Small Changes, Big Differences in your Retirement plan

The Power of 1% 

  How Small Changes Can Make Big Differences in your Retirement Plan

We have all heard that something – something 1% more, or something-something 1% better every day will have a massive effect on your life over the long run. How small changes can make big differences. It makes sense, if you could mathematically make yourself 1% better or more each day, you will be significantly better than you were at the beginning of the month or beginning of the year. It is a worthy pursuit. But it is very hard to calculate unless you are talking about running miles or lifting weights.

The concept is that a small change over a long period of time will have a massive impact on you and your life if done for a long time. This can be applied to so many things. Even an aircraft that is 1 degree off will land in a very different location than what was scheduled. But today I want to apply it to your financial life. Specifically, your 401k or retirement plan.

The “Power of 1%” is a motivational abstraction, why would I want this idea applied to a boring, old 401k plan? Because just 1% could make a massive difference in your life. These small changes can make big differences in your retirement plan. This one concept could make your retirement and life unimaginably better, and totally change the way you grow your wealth. Just 1% can be the difference between barely scraping by, to being a comfortable millionaire.

 

Power of 1%

 

The true key is to simply increase your 401k contribution by 1% at the beginning of the year, each year.

 

Let’s talk about how.

 

You have a 401k retirement plan and let’s say you are saving a decent amount of your money at 5% of your income, and your employer is either matching your contribution or putting in a percentage of your salary, depending on where you work.

Let’s take three pilots for this example, each in different stages in their career. 1. Rookie 2. Senior FO 3. Fully Tenured Captain that was flying bi-planes back in the day (joking). Pay will remain the same for easy math.

The Rookie makes $100,000 per year and is deferring 3% of his salary each year. In 5 years he would have put away $15,000 into his 401k. 3% seems like a lot, but over 5 years, that is only $15,000 for his retirement. Now let us see what would happen if he increases his deferral by just 1% each year. If he starts at 3% and increases each year by 1%, he will be at 7% (Year 1 was 3%) and over that time he would have contributed a total of $25,000! That is an extra $10,000 or 67% more than what he was normally doing.

Small Changes Big Differences in your Retirement plan

The Senior FO makes $250,000 per year and is deferring 5% into his 401k each year. When he retires in 10 years, he would have contributed $125,000 into his 401k. Not bad! But if he plans to retire, he should definitely do more. If he increased his contribution just 1% each year for 10 years, He would add $216,500 over his time, almost twice as much if he stuck with the 5% rate. Remember, you can only max out your side of the 401k contributions up to $19,500 each year, plus another $6,500 if you’re 50 or more, which is the case here. But you can always take that money and put it somewhere else. (Hint, hint Backdoor Roth Conversions) Here is the example:

Small Changes Big Differences in your Retirement plan

The last person is a Captain that will be retiring in 3 years. He has 3 years to put away as much money as possible. His salary is $350,000. He will need to put away 8% of his salary in order to meet his max of $26,000. Since he doesn’t have a lot of time to scale up every percent, he should just try to contribute as much as possible before he retires. If he maxes out, he will have $78,000 over 3 years! The more you can contribute to your 401k the better life will be.

 

The Tale of Two Pilots

 

Now let’s look at another example of how small changes can mean big differences in your retirement plan.

David and Susan both went to Metro State University to be pilots. They both were very good students, graduated from school, both worked for a regional liner and they just started flying for the same major airline. David loves to snowboard, vacation around the world, and party. He says  “As long as I’m covering my financial bases, I can do the things I enjoy.”

Susan loves to ski, read books, and spend time with her family. Living a comfortable life is important for her and she wants to make sure she can do the things she enjoys in the future. 

On their first day, they sit down with HR, and they are asked how much they want to start deferring in their retirement plan. David, whose friend told him to defer as much as he can, announces he will start with 5% of his $150,000 salary going to his 401k. When Susan sits down with HR, she says she can’t defer any dollars into her 401k because she wants to finish paying her student loans first. But she promises next year she will start with 1% of her $150,000. And the next year, 2% and so on. 

At Year 10, they both start getting paid $250,000. And at Year 20, they are making $300,000.

25 years later, after they both have amazing and fulfilling careers, they bump into each other at the DIA breakroom! “Wow!” They say for they haven’t seen each other for a long time. After a while of catching up, they talk about their retirement accounts. 

