where you have access to all manner of investment options, with a VUL you only have access to the fund options available with that insurer. With a variable life policy the death benefit is typically fixed, as it is with a whole life policy. You can also find a sub version, a variable universal life (or VUL) policy which possesses the investment options of a variable policy along with the policy flexibility traits of a universal policy. As I stated above, along with the additional options and flexibility involved in a variable or VUL policy comes additional expense and complexity. 

    These 3 types of insurance, Whole, Universal, Variable, can generally be categorized as Permanent Insurance since the policy and the death benefit remains in effect, with no termination date of the policy, as long as the premiums are paid.

    4. Term Life Insurance: expires at the end of the term, set premium, set death benefit, easy to compare between providers, less complex

    Term life insurance differs from the types of insurance discussed above in that it is not permanent, as the name implies it is only in effect for a set term. Typical term lengths are 10, 20, or 30 years. Term life policies are typically much cheaper than permanent life policies for this reason. With a permanent plan the insurer knows that they will have to make a death benefit payment as long as the insured continues to make their premium payments. However, with a term policy once the term is up the insurer is off the hook for the death benefit. A possible downside to term insurance is that you might outlive your policy. If your need for insurance still exists after the term has expired you will likely have to pay more in premiums for an additional term. Term insurance is by far the least complicated type of life insurance. There are only two components to decide on: the length of the term, and the value of the death benefit. Because of this it is much easier to compare between term plans from different insurers, and there are many places online where you can compare quotes for the same policies from different companies.

    5. Others

    The four types of insurance listed above are the main types of life insurance offered, but by no means are they the only kinds available. There is declining benefit insurance where the value of the death benefit declines over the term of the policy. These are usually designed to match the mortgage amortization schedule on a home, so that if the insured dies prematurely the death benefit from the insurance policy will pay off any remaining mortgage balance.

    There are also joint life insurance policies where two people are covered with the same insurance. These can be designed to pay out when the first person dies or after the second person dies, depending on the underlying reason for the insurance.

    Final Expense Insurance, often called burial insurance, is a policy designed for older individuals who want to make sure their final expenses are covered and their family do not have shoulder the costs after they pass. 

    Conclusion

    When evaluating insurance, you should ask yourself the question “what am I insuring against?” and keep this Einstein quote in mind.

    “Everything should be made as simple as possible and no simpler”

    For most people the simplest answer is a term policy that protects their family during their prime working years. If your situation requires something different or you were too intimidated to look into life insurance before, you now have a bit more information to help you with your search. 

    If you want to have a more detailed discussion about any of the above insurance types or want to know more about what strategies might be the right fit for your particular situation, feel free to email me at chris@steadyclimbfp.com or schedule a free introductory consultation.