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.
A helpful list for investors
It seems that everyone has a list on almost every topic, especially at year-end and the start of a new year. I sometimes wonder what to do with this information. Anna Prior’s Jan. 2, 2015 New York Times article, “The 15 Numbers Every Investor Needs to Know” is an exception. It provides an approach to planning. Following is a condensed discussion of the article:
- Know what allocation of stocks, bonds and cash is appropriate for you. Among the many factors to consider are: your financial goals, the value of your current investments, your health, your age, and your ability to withstand a drop in the value of your investments.
- Take advantage of your ability to contribute to your employers’ 401(k) retirement plan, if applicable, for your situation. The 2015 maximum contribution is $18,000 for a pretax traditional 401(k) plan and after-tax Roth 401(k) plan. Those 50 or older can contribute an additional $6,000. Understand the requirements and impact of taking distributions from your retirement plans.
- Be familiar with the general valuations of stocks. This will help you gage your investment risk. Compare the average price/earnings (PE) ratio of stocks to the current PE. The S&P 500 is commonly used as a proxy for the stock market.
- Some consider bonds as a source of safety for investors. It is difficult to predict how bonds will perform in the short-term. The yield on the 10-year Treasury note will give you an indication of what the yield on bonds will be in the next 10 years or so.
- High investment costs will reduce your returns The expense ratios of your funds can be found in the fund prospectus, the website of the fund company and other media sources.
- Be aware of your adjusted gross income (AGI). This is the amount at the bottom of page one of you individual U.S income tax return. The AGI will determine if other taxes or limitations will apply to you. Examples are the 3.8% surtax on investment income, Medicare Part B & D premiums, deduction of some retirement plans, and some itemized deductions.
- Estate-tax exemption of the states are often lower than the U.S. estate exemption. This must be considered in your planing for your family, heirs and charitable entities.
- The amount of your essential and discretionary costs should be reviewed periodically. This is important for: retirement planning, insurance planning and maintaining an adequate reserve fund for the unexpected and untimely expenditures.
- Understand your health-care expenses. This is need for; insurance planning, retirement planning and maintaining an adequate reserve fund.
- Be aware of the difference between replacement cost and fair market value. The difference to rebuilding a home can vary from what the home would sell for. Replacing the contents of you home may be more than the fair market of the items.
- The difference between owning and renting a home can have a major impact on your cash flow and quality of life. The impact maybe more significant when buying a first home and when retiring.
- How long you are likely to live has a significant impact on your investment planning and cash flow planning.
- Your approach to borrowing and repaying loans impacts your cash flow planning, investment planning and retirement planning.
- Be aware of current and anticipated mortgage rates. These impact planning relating to refinancing and debt repayment (cash flow planning).
There are many moving factors in planning. An understanding of the parts and the alternatives are essential to a successful plan.
Reaching Your Goals
Gregory Karp, in his “Spending Smart” column “Money maxims: What dads can tell grads”, June 1, 2014 Chicago Tribune is the incentive for this blog.
Money can be saved or spent. How you handle money will have a significant impact on happiness and future financial well being. Studies relating to finances have increased in the last 15 years. Each year there seem to be more studies. Studies on happiness conclude that people are happier when they spend money on experiences rather than things. Other studies find that most people’s happiness increase as their income increases, up to about $70,000. Studies about retirement have found that the most important thing that anyone can do to reach their retirement living expenses is to save.
Saving is hard to do. Spending must be limited to available income. For most people, living within their income does not mean complete denial. It does require selectivity in the timing and amount of splurges.
Good daily spending habits are important. We have more control over daily spending habits than large items. Minimizing unnecessary and/or unwise expenditures will reduce many items that reduce the amount that can be saved on a regular basis. Most people give larger expenditures, such as homes and cars, significant thought and deliberation. They should also do the same for daily expenditures.
There are also studies that show that we should imagine ourselves in retirement. Aging Booth is an app that will show what you might look like when you age. You may have more incentive to save for that person. Contributing to a 401(k) plans and capturing any employer match may seem more important. Having part of your pay direct deposited to an investment account may also seem like a good way to be kind to the older you.
