MONEY Savings

When Good Investments Are Bad for Your Retirement Savings

Q: I have an investment portfolio outside of my retirement plans. That portfolio kicks out dividend and interest income. If I roll all that passive income back into my portfolio, can I count that toward my retirement savings rate? — Scott King, Kansas City, Mo.

A: No. The interest income and dividends that your portfolio generates are part of your portfolio’s total return, says Drew Taylor, a managing director at investment advisory firm Halbert Hargrove in Long Beach, Calif. “Counting income from your portfolio as savings would be double counting.”

There are two parts to total return: capital appreciation and income. Capital appreciation is simply when your investments increase in value. For example, if a stock you invest in rises in price, then the capital you invested appreciates. The other half of the equation is income, which can come from interest paid by fixed-income investments such as bonds, or through stock dividends.

If your portfolio generates a lot income from dividends and bonds, that’s a good thing. Reinvesting it while you’re in saving mode rather than taking it as income to spend will boost your total return.

But dividends can get cut and interest rates can fluctuate, so counting those as part of your savings rate is risky. “The only reliable way to meet your savings goal is to save the money you earn,” says John C. Abusaid, president of Halbert Hargrove.

It’s understandable why you’d want to count income in your savings rate. The amount you need to save for retirement can be daunting. Financial advisers recommend saving 10% to 15% of your income annually starting in your 20s. The goal is to end up with about 10 times your final annual earnings by the time you quit working.

How much you need to put away now depends on how much you have already saved and the lifestyle you want when you are older. To get a more precise read on whether you are on track to your goals, use a retirement calculator like this one from T. Rowe Price.

It’s great that you are saving outside of your retirement plans. While 401(k)s and IRAs are the best way to save for retirement and provide a generous tax break, you are still limited in how much you can put away: $18,000 this year in a 401(k) and $5,500 for an IRA. If you’re over 50, you can put away another $6,000 in your 401(k) and $1,000 in an IRA.

That’s a lot of money. “But if you’re playing catch-up or want to live a more lavish lifestyle when you retire, you may have to do more than max out your 401(k) and IRAs,” Taylor says.

Read next: How to Prepare for the Next Market Meltdown

MONEY Kids and Money

7 Bad Money Habits You’re Teaching Your Kids

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KidStock—Getty Images

Instant gratification isn't always a good thing.

Nobody’s perfect.

And if you are a parent, you’ve probably seen some of your imperfections in broad relief as your child imitates them. Where did he learn that tone of voice? Did she really just tell the pediatrician her favorite food is french fries?

Kids and teens are watching everything we do, and they pick up on how we manage money. And much as we want them to develop good financial habits, telling them about budgeting and compound interest is unlikely to make up for showing them that we buy on impulse and (hopefully) still manage to keep a roof over our heads. Because we presumably want to do a good job teaching our children healthy attitudes about money, what should we be doing?

Sam X Renick, entrepreneur and financial educator, has some ideas — and he reached out to other financial experts for input as well.

Renick said the overriding goal is to teach kids to be thoughtful about what they do with money. We want them to understand money is one of the tools you use to make dreams come true. What can you do with money? You can save it, invest it, spend it or give it away. And managing money well has the potential to make your life happier and less stressful.

It’s easier said than done, of course, but some parents make it even harder by accidentally modeling the very behaviors we hope our kids will avoid. Here are some of the bad money habits we may be inadvertently passing onto our kids.

1. Shopping without a list.

This is an invitation to waste money — and groceries, and a lot of us don’t need an invitation. It also makes us especially vulnerable to impulse buying. After all, what’s one more item that’s not on the list? For children, especially, it blurs the line between planned purchases and impulse buys. (And lists in general help people stay organized. Teaching children to use lists can help in many areas of life.)

2. Buying on impulse.

We don’t do well at teaching delayed gratification. Advertisers make it even harder. Ever seen an Internet “flash sale” that lasts only a few hours? Or notice the price changes on an item you HAVE been watching. It’s frustrating to see that deliberating a bit might mean paying more. Of course, long term, these “flash sales” will tempt you to buy things you probably don’t need and likely didn’t plan for because you couldn’t stand to miss the killer deal. The Internet and TV work hard to tempt us to buy on impulse. Show your child how advertisers try to manipulate us to make decisions that might not be in our best interests long-term. “Sleep on it” is a great habit to encourage.

