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Monday, June 15, 2015

Before You Retire: 3 Important Considerations

One of the advantages of being a financial adviser who specializes in working with pre-retirees and retirees is I get unique insights into both the benefits and regrets of retirement planning. Based on those insights please consider the following before you retire. 1) Purchasing or refinancing a home Remember banks lend money based on your income not your assets. I recently met with some folks who retired in their mid 50s. They will be living primarily off their savings until their pensions and social security income starts in their 60s. Unfortunately, they did not refinance their home while they were working and had good income. Even though interest rates have dropped, they are not in a position to refinance their mortgage because banks want to see a history of income before making a loan. Drawing interest and dividends from an investment portfolio is not looked upon favorably by lenders unless you have at least two years of income history from that source. So be sure to refinance or purchase your retirement home while you still have good income. If you have already retired, then you might consider using a single premium immediate annuity (SPIA) to generate income over a five-year period of time. The banks will look more favorably at income from a guaranteed SPIA contract than they would monthly draws from a money market account. 2)Budgeting for individual health insurance One of the biggest expenses facing people who retire early is the monthly expense for health insurance. Not too long ago, I met with a couple who retired in their late 50s; who did not research and understand the full cost of health insurance before they retired. Many people’s employers provide their health insurance so they are not aware of the cost for individual health insurance plans. Currently, a married couple in their late 50s, in Kitsap County, could be looking at monthly premiums for a high deductible HSA-qualified health plan that would start at $920 per month based on an $8,000 family deductible per year for the couple. The premiums would increase as deductibles decrease. Federal health insurance premium tax credits do exist that may help reduce your out-of-pocket insurance premiums when you purchase the insurance through the government healthcare exchange. For example, if we use the same information for the couple above, then they would be eligible for a health insurance premium tax credit based on their modified adjusted gross income (MAGI). If their MAGI for the year was $55,000, then they would receive a $704 per month tax credit toward their premiums, and their out-of-pocket insurance premium would be reduced to $219 per month. If their MAGI was $63,000, then they would have to shoulder the entire $920 per month since they would not eligible for any of those tax credits. Click here to learn how to estimate your income for the marketplace. Remember that income from a Roth IRA is tax free and is not counted toward your MAGI. If you are over age 59.5, have met the 5 year holding requirement and the distribution counts as qualified (non-taxable), then you may want to consider taking some of your retirement income from your Roth IRA instead to ensure your MAGI remains below the threshold to qualify for the premium tax credit. Click here to see a chart of the current income ranges that qualify for the premium tax credit. Also if you have health insurance through an employer plan (or former employer) or buy it privately then there is no credit to be had. 3) Creating a cash flow plan Retirement is all about cash flow not your net worth. Without income you do not have retirement. Your income will determine your lifestyle in retirement so you need to understand exactly how you will meet your income needs. A good retirement cash flow plan should start with a good budget to fully understand how much money you spend every month/year. You should make conservative assumptions about future inflation and the rate of return at which your money will grow. Remember the sequence of returns within your portfolio can make or break your plan. If you experience a significant loss in the year you retire, then it may be devastating to your overall future cashflow. You should also take into consideration your health and your family’s history of longevity to make informed decisions about when and how to start social security and pension income. If you are married, then you also consider the impact on your cash flow if one spouse were to pass away or have an extended medical issue that required ongoing treatments or care not covered by traditional health insurance or medicare. I’ve learned the more conservative an income plan that covers that gap between your guaranteed income and your budget, the more confidence people have as they transition through retirement. We can all learn from one another. There is a collective intelligence in specialization. You do not have to plan for retirement alone. Find someone who you can trust who specializes in retirement planning, and get a second opinion. “An ounce of prevention is worth a pound of cure.” Sometimes an outside perspective can help you see things that you may not be trained to see. What are some of the things you have learned as you prepare for or transition into and through retirement?

