IRS Announces New Waiver Procedure for Taxpayers Who Inadvertently Miss the 60-day Rollover Deadline
Background–direct and indirect (60-day) rollovers
If you’re eligible to receive a taxable distribution from an employer-sponsored retirement plan (like a 401(k)) you can avoid current taxation by directly rolling the distribution over to another employer plan or IRA (with a direct rollover you never actually receive the funds). You can also avoid current taxation by actually receiving the distribution from the plan, and then rolling it over to another employer plan or IRA within 60 days following receipt (a “60-day” or “indirect” rollover). But if you choose to receive the funds instead of making a direct rollover the plan must withhold 20 percent of the taxable portion of your distribution, even if you intend to make a 60-day rollover. (You’ll need to make up those withheld funds from your other assets if you want to roll over the entire amount of your plan distribution.)
Similarly, if you’re eligible to receive a taxable distribution from an IRA, you can avoid current taxation by either transferring the funds directly to another IRA or to an employer plan that accepts rollovers (sometimes called a “trustee-to-trustee transfer”), or by taking the distribution and making a 60-day indirect rollover (20% withholding doesn’t apply to IRA distributions).
Under recently revised IRS rules you can make only one tax-free, 60-day, rollover from any IRA you own (traditional or Roth) to any other IRA you own in any 12-month period. However, this limit does not apply to direct rollovers or trustee-to-trustee transfers (or to Roth IRA conversions). Because of the 20% withholding rule, the one-rollover-per-year rule, and the possibility of missing the 60-day deadline, in almost all cases you’re better off making a direct rollover or trustee-to-trustee transfer to move your retirement plan funds from one account to another.
Exceptions to the 60-day rollover deadline
But what happens if you do receive an actual distribution from your employer plan or IRA and you want to roll over the funds, but you’ve missed the 60 day deadline? There are limited statutory exceptions to the 60-day rule. For example, the time for making a rollover may be extended for those serving in a combat zone or in the event of a presidentially declared disaster or a terrorist or military action.
But the IRS also has the authority to waive the 60-day limit “where the failure to waive such requirement would be against equity or good conscience, including casualty, disaster, or other events beyond the [individual’s] reasonable control.” To seek a waiver you previously had to request a private letter ruling from the IRS. However, the IRS has just announced (in Revenue Procedure 2016-47) a simpler alternative to seeking a private letter ruling.
The new waiver alternative: “self-certification”
Under the new procedure, if you want to make a rollover but the 60-day limit has expired, you can simply send a letter (the Revenue Procedure contains a sample) to the plan administrator or IRA trustee/custodian certifying that you missed the 60-day deadline due to one of the following 11 reasons:
- The financial institution receiving the contribution, or making the distribution to which the contribution relates, made an error.
- You misplaced and never cashed a distribution made in the form of a check.
- Your distribution was deposited into and remained in an account that you mistakenly thought was an eligible retirement plan.
- Your principal residence was severely damaged.
- A member of your family died.
- You or a member of your family was seriously ill.
- You were incarcerated.
- Restrictions were imposed by a foreign country.
- A postal error occurred.
- Your distribution was made on account of an IRS tax levy and the proceeds of the levy have been returned to you.
- The party making the distribution delayed providing information that the receiving plan or IRA needed to complete the rollover, despite your reasonable efforts to obtain the information.
To qualify for this new procedure, you must make your rollover contribution to the employer plan or IRA as soon as practicable after the applicable reason(s) above no longer prevent you from doing so. In general, a rollover contribution made within 30 days is deemed to satisfy this requirement.
Effect of self-certification
It’s important to understand that this new self-certification process is not an automatic waiver by the IRS of the 60-day rollover requirement. The self-certification simply allows you and the financial institution to treat and report the contribution as a valid rollover. However, if you’re subsequently audited, the IRS can still review whether your contribution met the requirements for a waiver.
For example, the IRS may determine that the requirements for a waiver were not met because (1) you made a material misstatement in the self-certification, (2) the reason(s) you claimed for missing the 60-day deadline did not prevent you from completing the rollover within 60 days following receipt, or (3) you failed to make the contribution as soon as practicable after the reason(s) no longer prevented you from making the contribution. In that case, you may still be subject to additional income taxes and penalties. Because of this potential risk, some taxpayers may still prefer the certainty of a private letter ruling from the IRS waiving the 60-day deadline, despite the additional time and expense involved.
