Giving: What’s Your Plan?

Posted On May 11, 2015 By Admin In Financial Planning /

Charitable giving is a natural product of financial success. It is truly rewarding to be able to support people and organizations you believe in and help them to become successful and make our community and world a better place. A person is truly rich if they can give to others without fear of running out of money for themselves. And that’s why I am always amazed and inspired by my clients and friends who give generously, who tithe, and who do so with breathtaking confidence. The miser who can’t part with a single dollar may be able to accumulate, but hoarding or living in fear is the opposite of the financial peace we seek. Indeed, subscribing to an abundance mentality means that you can share your blessings with others and fully experience the joy of giving.

You may have questions about how to best achieve your charitable ambitions in conjunction with your other financial goals. If you have you ever asked yourself any of these questions, we have the answers and expertise to help you.

How much can we give to charity each year and still meet our goals for retirement and college savings?
How much can we give to family or friends without having to file a gift tax return?
What is the best way to give money to grandchildren? UTMA, 529 College Savings Plan, Children’s Trust, or other methods? What are the financial aid implications of my gift to a grandchild?
What tax benefits would we receive for donating appreciated securities, instead of donating cash, to our favorite charities?
Are we candidates for a Donor Advised Fund, a private foundation, or a family trust? How does a Donor Advised Fund work?
We’ve had a windfall year (sale of business, inheritance, etc.). How can we maximize our current year tax deductions and allow for future charitable bequests?
How can I provide for my spouse, if something should happen to me, and still be sure to leave something for my children or favorite charity. Which are the best accounts to leave to my spouse, children, or charities? And what tax implications will there be for my estate and beneficiaries?

These are all important considerations for a comprehensive financial plan, and while there is no one-size-fits-all answer, there are many tools and techniques which can help you make the most of your giving. Whether you’ve been investing for 5 years or 50 years, we’re here to give you the expert advice on how to achieve your giving goals as part of your overall financial plan.

Because we believe generosity is the pinnacle of financial independence, Good Life Wealth Management will donate a minimum of 10% of its profits annually to charitable organizations. For 2015, our primary recipient will be Operation Kindness, the largest and oldest no-kill animal shelter in North Texas.

Setting Your Financial Goals

Posted On May 5, 2015 By Admin In Financial Planning /

No achievement occurs by accident. It takes intention, planning, hard work, and perseverance to accomplish a significant task. For this reason, I have always been a big believer in setting goals in writing. For something to be a “goal”, it needs to be concrete and not merely a vague desire. Your chance of achieving a goal is dramatically improved when it is SMART: Specific, Measurable, Attainable, Realistic, and Timely. This simple, perhaps corny, acronym has guided many for decades because it works.

When a goal meets the SMART criteria, you can lay out a blueprint of steps you will take to accomplish your goal. We can break these steps down further into long-term, intermediate, and short-term goals. If your long-term goal is to graduate from college with a certain major, that will require a series of required and elective courses and credit hours you must complete. That is a four-year goal. The intermediate goal might be to pass specific courses this semester. You have to pass Econ 101 before you can take Econ 102. The short-term goal is to do the reading and homework that is assigned for this week. If you don’t do the short-term work, you cannot pass the course this semester, or graduate in four years. Your short-term goals feed into your intermediate goals and into your long-term goals.

This concept is so basic and universal, that it seems almost unnecessary to even need to mention this. Unfortunately, when it comes to finances, many people don’t apply this same thinking and planning process that has enabled them to succeed in other areas of life. They don’t set SMART goals, nor do they work on short-term objectives which will enable them to achieve their long-term goals.

Instead, they hope that the finances will magically take care of themselves. Or that they don’t need to worry about it now, because it will be easier later. Or fatalistically, that the game is rigged and that they shouldn’t even bother trying.

The desire should be to become wealthy. Unfortunately, this statement carries a social stigma for many of us. It’s not something we’d want to say in public, put on our resume, or post as our Facebook status. We are taught to be humble, eschew materialism, and reject greed, as we should. We have heard that the love of money is the root of all evil. We may sub-consciously believe that people who have money have gotten it by exploiting others, cheating, or deceit.

Unfortunately, these beliefs are ultimately self-limiting. They create an excuse for not setting financial goals and keep smart people poor. Chances are that you simply have not looked at finances as an area where you have as much control as other areas of your life. Many people spend more time planning their next vacation than they do planning their financial goals. Granted, a vacation is more fun than organizing your finances, but financial planning has to start with you. No one else can make you do it.

You need to sincerely have the desire to become wealthy. Without that strong drive, you will not be successful. It is like training for a marathon – you don’t just wake up one day and go run a marathon. It takes planning, training, perseverance, and dedication. If you cannot imagine yourself as deserving to be “wealthy”, you may find that another term may be more meaningful for you and resonates with you personally. Consider: financial independence, security, or abundance. As in “my desire is to create a life of abundance for my family”. Let’s avoid framing a goal in negative-terms, what it is not, but you could also say that the goal of financial independence is to eliminate stress and fear of running out of money. Whatever terminology or mantra fits best for you, it is essential that you adopt this desire earnestly.