Necessities and a reserve fund come first. The reserve fund provides a cushion for the frequent unexpected expenditures. Preretirement six months of living expenses is generally recommended. After retirement, a minimum of living expenses after reoccurring income (like social security) for a year is recommended.
The sooner a saving program is started the less required on a periodic basis. To determine how much to save, you need to set financial goals. Your progress should be monitored, at least monthly; more frequently is better. Without knowing the future, your circumstance will change from what you originally projected.
What priority do you place on your retirement?
The New York Times Feb. 28, 2014 article, “Save for Retirement First, the Children’s Education Second”, applies to other financial goals also. Two critical financial planning steps are to identify your financial goals and determine the priority of each. The cost of each goal and when you want to achieve the goal are also needed.
One objective in financial planning is to determine how much is needed to achieve your goals. Saving is almost always the way to have the funds needed. The longer you wait to start to save for financial goals, the harder it is to achieve. That is because more needs to be saved each year.
The challenge to be able to save for retirement becomes more difficult as the number of goals increase. You can borrow for some goals. Borrowing for retirement is generally not an alternative. Financing goals before retirement may decrease the ability to borrow in the future and increases future cash needs.
Children’s education, helping a child with the purchase of a home, helping children with their loans could reduce the amounts needed to maintain a comfortable retirement.
Possibly the expenses can be reduced. Attending local and in-state colleges are generally less expensive than private colleges. Having the children take out student loans also reduces the amount the parents will have to pay.
Contributing less into qualified retirement plans, including IRAs, (Plans) and borrowing from Plans reduces the amount that can be saved for retirement. Contributing to Plans allows the funds to grow free of annual income tax. This allows the income and growth to grow faster in Plans. Borrowing from a Plan reduces the potential return on the amount in the Plan. If the interest rate charged by the Plan is less than the amount a financial institution would charge, the amount of income in the Plan will be reduced.
A reserve account for the unexpected and emergencies should be given a very high priority. Without reserves, these types of expenditures could require the liquidation of investment when their values are low.
There are unintended consequences of not saving for retirement first. Your children may need to support their parents in retirement. A child may need to give up a job to care for a parent if the funds are not available for health care.
Set your priorities for yourself first. Any excess can be left to your heirs.
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Tax Court Says One Tax-Free Rollover per Year Means Just That
| Background The Internal Revenue Code says that if you receive a distribution from an IRA, you can’t make a tax-free (60-day) rollover into another IRA if you’ve already completed a tax-free rollover within the previous 12 months. The long-standing position of the IRS, reflected in Publication 590 and proposed regulations, is that this rule applies separately to each IRA you own. Publication 590 provides the following example: “You have two traditional IRAs*, IRA-1 and IRA-2. You make a tax-free rollover of a distribution from IRA-1 into a new traditional IRA (IRA-3). You cannot, within 1 year of the distribution from IRA-1, make a tax-free rollover of any distribution from either IRA-1 or IRA-3 into another traditional IRA. However, the rollover from IRA-1 into IRA-3 does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA. This is because you have not, within the last year, rolled over, tax free, any distribution from IRA-2 or made a tax-free rollover into IRA-2.” Very clear. Clear, that is, until earlier this year, when the Tax Court considered the one-rollover-per-year-rule in the case of Bobrow v. Commissioner. Bobrow v. Commissioner On April 14, 2008, he withdrew $65,064 from IRA #1. On June 10, 2008, he repaid the full amount into IRA #1. On June 6, 2008, he withdrew $65,064 from IRA #2. On August 4, 2008, he repaid the full amount into IRA #2. Mr. Bobrow completed each rollover within 60 days. He made only one rollover from each IRA. So, according to Publication 590 and the proposed regulations, this should have been perfectly fine. However, the IRS served Mr. Bobrow with a tax deficiency notice, and the case went to the Tax Court. The IRS argued to the Court that Mr. Bobrow violated the one-rollover-per-year rule. The Tax Court agreed with the IRS, relying on its previous rulings, the language of the statute, and the legislative history. The Court held that regardless of how many IRAs he or she maintains, a taxpayer may make only one nontaxable rollover within each 12-month period. “Taxpayers may rely on a proposed regulation, although they are not required to do so. Examiners, however, should follow proposed regulations, unless the proposed regulation is in conflict with an existing final or temporary regulation (Internal Revenue Manual 4.10.7 issue resolution). “IRS Publications explain the law in plain language for taxpayers and their advisors. They typically highlight changes in the law, provide examples illustrating Service positions, and include worksheets. Publications are nonbinding on the Service and do not necessarily cover all positions for a given issue. While a good source of general information, publications should not be cited to sustain a position” (Internal Revenue Manual 4.10.7 issue resolution). This maybe why neither the IRS nor Mr. Bobrow appears to have cited the Service’s long-standing contrary position in Publication 590 and the proposed regulations. So what’s the rule now? And don’t forget–you can make unlimited direct transfers (as opposed to 60-day rollovers) between IRAs. Direct transfers between IRA trustees and custodians aren’t subject to the one-rollover-per-year rule. *The one-rollover-per-year rule also applies–separately–to your Roth IRAs. Roth conversions don’t count as a rollover for this purpose.