Remember, you can make only one tax-free, 60-day, rollover from any IRA you own (traditional or Roth) to any other IRA you own in any 12-month period. This limit does not apply to direct rollovers or trustee-to-trustee transfers (or to Roth IRA conversions).
Also keep in mind that you can generally leave your funds in a 401(k) or similar plan (at least until the plan’s normal retirement age) if your vested account balance at the time you terminate employment exceeds $5,000.
The foregoing is provided for information purposes only. It is not intended or designed to provide legal, accounting, tax, investment or other professional advice. Such advice requires consideration of individual circumstances. Before any action is taken based upon this information, it is essential that competent, individual, professional advice be obtained. JAS Financial Services, LLC is not responsible for any modifications made to this material, or for the accuracy of information provided by other sources.
IRS warning about fake emails(CP2000) relating to the Affordable Care Act
Confronting the latest scheme to target taxpayers, the IRS and its Security Summit partners warned Thursday that scammers have sent fake emails purportedly containing CP2000 notices, which are used in the IRS’s Automated Underreporter Program. The IRS emphasized that it never sends these notices by email, and instead uses the U.S. Postal Service (IR-2016-123).
The notices contain an IRS tax bill supposedly related to the Patient Protection and Affordable Care Act and 2014 health care coverage. They use an Austin, Texas, post office box and request payments to the “I.R.S.” at the “Austin Processing Center.” The email also contains a payment link. The fraudulent email lists the letter number as “105C.”
The IRS explains that its procedures for taxpayers who owe additional tax require taxpayers to write checks payable to the “United States Treasury,” not the “I.R.S.,” as in the fake notice. It also advises taxpayers that they can check a notice’s validity on the IRS’s website by doing a search, and they can see sample notices at Understanding Your IRS Notice or Letter.
IRS impersonation scams take many forms: threatening telephone calls, phishing emails and demanding letters. Learn more at Reporting Phishing and Online Scams.
Taxpayers who receive this scam email should forward it to phishing@irs.gov and then delete it from their email account.
Taxpayers should always beware of any unsolicited email purported to be from the IRS or any unknown source. They should never open an attachment or click on a link within an email sent by sources they do not know.
New Real Estate Sector Puts Equity REITs in the Spotlight
Publicly traded REITs and other listed real estate companies are being moved to a distinct Real Estate sector by S&P Dow Jones Indices and MSCI.
S&P Dow Jones Indices and MSCI recently moved publicly traded equity real estate investment trusts (REITs) and other listed real estate companies from the Financials sector into a new, separate Real Estate sector effective September 1, 2016. (Mortgage REITs remain in the Financials sector, along with banks and insurance companies.) There are now 11 headline sectors instead of 10. It’s the first time a new sector has been added to the Global Industry Classification Standard (GICS®) since it was created in 1999. (1)
The move has implications for investors, because S&P and MSCI indexes are common benchmarks for investment performance, and the GICS is often used as a framework for portfolio construction. By some estimates, fund managers could shift as much as $100 billion to the Real Estate sector in a collective effort to follow the market weightings of various indexes. (2)
The change could also affect the asset allocation decisions of some individual investors by drawing more attention to equity REITs as income-generating assets with the potential for capital appreciation.
Fixed-income appeal
An equity REIT is a company that combines capital from investors to buy and manage income properties such as apartments, shopping centers, hotels, medical facilities, offices, self-storage units, and industrial buildings. Publicly traded REIT shares can generally be bought or sold on an exchange at a moment’s notice, making them more liquid than physical real estate investments, which involve transactions that can take months to complete.
Many REITs generate a reliable income stream regardless of share price performance, primarily because they are required by law to pay out 90% of their taxable incomes as dividends to stakeholders. In the second quarter of 2016, the S&P REIT index had a dividend yield of 3.73%. (3) The performance of an unmanaged index is not indicative of the performance of any specific security. Individuals cannot invest directly in an index.
REIT share prices can be sensitive to interest rates. As rates rise, steady dividends may appear less attractive to investors relative to the safety of bonds offering similar yields. On the other hand, current fundamentals, including modest economic growth, lower unemployment, and rising rents, are generally seen as positive conditions for REITs and other real estate businesses.
