Meritage Periodical - December 2021

Advisor Perspective

Prompting critical thinking and conversations around issues in our industry. Not intended as personal financial advice.

How big should my cash reserve be?

It’s human nature to look for rules of thumb to answer questions like this one. However, as financial planners, we have learned that rules of thumb can be disadvantageous. In the question of maintaining a cash reserve, the common rule of thumb we hear in the industry is to have enough cash to cover 3-6 months of expenses. We feel that this is a good starting point, but it needs to be customized for individual circumstances and adjusted upward or downward based on factors specific to your situation. Some of the factors with potential to impact your cash reserve needs are your level of job security, potential variability of income, and potential scope of liabilities (i.e., owning a second home gives you two roofs that could spring a leak).

One of the biggest disconnects we see in cash flow planning is younger people so focused on growing their investments that they don’t have adequate emergency reserves for the risks they’re facing, such as job loss or major car repairs. This is a time in life where many people are looking at cash in the bank as something that’s not earning for them, while they might be better served thinking of that cash as providing them with valuable flexibility. This flexibility isn’t only about addressing risk, but also about opportunities. You can only invest in your best friend’s start-up business if you have the cash. 

We see the opposite extreme with some of our retired clients. They’ve accumulated significant resources and it’s easy for them to have large cash reserves, but they are at a time in life where they may no longer need them. For example, job loss is no longer a risk—no one is going to fire you from being retired! During retirement, you’re primarily trying to turn your assets into supplemental income and having excess cash reserves may be robbing you of additional income to better improve your lifestyle or spoil your grandkids. 

For example, a common situation is a retired couple with a $100,000 emergency cash reserve, no mortgage on their home, and steady regular income from social security and their portfolio. Financial life has become relatively simple, but an emergency could still always happen. Each year that $100,000 sits idle in the bank is a year they forgo the income that money could have created if it were invested. For this example, let’s assume that $100,000 could be yielding a 4% income stream, or $4,000 a year. That’s a pretty great vacation! A potential cash flow emergency could be just as well addressed by having a home equity line of credit available, with no cost associated unless they draw on the line—and there may be no emergency for years or decades that requires them to tap into it. However, there is a huge opportunity cost to sitting on an excess cash reserve in retirement. 

3-6 months of emergency cash reserve is better as a starting point than a rule of thumb. We’d encourage our younger clients to think about the value of flexibility that cash reserves can provide, if the complexity of your life requires it. For retired folks, we’d encourage you to think about the opportunity cost of having excess cash reserves, and what you’re giving up in terms of income.

Timely Topics

Updates and reminders that may impact your personal financial planning

Social Security & Medicare

Social Security benefits will receive a 5.9% cost-of-living adjustment for 2022. This will be the largest increase in decades. However, don’t expect to see all of that hit your bank account—the standard premium for Medicare Part B, which covers outpatient care and durable equipment, will be $170.10 next year, up $21.60 from $148.50 this year. Medicare imposes surcharges on higher-income beneficiaries. In 2021, surcharges were applied to incomes above $88,000 and $176,000 for those filing Single and Married Filing Jointly, respectively. In 2022, these figured are being raised to $91,000 and $182,000. So, some good news!

Contribution Limit Increases

The IRS recently announced the 2022 contribution limit increases for the following:

• 401(k)s, 403(b)s, most 457 plans, and the federal government’s Thrift Savings Plan will increase from $19,500 to $20,500. The catch-up contribution limit is $6,500 for those age 50 and older.
• Simple IRA contribution limits will increase from $13,500 to $14,000, with a $3,000 catch-up for those age 50 and older.
• For Health Savings Accounts (HSA), the maximum contribution in 2022 for an individual is $3,650 and $7,300 for a family, up $50 and $100 respectively, with an additional $1,000 catch-up contribution limit if age 55 or older. 

Now is a good time to review your contribution rate for 2022.

2021 Tax Filing

2022 is about to arrive, and with it the task of completing our tax filing. Employers are required to send you W-2 forms no later than January 31st. Upon receiving a W-2, most people would like to get their tax filing done as soon as possible. We want to provide a friendly reminder that custodians of investment accounts have an extended timeline to send 1099s for your investment accounts. Also, investors with interest in partnerships may receive this information even later in the year. The point of sharing this is to remind you that you can only do your taxes as fast as your unique situation allows.