Question:
Do you recommend we take our mandatory withdrawals from our IRA all at once or periodically throughout the year?
Answer:
The answer depends. If you use the mandatory withdrawals from your IRA for living expenses, then we generally recommend taking monthly distributions. We find that retirees are usually better at budgeting when receiving a monthly “paycheck” from their retirement funds. If you do not need the funds from your IRA for your expenses, we suggest taking a lump sum distribution at the end of the year. Your mandatory withdrawal is based on the account balance as of Dec. 31 of the previous year. By leaving the funds in your account until the end of the year, the dividends and interest accrued stay in the account.
However, you must be vigilant and remember to take your required distributions by Dec 31st each year. If you do not take your distribution, the IRS will penalize you 50% of what you are supposed to take; therefore, if your required minimum distribution is $50,000, the IRS will penalize you $25,000. If you do not need the money, however, you may consider taking an in-kind transfer rather than liquidating the stocks. If you have stocks in your IRA, you should be able to transfer them to your taxable accounts.
Question:
I read about Target Maturity Bond ETFs on the Schwab website. I understand the Henssler strategy of purchasing bonds with money according to the Ten Year Rule, and the downside of purchasing bond funds. Instead of buying an individual bond, would these target date ETFs be quite similar?
Answer:
We recommend to our clients that you use bonds to secure your wealth when nearing retirement. Being that the assets are saved for spending needs in later years, the most important item we are concerned with is bankruptcy. Therefore, we purchase high quality bonds.
Target maturity bond exchange-traded funds (ETFs) hold bonds that are all expected to mature in the same year. The current choices include investment-grade corporate bonds, high yield bonds and municipal bonds.
Looking more closely, we see that some corporate bond ETFs offer target maturities from 2013 to 2021. Most hold large portions of A and BBB rated bonds, which is too much risk according to the Henssler investment criteria. We believe investors should diversify their fixed-income portfolios, as many issuers can reduce your bankruptcy risk. Guggenheim has a set of corporate bond ETFs with maturity dates between 2013 and 2022. The short maturities have a large exposure to the Financial sector—some more than 70%. The longer term funds are heavily exposed as well—more than 30% for 2019 maturities. Longer maturities also have a large exposure to low quality.
iShares was among, if not, the earliest to offer a fixed-income target maturity ETF. In being first, they have addressed some of the above issues by developing corporate bond ETFs without exposure to the Financial sector, as well as those with the sector exposure. Having no Financial sector exposure forces them to pick up heavy exposure to Industrials. Though the credit rating is still low at A-, it is slightly better than the BBB+ rating for funds with Financial sector exposure.
Municipal bond target maturity ETFs have maturities from 2014 to 2018. Overall, they carry a better credit rating of A+, but they have a wide diversity of funding. We prefer to stick with General Obligation municipal bonds. With California and New York as the top holdings, it is difficult to compare after tax yield, as the state tax is taken from the equation. However, federal tax rates can be applied. The average yield to maturity on a 2017 fund is 0.9% versus a CD at 1.45% for a similar maturity. This is close to the after-tax CD return for investors in the 39% tax bracket. In our opinion, anyone with a tax bracket below 39% should be better off buying a CD with FDIC insurance given current average yield to maturity rates on municipal bond ETFs.
It is not clear to us the price an investor should receive when these ETFs “mature.” Some providers say they reduce their positions with time to reflect the features of a bond maturing in the targeted date, but they do not mature to give the investor cash at the target date. This means they become a short-term Treasury bond over time. This may fit for some. However, it is not like others, which pay the investor cash as underlying holdings mature. Some funds have a dividend reinvestment plan whereby dividends are reinvested instead of being sent to the investor. This should cause basis to adjust in taxable accounts. These bonds are too new to fully understand how they might function through all market cycles. While they are very enticing, we remain skeptical.
Question:
I’m 23 and my employer automatically enrolled me in our 401(k) after six months of employment. My Dad told me to just stick with it. But I’m looking at the investments, and I’m lost. I’m in a Vanguard Target Retirement 2055 fund. At my age is it just better to leave it there?
Answer:
Target date funds gained popularity in 2007. The idea is that the investment mix changes over time as they get closer to the target retirement date. An investor picks a fund that closely matches his target retirement date—in this case, at 23, this investor will likely retire close to 2055. The funds generally start aggressively invested in stocks. As 2055 approaches, the investment mix should become more conservative.
These funds became a popular choice for 401(k) plans to select as their qualified default investment alternative. This is the option chosen for participants who do not specify how they would like their contributions invested. These funds are particularly popular for plans with an automatic enrollment feature. Employees must opt out of participating in the retirement plan.
Generally we like target date funds for investors who do not want to fuss with their investments. However, the funds vary greatly. Some start 100% invested in stocks and gradually become conservative. Others may start at a 75/25 stock to bond mix and change to 25/75 stocks to bonds a few years before the target date. Most investors try to measure these by performance. We recommend you look at the underlying investment mix and consider the fees charged by the fund.
At Henssler Financial we believe you should Live Ready, and that includes consulting experts for financial matters you do not understand. If you have questions regarding your financial situation, the experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or email at experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