Diversification tool
Breaking real estate out of the Financials sector acknowledges that the industry’s business models and ties to underlying property markets produce a distinctive risk-return profile, including a relatively low correlation to the rest of the stock market. (4) Because the share prices of equity REITs don’t rise and fall in lockstep with the broader stock market, including them in your portfolio could help reduce the overall level of risk.
The return and principal value of all stocks, including REITs, fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Diversification and asset allocation do not guarantee a profit or protect against investment loss; they are methods used to help manage investment risk.
REIT distributions are taxable to the extent they include any ordinary income and capital gains. Some REITs may not qualify as a REIT as defined in the tax code, which could affect operations and negatively impact the ability to make distributions.
There are inherent risks associated with real estate investments that could have an adverse effect on financial performance. Such risks may include a deterioration in the economy or local real estate conditions; tenant defaults; property mismanagement; and changes in operating expenses (including insurance costs, energy prices, real estate taxes, and the cost of compliance with laws, regulations, and government policies).
Breaking real estate out of the Financials sector acknowledges that the industry’s business models and ties to underlying property markets produce a distinctive risk-return profile, including a relatively low correlation to the rest of the stock market.
(1) , (3) S&P Dow Jones Indices, 2015-2016
(2) Investor’s Business Daily, March 18, 2016
(4) FinancialAdvisor.com, March 1, 2016
The foregoing is provided for information purposes only. It is not intended or designed to provide legal, accounting, tax, investment or other professional advice. Such advice requires consideration of individual circumstances. Before any action is taken based upon this information, it is essential that competent, individual, professional advice be obtained. JAS Financial Services, LLC is not responsible for any modifications made to this material, or for the accuracy of information provided by other sources.
The British Are Leaving! Why the Brexit Matters to Investors
Here’s an overview of the economic issues surrounding the Brexit, and what this historic
decision could mean for the United Kingdom, world trade, and international investors.
On June 23, citizens of the United Kingdom (England, Scotland, Wales, and Northern
Ireland) voted to leave the European Union by a margin of 52% to 48%.1 Though pre-election
polls suggested that public opinion was evenly divided, when the election results became
clear, financial markets around the world reacted swiftly to concerns about potential economic
ramifications of a British exit—or Brexit—from the EU.
On June 24, the British pound plunged more than 10% against the dollar to its lowest point
since 1985, before recovering slightly to settle nearly 8% lower at the end of the day.2 European
stocks suffered the worst sell-off since 2008, with the Stoxx Europe 600 Index tumbling 7%, and
the Japanese Nikkei Index posted a one-day drop of 7.9%.3–4 In the United States, the S&P 500 Index fell 3.6%, reversing year-to-date gains.5
Here’s an overview of the economic issues surrounding the Brexit, and what this historic
decision could mean for the United Kingdom, world trade, and international investors.
The EU and the Referendum
The European Union was formed after World War II to help promote peace through
economic cooperation. Over time, it became a common market, allowing goods and people to
move freely around 28 member states as if they were one country. The U.K. joined the trading
bloc in 1973, when there were only 9 member states.
In 2012, Prime Minister David Cameron rejected calls for a referendum on EU membership
but later agreed to hold one if the Conservative party won the 2015 election.6 The leaders of
all five major political parties campaigned to remain in the EU, including Cameron, warning
voters that leaving the EU was a leap into the unknown that could damage the U.K.’s economy
and weaken national security.7
Brexit supporters said leaving the EU allows the nation to take back control over business,
labor, and immigration regulations and policies. They also claimed the money being
contributed to the EU budget (a net contribution of 9.8 billion pounds in 2014) would be better
spent on infrastructure and public services in the U.K.8
Economic Expectations
The negative outlook for the U.K. economy depends on the terms of trade deals yet to
be negotiated with the EU and other nations. For example, the International Monetary Fund
(IMF) projects that U.K. gross domestic product could decline about 1.5% by 2021, assuming
the United Kingdom is granted access to the EU market quickly. Under a more adverse
scenario (which assumes trade defaults to World Trade Organization rules), the IMF projects a
precarious decline in GDP of about 4.5%.9
The U.K.’s departure strikes a serious blow to the EU, which has been beleaguered by debt
crises, a Greek bailout, the influx of millions of refugees, high unemployment, and weak GDP
growth. If trade activity and business conditions in the region deteriorate, it’s possible that the
U.K. and the EU could fall back into recession.