3. Teaching entitlement.

Why are we going out to dinner and letting you order anything you want? Because you are a great kid! You… told the truth, got a good grade or got a soccer-participation certificate. Or you didn’t, and now you’re disappointed. Either way, a treat is in order. (Treats are not wrong, by the way. You can explain to your child that treats are in your budget. But the people who are most experienced handling the money and who have the most knowledge of the family’s finances will make the major decisions. Translated, this means the adults pick the restaurant and tell the children which entrees they may choose from or what the price limit is.)

4. Focusing exclusively on the now.

Even if you are putting away money for vacations, if that is invisible to kids, they are not learning about it. “Let’s eat at home and save the difference in what it would cost for vacation,” can help make your intentions clear. You can even save the money in a jar so they can see it. It’s easier to say “we can’t afford it,” because YOU know that you can’t afford both lots of dinners out and a trip to Disney, but your kid may understand only that you can’t afford to go through the drive-thru, rather than that you are consciously choosing to direct your money toward something else — that you are delaying gratification.

5. Speaking in terms of dollars, not percentages.

Renick says it’s important for kids to learn that not only is a nickel worth more than four pennies, it’s worth 20% more. It’s easy not to care about a penny, but 20% seems worth worrying about. And it is. Would they prefer to earn $20 for a chore or just $16? It’s still 20%, and it’s worth saving. “The concept is if you get in the habit of taking care of small details (financial choices) the habit and behavior will carry through to larger financial choices,” Renick said. Go ahead and save where you can — and show your kids that little things add up. (And hopefully, when they are in the workforce, that 401(k) match offered by your kid’s employer will seem too big to pass up.)

6. Giving them “spending money.”

The idea behind this can be smart — hoping they will learn to prioritize. That’s a good goal, certainly. But Renick would suggest giving them money to manage… and rewarding saving if they show some restraint. He gives as an example a child with $100 to spend (or save) at Disneyland. What if you told a child that he or she could KEEP any money not spent at the park? Do you think he or she would care more about getting the most value for the money and would check carefully to see what concessions cost before ordering?

Routinely giving them the money may be a problem as well. Kids can earn money. Renick said his father used to tell him that he could have anything he wanted — as long as he was willing to work for it. Having to work can also help teach the value of money, when you begin to think about whether thing you need or want is really worth the time you’ll spend earning the money to buy it.

7. Indulging in spendy habits, like a daily Starbucks or cigarettes.

Despite what we say, we show them that the gratification today is more valuable to us than the sacrifice involved in putting some of that money in a 401(k) or saving it for a family vacation.

What Should We Be Teaching Them?

Talking to kids about money can feel awkward and difficult, especially if our own parents didn’t tell us much (or overshared, resulting in kids worrying about money).

Tim Hamilton, founder and managing director of FinancialFamilies.com, a fee-only service on Ohio, said it can also be difficult if the parents are not on the same page. “I work with the occasional couple where one spouse was provided for endlessly as a child and the other spouse occasionally, or regularly, went without. . . . At the very least, the couple needs to effectively communicate their perspectives on an ongoing basis,” he said in an email.

On one hand, you don’t want children to become so worried about money that they cannot spend. Another financial educator told Renick that her sibling, who has a high income now, still shops at thrift stores and often wears ill-fitting clothes as a result (not taking those clothes to a tailor, either), because spending is uncomfortable and upsetting. Nor do you want them to not give money a thought — seeing a credit card as a license to spend and failing to budget or save.

So what does a healthy attitude look like? Renick asked financial educator Leslie Girone, and here’s how she defines financial success: “doing something you love, having supportive family and friends, and not worrying about money 24/7.” Hopefully, we can model that, too, while we’re trying to explain the magic of compound interest, the pitfalls of too much debt, or the importance of keeping up to speed on your credit.

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MONEY First-Time Dad

What Millennials are Getting Right About Retirement

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Jeffrey Coolidge—Getty Images

And what this generation still doesn't understand about investing for their future.

I was born between 1980 and 2000. This simple fact, over which I had no control, means that I am a millennial — a term that seems to become more loaded with each passing day.

Depending on whom you ask, millennials are lazy, highly educated, entitled, outwardly focused, technologically savvy, impersonal, cheap, indebted. We also have sophisticated palates and an aversion to risk. We’re afraid to commit, apolitical, and unmoored to institutions. And we love craft everything.

Ascribing an ever-expanding series of contradictory descriptors, however, has the effect of making millennials seem alien. Yet the truth is, young professionals today are simply rational actors navigating significant financial hurdles while balancing short and long-term goals.