Friday, December 12, 2014

Guarding Against Fraud

In a survey of American adults aged 40 and older, 84% revealed that they had been solicited to participate in a potentially fraudulent offer, and 11% had lost money after engaging in such an offer.1
The root of this problem — besides the endless efforts of criminals — seems to be naiveté and unwarranted trust on the part of those who are deceived. A large percentage of respondents were unable to spot fraudulent sales pitches and found the unrealistic promises appealing (see chart). Although people of any age can be victims of fraud, criminals are more likely to target those who are 65 and older; this age group is also more likely to lose money when they are targeted.2

Fraud is complex, and a list of fraudulent schemes could fill many pages. Here are three basic principles to keep in mind.
If an investment sounds too good to be true, it probably is. Investing is a long-term process that requires research, patience, and rational decision making. Investments with the potential for higher rates of return typically have a higher degree of risk and the potential for loss of principal.
Never send money based on the promise of getting money. This type of scam may take many forms. Common examples include: (1) an email or letter promising a large amount of money in return for a small up-front fee; and (2) an authentic-looking check that you are asked to deposit in your account, keep a percentage as a fee, and wire the balance to an address. Even if your bank initially credits your account, you could be liable for the money if the check is found to be fraudulent.
Just because it looks official doesn’t mean it is. You might receive a letter, email, or phone call that appears to be from the IRS or a federal, state, or local government agency, either demanding a payment or seeking personal information. You might even be directed to an official-looking website. If you have any doubt, contact the agency directly. Never provide personal information until you’re satisfied that you’re dealing with a legitimate agency that needs the information.
Regardless of how a fraudulent scheme is presented, your best defense may be a good dose of skepticism and common sense.
1–2) FINRA Investor Education Foundation, 2013
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2014 Emerald Connect, LLC.

Wednesday, November 12, 2014

Tips for Your 2014 Taxes

The end of the year will be here before you know it, but there’s still time to take steps that may help reduce your 2014 tax liability. Here are some ideas to consider.
Increase tax-advantaged retirement contributions. If you participate in a workplace retirement plan, the deadline to make 2014 contributions is December 31. Your employer’s plan may allow you to increase or decrease contributions at any time. IRA contributions for 2014 can be made up to the April 15, 2015, tax filing deadline. (See chart for retirement plan contribution limits.)
Consider deferring income. Depending on your situation, consider deferring income (including investment income) to next year. Because the tax rates on income, dividends, and capital gains are permanent, it should be easier to strategize from one year to the next. Keep in mind that if your modified adjusted gross income exceeds $200,000 ($250,000 if filing jointly), you might be affected by the 3.8% unearned income tax on net investment income.

Contribute to charity. Contributions of cash and noncash items to qualified charitable organizations are generally deductible if you itemize deductions. Be sure to keep all receipts and other documents required by the IRS.
Make January payments early. If you itemize, paying your January mortgage payment this year could increase your interest deduction. If possible, consider making other payments before the end of the year, such as business expenses if you are self-employed.
Use your FSA. Although this probably won’t change your tax liability, be sure to use funds from health-care and dependent-care flexible spending accounts (FSAs) by December 31. Depending on how they’re set up, some plans may allow a carryover or grace period to use any leftover funds. 
Even if you began tax planning earlier in the year, you may have a clearer picture of your financial situation now, so it might be worthwhile to reexamine your strategy. Before you take any specific action, be sure to consult with your tax professional.

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2014 Emerald Connect, LLC.

Tuesday, September 30, 2014

Global Static: Geopolitics and U.S. Markets

When a Malaysia Airlines jet crashed over Ukraine on July 17, 2014, due to a suspected missile attack by pro-Russia separatists, the U.S. stock market dropped sharply, with the S&P 500 declining by 1.2%.1 The next day, with no new information regarding the crash, strong corporate earnings caused the market to rebound, regaining most of its losses from the previous day.2 By the following week, the S&P 500 had surpassed its level before the airliner crash.3
On August 14, the market closed strong, due in part to conciliatory remarks regarding the Ukrainian conflict by Russian President Vladimir Putin.4 Yet the following day, when news broke that Ukrainian forces had attacked a Russian convoy that crossed the border from Russia, the S&P 500 dropped more than 1% over an hour-and-a-half period, only to bounce back by the end of the day.5
As these examples illustrate, the U.S. stock market tends to react quickly to geopolitical events, but recently such reactions have been short-lived. Over the longer term, the market generally moves on more fundamental domestic economic issues. With this in mind, it might be helpful to consider some current geopolitical issues and what effect, if any, they could have on the U.S. economy.