David smiles and boasts “I’ve been saving 5% of my salary since the first day I got here, and now I have saved $282,500 of my salary” as he calculates in his Excel spreadsheet:

“Very impressive!” Says Susan, as she tabulates how much she has saved. She started saving with nothing, but she promised she would increase her contribution by just 1% each year. After she does some math, she shows David how much she has saved. Smug David leans forward and stares, mouth open, at the numbers from Susan’s tablet…

“You saved $439,500?! Wow! I thought you said you were doing none, how did you beat me? That’s almost twice as much as I’ve saved, and I’ve been doing 5% my entire career!”

“Slow and steady wins the race” Susan smiled. 

Just a small change can make a huge difference in your retirement plan. And just because you start off slow doesn’t mean you’re out. Don’t get discouraged, just try to be 1% better. Like Susan!

 

What’s Next?

 

If you are just starting out or in your mid-career, increasing your retirement plan contributions by just 1% this year will have a huge impact on your retirement accounts and life. This doesn’t even factor in the potential increased growth that your account could receive. Lastly, your salary regularly increases with inflation, usually around 2% to 3% each year. If you just took 1% from that, you would hardly notice the change in your cash flow. 

This strategy is something relatively new but is gaining more traction among plan sponsors and large companies. Many of them are automatically enrolling employees into automatically increasing their deferral, or at least strongly encouraging that their employees increase their 401k contribution each year. Hopefully, these examples have made it clear the importance of growth for your retirement. 

Do you have a financial plan? Please reach out for a complimentary discovery meeting with our CERTIFIED FINANCIAL PLANNERS™ to help give you a clear path to a successful story. Susan would 🙂

 

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United Airline Layoffs. What to do if you are laid off.

United Airline Layoffs

 

Economic downturns often hit the airline industry harder than most. Once again, the airline industry has been grounded by the pandemic and the corresponding economic conditions. As such, layoffs are looming.  United Airlines announced it will be laying off thousands of employees, estimated to be 36,000 by October 1, 2020. Additionally, United Airlines said the jobs of more than 14,000 employees are at risk when federal aid expires in the spring of 2021. These layoffs could affect everyone from customer service employees, flight attendants, to pilots. Many other airliners may follow suit.

The fallout from 9/11 and the impact of the 2008 Financial Crisis took the airline industry roughly 2-3 years to recover. It is hard to say how long the coronavirus impact will last or how it will all turn out.

If you are worried you might be one of the airline employees to be laid off or already have been, there are many concerns you may have.  From how to pay bills, to how long will this last, to how to keep medical insurance and benefits… the list goes on.

 

What should I do if I am laid off?

 

We have put together some tips, ideas, and strategies to help you get through this tough situation. 

 

Covering your living expenses

 

Being able to cover your living is by far the most important question and concern.  There are a number of strategies to help navigate this and there are also some new provisions from the CARES ACT that can help if you are a United Airline employee who has had to face the layoffs. 

 

Your emergency fund

 

An emergency fund is a savings account or separate account that is set aside for when the unexpected happens, like being laid off.  We recommend that our clients have 3-6 months of their monthly expenses saved in this kind of account. The goal is to use this money to pay for your mortgage, food, etc.  It is designed to help you bridge the gap of unemployment to your next job or getting rehired when things recover.  

One often-overlooked task is once you are employed again to refill your emergency fund. This account can help you in a tough situation but be sure to replenish it to ensure it is there for the next time something unexpected comes up. 

If you do not have an emergency fund in place, read on for some other ideas that can help. 

 

Claiming unemployment

 

If you received a WARN, it is important to start planning ahead now. You can now qualify for weekly unemployment payments from the state in which you worked.  Many people fly out of a hub that is different from the state that they live in. When applying for unemployment, use the state that you work out of. Selecting reason for unemployment: “Coronavirus” can streamline the paperwork process. A quick Google search of your state and unemployment will land you on the right page. Look for “.gov” in the address. The CARES Act is adding $600 per week into unemployment checks but is set to end on July 31st. This may be extended as the impact of the virus continues. 

 

Mortgage Forbearance

 

Mortgage Forbearance means you can postpone your mortgage payment temporarily. For 180 days you can request a forbearance from your mortgage lender. If granted it means you will not have to pay your mortgage for about 6 months.  However, this is not mortgage forgiveness. You still owe the full amount and interest still accrues on the months you do not pay.  You will need to work out the details and repayment plan with your lender as each situation is different.  Per the CARES Act, no additional fees or penalties will be applied if you require forbearance.