I view money like water – it is the most abundant resource on the planet, available to us in vast and limitless quantities. The world is literally awash in money. However, it is also true that many of us live in a desert where water is scarce and hard to come by. We can bemoan this fact, but that will not get us any closer to the water. Even worse, we may have decided to live in the desert, but then claim that we have no choice. We think that because there is no water here, that there is no water anywhere, which is false. We may give up, since there is no water here. Or, we may stubbornly keep digging a deeper well, even though our efforts are getting us nowhere.

We have to empower ourselves to recognize that there is no one holding us back from finding water. We should stop blaming ourselves if we do not find water where it isn’t located. But we do have to move on, and accept that we will go to where the water is. Some people seem to be natural at finding water, and once they have that skill, they don’t ever have to fear being thirsty again. They have created a well that provides them abundantly. Even if they lost all the water they have now, they could go out and find more. It is there for the taking.

Many people fail to realize that they are in a desert and think that those who have an abundance of water are smarter, harder-working, lucky, or just born with it. And while that may sometimes be true, I can tell you that many, many people who lead a life of abundance are not better educated or any of these things. They simply have taken a step back and made deliberate choices to be where the water is located. They believe that they do deserve abundance and will take the steps to earn all that they can.

A desire for wealth will not take you very far by itself. For this to become a goal that you can use to take actionable steps, it must be more concrete. A SMART goal gives you the road map and lays out your short-term, intermediate, and long-term goals.

When I started Good Life Wealth Management, a few advisors told me to set high account minimums and only accept clients who had $500,000, $1 million, or more. I understand their business rationale, but previously working at a firm where a $1 million account was considered a nuisance, I missed the thrill of helping investors set goals and chart their own road map.

If you’ve been waiting to get started, afraid to find out how much you should be doing, don’t delay further. Let’s get started on your goals today.

Fixed Income: Four Ways to Invest

Posted On April 28, 2015 By Admin In Portfolio Management /

Fixed Income is an essential piece of our portfolio construction, a component which can provide cash flow, stability, and diversification to balance out the risk on the equity side of the portfolio. Although fixed income investing might seem dull compared to the excitement of the stock market, there are actually many different categories of fixed income and ways to invest. As an overview, we’re going to briefly introduce the various tools we use in our fixed income allocations.

1) Mutual Funds. Funds provide diversification, which is vitally important in categories with elevated risks such as high yield bonds, emerging market debt, or floating rate loans. In those riskier areas, we want to avoid individual securities and will instead choose a fund which offers investors access to hundreds of different bonds. A good manager may be able to add value through security selection or yield curve positioning.

While we largely prefer index investing in equities, the evidence for indexing is not as conclusive in fixed income. According to the Standard & Poor’s Index Versus Active (SPIVA) Scorecard, only 41% of Intermediate Investment Grade bond funds failed to beat their index over the five years through 12/31/2014. Compare that to the 81% of domestic equity funds which lagged their benchmark over the same five year period, and you can see there may still be an argument for active management in fixed income.

2) Individual Bonds. We can buy individual bonds for select portfolios, but restrict our purchases to investment grade bonds from government, corporate, and municipal issuers. The advantage of an individual bond is that we have a set coupon and a known yield, if held to maturity. While there will still be price fluctuation in a bond, investors take comfort in knowing that even if the price drops to 90 today, the bond will still mature at 100. It’s difficult for a fund manager to outperform individual bonds today if their fund has a high expense ratio. You cannot have a 1% expense ratio, invest in 3% and 4% bonds, and not have a drag on performance.

Those are the advantages of individual bonds, but there are disadvantages compared to funds, including liquidity, poor pricing for individual investors, and the inability to easily reinvest your interest payments. Most importantly, an investor in individual bonds will have default risk if we should happen to own the next Lehman Brothers, Enron, or Detroit. Bankruptcies can occur, and that’s why we only use individual bonds in larger portfolios where we can keep position sizes small.

3) Exchange Traded Funds (ETFs). ETFs offer diversified exposure to a fixed income category, but often with a much lower expense ratio than actively managed funds. ETFs can allow us to track a broad benchmark or to pinpoint our exposure to a more narrow category, with strict consistency. Fixed income ETFs have lagged behind equity ETFs in terms of development and adoption, but there is no doubt that bond ETFs are gaining in popularity and use each year.