Take retirement. I’m about 36 years from turning 65, which means I have a number of competing interests. I know that every dollar I put away in my 401(k) will help me replace my income when I no longer work (especially if it’s matched by my employer). But each dollar saved is a dollar not spent on child care or rent or paying down student loan debt. My wife and I are conscientious about our finances, but our income can be stretched so far.

Other millennials are struggling with these choices too. But all things considered, we’re actually doing quite nicely — contrary to the prevailing narrative.

T. Rowe Price recently released its exhaustive Retirement Saving & Spending Study and found millennials are socking away 6% of their annual salary, while boomers saved 8%. Meanwhile four-in-ten millennials are saving a higher percentage of their income in their 401(k) compared to a year ago, compared to 21% of boomers. Moreover three-quarters of millennials track their expenses carefully and 67% say they stick to a budget, both higher than boomers.

Young savers are also more open to nudging than their older colleagues, a sign of our humility when it comes to financing retirement.

Almost half of millennials who were auto-enrolled into a 401(k) plan wished their bosses had penciled them in at a higher rate. (The prevailing introductory savings percentage is 3%.) Only about a third of boomers wished the same. More than a quarter of millennials said they wouldn’t opt out if the auto-enrollment level was set at 10% or greater.

What kind of investments are millennials being enrolled into? According to Vanguard’s How America Saves report, which looks at the savings habits of almost 4 million participants, eight-in-ten new retirement plan entrants were solely invested in a professionally managed allocation. That means they put their money in a professionally managed target date fund, a balanced fund, or a managed account advisory service that customizes investor portfolios.

And while auto-enrollment may put new workers at a measly 3% contribution, 70% of millennials increase contributions annually. Moreover almost 40% of plans default to 4% or more compared to 28% in 2010.

Of course, there is room for improvement.

Starting early is a necessary element of achieving your retirement goals, but not sufficient. If you save 6% of your income, according to Vanguard, you’ll take have about $275,000 by the time you hit 65 (assuming a 4% real rate of return and an annual salary growth rate of 1%.) Putting away 10% will net you almost $460,000. So millennials could stand to save more.

Millennials would also do well to have a firmer grasp of what it is they’re actually investing in. For instance, almost 70% of millennials who use target-date funds agreed with the statement, “Target date funds are usually less risky than balanced funds.” This isn’t really accurate.

How risky a target date fund is depends largely on what “target date” you choose. For instance the Vanguard Target Retirement 2050 Fund — designed for younger workers who won’t retire until around the year 2050 — consists of about 90% equities. A traditional balanced fund, on the other hand, generally holds about 60% to 70% in stocks.

Millennials also don’t appreciate the diversification offered by a target date fund. Because each target date fund invests in a wide array of stocks, bonds, and other assets, these vehicles are designed to be a one-fund solution. Yet almost 80% of those same millennials agreed with the statement “It’s better to hold additional funds in your 401(k) than just a target date fund.”

Then there are those millennials who aren’t saving at all.

While it’s easy to say they lack prudence and acquiesce to the immediate pleasure of money, it’s more accurate to note that they probably cannot afford to save. The median personal income of non-savers is $28,000, almost $30,000 less than savers. Non-savers are not only more likely to have student loan debt, but their balances are higher.

My wife and I don’t save nearly enough for retirement, but then again, we don’t save enough period. Raising a small child in Brooklyn doesn’t help, neither does our chosen professions in the notoriously high-paying education and journalism sectors.

But we do what we can and when other expenses fall off (like when our son starts school) or we enjoy a nice raise we’ll direct that cash flow into our retirement and emergency funds. Millennials, after all, are practical.

MONEY retirement income

4 Ways to Bridge the Retirement Income Gap

Gregory Reid; prop styling by Renee Flugge

Think you can't afford to delay taking Social Security once you retire? These steps can help.

If you’re on the verge of retirement, you’ve probably heard this Social Security advice: Delay claiming your benefit as long as possible, and it will increase by 7% to 8% each year you wait.

Great idea, except for one problem. Once you retire, how do you come up with enough money to live on until benefits kick in? Two-thirds of workers file before full retirement age—currently 66—and only about 2% wait until 70, when benefits max out.

The good news is that you can make waiting easier, assuming you have money saved up or have other sources of cash. Even if you defer claiming your benefit for only a year or two, you’ll permanently boost your income and financial security. Here are four strategies for delaying.