Next Steps
Once Article 50 of the Lisbon Treaty is invoked, the formal process of leaving the EU will
begin, opening up a two-year window of negotiations on the terms of the exit. The U.K. will
remain a member of the EU until it officially departs.10
The U.K. is the first nation to break away from the EU, but a larger concern is that anti-EU
factions in other nations could be empowered to follow suit. Moreover, Scotland could seek
independence from the U.K. in order to remain in the EU, and Northern Ireland might consider
reunification with the Republic of Ireland.11
What About Us?
The EU is the largest trading partner of the United States, so the Brexit complicates
pending trade negotiations and will require adjustments to existing agreements. It may also
take time to forge new deals with the U.K.12
U.S. companies with a significant presence in the U.K. could take a hit. With the British
pound weakening against an already strong dollar, U.S. exports become more expensive,
reducing foreign sales. The U.S. economy is not as vulnerable as the EU, but the U.S. Federal
Reserve may be more likely to delay its decision to raise interest rates until the consequences
of the Brexit on U.S. and global markets can be assessed.13
Brexit-related anxiety could continue to spark market volatility until the details are finalized
and the economic fallout is better understood, possibly for several years. Having a sound
investing strategy that matches your risk tolerance could prevent you from making emotional
decisions and losing sight of your long-term financial goals.
Investments are subject to market fluctuation, risk, and loss of principal. Investing internationally
carries additional risks such as differences in financial reporting, currency exchange risk, as well as economic
and political risk unique to a specific country. This may result in greater share price volatility.
Shares, when sold, may be worth more or less than their original cost. The performance of an unmanaged
index is not indicative of the performance of any specific security. Individuals cannot invest in any
index.
1-2, 7, 10-11) BBC News, June 24, 2016
3, 5) Bloomberg.com, June 24, 2016
4) Reuters, June 24, 2016
6) The New York Times, June 25, 2016
8) CNNMoney, June 2, 2016
9) International Monetary Fund, 2016
12-13) The Wall Street Journal, June 24, 2016
The foregoing is provided for information purposes only. It is not intended or designed to provide legal, accounting, tax, investment or other professional advice. Such advice requires consideration of individual circumstances. Before any action is taken based upon this information, it is essential that competent, individual, professional advice be obtained. JAS Financial Services, LLC is not responsible for any modifications made to this material, or for the accuracy of information provided by other sources.
Federal Income Tax Returns Due
The federal income tax filing deadline for most individuals is Monday, April 18, 2016. That’s because Emancipation Day, a legal holiday in Washington, D.C., falls on Friday, April 15, this year. If you live in Massachusetts or Maine, you have until Tuesday, April 19, to file your return because Patriots’ Day, a legal holiday in both states, is celebrated on April 18.
Not ready to file?
You can file for an extension using IRS Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Filing this extension gives you an additional six months (until October 17, 2016) to file your federal income tax return. You can also file for an automatic six-month extension electronically (details on how to do so can be found in the Form 4868 instructions).
Outside of the country?
Special rules apply if you are living outside of the county, or serving in the military outside the country, on the regular due date of your federal income tax return.
Pay what you owe by the due date of the return.
Filing for an automatic extension to file your return does not provide any additional time to pay your tax. Make the best estimate you can of the amount you owe. You should pay the estimated amount by the April 18 (April 19 if you live in Massachusetts or Maine) due date. If you don’t, you will owe interest, and you may owe penalties as well. If the IRS believes that your estimate of taxes was not reasonable, it may void your extension.
Do not make the mistakes of thinking you do not have to pay any tax until you file your tax return. If you absolutely cannot pay what you owe, file the return and pay as much as you can afford. You’ll owe interest and possibly penalties on the unpaid tax, but you will limit the penalties assessed by filing your return on time, and you may be able to work with the IRS to pay the unpaid balance (options available may include the ability to enter into an installment agreement).
When investing should you follow your gut?
Jason Zweig’s Wall Street Journal March 18, 2016 article, “The Three Worst Words of Stock-Market Advice: Trust Your Gut” is insightful. The substance of the article is stated in a quote from Benjamin Graham’s book, “…The investor’s chief problem-and even his worst enemy-is likely to be himself.”
