INTRODUCTION TO PERSONAL FINANCE Julie Huang, Pharm.D. CSHP New Practitioner/Student Webinar Sept 11, 2019

Learning Objectives To evaluate the financial status by understanding the benchmarks for various savings goals and income to debt ratio To understand the power of compounding - why save now and what happens if you wait until later To demonstrate how to set your financial goals – how to prioritize and establish sustainable plan To introduce retirement planning regarding different types of retirement savings and their characteristics

First Things First Assess your current financial situation Monthly Budget Sheet for accurate estimate Monthly Net Surplus – should be at least 20% of your take home income Senator Elizabeth Warren suggested 50/30/20 rule in her book “All Your Worth: The Ultimate Lifetime Money Plan.”  Basic rule to divide after-tax income, spending 50% to needs, 30% to wants and 20% to savings https://www.investopedia.com/ask/answers/022916/what-502030-budget-rule.asp

Monthly Budget Sheet Must be realistic and accurate Identify discretionary expenses vs. non- discretionary expenses Use Year-End Summary provided by credit card if available Update as needed

Ratio for Financial Security Liquidity Ratios Ratio Formula Measures Benchmark Emergency Fund Cash& Cash Equivalents Monthly Non-Discretionary Cash Flow The number of months of non-discretionary expenses in the form of cash and cash equivalents 3-6:1 Current Ratio Cash& Cash Equivalent Current Liabilities The number of times a client can satisfy their short-term liabilities 1-2 Debt Ratios   Housing Ratio 1 (HR1) Housing Cost Gross Pay The percentage of income spent on housing debt ≤ 28% Housing Ratio 2 (HR2) Housing Cost + Other Debt Payment Gross Pay The percentage of income spent on housing and all other recurrent debt ≤ 36% Ratio for Financial Security Savings Rate Savings+ Employer Match Gross Pay The percentage of income saved towards a retirement goal. Goal Driven At Least 10-13% if starts early (age 25-35) Where do I stand financially? Once identify the realistic expenses, compare against the bench marks Start with building the Emergency Fund If planning to buy a house, important to ensure budget your purchase price based on Housing Ratios for loan approval Dalton, M., Dalton, J., & Oakley, K. (2017) Cases in Financial Planning: Analysis and Presentation, 3rd Ed., 39.

First Things First Debt avoidance and reduce spending Assess your current financial situation Monthly Budget Sheet for accurate estimate Debt avoidance and reduce spending Start while in school Only borrow what you absolutely need Take out instead of dine out Start Savings NOW

Power of Compounding

Power of Compounding Why now and not later? Every decade of delayed savings require more than double the amount to catch up

Set Your Financial Goal What are you saving for? Immediate term (now) Credit Card debt Health and long-term disability insurance Reserve fund (3-6 month non-discretionary expenses) Short-term (1-5 years) Down payment for the first house Pay down student loan Pay off car payment Medium- long term (5-10 years and beyond) Saving for rental property down payment 529 college fund Payoff Student Loan Retirement saving Use John’s co-worker’s example for health and long-term disability need

Set Your Financial Goal What are you saving for? Prioritize and set budget for your goal to allocate savings Use SMART goal Specific Measurable Attainable Realistic Time Bound Prioritize the goal start from thinking about what is the ROI for this spending? Give example of my wedding cost Sample SMART Goal: I would like to save $100,000 in down payment to buy a $500K condo in Pasadena in 5 years by saving $1400 per month – Is this realistic? How about if extend the savings time to 7 years? – monthly savings is $900 per month to achieve $100,000 down payment

Retirement Planning How much do you need to retire? Plans available for retirement Getting to Zero - How to pay as little tax as possible in retirement

How much do you need for retirement? Start with 10-13% of gross pay (including employer match) for retirement savings Assess your weekend lifestyle Different methods to calculate retirement needs: Annuity Method Uneven Cash Flow Method Capital Preservation Model Purchasing Power Preservation Model