Work … Just a Little

Because Social Security will come to only a fraction of your salary—typically $20,000 to $25,000 if you retire at $100,000 a year—you need work only a fraction of the time to replace it. Some companies have phased-retirement programs letting older workers cut their hours; if your employer doesn’t, maybe you can negotiate a schedule light enough to feel like retirement. Want a change? Start exploring part-time opportunities in new fields, suggests psychologist Robert Delamontagne, author of The Retiring Mind.

The upside is not just financial. “For many people,” says Delamontagne, “working part-time, especially if you are highly engaged, can increase health and happiness.”

Go Halfway

If you’re married, both of you can delay claiming retirement benefits on your own work records at the same time that one of you receives Social Security money—payments that can be equal to half of what the other spouse would be due at full retirement age.

To do this, follow what’s known as a file-and-suspend strategy, says Jim Blankenship, a planner in New Berlin, Ill. At full retirement age, the higher-earning spouse files for benefits, then suspends payments. Then the other spouse files for spousal benefits. If the primary earner is due, say, $2,500 a month at full retirement age, the spouse would receive $1,250. Meanwhile, the eventual monthly retirement benefits for each spouse—based on his or her own earnings—would continue to grow until he or she starts taking checks or reaches age 70. Wait until you’re both at full retirement age to do this, or your benefits will be trimmed.

Use the free Social Security calculator at FinancialEngines.com to see how this would work for you, or pay up for customized guidance at MaximizeMySocialSecurity.com ($40) or at SocialSecuritySolutions.com (starts at $20).

Take Bigger Withdrawls

Ideally, you would minimize the odds of exhausting your portfolio in retirement by limiting your initial annual withdrawal to 3% to 5% of your savings (then adjusting for inflation). If that’s not an option, you might try the riskier strategy of starting at a higher rate, then lowering it once you claim benefits.

Although this approach may seem counterintuitive, the longer you wait to claim, the lower your chances of running out of money—as long as you keep your inflation-adjusted income level until you claim, says Morningstar’s head of retirement research, David Blanchett. The gains to be had from a higher monthly benefit more than offset the increased drain on your portfolio (see the chart at left). But before you try this strategy, Blanchett advises testing it with a Social Security calculator or consulting a financial planner.

Start With Your 401(k)

Whatever your withdrawal rate, take advantage of your low tax bracket before Social Security and mandatory withdrawals from retirement accounts kick in. Pull money from your pretax accounts, such as your 401(k) or traditional IRA, where most of your investments likely sit, says Baylor University finance professor William Reichenstein, a principal at Social Security Solutions.

His reasoning: After age 70½ you’ll have to take required minimum distributions from those pretax accounts. Added to your Social Security checks, those RMDs may generate more income than you need—and more taxes. (For married couples filing jointly and making over $32,000, up to 85% of Social Security benefits are taxed.) By withdrawing pretax money in your sixties, before you have to, you’ll have smaller RMDs later, an easier time controlling your income, and a portfolio that—because you’ll lose less of it to taxes—is more likely to last you in retirement.

Read next:This Is the Maximum Benefit You Can Get from Social Security

Money
MONEY withdrawal strategy

Which Generates More Retirement Income—Annuities or Portfolio Withdrawals?

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Getty Images

People's overconfidence in their investing ability makes them less likely to opt for guaranteed income.

New research by Mark Warshawsky, the retirement income guru who’s now a visiting scholar at George Mason University’s Mercatus Center, suggests more retirees should consider making an immediate annuity part of their retirement portfolio—and also highlights a reason why many people may simply ignore this advice.

When it comes to turning retirement savings into lifetime retirement income, many retirees and advisers rely on the 4% rule—that is, withdraw 4% of savings the first year of retirement and increase that amount by inflation each year to maintain purchasing power (although in a concession to today’s low yields and expected returns, some are reducing that initial draw to 3% or even lower to assure they don’t deplete their savings too soon).

But is a systematic withdrawal strategy likely to provide more income over retirement than simply purchasing an immediate annuity? To see, Warshawsky looked at how a variety of hypothetical retirees of different ages retiring in different years would have fared with an immediate annuity vs. the 4% rule and some variants. The study is too long and complicated to go into the particulars here. (You can read it yourself by going to the link to it in my Retirement Toolbox section.) The upshot, though, is Warshawsky concluded that while an annuity didn’t always outperform systematic withdrawal, an annuity provided more inflation-adjusted income throughout retirement often enough (with little risk of ever running out) that “it is hard to argue against a significant and widespread role for immediate life annuities in the production of retirement income.”