4) Closed End Funds (CEFs). CEFs have been around for decades, but are not well known to many investors. Closed End Funds have a manager, like a mutual fund, but issue a fixed number of shares which trade on a stock exchange. The result is a pool of assets which the fund can manage without worry about inflows or redemptions, giving them a more beneficial long-term approach. With this structure, however, CEFs can trade at a premium or a discount to their Net Asset Value (NAV). When we can find a quality fund trading at a steep discount, it can be a good opportunity for an investor to make a purchase. Unfortunately, CEFs tend to have higher volatility than other fixed income vehicles, which can be disconcerting. We don’t currently have any CEF holdings as core positions in our portfolio models, but do make purchases for some clients who have a higher risk tolerance.

Where fixed income investing can become complicated is that within each category (such as municipal bond, high yield, international bond, etc), you also have to compare these four very different ways of investing: mutual funds, individual bonds, ETFs, or CEFs. They each have advantages and risks, so it’s not as easy as simply choosing the one with the highest yield or the strongest past performance. And that’s where we dive in to each option to examine holdings, concentrations, duration, pricing and costs.

There are other ways to invest in fixed income, such as CDs, or annuities, and we can help with those, too. But most of our fixed income investing will be done with mutual funds and ETFs. In larger portfolios, we may have some individual bonds, but will always have funds or ETFs for riskier categories.

Investors want three things from fixed income: high yield, safety, and liquidity. Unfortunately, no investment offers all three; you only get to pick two. Where we aim to create value is through a highly diversified allocation that is tactical in looking for the best risk/reward categories within fixed income.

Will the IRS Inherit Your IRA?

Posted On April 20, 2015 By Admin In Financial Planning /

For several years, there has been a proposal in Washington to eliminate the Stretch IRA, also known as the “Inherited IRA” or “Beneficiary IRA”. Currently, when your beneficiary inherits your IRA, they can keep the account tax-deferred by leaving the assets in a Stretch IRA. While they have to take Required Minimum Distributions, using a Stretch IRA keeps distributions small and taxes low, as well as encourages beneficiaries to use the money gradually rather than spend their inheritance immediately.

Congress is looking for new ways to reduce the budget deficit, and according to IRA expert Ed Slott, it is increasingly probable that the Stretch IRA will be eliminated in the near future. Forcing beneficiaries to withdraw their inherited IRAs will raise billions in tax revenue, while allowing politicians to say that they haven’t raised tax rates.

If the Stretch IRA is repealed, beneficiaries will have to withdraw all of an inherited IRA – and pay taxes on the distributions – within five years. For many retirees, their retirement accounts are their largest assets. Many have accumulated a significant sum, often $1 million or more. If your beneficiary receives a $1 million IRA in one year, regardless of whether they spend the money or invest it, they could owe up to $396,000 in income tax. Even spreading the withdrawal over five years ($200,000 a year) will push any tax payer into a high tax bracket where the IRS will collect 28%, 33%, or more from your IRA.

If you aren’t touching your IRAs because you have other sources of retirement income, such as a pension, Social Security, or other investments, you may have been thinking that you would leave the IRA to your heirs and not take any withdrawals. It’s a very generous plan, but if the Stretch IRA is repealed, a significant amount of your IRA is going to end up in the pockets of the IRS.

What can you do to minimize the taxes and maximize the amount your heirs will receive? Here are three ways to accomplish this:

1) Buy life insurance. Use your IRA money to fund a permanent life insurance policy, such as a level premium Universal Life policy. Life insurance death benefits are received income tax-free. Purchase a $1 million policy for your beneficiaries and they will receive all $1 million tax-free.

For example, a healthy 65-year old male can purchase a $1 million Universal Life policy for as little as $17,218 per year. That is a sizable premium, but not a bad deal to guarantee your heirs a $1 million payout, tax-free. While funding those premiums from your IRA does create taxes, the taxes paid will be lower if you take small withdrawals over a period of many years rather than leaving your heirs in a position of having to take the entire distribution over 5 years (or 1 year if they don’t do the distribution correctly).

If you don’t need the income from your RMDs, using those distributions to fund a life insurance policy may have a significant benefit for your heirs.

2) Leave to Charity. There is a way to pay no tax on your IRA on death and that is to leave the account to a charity. 501(c)(3) non-profit organizations will not have to pay any income tax when they are named as the beneficiary of your IRA or retirement accounts. If you were planning to leave something to charity, make sure that bequest is from your IRA and not from a regular account.

For example:

Scenario 1: You leave a $1 million taxable account to charity and a $1 million IRA to your daughter. The charity receives $1 million, but your daughter will owe taxes up to $396,000 on the IRA, leaving her with as little as $604,000.

Scenario 2: You leave the $1 million taxable account to your daughter and the $1 million IRA to the charity. The charity receives $1 million, your daughter receives $1 million (and a step-up in cost basis), and the IRS gets zip. Much better!

3) Spread out your IRA. If you leave $1 million to one beneficiary, they will have to pay tax on the entire amount. If you leave the IRA to 10 beneficiaries (perhaps grandchildren, nieces, nephews, etc.), the tax due will be much less on $100,000 for 10 tax payers than on $1 million received by one person.