Is Russia an Economic Threat?
The ongoing Ukrainian conflict is serious, and it’s natural for Americans to be concerned about a resurgence of Russian militarism. However, direct trade between the United States and Russia is minimal, amounting to about 1% of U.S. foreign trade.6 The larger issue is Europe’s dependence on Russia’s natural gas and the potential consequences if Russia were to cut off the supply. This worst-case scenario could have a major impact on Europe and might reduce U.S.-European trade, but it seems unlikely because
of its potentially destructive impact on Russia’s economy.7

Moreover, it appears that tough economic sanctions imposed on Russia by the United States and the European Union have begun to have an effect, as evidenced by the fact that the largest Russian oil company asked the government to help bail it out of massive debt.8
Reduced trade with Russia in the short term may slow the still-struggling European economy. While U.S. gross domestic product (GDP) rose by 4.0% in the second quarter, eurozone GDP was flat. Germany, which maintains an important trade relationship with Russia, saw GDP drop by 0.2%.9–10 However, Germany’s economic minister predicted that Europe’s largest economy should show growth by the end of the year.11
What About Iraqi Oil?
The escalation of armed insurgence in Iraq has raised concerns about oil supplies and further involvement by U.S. forces. The major Iraqi oil fields are far from the fighting, and world oil supplies are sufficient to withstand a decline in Iraqi production. Oil prices spiked briefly in mid-June when the Iraq insurgency flared, but have declined through July and August.12 Though the situation remains volatile, recent gains on the ground and the transition to a new, more moderate Iraqi prime minister appear to be hopeful signs.13

Should You Cry for Argentina?
On July 31, 2014, after Argentina defaulted on a debt payment to U.S. creditors, the S&P 500 lost 2% of its value and took more than two weeks to regain its losses.14–15 Considering that Argentina accounts for less than 0.4% of U.S. trade, the reaction seems overblown.16 In fact, some investors who thought the U.S. market was due for a correction might have used the Argentina default as an “excuse” to sell stocks.17 If so, this only affirms the principle that investment decisions should be based on long-term fiscal trends rather than on events in a single country or region.

Focus on Your Own Strategy
As this brief overview demonstrates, there are always international flash points, and the market may rise and fall on news from abroad. But geopolitical events tend to create temporary “noise” rather than having a lasting effect.

Over the long term, U.S. stocks are driven primarily by the U.S. economy, and thus far in 2014 the economic news has been mostly positive: Corporate earnings have been strong, and more people are finding jobs.18 It’s generally wise to downplay the global noise and maintain an appropriate investment strategy based on your personal situation, risk tolerance, and long-term goals.
The return and principal value of stocks fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.
The S&P 500 is an unmanaged group of securities that is considered to be representative of the U.S. stock market in general. The performance of an unmanaged index is not indicative of the performance of any specific investment. Individuals cannot invest directly in an index. Past performance is no guarantee of future results; actual results will vary.
1) MarketWatch, July 17, 2014
2) Associated Press, July 18, 2014
3, 5, 15) Yahoo! Finance, August 18, 2014
4) Reuters, August 14, 2014
6, 16) U.S. Census Bureau, 2014
7) Business Insider, August 11, 2014
8) Bloomberg, August 14, 2014
9) U.S. Bureau of Economic Analysis, 2014
10–11) Reuters, August 14, 2014
12) Fox Business, August 18, 2014
13) The Washington Post, August 18, 2014
14, 17) USA Today, July 31, 2014
18) CNNMoney, August 19, 2014

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security.