Now, does this mean all retirees should own an immediate annuity? Of course not. There are plenty of reasons an annuity might not be the right choice for a given individual. If Social Security and pensions already provide enough guaranteed income, an annuity may be superfluous. Similarly, if you’ve got such a large nest egg that it’s unlikely you’ll ever go through it, you may not need or want an annuity. And if you have severe health problems or believe for some other reason you’ll have a short lifespan, then an annuity probably isn’t for you.

Even if you do decide to buy an annuity, you wouldn’t want to devote all your assets to one. The study notes the advantage of combining an annuity with a portfolio of financial assets that can provide liquidity and long-term growth, and suggests “laddering” annuities rather than purchasing all at once as a way to get a better feel for how much guaranteed income you’ll actually need and to avoid putting all one’s money in when rates are at a low.

But there’s another part of the paper that I found at least as interesting as the comparison of systematic withdrawals and annuities. That’s where Warshawsky says he worries whether the “lump sum culture” of 401(k)s and IRAs will interfere with people seriously considering annuities. I couldn’t agree more. Too many people laser in on their retirement account balance—the whole, “What’s Your Number?” thing—rather than thinking about what percentage of their current income they’ll be able to replace after retiring. And when choosing between, say, a traditional check-a-month pension vs. a lump-sum cash out, many people still tend to put too little value on assured lifetime monthly checks.

Although the paper didn’t mention this specifically, I think there’s a related problem of people’s overconfidence in their investing ability that makes them less likely to opt for guaranteed income. I can’t tell you the number of times after doing an annuity story that I’ve gotten feedback from people who essentially say they would never buy annuity because they think they can do better investing on their own—never mind that that’s difficult-to-impossible to do without taking on greater risk because annuities have what amounts to an extra return called a “mortality credit” that individuals can’t duplicate on their own.

Along the same lines I’m always surprised by the number of people who pooh-pooh the notion of delaying Social Security for a higher benefit because they’re convinced they can come out ahead by taking their benefits as soon as possible and investing them at a 6% to 8% annual return (although why anyone should feel confident about earning such gains consistently given today’s low rates and forecasts for low returns is puzzling).

Clearly, we all have to make our own decisions based on our particular circumstances about the best way to turn savings into income that we can count on throughout retirement, while also assuring we have a stash of assets we can tap for emergencies and unexpected expenses. There’s no one-size-fits-all solution. That said, I think it’s a good idea for anyone nearing or already in retirement to at least consider an annuity as a possibility. If you rule it out, that’s fine. Annuities aren’t for everyone. Just be sure that if you’re nixing an annuity, you’re doing it for valid reasons, not because of a misplaced faith in your ability to earn outsize returns or because you’re unduly swayed by lump-sum culture.

Walter Updegrave is the editor of RealDealRetirement.com. If you have a question on retirement or investing that you would like Walter to answer online, send it to him at walter@realdealretirement.com.

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MONEY

Something Very Significant Just Happened to 401(k) Plans

sea of golden eggs, many emptied
Alamy

We've reached a tipping point

For decades, legions of American workers dutifully poured money into their 401(k) retirement plans. Overall contributions to these plans easily outnumbered withdrawals from the accounts of retirees ready to start using the money saved up to enjoy their golden years.

Now, however, data cited by the Wall Street Journal indicates that withdrawals from 401(k) plans are exceeding contributions. We’ve reached a tipping point largely due to the combination of retiring baby boomers and younger workers who are incapable or less interested in saving.

“Millennials haven’t moved into a higher savings rate yet,” Douglas Fisher, the head of policy development on workplace retirement for Fidelity Investment, which manages millions of 401(k) plans. “We need to start getting them to the right level.”

The most immediate implications of withdrawals exceeding contributions will be felt by the retirement industry—the companies that manage all of those 401(k)s and collect fees from them. As for the average retiree, or the average worker who one day hopes to retire, it’s unclear what effects, if any, this turn of events will have. In one likely scenario, some money-management firms are expected to lower their fees in order to increase market share in the increasingly competitive retirement plan space.

Read next: The Risky Money Assumption Millennials Should Stop Making Now

MONEY College

6 Financial Musts for New College Grads

New college grads on procession
Spencer Grant—Getty Images

Nail these moves and you're on your way to financial success.

You did it! You passed your finals, you graduated from college, and you even landed the coveted job you have been working so hard to get. So now what?