Please note that spouses can roll their deceased spouse’s IRA into their own IRA and treat it as their own. If the Stretch IRA is repealed, this may not be a problem for leaving an IRA to your spouse. However, if your spouse consolidates both of your IRAs into one account, the tax problem for the subsequent heirs will have become even more significant.

The one good thing about IRAs is that you can change your beneficiaries at any time without having to re-do your Will and other documents in your Estate Plan. It is very important to remember that your IRA beneficiary designations override any instructions in your Will, so it is vital to have your beneficiary designations correct and up-to-date.

Not sure where to begin with your Estate Plan? We can help you find the right solution for your family, using our Good Life Wealth planning process. Interested in finding out more about life insurance? I’m an independent agent and can help you choose the best insurance policy for your goals. Call me with your questions, reducing taxes is my passion!

Rethink Your Car Expenses

Posted On April 13, 2015 By Admin In Financial Planning / 1 Comment

“Don’t be penny wise and pound foolish.”

This old nugget of wisdom remains relevant today with many people feeling frustrated that even with a decent income, it seems so difficult to save as much as we’d like for retirement and our other financial goals. Rather than worrying about the pennies, I think investors who want to increase their saving are best served by focusing on their two biggest expenses: their home and cars.

Although not a great investment, a home is generally an appreciating asset and offers some valuable tax deductions. It is possible to have too much home and be house rich and cash poor, but our focus is better first directed on car expenses. I love cars, as do most Americans. A car represents freedom, and as a kid, I couldn’t wait to learn to drive. I took my drivers permit test right on the day of my 16th birthday. We view our cars as a representation of our self, our status, and our importance. Yes, even Financial Advisors are guilty of this irrational vanity! (Or is it insecurity?)

Unfortunately, a car is a depreciating asset and often our biggest expense outside of our home. New car prices seem to have outpaced wage growth, and everyone always wants the latest and greatest. We have to set priorities for how we use our income, and any money we spend on a car is gone. You won’t get it back, it’s just flushed away. That’s money we can’t invest and can’t use to create our future independence and income. If you want to have more of your money working for you, it pays to be smart about your cars. Here are five ways to keep your automotive expenses down.

1) Keep what you have. Cars greatest depreciation is in their first 3-5 years, so if you can keep your car longer, your annual costs will be lower. The more frequently you replace your cars, the more expensive it will be. That’s the number one thing you can do: keep your vehicles 7-12 years. The more often you sell one car and buy another, the higher your costs over time.

2) Don’t fear the occasional repair. Today’s cars are more dependable and long-lasting than ever. Psychologically, people hate repairs, since they seem to always occur at the most inopportune moments. Many people would rather spend $500 a month on a new car payment rather than risk having $1,000 to $2,000 a year in maintenance and unplanned repairs. Does it make sense to spend $6,000 a year to avoid spending $2,000? Probably not, but this is what you are doing if you think that you must sell a car as soon as it is past its warranty.

It’s true, it feels much worse to spend $2,000 on an unplanned repair than to spend the same amount in scheduled car payments. In behavioral finance, this is called “prospect theory”, where people feel the impact of a loss much more severely than the benefit of an equivalent gain. Unfortunately, this can lead to less than ideal decisions, such as buying a $40,000 car because we’re upset over a $400 repair.

If a car is in relatively good shape, it will most likely be cheaper to keep a car with 100,000 miles on the road, rather than replacing it with a new car.

3) Pay cash for your cars. Most people don’t want to spend $60,000 on a new car, even though we all want that $60,000 car. I’d like to first point out the opportunity cost here. At a hypothetical 8% rate of return, spending $60,000 today on a car means not having $120,000 in 9 years, $240,00 in 18 years, or $480,000 in 27 years. That’s a steep price for a car. Which would you rather have, a new car today or potentially an additional $480,000 at retirement?

The strategy of paying cash for cars isn’t just about saving on interest payments; it’s about changing your behavior. Paying cash will force you to spend less, to look at used cars, and to keep your current car longer. Too often, I hear people brag that they got a new car and kept their payment the same. So what! Your current payment was going to end – all you’ve done is keep yourself in debt for another 5 or more years.

If you currently have a car payment, once your payments end, set aside that monthly amount in a savings account for your next car. Paying cash forces you to delay buying a new car. Otherwise, it’s very easy to take a loan for a new vehicle and then rationalize why you “needed” a new car.

4) Save money on maintenance. If you’re handy with tools, you can save a lot of money by doing some routine maintenance yourself. My dealership wanted $499 for a 30,000 mile service consisting of an oil change, tire rotation, brake fluid change, and replacement of two air filters. I did the work myself and spent less than $70 on materials. Oil changes are cheap, so you can’t save much there, but you can save a lot if you learn to replace your brakes.