The article references research by “…finance professors William Goetzmann and Robert Shiller of Yale, along with Dasol Kim of Case Western Reserve University, have analyzed the Yale surveys and found that investors’ forecasts regularly look more like aftercasts—simple projections of the recent past into the future.”
“Prof. Shiller… has been surveying investors about their expectations since 1989.” One question is…What are the odds of a one-day crash of at least 12% in the U.S. stock market over the next six months? The probable answer was about 10 times the probability. “Remarkably, professional investors exaggerate the odds almost as badly as individual investors do.” “What’s more, the new study suggests, you probably should have put higher odds on an imminent crash back in January than you would now or would have six months or a year ago. That is partly because a sharp recent drop makes future declines seem more probable, and partly because the news media uses words like “crash” much more often after the market falls sharply.” “Naturally, investors tend to be complacent when they should be worried and afraid when they should be optimistic.”
“Words charged with negative emotion not only darken your view of the future, but they may make you feel that riskier investments have a lower—rather than a higher—potential return.”
“Dates like Oct. 28, 1929, and Oct. 19, 1987, when the Dow Jones Industrial Average fell 13% and 23% respectively, can “evoke a sense of doom,” says Prof. Goetzmann of Yale. ‘Crashes have a remarkably long life in the public imagination. Their echoes can last for decades’.”
Having a plan with a target allocation can help restrain reacting to your gut. This provides a map to achieve your financial goals. Your plan should be reviewed when your goals, priorities or circumstance change. You should review your investments periodically to see if they still fit the reason you chose the investment. There is not a consensus of how frequently you should review your plan and investments. Making changes too frequently is trading rather than investing. Very few are consistently successful at trading. There are costs and possible tax consequences when trading. Your plan should identify when the investment should be adjusted to meet your target (rebalancing). Set a percent or dollar amount of change that would justify rebalancing.
Generally rebalancing will increase the long-term performance. Waiting too long can reduce your returns.
Highlights from various articles of note
Target Date Funds:
An article by John Sullivan in the inaugural issue of “401k Specialist” discussed Target Date Funds (TDF). The article is based on a panel discussion at the 2015 Morningstar Investment Conference. Initially these funds were disappointing. One area of concern related to asset-class diversification. The question was not just about the ratio of stocks to bonds. The portion in domestic, foreign and alternative investments was also a concern. Another area requiring improvement was how the mix of assets changed over time and during retirement.
TDFs have improved since their introduction. Three companies account for 70% of the assets in these funds. At one point they accounted for 80%. Only one firm had funds (3) in the highest 10 performing funds. The other top performing TDF’s were from 2 other firms.
The greatest benefits of TDFs from my viewpoint is the improvement in investor behavior. “Investors are using them well. They don’t exhibit the typical behaviors of fear and greed with target date funds, and as a result stay the course and remain invested longer.”
Not all TDFs are the same. You want one that is consistent with your situation and your plan.
Retirement Planning Calculators:
This is the subject of a Wall Street Journal article, “New Study Questions Retirement Planning Calculators’ Accuracy.” This article was update online Feb. 22, 2016.
The article discusses an academic study of 36 retirement planning calculators. “… ‘in most cases, the available offerings are extremely misleading ‘ and generally not helpful to consumers trying to figure out if they will have enough money to cover their expenses for the rest of their lives.”
The study was based on “… a hypothetical couple in their late 50s earning $50,000 each and aiming to retire at ages 65 and 63.” The calculators were described as “…free and low-cost…” The cause of the misleading results was the limited amount of information used by the calculators.
“…the researchers identified a list of more than 20 factors they believe should be included…”
Do not use the simplest calculator available. Pick one that has many questions. Also review the assumptions they are using. All calculators are use assumptions. Some assumptions to all calculators are: life expectancy, health, inflation rates, investment returns. Other questions would include the amount of your current investments and amounts you are currently savings.
There’s Still Time to Contribute to an IRA for 2015
There’s still time to make a regular IRA contribution for 2015! You have until your tax return due date (not including extensions) to contribute up to $5,500 for 2015 ($6,500 if you were age 50 by December 31, 2015). For most taxpayers, the contribution deadline for 2015 is April 18, 2016 (April 19, 2016, if you live in Maine or Massachusetts).