Many grads are carrying student loans that will be weighing them down for years to come. Since you’re facing plenty of new expenses—moving, rent, furniture, a suitable office wardrobe—now is a great time to make a financial plan. Here are six things every new graduate should do:

1. Make a budget

A good starting place for your monthly budget can be easily remembered as “50-30-20.” When you receive your first paycheck, sit down and figure out what your monthly take home pay will be. Out of that, put 50% toward needs such as rent, utilities, and groceries. Thirty percent goes toward “wants” such as shopping, entertainment, restaurants, and fun. The final 20% goes to your savings and debt repayment. If your student loans are substantial, you may have to flip the percentages so that 30% goes towards debt repayment and 20% toward wants. By following this plan, you can quickly put a dent in those loans.

2. Manage your debt

Student loans often have multiple tranches with varying interest rates that can be fixed or variable. Your best option is to pay off the loans with the highest interest rates first, though that practice is far less common than you might think. When the time comes to start repaying, access your student debt details online to figure out the interest rates for each tranche. Pay the minimum towards the balances with the lowest interest rates and make your largest debt payments on the balance with the highest interest rate. The biggest mistake you can make is paying the minimum into each loan and waiting until you “make more money when you’re older” to deal with them.

3. Prepare for emergencies

An emergency savings account is the best way to plan for the unexpected. What would you do if your car breaks down and you need $800 to get it fixed? If your laptop stops working and you need one for work, how will you buy a new laptop? What would you do if you lost your phone? People often go into debt to cover unexpected expenses, but it’s a problem that can be solved with a little planning. By contributing a small amount of each paycheck into a conservative investment saving account, you can be better prepared to pay for life’s inevitable emergencies.

4. Take advantage of a 401(k) match

Most employers offer 401(k) retirement plans and many offer some form of a match. A traditional 401(k) is an employer-sponsored retirement plan that allows you to save and invest a portion of your paycheck before taxes are taken out, thus decreasing your tax liability. When an employer offers a match, they are matching your contributions, often up to a certain percentage of your income. By choosing not to fully participate in these programs, you are effectively turning down free money from your employer.

Some employers also offer a Roth 401(k), where your contribution is made with after-tax dollars (meaning that you pay the taxes now) and the funds grow tax-free for retirement. The Roth 401(k) is often seen as the better option for younger investors who are typically in a lower tax bracket and who would not get as much benefit from a tax deduction today as they would in retirement.

5. Open a Roth IRA

Similar to a Roth 401(k), a Roth IRA is an individual retirement account allowing you to invest up to $5,500 for the 2015 tax year. These accounts are often considered ideal for younger investors, who may benefit from decades of tax-free compounded growth. Investing $5,500/year from age 22 to age 30 may create an account of more than $1 million when you’re using those funds in your retired years. If you invested the same amount annually but waited until your 30s to start, your account might be worth half as much. For Roth IRA contributions in the 2015 tax year, your modified adjusted gross income must be less than $116,000 if you’re single (or a combined $183,000 if married.)

6. Automate your savings

By setting up automatic transfers from your checking account to your Roth IRA and emergency savings, you’re effectively drawing money straight from your paycheck. This allows your plan to be put into action with minimal maintenance and oversight on your end.

Congratulations, graduate! With these six tips you could be on your way to a successful financial future.

Voya Retirement Coach Joe O’Boyle is a financial adviser with Voya Financial Advisors. Based in Beverly Hills, Calif., O’Boyle provides personalized, full service financial and retirement planning to individual and corporate clients. O’Boyle focuses on the entertainment, legal and medical industries, with a particular interest in educating Gen Xers and Millennials about the benefits of early retirement planning.

MONEY Financial Planning

6 Incredibly Common Financial Mistakes You Really, Really Don’t Want to Make

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Adam Gault—Getty Images/OJO Images RF

Have you made any of these money mistakes?

We all make mistakes, and through them, we learn. But when it comes to finances, it is best not to take the trial-and-error approach. Avoiding some of the following financial mistakes might save you a great deal of money and heartache.

1. Cashing out a retirement account to pay off loans. Substantial income tax penalties can hit you if you tap into retirement accounts before a certain age. Even if there are no penalties, cashing out an entire account at once potentially puts you in a higher tax bracket.

The amounts you withdraw before you reach 59½ are called early or premature distributions. They may be subject to an additional 10% tax. (As always, there are some exceptions to this rule, so consult with a qualified accountant, financial advisor or the Internal Revenue Service.)

The Great Recession forced many people to tap into retirement accounts to pay mounting bills and loans. This was a measure of last resort, but the moral of this story is: If you have to take a distribution, you should at least understand the tax implications up front and mitigate the impact.