Don’t try to save money by skipping preventative maintenance. Make sure you change all fluids on the factory recommended schedule. Even if you do some work yourself, I’d also suggest developing a good relationship with an independent mechanic who you trust to give you honest advice.

5) Know when to buy new, buy used, or lease. The price of used cars has skyrocketed in recent years. It used to be that a 1-year old car had lost 20% or more of its value. Today, that can be under 10% for some popular makes and models. This increased residual value has changed some of the old rules about car buying. A gently used 2-3 year old car is, in many cases, not the bargain that it was 10 years ago. In those situations where resale value is very high, you might actually consider buying new. This will improve your future resale value, keep you under warranty longer, and possibly offer better terms on any financing. If you’re planning to keep the car for a long time (7-12 years), starting with a new car can be a good decision.

Buying used cars used to be an easy way to save 30% or more. There are still some good deals on used cars, but consider dependability, any remaining factory warranty, and the cost of maintenance on used vehicles. If you get bored with vehicles after a couple of years, used cars will have less depreciation than buying new.

Leasing is more expensive than keeping your cars for as long as I’d suggest. However, it is still a good alternative to buying a new car every three years, provided you drive fewer miles than stipulated in your lease agreement (often 10,000 or 12,000 miles per year). For models with high residual values, lease rates have stayed low.

Manage your car depreciation like you would any other liability. At the end of the day, a car is just a way to get from point A to point B. It doesn’t define us, who we are, or what our value is to our family or society. If you have other priorities like retiring early, buying a vacation home, or making your first million (or your second or third million), recognize when your car buying is not helping you get closer to achieving your more important goals.

Which IRA is Right For You?

Posted On April 6, 2015 By Admin In Retirement Planning / 3 Comments

We talk about Individual Retirement Accounts (IRAs) regularly, yet even for long-time investors, there are often some gaps in understanding all your options. This means that many investors are missing chances to save money on taxes, which is the primary advantage of IRAs versus regular “taxable” accounts.

Here’s a primer on the six types of IRAs you might encounter. For each type of IRA, I’m including an interesting fact on each, which you may be something you haven’t heard before! All numbers are for 2015; call me if you have questions on 2014 eligibility.

1) Traditional IRA. This is the original IRA, yet has the most complicated rules. Anyone can contribute to a Traditional IRA. Contributions grow tax-deferred and then you are taxed on any gains when the money is withdrawn.

The confusing part of the Traditional IRA is whether or not you can deduct the contribution from your income taxes. If you are in the 25% tax bracket, a $5,500 contribution will reduce your taxes by $1,375. Anyone can contribute, but not everyone can deduct their contribution. Here are the rules for three scenarios:

a) If you are not eligible for an employer sponsored retirement plan (and your spouse is also not eligible for one), then you (and your spouse) can deduct your IRA contributions.

b) If you are covered by an employer sponsored retirement plan, you can deduct your contribution if your Modified Adjusted Gross Income (MAGI) is below $61,000 (single), or below $98,000 (married, filing jointly).

c) If your spouse is covered by an employer sponsored plan, but you are not, you can deduct your contribution if your joint MAGI is below $183,000.

I suggest avoiding non-deductible contributions to a Traditional IRA as the deduction is the main benefit. If you’re eligible for a Roth IRA, never make a non-deductible contribution to a Traditional IRA. Non-deductible contributions create a cost basis for your IRAs, which you will have to track for the rest of your life. It’s a headache you don’t need.

Spouses can contribute to an IRA based on joint income, even if they do not have an income of their own. You cannot contribute to a Traditional IRA in the year you reach age 70 1/2. At that point, you must start Required Minimum Distributions. A premature withdrawal, before age 59 1/2, is subject to a 10% penalty, in addition to any income taxes due.

Interesting Fact: A Rollover IRA is a Traditional IRA. You can roll a 401(k) or other employer sponsored plan to a Traditional IRA or a Rollover IRA; they receive the same treatment. 401(k) plans are governed by Federal ERISA rules, whereas IRAs are protected under state creditor laws. If you want to remain under the Federal Regulations, you should designate the account as a “Rollover IRA” and not commingle with a Traditional IRA. I consider this step unnecessary. In Texas, we have robust protection for IRAs, so you are not at risk by consolidating accounts into one Traditional IRA.

2) Roth IRA. In a Roth IRA, you contribute after-tax dollars, so there is no upfront tax deduction. Your account grows tax-free, and there is no tax due on withdrawals in retirement. The Five Year Rule” requires you to have had a Roth open for at least 5 years before you can take tax-free withdrawals in retirement. So, if you open a Roth at age 58, you would not be able to access tax-free withdrawals until age 63.

Not everyone is eligible to contribute to a Roth IRA. To be eligible for a full contribution, your MAGI must be below $116,000 (single), or $183,000 (married).