 

Retirement Account Withdrawals

 

Taking a distribution or withdrawal from your 401(k) should be a last resort. The money in your 401(k) is meant for your retirement. However, with the intensity and impact of the United Airline layoffs caused by COVID-19, the CARES Act has set up many relief options.

Traditionally, you could not access your retirement account before the age of 59 1/2 without having to pay a 10% penalty and income tax.  The CARES Act has waived this 10% penalty.  Since all retirement accounts (Roths excluded) are funded with pre-tax dollars and the income tax is normally due in the year of a distribution. 

The CARES act has allowed distribution in 2020 up to $100,000 be taken out and the taxes are due over the next 3 years. For example, if you take out $90,000 from your retirement account, you will have to pay tax on $30,000 in 2020, $30,000 in 2021, and $30,000 in 2022. That is much better than having to pay all $90,000 in 2020. The money will come out of your account’s investments pro-rata, so if you have half your money in large-cap stocks and half in small-cap stocks, the money will be sold in them equally to fund the distribution.

Reach out to your 401(k) provider Charles Schwab or Fidelity for details.

 

401(k) Loan

 

Taking a loan from your 401(k) is not a good idea because you will be taxed on the distribution, and you will have to repay the loan. There could potentially be many more downsides to taking a loan rather than just distributing the money.  If you are furloughed or leave the plan, you will be subjected to a faster repayment schedule.

If you take out a loan, you will be taxed on the loan amount, plus you will have to use after-tax dollars to pay back the loan. In the grand scheme of things, once you repay the 401(k) loan, you will still be subjected to income tax when you take the money out when you retire. So you will be taxed TWICE on the money, instead of just at the distribution.

 

Miscellaneous Items

 

Many car manufacturers are offering payment deferrals during this time. If you are unable to make payments comfortably on your car, be sure to reach out to your car’s manufacturer finance department to discuss payment options. Many newer cars (2018 or newer) will have more generous payment options than older vehicles.

Also, a voluntary separation could be a good idea if you are close to retirement. The benefits of the United Airlines Retirement Health Account (RHA) can help you pay for medical insurance. 

 

What about my  Benefits if I am laid off??

 

United Airline layoffs are hard enough, luckily you can retain certain benefits. For instance, health insurance, RHA, and you’re retirement accounts can still provide you benefits.

 

Health Insurance

 

COBRA is a government bill that lets you keep your medical insurance with your company for up to 3 years. You will have the same coverage and plan, except you will have to pay 100% of the premium (plus a 2% premium for administration costs for a total of 102%) Look at your most recent pay stub to see how much you and your employer were paying for medical insurance.

 

Retirement Health Account

 

Your Retirement Health Account (RHA) is a unique account granted directly to United from a private letter ruling with the IRS. The RHA is used to pay for out-of-pocket medical expenses and health insurance premiums when retired, furloughed, or separated from service. The RHA can also be used to pay for your COBRA premiums. Click here for more details on how to use your RHA.

 

401(k) and Retirement Investments

 

There are some options you can choose to do with your 401(k) when you have faced a layoff.

  1. You can keep it with the company.  Nothing will change as you will have the same investment options and access.
  2. You can withdraw the money, as we mentioned above.  However, this is not the best action to take if it can be avoided.
  3. You can roll your money into an IRA.  There are no taxes on this move, and it can give you more investment options and control of your money.

Our preference is to roll your 401(k) over into an IRA so that you have better access to your account while avoiding the administration and investment fees from United, Fidelity, or Charles Schwab. We can build you a custom portfolio based on your needs and our custom investment research for a fee typically lower than your Fidelity and Charles Schwab 401(k) options.

Our expertise is working with pilots and aircrew in providing them the best investments through our relationship with Charles Schwab. Leveraging our partnership with Charles Schwab we can build you a custom portfolio in your PCRA.

 

What’s Next?

 

We can help you navigate one of the most difficult times the airline industry has ever faced, and that is really saying a lot! We work with many pilots, crew members, and their families and help them prepare for a successful retirement and reach their financial and life goals.

Bonfire Financial is a fiduciary, fee-only,  financial advisor.  We have a staff of Certified Financial Planners™ that specialize in helping United Airline Employees and Pilots.

As a United Airline or major airline employee, we would like to offer you a free consultation to help answer any questions you may have and help you get a game plan in place. Scheduled your call now. 