Annuity Method Simplest way to calculate retirement needs in 4 steps Newly graduated pharmacist, age 28 with annual salary of $100,000 estimates the retirement need of $80,000/year in today’s dollar. Hoping to retire at age 65 and live until age 90. Inflation at 3% and investment return of 9% Step 1: Determine the funding amount in today’s dollars $80,000 (or subtract any other benefit due – i.e. social security benefit, pension) Step 2: Inflate the needs from Step 1 to the beginning of retirement $238,820 first year needs for retirement (37 years of work life expectancy with 3% inflation) Step 3: Determine the funding needs at retirement age $3,104,280 (25yr retirement life expectancy with annual need of $238,829 plus 3% inflation and 9% investment return) Step 4: Determine the required annual savings amount $12,015 annual savings (37 yrs of savings with 9% annual return) Just for fun, did the same calculation except starting at age 35. Step 1 – same at $80,000. Step 2 - $194,180 (less because less years of inflation), Step 3 - $2,524,032, Step 4 - $18,517 per year (difference of over $6000 annually or $500 per month)

Retirement Plans Tax Sheltered Annuity/403(b)/ 401 (k) Traditional IRA vs Roth IRA

Tax Shelter Annuity (TSA) / 403(b) / 401(k) Tax deferred – reduce taxable income now but taxable with distribution Max contribution - $19,000 in 2019 Do not invest in default selections Review holdings for different funds Spread risk Assess risk tolerance Spread contributions throughout the year. Except … Avoid borrowing from your TSA/403(b)/401(k) unless ROI is greater than 10% return Dalton, M., Dalton, J., (2018) Retirement Planning & Employee Benefits, 14th Ed., 542-548

IRAs Traditional IRA Roth IRA Anyone can contribute Tax-free contributions ($6,000 max, $7,000 if >50), unless intended for backdoor Roth IRA conversion, then must be non-deductible contribution Withdrawals and earnings are taxed Must start making withdrawal at age 70½ - Required Minimum Distribution (RMD) is calculated based on the prior year end plan balance Beneficiaries pay taxes on inherited IRAs May begin taking withdrawals at 59½ Contributions lower your taxable income to help qualify for tax incentives (child tax credit, student loan interest deduction) Roth IRA 2019 limit - Single: AGI<$135K, Married: AGI<$199K Contributions must be after tax ($6,000 max, $7,000 if >50) – must designate non deductible contribution Withdrawals and earnings are tax-free Withdrawals not required during account holder’s lifetime Beneficiaries can stretch distributions over many years and don’t owe income taxes on withdrawals (estate taxes may apply) - May begin taking withdrawals at 59½ Dalton, M., Dalton, J., (2018) Retirement Planning & Employee Benefits, 14th Ed., 468-492

Why Tax Free Distribution So Important? Illustration shows $13,270 in income tax savings when taking 40% ($40,000) from 401(k) and 60% ($60,000) from Roth IRA (tax free) compared to 100% of $100,000 distribution from 401(k) when filing income tax as married filing jointly (MFJ)   100% ($100,000) funded from 401(k) 40% ($40,000) funded from 401(k) and 60% ($60,000) funded from Roth IRA Taxable Income $100,000 $40,000 Estimated Annual Social Security Benefit of $30,000 ($2500/mo)* Up to 85% = $25,500 is taxable as ordinary income when reported income is >$44,000 Up to 50% = $15,000 is taxable as ordinary income when reported income is between $32,000-$44,000 Total Reportable Income $125,500 $55,000 Tax Bracket (2018) 22% 12% Income tax calculation** $125,500 x 22% - $8121 $55,000 x 12% - $381 Income tax owed $19,489 $6,219 Total tax savings $13,270 *Social Security income tax reference with https://www.ssa.gov/planners/taxes.html **Tax bracket and tax schedule reference with https://www.irs.gov/pub/irs-pdf/p505.pdf page 19

Next Step Start Saving NOW Do not change your lifestyle drastically with pay increase Take advantage of power of compounding Set a SMART goal for your financial planning Start saving in Roth IRA account – build as much retirement savings in ‘tax free’ bucket Don’t work hard for your money. Have your money work hard for you Return of Investment (ROI) Opportunity cost

Julie Huang, Pharm.D. julie.huang@kp.org Thank You! Julie Huang, Pharm.D. julie.huang@kp.org