You can contribute to a traditional IRA, a Roth IRA, or both, as long as your total contributions don’t exceed the annual limit (or, if less, 100% of your earned income). You may also be able to contribute to an IRA for your spouse for 2015, even if your spouse didn’t have any 2015 income.
Traditional IRA
You can contribute to a traditional IRA for 2015 if you had taxable compensation and you were not age 70½ by December 31, 2015.
However, if you or your spouse was covered by an employer-sponsored retirement plan in 2015, then your ability to deduct your contributions may be limited or eliminated depending on your filing status and your modified adjusted gross income (MAGI) (see table below). Even if you can’t deduct your traditional IRA contribution, you can always make nondeductible (after-tax) contributions to a traditional IRA, regardless of your income level. However, in most cases, if you’re eligible, you’ll be better off contributing to a Roth IRA instead of making nondeductible contributions to a traditional IRA.
| 2015 income phaseout ranges for determining deductibility of traditional IRA contributions: | ||
| 1. Covered by an employer-sponsored plan and filing as: | Your IRA deduction is reduced if your MAGI is: | Your IRA deduction is eliminated if your MAGI is: |
| Single/Head of household | $61,000 to $71,000 | $71,000 or more |
| Married filing jointly | $98,000 to $118,000 | $118,000 or more |
| Married filing separately | $0 to $10,000 | $10,000 or more |
| 2. Not covered by an employer-sponsored retirement plan, but filing joint return with a spouse who is covered by a plan | $183,000 to $193,000 | $193,000 or more |
Roth IRA
You can contribute to a Roth IRA if your MAGI is within certain dollar limits (even if you’re 70½ or older). For 2015, if you file your federal tax return as single or head of household, you can make a full Roth contribution if your income is $116,000 or less. Your maximum contribution is phased out if your income is between $116,000 and $131,000, and you can’t contribute at all if your income is $131,000 or more. Similarly, if you’re married and file a joint federal tax return, you can make a full Roth contribution if your income is $183,000 or less. Your contribution is phased out if your income is between $183,000 and $193,000, and you can’t contribute at all if your income is $193,000 or more. And if you’re married filing separately, your contribution phases out with any income over $0, and you can’t contribute at all if your income is $10,000 or more.
Even if you can’t make an annual contribution to a Roth IRA because of the income limits, there’s an easy workaround. If you haven’t yet reached age 70½, you can simply make a nondeductible contribution to a traditional IRA, and then immediately convert that traditional IRA to a Roth IRA. Keep in mind, however, that you’ll need to aggregate all traditional IRAs and SEP/SIMPLE IRAs you own–other than IRAs you’ve inherited–when you calculate the taxable portion of your conversion. (This is sometimes called a “back-door” Roth IRA.)
Finally, keep in mind that if you make a contribution to a Roth IRA for 2015–no matter how small–by your tax return due date, and this is your first Roth IRA contribution, your five-year holding period for identifying qualified distributions from all your Roth IRAs (other than inherited accounts) will start on January 1, 2015.
The foregoing is provided for information purposes only. It is not intended or designed to provide legal, accounting, tax, investment or other professional advice. Such advice requires consideration of individual circumstances. Before any action is taken based upon this information, it is essential that competent, individual, professional advice be obtained. JAS Financial Services, LLC is not responsible for any modifications made to this material, or for the accuracy of information provided by other sources.
The No. 1 stock over 30 years illustrates the advantage of index funds.
The “super stocks” over this period “…have all undergone at least one near-death experience.” according to David Salem. “Balchem shows the patience, grit and good luck it takes for a company to turn into a superstock.”
“The stock didn’t attract a single major institutional holder until 1999, even though it had returned an average of 21.3% annually over the previous decade.
“Investment professionals often ridicule index funds-those autopilot portfolios that mechanically own every stock in a market benchmark – for holding overpriced stocks and riding them all the way down. But one of the unsung virtues of index funds is that, by design they cling to their holding through even the worst downdrafts.”
His summary of the article is that most people are better off with index funds. “In the long term, capturing the full upward sweep of a super-stock requires enduring several near-death experiences along the way.”
The article did not attempt to discuss the differences among index funds. The differences are important in developing a portfolio. Each index may include different companies or a different mix of companies. Size, industry, location, performance are examples of differences. The type and portion of companies can vary. The expenses of each fund also vary. Very few individuals can outperform the market. Select funds that are best for you.