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United Employee Benefits: How to Leverage Your RHA for Tax-Free Growth

United Airlines Employee Benefits: Retirement Health Account

 

Working as a United Airline Employee has more benefits than just a 401(k) plan or free flights. United provides a Retirement Health Account that gives you another resource to fund medical expenses in retirement.  When doing financial plans for our clients many of which are pilots, one important issue that often comes up is how to fund health care.  The United RHA is a great tool for that.

 

What is an RHA?  

 

The United Retirement Health Account is a health expense reimbursement account like a Health Saving Account (HSA) but one you use in retirement. United Airlines ALPA Retirement Health Account (RHA) allows retired United and legacy Continental pilots to reimburse themselves tax-free for qualified health expenses for them, their spouse, and dependents in retirement. For that reason, it truly is one of the great United Employee benefits.

 

Eligible expenses include:

  • Doctor visits
  • Co-pays
  • Dental premiums
  • Insurance premiums
  • Medicare
  • Long Term Care insurance premiums

 

The RHA is a fringe benefit provided by United and is a unique savings account that most companies do not have. United basically got the blessing of the IRS through a private letter ruling to have this plan.  Because it is more of a one-off plan the rules are more opaque and restrictive.

 

How does the RHA work?

 

Unlike other United Airlines employee benefits, the RHA is funded by United only. No employee money is ever contributed to the account. Every working hour, United contributes $1.00 to your account. More importantly, when your 401(k) limit is reached, all employer contributions will continue, but spill into the RHA. United contributes 16% of your salary into your 401(k), and once the 401(k)  limit is reached at $57,000 in 2020 (not including the employee age 50 catch-up of $6,500 in 2020), further contributions will spill into the RHA. Forfeited vacation can be contributed to either the PRAP or RHA at the employees’ discretion.

 

What can I use the RHA for?

 

The RHA is meant for medical expense reimbursement in retirement or separation of service only. The account itself is held in a pooled account with other employees and pilots at United, and cannot be moved into an individual account. As such, the benefit of the RHA is to allow you and your spouse and dependents to reimburse any health expenses and premiums tax-free.

According to a study done by Fidelity, the average 65-year old couple retiring in 2019 can expect to spend $285,000 in healthcare and medical expenses. Medical expenses increase at nearly twice the rate of inflation, and will likely continue to grow in the future. The RHA allows retired employees and pilots to maximize their retirement benefits by providing a tax-free vehicle to pay for medical expenses, without having to access taxable or tax-deferred accounts like your 401(k).

 

An example

 

Take for example, Sarah. Sarah is a retired pilot and can use her 401(k) to pay for regular retirement expenses. The issue that she runs into is that distributing from her 401(k) will recognize that income. If she is currently in the 22% tax bracket and takes out $50,000 per year to pay for expenses, she will need to pay $11,000 in tax for that year. Sarah needs surgery and will need to pay $10,000 out of pocket. She will pay that money from her checking account, and reimburse herself from the RHA for $10,000. Because she used the RHA for a qualified health expense, she will not have to pay any taxes. If Sarah made the mistake of using her 401(k) for the expense, she would need to pay an extra $2,200 to the government!

The RHA can be used to pay for Medicare premiums, co-pays, insurance premiums, dental insurance premiums and expenses, and even long-term care insurance premiums. The RHA can grow rather quickly and it can be very useful for your family. For example, if you have a balance of $0 in your RHA, and United contributes $5,000 each year for 20 years, and you expect an annual return of 6%, your ending RHA value will be $183,928 of tax-free dollars at 65! If you have contributed $10,000 per year, you would have $367,856!

 

Eligible Expenses

 

All of the following in red are covered by the RHA. The blue are non-eligible medical expenses that must be paid out-of-pocket. 

United Airline Employee Retirement RHA

(Image: Further/SelectAccount Family of Products)

 

When can I excess the money in my RHA?

 

There are a few times in which you will be able to access your RHA. The most straightforward one is in retirement. Also, if you are laid off or fired you will be able to access it. Additionally,  if you are furloughed, you can use the RHA to pay for COBRA premiums until you get back to work. Just another one of the United Employee Benefits.

 

How do I maximize my RHA?