Monday, September 8, 2014

Creative Ways to Cut Your 401(k) Fees

This story appears in the September 8, 2014 issue of Forbes.                                                                    
What’s your 401(k)’s composite expense ratio? Higher than 0.1% a year? Then you should be looking for an escape hatch. It could save you a pile of money.
If the mere question about ratios leaves you flummoxed, you have company. Plenty of employees don’t pay attention to what they are losing to fund fees. They should.  The difference between high-cost funds and low-cost funds could easily add up over the course of a career to several hundred thousand dollars.
The operators of retirement plans and even employers do not necessarily mind the state of confusion that prevails. One way or another the considerable paperwork cost of a 401(k) must be paid, and the most common way to do that is to extract it via fund expense ratios. The plan may offer a few bargain funds, yet still depend for its economics on having most of the workers wander blindly into higher-fee options.
To get your costs down, you may have to be a bit creative. Consider these real-life cases.
X, 23, has just joined a fast-growing West Coast technology firm. The pay is high, but the 401(k) plan is bad. There’s no employer match, and most of the funds on offer are expensive. Employees who sign up but neglect to make an investment choice are deposited into a balanced fund (a mix of stocks and bonds) that costs a rapacious 1.28% of assets annually.
Not wanting to pass up the valuable tax deferral, X is contributing the maximum $17,500 a year. She wants a mix of stocks and bonds. There’s one cheap stock fund available, an S&P 500 index fund at 0.09% a year. But the cheapest bond fund, American Century Ginnie Mae, costs 0.55%.
Solution: She will put her entire 401(k) contribution into the stock index fund. Then she will restore her balance by adjusting other assets. She has an inherited IRA at low-cost Vanguard. She’ll shift some of that money from stocks to bonds. With an investment of $10,000 or more, she is eligible for the bargain share class of the Vanguard Total Bond Market Index mutual fund. Annual cost: 0.08%.
Y, 37, is a new partner in a medical practice. There are all manner of compliance costs for retirement plans, and those costs must be recouped. The best the three docs could do was a menu drawn from the American Funds collection, priced at 0.58% to 1.13% a year.
The doctor’s plan has an escape hatch. For a $100 transaction fee, a participant can use a “brokerage window” to buy just about any security. When his balance gets big enough, it will make sense for him to pay the fee and buy a dirt-cheap exchange-traded fund on the New York Stock Exchange. Schwab and Vanguard have ETFs costing as little as 0.05% a year.
Suppose Dr. Y moves $100,000 over to the Schwab U.S. Aggregate Bond ETF, with an expense ratio of 0.06%. His annual portfolio cost will go from $580 (or worse) to $60. He’ll gladly pay the $100 transaction fee, a brokerage commission and a bid/ask spread of a few cents per ETF share.
Z is a 61-year-old manager at a nonprofit with a Fidelity-managed 403(b) plan, something very similar to a 401(k). The menu includes some low-expense stock index funds. But the cheapest fixed-income choice is the Fidelity Intermediate Bond Fund at 0.45% a year.
The $500 million plan has a brokerage window with a $75 fee. This window is opened just a crack: Z may not buy ETFs, and when he gets a Vanguard fund he is herded into the expensive share class.
Last year Z crawled through the window with $172,000, putting the money into the Vanguard bond market index fund at an expense ratio of 0.2%. His savings will run to $430 a year.
A survey by benefits consultants Aon Hewitt found that 76% of large employers have workers pick up all the costs of 401(k) administration. Among employers that push all or some of the costs onto employees, a rising minority (now 26%) assess account administration fees, such as $25 per account per year. The rest continue the tradition of burying costs in overpriced funds, a practice that helps youngsters with tiny balances but hurts workers who have been around long enough to accumulate respectable sums.
The game seems to be tilting to the older workers. Two in five large-company plans have the brokerage escape hatch .