Interesting Fact: There are no RMDs on Roth IRAs and no age limits. Even after age 70 1/2, you can contribute to a Roth IRA (provided you have earned income) or convert a Traditional IRA to a Roth.

3) “Back Door” Roth IRA. This is not a separate type of account, but rather a funding strategy. If you make too much to contribute to a Roth IRA, you can fund a Non-Deductible Traditional IRA, then immediately convert the account to a Roth. You pay taxes on any gains, but since there were no gains, your tax due is zero. Very important: the conversion is only tax-free if you do not have any existing Traditional IRAs.

Both Traditional and Roth IRAs are subject to a combined contribution limit of $5,500, or $6,500 if age 50 or older.

Interesting Fact: Thinking of rolling your old 401(k) to an IRA? Don’t do it if you might want to do a Back Door Roth in the future. Rolling to an IRA will eliminate your ability to do a tax-free Roth conversion. Instead, leave your old 401(k) where it is, or roll it into your new 401(k).

4) Stretch IRA, also called an Inherited IRA or a Beneficiary IRA. If you are named as the beneficiary of an IRA, the inherited account is taxable to you. If you take the money out in the first year, it will all be taxable income. With a Stretch IRA, you can keep the inherited IRA tax-deferred, and only take Required Minimum Distributions each year. Note that Stretch IRA RMDs are based on the original owner’s age, so you cannot use a regular RMD calculator to determine the amount you must withdraw.

Interesting Fact: a spouse who inherits an IRA from their deceased spouse does not have to do a Stretch IRA. Instead, he or she can roll the IRA into their own account and treat it as their own. This is especially beneficial if the surviving spouse is younger than the decedent.

5) SEP-IRA. SEP stands for Simplified Employee Pension. A SEP is an employer sponsored plan where the employer makes a contribution of up to 25% of the employee’s compensation, with a contribution cap of $53,000. Since it is an employer plan, you cannot discriminate and must make the same contribution percentage for all employees. As a result, pretty much the only people who use a SEP are those with no employees. The SEP is most popular with people who are self-employed, sole proprietors, or who are paid as an Independent Contractor via 1099 rather than as an Employee via W-2.

Let’s say you have a regular job and also do some freelancing as an Independent Contractor. You can contribute to the 401(k) through your employer AND contribute to the SEP for your 1099 work. You can also do a SEP in addition to a Traditional or Roth IRA.

Interesting Fact: The SEP is the only IRA which you can fund after April 15. If you file a tax extension, you have until you file your taxes to fund your SEP. We can accept 2014 SEP contributions all the way up to October 15, 2015.

6) SIMPLE IRA is the Savings Incentive Match Plan for Employees. It’s like a 401(k), but just for small businesses with fewer than 100 employees. Employees who choose to participate will have money withheld from their paycheck and invested in their own account. The employer matches the contribution, up to 3% of the employee’s salary. This is a great option for small businesses because the costs are low and the administration and reporting requirements are easy. The 2015 contribution limit is $12,500, or $15,500 if over age 50.

Interesting Fact: Traditional and SEP IRAs have a 10% penalty for premature distributions prior age 59 1/2. For a SIMPLE IRA, if you withdraw funds within two years of opening the account, the penalty is 25%. Contributions made by both the employee and employer are immediately vested, so the high penalty is to discourage employees from raiding their SIMPLE accounts to spend the employer match.

IRAs are a very important tool for wealth accumulation, yet a lot of investors miss chances to participate and maximize their benefits. Since the contribution limits are low, it can be tough to make up for lost years. Your best bet: meet with me, bring your tax return and your investment statements and we can discuss your options.

Our Investment Process

Posted On April 1, 2015 By Admin In Portfolio Management / 1 Comment

Growth Versus Value: An Inflection Point?

Posted On March 30, 2015 By Admin In Portfolio Management /

Over time, Value stocks outperform Growth stocks. There are a number of reasons why this has held true over the history of the market. Value stocks may include sectors which are currently out of favor and inexpensive. Investors, on the other hand, are sometimes willing to pay too much for a sensational growth story rather than a boring, blue chip company. Often, those great sounding stocks flame out rather than shooting higher as hoped. The result is that the long-term benefit of value strategies has persisted.

Although the “Value Anomaly” is a historical fact, it hasn’t worked in all periods, and we’re at such a point in time now. Growth has actually outperformed value over the past decade. Even though growth beat value in only 5 of the past 10 calendar years, the cumulative difference is notable. Over the past 10 years, the Russell 1000 Growth fund (IWF) has returned an annualized 9.18% versus 7.10% for the Russell 1000 Value (IWD). And so far this year, Growth (IWF) is up 5%, whereas Value (IWD) has gained only 0.63%.