2. Missing retirement account rollover dates. You can move your wealth around by receiving a check from a qualified retirement account and deposit that money into another retirement account within 60 calendar days.

If you miss the deadline, the IRS treats the amount as a taxable distribution. Further, your 401(k) plan provider withholds 20% for federal income taxes. You have to add funds from other sources equal to the gross distribution to avoid possible tax penalties.

The lesson here? Rollover your accounts using a trustee-to-trustee transfer whenever possible. Having your custodian send your funds to another directly may be a better way to do a rollover.

3. Failing to update beneficiaries. Forgetting to remove a former spouse’s name as the beneficiary on retirement accounts or insurance policies happens. This could result in failing to provide for your children, a new spouse or other loved ones. Check your beneficiary designations annually and when a major life transition, such as a marriage, divorce or birth, occurs.

4. No will. If you do not have a will, when you die, the laws of intestacy determine who receives your assets. Drafting a will helps you maintain control of these important matters. Speak with an attorney to discuss preparing a will that documents where you want your money to go when you’re gone. Once you draft the will and name the beneficiaries or guardians, review it every few years and when things in your life change.

5. No power of attorney. A power of attorney (or POA) is an important document that allows you to select a point person (often a spouse or trusted family member) to make decisions on your behalf. This person can access your finances and help with bills, medical expenses and sign tax returns.

If you do not have a POA in place, and you become incapacitated, your family has to petition the courts for a conservatorship. This process often takes months, costs thousands of dollars and thus compounds the financial pressure.

The lesson here is to speak with an attorney to help select a POA, and while you’re at it, discuss a health-care proxy, your agent would make medical decisions on your behalf, should you be unable to convey your wishes.

6. Single-life only pension. When you start taking your pension benefits, you can choose to get payments that last for just your life or for the lives of both you and your spouse. This is an irrevocable decision.

The monthly payout is higher with a single-life pension versus joint ones. Many people often take the highest pension option available. They don’t realize that upon death, their spouse may end up relying solely on Social Security.

You might think that you will outlive your spouse, or that he or she does not need the income, but no one can predict the future. Consult with a financial advisor about your pension options and income needs.

Read next: 5 Old-School, Low-Tech Budgeting Strategies That Work

Heidi Clute, CFP, is the majority owner of Clute Wealth Management in South Burlington, VT and Plattsburgh, NY, an independent firm that provides strategic financial and investment planning for individuals and small businesses in the Champlain Valley region of New York and Vermont.

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MONEY Social Security

Are Social Security Benefits Taxable?

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Your marital status, total income and location all come into play.

Saving for retirement is a crucial part of preparing for your financial future — but that doesn’t mean you shouldn’t plan for Social Security benefits. You can calculate what your Social Security income will be to help provide an estimate of your benefits and what other savings you will need to lead the lifestyle you want in retirement. While you may have heard about a time when these payouts were tax-free, that is no longer the case. In short, Social Security benefits are taxable. But in reality, it is not that simple — taxability depends on marital status, total income and location. If you have some additional retirement income, besides Social Security, coming from a salary, pension, IRA or 401(k), you will likely be over the income limits and can expect that up to 85% of your Social Security benefits will be taxable.

Income Limits

The portion of your benefits you are taxed on depends upon your income. The Internal Revenue Service sets limits for calculating tax liability every year. In 2015, you will pay income taxes on up to 50% of your benefits if you are filing as an individual with combined income between $25,000 and $34,000. If you have more than $34,000 in combined income, you could be subject to taxes on up to 85% of your benefits. For couples, the amounts are $32,000 and $44,000 for up to 50% and about $44,000 for up to 85%. In this case, “combined income” means the total of your adjusted gross income, the nontaxable interest and half of your Social Security benefits. If Social Security benefits are your only source of income and your total is below $25,000, your benefits will not be taxed at all — but you may not have the comfortable retirement you imagined.

Federal & State Taxes

If you will have to pay taxes on your benefits, up to 85% every dollar of income you make over the limit will be subject to federal income tax. This can get complicated to predict, so the IRS offers a worksheet and e-file software to help you calculate your Social Security tax liability. It’s a good idea to check with your local tax pro or an accountant about state and local taxes because the rules vary by location. Some states offer exemptions and credits based on age or income and at least some Social Security is tax-exempt in most states, but there is usually a range.