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. |
IRA and Retirement Plan Limits for 2014
| The release of the 2014 limits is a reminder to make sure you maximize your 2013 contributions before December 31, 2013 in addition to starting your 2014 planning. | |||||||||||||||||||||||||||||||||||
| IRA contribution limits The maximum amount you can contribute to a traditional IRA or Roth IRA in 2014 remains unchanged at $5,500 (or 100% of your earned income, if less). The maximum catch-up contribution for those age 50 or older in 2014 is $1,000, also unchanged from 2013. (You can contribute to both a traditional and Roth IRA in 2014, but your total contributions can’t exceed this annual limit.)Traditional IRA deduction limits for 2014 The income limits for determining the deductibility of traditional IRA contributions have increased for 2014 (for those covered by employer retirement plans). For example, you can fully deduct your IRA contribution if your filing status is single/head of household, and your income (“modified adjusted gross income,” or MAGI) is $60,000 or less (up from $59,000 in 2013). If you’re married and filing a joint return, you can fully deduct your IRA contribution if your MAGI is $96,000 or less (up from $95,000 in 2013). If you’re not covered by an employer plan but your spouse is, and you file a joint return, you can fully deduct your IRA contribution if your MAGI is $181,000 or less (up from $178,000 in 2013).
*If you’re not covered by an employer plan but your spouse is, your deduction is limited if your MAGI is $181,000 to $191,000, and eliminated if your MAGI exceeds $191,000. Roth IRA contribution limits for 2014 The income limits for Roth IRA contributions have also increased. If your filing status is single/head of household, you can contribute the full $5,500 to a Roth IRA in 2014 if your MAGI is $114,000 or less (up from $112,000 in 2013). And if you’re married and filing a joint return, you can make a full contribution if your MAGI is $181,000 or less (up from $178,000 in 2013). (Again, contributions can’t exceed 100% of your earned income.)
Employer retirement plans The maximum amount you can contribute (your “elective deferrals”) to a 401(k) plan in 2014 remains unchanged at $17,500. The limit also applies to 403(b), 457(b), and SAR-SEP plans, as well as the Federal Thrift Savings Plan. If you’re age 50 or older, you can also make catch-up contributions of up to $5,500 to these plans in 2014 (unchanged from 2013). (Special catch-up limits apply to certain participants in 403(b) and 457(b) plans.) If you participate in more than one retirement plan, your total elective deferrals can’t exceed the annual limit ($17,500 in 2014 plus any applicable catch-up contribution). Deferrals to 401(k) plans, 403(b) plans, SIMPLE plans, and SAR-SEPs are included in this limit, but deferrals to Section 457(b) plans are not. For example, if you participate in both a 403(b) plan and a 457(b) plan, you can defer the full dollar limit to each plan–a total of $35,000 in 2014 (plus any catch-up contributions). The amount you can contribute to a SIMPLE IRA or SIMPLE 401(k) plan in 2014 is $12,000, unchanged from 2013. The catch-up limit for those age 50 or older also remains unchanged at $2,500.