Fed Rate Hike: What Does It Mean?
Federal funds rate raised
On Wednesday, December 16, 2015, the Federal Reserve raised the federal funds target rate, the interest rate at which banks lend funds to each other (typically overnight) within the Federal Reserve System. Since December 2008, the Fed had kept the range at a previously unheard-of level of 0% to 0.25% to help ensure that credit would be available to promote economic recovery. With this change, the target range will be 0.25% to 0.50%. In announcing its decision, the Federal Open Market Committee explained that the economy has been expanding moderately and is expected to continue expanding at a similar pace. The Committee also stated that it expects labor market conditions will continue to strengthen and that inflation will rise to 2% over the medium term.
Since the federal funds rate is a short-term rate that banks pay to borrow money, it is a factor in how banks set their own rates. The federal funds rate also serves as a benchmark for many short-term rates, such as saving accounts, money market accounts, and short-term bonds.
Additional increases ahead?
According to the Committee, “[i]n determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation.” (Source: Federal Reserve Press Release, December 16, 2015) The Committee stated that it expects economic conditions will result in only gradual increases to the federal funds rate. This means that it’s possible there will be additional small increases in the coming year, though it is unlikely there will be a large jump.
What does it mean for you?
First, it’s important to put things in perspective. Despite all the headlines, by any measure this is a small increase. And the increase itself is a reflection of an improving economy.
The federal funds rate does have an effect on interest rates in general, though. So, here are some things to consider:
- Bond prices tend to fall when interest rates rise. Longer-term bonds may feel a greater impact than those with shorter maturities. That’s because when interest rates are rising, bond investors may be reluctant to tie up their money for longer periods if they anticipate higher yields in the future; and the longer a bond’s term, the greater the risk that its yield may eventually be superceded by that of newer bonds. Of course, while bonds redeemed prior to maturity may be worth more or less than their original value, if you hold a bond to maturity, you would suffer no loss of principal unless the issuer defaults.
- Rising interest rates can affect equities as well, though not as directly as bonds. For example, companies that have borrowed heavily in recent years to take advantage of low rates could see borrowing costs increase, which could affect their bottom lines. And if interest rates continue to rise to a level that’s more competitive with the return on stocks, investor demand for equities could fall.
- Rising interest rates could eventually help savers who have money in cash alternatives. Savings accounts, CDs, and money market funds are all likely to provide somewhat higher income. The downside, though, is that if higher rates are accompanied by inflation, these cash alternatives may not keep pace with rising prices.
- The prime rate, which commercial banks charge their best customers, is typically tied to the federal funds rate. Though actual rates can vary widely, small-business loans, adjustable-rate mortgages, home-equity lines of credit, credit cards, and new auto loans are often linked to the prime rate, which means that when the federal funds rate increases, the rates on these types of loans tend to go up as well.
- Although a number of other factors come into play, increases in the federal funds rate may also put some upward pressure on new fixed home mortgage rates.
The bottom line? Don’t overreact. But do take this opportunity to think about how rising interest rates could affect you, and consider discussing your overall situation with your financial professional.
All investing involves risk, including the possible loss of principal, and there can be no assurance that any investment strategy will be successful. Before investing in a mutual fund, carefully consider the investment objectives, risks, charges, and expenses of the fund. This information can be found in the prospectus, which can be obtained from the fund or from your financial professional. Read it carefully before investing.
An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although a money market fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund. Bond funds are subject to the same inflation, interest-rate, and credit risks associated with their underlying bonds. As interest rates rise, bond prices typically fall, which can adversely affect a bond fund’s performance.
There is no assurance that working with a financial professional will improve investment results. However, a financial professional who focuses on your overall objectives can help you consider strategies that could have a substantial effect on your long-term financial situation.
The foregoing is provided for information purposes only. It is not intended or designed to provide legal, accounting, tax, investment or other professional advice. Such advice requires consideration of individual circumstances. Before any action is taken based upon this information, it is essential that competent, individual, professional advice be obtained. JAS Financial Services, LLC is not responsible for any modifications made to this material, or for the accuracy of information provided by other sources.
This graph represents the effective federal funds rate from 1981 through 2014. Source: Board of Governors of the Federal Reserve System (www.federalreserve.gov), December 16, 2015