Tuesday, July 22, 2014

Pre-tax and Post-tax IRA contributions: Eat your vegetables first

Marginal income tax rates are at an historical all-time low. Our Government debt is at an all-time high and currently 17.5 trillion dollars. Ten thousand baby boomers are retiring every single day. Social Security is expected to only be able to pay .77 cents for each dollar of scheduled benefits by the year 2033, and we have recently overhauled the health care system, which is likely to cost us all a lot of money as we shift health care responsibility from individuals to the government. These are just a few of the reasons that so many people are considering tax planning as part of their overall financial well being, and these are some of the reasons why I’ve recently converted more of my traditional IRAs to Roth IRAs. But what about those who have both pre-tax and post-tax contributions inside of a traditional IRA. Should an investor convert the post-tax contributions to a Roth?
One of the questions I am getting asked more and more these days has to do with the mechanics for conversions from a traditional IRA to a Roth IRA. As you probably know a traditional IRA is typically funded with pre-tax dollars and defers taxation into the future while a Roth IRA is funded with post-tax dollars and future distributions are, in most instances, free from federal income tax. So should you be deferring taxes into the future given the reality of our current economic conditions or not?
I recently consulted with a person who had made both pre-tax and post-tax contributions to his IRA.  He was interested in converting only the post-tax portion of his IRA to a Roth.
Before I get too deep into the weeds, let me explain that most individuals can make contributions to an IRA, but depending on the amount of income they have will determine if  the contribution is tax deductible in the year they make the contribution or not. A pre-tax contribution is money that was contributed to the IRA and was not taxed at the time of the contribution. Pre-tax contributions are what the majority of  people contribute to an IRA.
A post-tax contribution is where the individual already paid taxes on the income received and made a contribution to their IRA, but did not receive a tax benefit in the year of the contribution. This usually occurs for high income earners and they may also be precluded completely from being able to contribute to a Roth IRA. For example a married couple filing a joint tax return in 2014 covered under a workplace retirement plan will have tax deductions phased out for contributions to an IRA when their income is between $96,000 – $116,000.  That same married couple not covered by a workplace retirement plan will have tax deductions phased out when contributing to an IRA when their income is between $181,000 – $191,000, and a married couple filing jointly with a modified adjusted gross income of more than $191,000 is ineligible to contribute to a Roth.
If all of the money being considered for conversion to a Roth IRA was in traditional IRAs and was pre-tax dollars, then the rules are very clear and easy to understand. You simply pay tax on the amount you convert in the year you convert.
Things get a little more complicated when you have both pre-tax and post-tax contributions to a traditional IRA since it is not possible to convert only the post-tax contributions of a traditional IRA to a Roth IRA. The IRS has a pro-rata rule that requires you to add the value of all your IRAs and determines what percentage is post-tax vs pre-tax. Then when you convert dollars from your traditional IRA to a Roth IRA, a portion of the conversion is considered taxable and a percentage is not taxable based on the pro-rata formula.
For example, you had a rollover IRA with $90,000 of pre-tax contributions and a traditional IRA with $10,000 of post-tax contributions. The IRS would require you to add $90,000 + $10,000 = $100,000 of total IRA assets. Then you divide $10,000 / $100,000 and find that 10% of the IRA assets would be considered tax free upon conversion. So if you were to then convert just the post-tax traditional IRA of $10,000, then the IRS would consider 10% of that IRA conversion to be post-tax money and 90% to be pre-tax. On the $10,000 dollar conversion, $9,000 would be taxable as ordinary income  and $1,000 would not be taxable.
When consulting with people on these rules they sometimes express frustration and feel this is unfair and double taxation because they have already paid tax on the $10,000 in the post-tax traditional IRA. I understand why people feel this way however these are how the IRS rules work, and the IRS uses the sum of all your IRA accounts and does not view them independently of one another for the purpose of converting traditional IRAs to a Roth IRA.
When people have both both pre- and post-tax IRA contributions, they should track the basis of the post-tax contributions in their traditional IRA using form 8606 when filing their taxes every year. This way they will know how much of their future distributions will be taxable vs tax free when they begin taking money out of their retirement accounts.
When I was growing up my dad used to teach us to delay gratification. To eat our vegetables first and dessert last. One of my favorite quotes is from Jim Rohn who said, “All men will experience pain. The pain of discipline or the pain of regret. The pain of discipline weighs an ounce compared to the pain of regret that weighs a ton.”  Paying taxes now may not be fun, but I have a feeling paying taxes in the future might really be painful.
Everyone of us are lucky to live in the greatest country in the world and most people I know don’t mind paying their fair share of taxes. For a lot of people it makes sense to diversify future tax liabilities. In my mind converting a traditional IRA to a Roth IRA is the equivalent of eating your vegetables first and saving the dessert for later. I personally really like the idea of a tax-free retirement.