Simplifying the Process

You can make the tax burden on your Social Security benefits simpler by paying these costs gradually throughout the year instead of all at once. You can either ask the Social Security Administration to withhold taxes from your benefit check by submitting a W-4V or pay quarterly estimates. If you are very concerned about tax burden in retirement, it’s a good idea to start saving early and generously with a Roth IRA, as this account uses after-tax dollars. You will never have to take required minimum distributions and you will not have to pay taxes on payments down the road because you already have.

Retirement can be tricky, so it’s important to stay on top of your finances and look for ways to improve your Social Security benefits. Check regularly to ensure you are saving enough for retirement in other ways like a 401(k) or IRA to supplement the money you can expect from Social Security. While paying taxes may not be enjoyable, this is an indication that you have saved sufficiently and will not have to live solely on these Social Security payments.

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MONEY strategy

Master The Art of Rebalancing Your Investment Portfolio

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Rebalancing is the most helpful when it is most difficult.

Portfolio design and rebalancing is both a science and an art. Understanding the science (see our previous article) is akin to understanding the physics of why a spinning ball hooks and bends. The art is the execution of the science, such as when you are actually playing soccer or golf.

It is the execution and follow-through that produces the desired outcome.

Knowing that rebalancing boosts returns is useless unless you as the investor have the time, discipline and nerve to follow through and actually strike the ball.

Rebalancing is the most helpful when it is most difficult. The exercise involves selling the investments that have appreciated and buying the assets that have recently gone down. People are biased to believe that recent occurrences will continue. When it comes to the markets, this instinct must be overcome.

This is one area where an investment advisor can add value. Even an advisor who does nothing other than help you set an asset allocation and then rebalance once a year might boost your returns by 1.6 percentage points over a buy and hold strategy. This rebalancing also lowers the volatility of your portfolio. Together, these bonuses help increase the likelihood that you will reach your retirement goals.

Yes, you could do this yourself, but many investors don’t. A few investors buy and hold investments while an even greater number chase returns, moving in the exact wrong direction. Even an advisor who only keeps you from chasing past performance might significantly boost your returns.

If you choose to rebalance yourself, you can accomplish this most easily by automating your rebalancing. Automatic rebalancing is most common in 401(k) accounts. If your account offers the feature, take advantage of it. If you must choose specific months or days to rebalance, we suggest May 1 and Oct. 1.

The important thing is to make sure your portfolio is regularly rebalanced. If the only available rebalancing method is manual, the danger is that you will emotionally pick the point to rebalance which will be the exact wrong time. Instead, you should pick times of the year blindly and then stick with it.

That said, receiving the rebalancing bonus requires that investors have an asset allocation plan in the first place. Most do not.

Your asset allocation definition matters. Rebalancing works best with non-correlated asset categories, like emerging market stocks and U.S. stocks. If you define your asset classes incorrectly, rebalancing between them may not help.

You should not define your asset class as one industry of the economy. One industry could lose value indefinitely as another industry rises to take its place. Rebalancing into a failing industry only brings your returns down with it.

Meanwhile, you dodge this problem with broader asset class definitions. Technology, basic materials, and manufacturing are good, broad definitions while VHS rentals, diamonds and buggy whips are too narrowly defined and may fail you.

It is even better to have two levels of asset class definitions: asset classes, like U.S. stocks and resource stocks, which are non-correlated categories – and then sub-categories, like technology, basic materials and manufacturing, which although they have some correlation are not highly correlated.

Lastly, some sectors such as gold or small cap growth are not on the efficient frontier, which identifies portfolios that achieve the highest return and the lowest volatility. Including them in your asset allocation is simply the wrong move. Rebalancing to a poorly designed asset allocation often means moving money from categories that are on or near the efficient frontier into inefficient investments, hurting returns.

There is a great deal to be said about the method of rebalancing. Keeping transaction costs and capital gains taxes low when rebalancing also helps boost the return.

Funds with high expense ratios put a drag on returns. Even an index fund drops off the efficient frontier when the expense ratio becomes excessive. Rebalancing into bad funds also hurts your returns.

While the science and art of setting an asset allocation and regularly rebalancing back to it is not an easy discipline, it can boost returns by as much as 1.6 point over a buy and hold strategy, and even more over buying and chasing returns.

There is an art to rebalancing, but it is better to rebalance poorly than not at all.

David John Marotta, CFP, AIF, is president of Marotta Wealth Management Inc. of Charlottesville, Va., providing fee-only financial planning and wealth management at www.emarotta.com and blogging at www.marottaonmoney.com. Both the author and clients he represents often invest in investments mentioned in these articles. Megan Russell is the firm’s system analyst. She is responsible for researching problems and challenges, and finding efficient solutions for them.

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