The last time growth showed a marked divergence from value was the 90’s. And at that time, we saw the valuations of growth companies rise to unsustainable levels. This largely occurred in the tech sector, where for example, we saw Cicso trade for more than 200 times earnings, and become the most valuable company in the world in 2000. Eventually, growth corrected with the bursting of the tech bubble, and we saw value stocks return to favor. These are the cycles of the market, as inevitable as the seasons, although not as consistent, predictable, or rational!

I don’t think we’re in bubble territory for the market today, but some popular growth names have certainly started to become expensive and value is looking like a relative bargain. Looking at the top 10 stocks in the both indices, the growth stocks have an average PE of 27, versus 17 for the 10 largest value companies. Some of that difference is Facebook, #4 on the Growth list, with a PE of 75. However, the difference in valuation is across the board. Two of the largest value companies, Exxon Mobil and JPMorgan Chase have a PE of only 11.

So, what are the take-aways from the Growth/Value divergence?

Growth has outperformed value in recent years. This will not continue forever.
Our portfolios are diversified, owning both growth and value segments. We have a slight tilt towards value, which we will continue. When value returns to favor, this will benefit not only pure value funds, but will also likely help dividend strategies, low volatility ETFs, and fundamentally-weighted funds.
As the overall market becomes more expensive, I would expect to see that we will move from a unified market, where all stocks move up or down together, to a more segmented market, where stocks move more based on their valuation and fundamentals. Global macro-economics have been the primary driver of stock prices in recent years, but this should abate somewhat as the recovery continues.

We won’t know if we’ve reached an inflection point, where value will overtake growth, until well after the fact. Growth can’t outperform indefinitely, and as investors become more cautious, value stocks will start to look more and more attractive. That’s what we’re seeing in the market today and why we started to increase our value holdings in 2015.

Source of fund data: Morningstar, through 3/27/2015

How Much Can You Withdraw in Retirement?

Posted On March 24, 2015 By Admin In Retirement Planning /

With corporate pensions declining in use, retirees are increasingly dependent on withdrawals from their 401(k)s, IRAs, and investment accounts. The challenge facing investors is how to plan these withdrawals and not run out of money even though we don’t know how long we will live or what returns we will receive in the market on our portfolio.

Pensions and Social Security provide a consistent source of income that you cannot outlive. When I run Monte Carlo simulations – computer generated outcomes testing thousands of possible scenarios – we find that the larger the percentage of monthly needs that are met from guaranteed sources, the lower chance the investor will run out of money due to poor market performance from their portfolio.

If you do have a pension, it is very important to consider all angles when deciding between a lump sum payout and participating in the pension for the rest of your life. It is not a given that you will be able to outperform the pension payments, especially if you are healthy and have a long life expectancy.

The most obvious way to avoid running out of money (called longevity risk by financial planners) would be to annuitize some portion of your portfolio through the purchase of an immediate annuity from an insurance company. While that would work, and is essentially the same as having a pension, very few people do this. You’d be giving up all control of your assets and reducing any inheritance for your beneficiaries. With today’s low interest rates, you’d probably be less than thrilled with the return. For example, a 65-year old male who places $100,000 in a single life immediate annuity today would receive $542 a month.

The problem with annuitization, besides giving up your principal and not leaving anything for your heirs, is that it doesn’t allow for any increase in expenditures to account for inflation. There are three approaches we might use to structure a withdrawal program for a retiree.

1) Assume a fixed inflation rate. In most retirement planning calculators, projected withdrawals are increased by inflation to maintain the same standard of living. After all, who doesn’t want to keep their standard of living? The result of this approach is that the initial withdrawal rate then must be pretty low. 20 years ago, the work of William Bengen established the “4% rule” which found that a withdrawal rate of 4% would fund a 30-year retirement under most market conditions.

On a $1 million portfolio, 4% is $40,000 a year. But that is just the first year. With 3% inflation, we’d plan on $41,200 in year two, and $42,436 in year three. After 24 years, withdrawals would double to $80,000. The 4% rule is not the same as putting your money in a 4% bond; it’s the inflation which requires starting with a low initial rate.

While we should plan for inflation in retirement, this method is perhaps too rigid in its assumptions. If a portfolio is struggling, we’re not going to continue to increase withdrawals by 3% and spend the portfolio to zero. We have the ability to respond and make adjustments as needed.

2) Take a flexible withdrawal strategy. We may be able to start with a slightly higher initial withdrawal rate if we have some flexibility under what circumstances we could increase future withdrawals. In my book, Your Last 5 Years: Making the Transition From Work to Retirement, I suggest using a 4% withdrawal rate if you retire in your 50’s, a 5% rate if you start in your 60’s, and 6% if retiring in your 70’s. I would not increase annual withdrawals for inflation unless your remaining principal has grown and your withdrawal rate does not exceed the original 4, 5, or 6%.

This doesn’t guarantee lifetime income under all circumstances, but it does give a higher starting rate, since we eliminate increases for inflation if the portfolio is shrinking. Under some circumstances, it may even be prudent to reduce withdrawals to below the initial withdrawal amount temporarily. That’s where having other sources of guaranteed income can help provide additional flexibility with your planning.