Note: Contributions can’t exceed 100% of your income. The maximum amount that can be allocated to your account in a defined contribution plan (for example, a 401(k) plan or profit-sharing plan) in 2014 is $52,000 (up from $51,000 in 2013), plus age-50 catch-up contributions. (This includes both your contributions and your employer’s contributions. Special rules apply if your employer sponsors more than one retirement plan.) Finally, the maximum amount of compensation that can be taken into account in determining benefits for most plans in 2014 has increased to $260,000, up from $255,000 in 2013; and the dollar threshold for determining highly compensated employees remains unchanged at $115,000. |
What about Happines?
Most of us do not reflect about what is most important to us. I was surprised to see this discussed in an article by Jason Hsu, Chief Investment Officer of Research Affiliates. The last paragraph of the article raises issues we all should consider. The following is from the last paragraph of the article:
“… We spend our lives working and hoping for a few good, healthy years in retirement. The experts seem to want to tell us that demographics and other economic forces are likely to surprise even those of us who save religiously with a rather austere retirement if not one that is characterized outright by lacks and insufficiencies. I can’t help but think that all this talk about optimizing output and consumption disregards the most important question: What about happiness? There is wisdom in the ancient prescription that happiness is not having what you want but wanting what you have. So love your parents, and love your friends’ parents, too. Love them for their wisdom; love them for their driving-you-mad-by-treating-you-like-a-five-year-old; love them for the free babysitting and house sitting; love them for their frailty, which teaches all of us some humility and humanity. They will live a good long time and lean heavily on us for support and, most of all, for love. And, in turn, we and our children will also be surrounded by love. In that world, there is no rationing but only abundance.”
A financial plan is essential for you to know how to invest your money.
To over simplify, financial planning is how you manage your finances and establish a path to reaching your goals. Investment management is one part of managing your finances. It is the part that determines how your savings will be invested.
Financial planning starts with your goals. The amount and timing are critical. Prioritizing your financial goals is necessary. You can assign a priority of 1 to 10 or categorize your goals by what is needed, what is wanted and what is wished for. This will be essential as you monitor your progress. Life and unanticipated events are not controllable and may require adjustments. Adjustments may result in changes to your goals, the timing of your goals, or your spending.
A reserve fund is needed to absorb unexpected events. Reserves should be held so that they are quickly assessable, that is, liquid. Six months of reserve are generally recommended. As you approach each goal, the reserve fund should be increased. This will avoid the impact of fluctuating investment values when the funds are needed. The amount of liquid assets should be increased as you near retirement. This minimizes the need to sell investments when the market is depressed. Two years of liquid funds are generally recommended for retirees. A portion of the funds for living expenses in retirement might be held in short-term bond funds or bonds.
Investments are purchased with the amount of your savings that exceed your reserves. The amount that is used for investments must be sufficient to reach your goals. Education expenses and health care are two categories of expenses that have exceeded what people anticipated. Many people underestimate the amount they will need in retirement. Because life expectancy has increased and people have retired early, many people will not be able meet their retirement goals.
The planning process needs to consider the above events and your ability to withstand losses.
The above has touched on cash planning, investment planning, education planning, risk assessment and retirement planning. All the planning areas need to fit together. How you manage your investments is dependent on the other areas of your financial plan.
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Do you know how much to save?
This is a question I am asked frequently. I respond with “it depends” followed by a series of questions. There are many rules of thumb used to answer this question. A “rule of thumb” is a rough and easy estimation. It is not based on a specific situation.
Following are some of the questions that should be asked. What is the purpose of the expenditure? How important is the expenditure? Is the expenditure something that is needed, wanted or just a wish? What are the alternatives? Is the cost known? When will the expenditure be made? An estimate can be calculated once the variables are identified.
The savings and the variables need to be monitored. Life is a journey with many twists and turns. There will be many unanticipated expenditures, opportunities and windfalls. You need to identify what you did not plan for so that you can identify when you need to change what you are doing
Financial cycles may impact your ability to meet your expectations. The available rates of returns will vary. If you anticipated too high of a rate of return, you will save less than you planned. If your earnings do not grow as much as you anticipated you will have less than you expected. If your living expenses increase more than your income you will not meet you goals. If the reverse happens you will save more than you planned. That is easier to deal with than not saving enough.
You should monitor your savings and review your goals at least annually. The sooner you adjust to adverse events, the easier it will be modify what you are doing and improve your ability to achieve your goals.
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