 

If you are nearing retirement, you may be seeing that you have a very large 401(k), which can also mean a very large tax problem when you go to withdraw from it in retirement, especially with Required Minimum Distributions (RMD) beginning at 72 years old with the new SECURE retirement act. To maximize RHA funding, you can contribute more to your 401(k), up to $19,500 in 2020. Moreover, if you maximize your contribution, you will have only $37,500 ($57,000-$19,500) left for the employer to contribute. Say if you make $280,000 in 2020, United will contribute $44,800. Because there is only $37,500 left for United to fund the 401(k), the rest, $7,300, will spill into the RHA. Therefore, if you wish to save more in your RHA, you can maximize your contribution early in the year to fund the 401(k) using your employee contribution.

Further, you can also elect to move all forfeited vacation days into the RHA. You can maximize or minimize what is in your RHA by either over- or under-funding your PRAP using your employee contribution or forfeited vacation. The United Retirement & Insurance committee has an RHA spill calculator available to you, to estimate your projected RHA funding.

Here is an example of two pilots, they both make $280,000. Both pilots are 47 years old. Tom (Pilot A) maxes his 401(k) contribution up to $19,500. Bill (Pilot B) contributes $10,000 to his 401(k). Remember, the total amount allowed in the 401(k) per year is $57,000. Any amount over will spill into the RHA:

Salary United’s 16% Contribution Pilot’s Personal Contribution Total Contribution (limit of $57,000) Spill into RHA (above $57,000)
Tom (A) $280,000       $44,800     $19,500     $64,300 $7,300
Bill (B) $280,000       $44,800     $10,000 $54,800 $0

How do I limit contributions to my RHA?

 

Because United funds your RHA based on your salary, there is no way to avoid contributing to the RHA if United has maximized your 401(k) contribution. Based on the 401(k) rules, the 401(k) spill will begin once a pilot has reached a total of $57,000 contributed in his 401(K) in 2020 (not including $6,500 in catch-up at 50). All employer contributions will go to the RHA  after that. By underweighting what you contribute into the 401(k), you can limit the amount of spill into the RHA. If you have a salary of $250,000 and United contributes 16%, you will have $40,000 in your 401(k). You still have $17,000 without having any spill into the RHA ($57,000 – $40,000 = $14,000 left to fund). Regardless, you are not losing money when United contributes to the plan. It is essentially a free benefit to you.

 

What happens to my RHA if I die?

 

The RHA can be used by you, your spouse, and qualified dependents. If you are 65, and your children now support themselves, they are not considered to be your dependent. When you die, your spouse will be able to use and access the RHA. Once your spouse dies, and you have no dependents, any remaining amount in the RHA will be reverted back into the pooled investment account at the record keeper. The RHA is not able to be inherited like other accounts. Therefore, it is important to take advantage of your RHA when you are able to use it so you don’t leave any money on the table. 

 

The RHA and Tricare for Life

 

Many pilots are retired military and will use Tricare to supplement part of their medical coverage. For example, a family on Tricare for Life in retirement will still be using Medicare Part A & B, and Tricare is used in conjunction to pay for coverage outside of hospital stays (A) and doctor’s visits (B).  Similarly, Tricare is used for other coverage such as prescription drugs, and the remaining premiums from Medicare Part B. Tricare and Medicare Part A & B cover most health-related expenses, but the RHA can be used tax-free to cover other parts such as dental insurance premiums, long term care insurance premiums, vision plans, therapy, and other eligible medical expenses outside of Medicare and Tricare coverage.

 

RHA to fund long term care insurance premiums

 

According to Genworth Insurance, $51,480 in 2019 was the national annual median cost of In-Home Care. Long-term care can quickly drain older Americans’ retirement and savings. According to AARP, 52% of people turning 65 in 2017 will need long-term care at some point. The estimated cost for end-of-life care in 2016 ranged from $215,820 and $341,651 according to Alzheimer’s Association. Ultimately, the last thing you want is to drain your worth in your final years and not be able to leave anything to your estate, children, heirs, and charities.

Long-term care insurance is one way to pay for long-term care and nursing care. LTC insurance can cost up to $3,000 per year for one person and can be even more if you have a family history of dementia. Luckily, you can pay for LTC insurance premiums tax-free with the RHA. Therefore, you can have LTC insurance and leverage your RHA’s tax-free characteristics. 

The Retirement Health Account might just be one of the best United employee benefits out there. It’s employer-funded, more money without more taxes, extra money for health care expenses during retirement benefit.

 

Questions?

 

We are here to help. Bonfire Financial acts as a fiduciary financial advisor for our clients. We have a staff of Certified Financial Planners™ that specialize in helping United Airline Employees and Pilots with their retirement and benefits. Schedule a free consultation with us today. We’d love to talk to you. 

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