3) Use an actuarial method. This means basing your withdrawals on life expectancy. Required Minimum Distributions (RMDs) are a classic example of an actuarial strategy: you take your account value and divide by the number of years of life expectancy remaining. If your life expectancy is 25 years, we take 1/25, or 4%. The next year, the percentage will increase. By the time someone is in their 90’s, their life expectancy will be say three years, suggesting a 33% withdrawal rate, which may work, but obviously will not be sustainable. However, the more practical problem with using the RMD approach is that many people aren’t able to cut their spending by 20% if their portfolio is down by 20% that year. So even though it has a sound principle for increasing withdrawals, the withdrawal amounts still require flexibility based on market results.

But there are other ways to use the actuarial concept, and even my approach of different rates at different retirement ages is based on life expectancy. There’s no single method that will work in all circumstances, but my preference is to take a flexible strategy. But this does mean being willing to reduce spending, and forgo or even cut back inflation increases, if market conditions are weak.

We have a number of different tools available to evaluate these choices throughout retirement, but the other key factor in the equation is asset allocation. Bengen found that his 4% rule worked with equity allocations between 50% and 75%. Below 50% equities, the portfolio struggles to keep up with inflation and withdrawals become more likely to deplete the assets in the 30-year period. Above 75% equities, the portfolio volatility increases and rebalancing benefits decrease, increasing the number of periods when the 4% strategy would have failed.

When sorting through your options, you need candid and informed advice about what will work and under what circumstances it would not work. We hope for the best, but still have a plan for contingencies if the market doesn’t cooperate as we’d like. We will be able to consider all our options as the years go by and be proactive about making adjustments and corrections to stay on course. For any investor planning for a 30-year retirement, it’s not a matter of if the market will have a correction, but when. It’s better to have discussed how we will handle that situation in advance, rather than waiting until the heat of the moment.

Deferral Rates Trump Fund Performance, Rebalancing as Key to Retirement Plan Success

Posted On March 16, 2015 By Admin In Retirement Planning /

A study by the Putnam Institute, “Defined Contribution Plans: Missing the forest for the trees?” contends that while a number of variables, such as fund selection, asset allocation, portfolio rebalancing, and deferral rates all contribute to a defined contribution plan’s effectiveness — or lack thereof — it is deferral rates that should be placed near the top of the hierarchy when considering ways to boost retirement saving success.¹

As part of its analysis, the research team created a hypothetical scenario in which an individual’s contribution rate increased from 3% of income to 4%, 6%, and 8%. After 29 years, the final balance jumped from $138,000, to $181,000, $272,000, and $334,000, respectively.

Even with a just a 1% increase — to a 4% deferral rate — the participant’s final accumulation would have been 30% greater than it would have been using a fund selection strategy defined as the “Crystal Ball” strategy, in which the plan sponsor uses a predefined formula to predict which funds may potentially perform well for the next three-year period. Further, the 1% boost in income deferral would have had a wealth accumulation effect nearly 100% larger than a growth asset allocation strategy, and 2,000% greater than rebalancing. Of course these results are hypothetical and past performance does not guarantee future results.

One key takeaway of the study was for plan sponsors to find ways to communicate the benefits of higher deferral rates to employees, and to help them find ways to do so.

Retirement Savings Tips

The Employee Benefit Research Institute reported in 2014 that 44% of American workers have tried to figure out how much money they will need to accumulate for retirement, and one-third admit they are not doing a good job in their financial planning for retirement.² Are you? If so, these strategies may help you to better identify and pursue your retirement savings goals:

Double-check your assumptions. When do you plan to retire? How much money will you need each year? Where and when do you plan to get your retirement income? Are your investment expectations in line with the performance potential of the investments you own?

Use a proper “calculator.” The best way to calculate your goal is by using one of the many interactive worksheets now available free of charge online and in print. Each type features questions about your financial situation as well as blank spaces for you to provide answers. But remember, your ultimate goal is to save as much money as possible for retirement regardless of what any calculator might suggest.

Contribute more. At the very least, try to contribute enough to receive the full amount of any employer’s matching contribution. It’s also a good idea to increase contributions annually, such as after a pay raise.

Retirement will likely be one of the biggest expenses in your life, so it’s important to maintain an accurate cost estimate and financial plan. Make it a priority to calculate your savings goal at least once a year.

Today’s blog content is provided courtesy of the Financial Planning Association.

Source/Disclaimer:

¹Putnam Institute, Defined Contribution Plans: Missing the forest for the trees?, May 2014.

²Ruth Helman, Nevin Adams, Craig Copeland, and Jack VanDerhei. “The 2014 Retirement Confidence Survey: Confidence Rebounds–for Those With Retirement Plans,” EBRI Issue Brief, no. 397, March 2014.

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