Your Money Matters More

Retirement is Personal

Retirement is personal:  it can be an elusive goal or it can be a well -planned gift to yourself after a long career.  There are key milestones in this process. To avoid tax penalty waiting until you reach the age of fifty-nine and a half to take distributions from your qualified plan maximize your benefit. Contribute the maximum matched dollar value—the more the better—and keep it invested.  When you do reach fifty-nine and a half you have more options. Remember though, fifty-mine and a half is a number; retirement is a goal.

 

To avoid any penalty from a qualified plan your birthdays count. Once you are fifty-nine and a half, there is no longer a penalty to remove your money, but your money can still work for you if you leave it.  The penalty is considerable: it not only becomes taxable income, but there is an additional ten percent tax on the amount of the withdrawal. Conversely, if your money is not in a qualified plan these restrictions do not apply…you will have already paid tax each year as it accrued but you will have less to invest and you will have less accumulating tax defered. As always, talk to a Certified Financial Planner (CFP) before making any move.

Putting away the maximum dollar amount matched by your employer makes you less dependent on the rate of return as your investment accumulates funds. If you can add other moneys to this amount they too can grow tax deferred. The tax deferral allows you to accumulate money faster. For example if your 401(k) is being invested at the rate of $3,000 a year, you are not only saving the whole $3,000, but you are also compounding interest on that investment tax defered. If you are able to leave it until you are fifty-nine and a half, you will not pay tax until it is distributed.

Waiting until you are at the optimal age, you can take the entire amount or you can take any amount you need to live on and let the balance ride.  Determine with your CFP what supports your lifestyle. You can control your taxable income by controlling your distributions. The ability to combine your defined contribution plans gives you better economy of scale when it comes to selecting your investments, also.  

Although fifth-nine and a half is the point where penalties no longer occur, retiring later can have even greater benefit.  Your CFP can walk you through these options based on your personal financial standing. Begin planning as soon as possible to allow for the optimal benefit when using a defined contribution plan.  When the time is right—enjoy! 

Children are Expensive

 Children are expensive. That is a given: but the cost of higher education is growing at an unprecedented rate. A 529 Plan, a type of college savings fund, is a tax free way to accumulate money for college expenses. After the birth of a child, begin to put money away for college. The owner of the account can contribute for a named beneficiary. If for some reason the beneficiary chooses not to use it the owner can transfer it later to a different student. 

There are a wide selection of plans available. Each State has its own plan with some offering more than one, and an investor can choose from any of these. Each state provides its own residents additional incentives, but these tax incentives should be subordinate to the underlying returns of the investments of the plan. Always seek the advice of a Certified Financial Planner (CFP) when selecting a plan. 

Recent graduates have left college with a crushing debt load. An alternative to this is paying out of pocket. Making wise investments early allows compounding of returns to work for you. This is just one of the tools that your CFP has in their arsenal.  

6 Steps to reduce your income tax for this year

1. Max out your at least your matched retirement plan deductible contributions
2. Recognize any capital losses in your taxable accounts
3. Prepay as many deductible expenses in this tax year
4. Make as many non-cash contributions to charity that you can (Including that old broken down car that you no longer need)
5. Have an accounting of medical expenses ready for your tax preparer including prescriptions, deductibles and direct medical expenses
6. Have an accounting of your miscellaneous expenses that include moving expenses and non-reimbursed business expenses

If you have done as many of these items as you can you will be better prepared when it comes to the time for filing your income taxes!

Portfolio Construction

When developing a portfolio for the average investor the key points you need to consider are: time horizon, taxability, liquidity, risk and diversification. 

 

• The first thing you have to figure out is what time frame you are going to need the money.  The longer time you have before you need the money the more aggressive you can be.  Due to the time you have to ride out cycles of the stock market.  Saving for retirement is different than saving for the down payment for the purchase of a house.  You can invest for the long term if you have a number of yours until you need the funds.  By increasing the amounts of risk you are taking you can statistically increase your returns.

 

• The second thing to take into account is how the money is going to be taxed.  Investments that are in a tax-free environment can stand more ordinary income. With taxable income you can write-off losses that you incur.  Also capital gains are preferable to ordinary income in a taxable environment.

 

• The next area that you need to worry about is the amount of liquidity available with your portfolio.  The longer you have to invest the more able you are to use illiquid assets like real estate.  Real estate functions on a longer cycle than stocks.

 

• You can’t expect return without taking a little risk.  Risk translates volatility. The level of risk that you take is what you personally can tolerate.  Risk is measured in different ways including standard deviation and/or beta.  They are measured relative to the standard deviation and/or beta respectively of the market as a whole.

 

• Last but not least to be sure that your portfolio is diversified by having enough holding, by industry and by type of investment.  Income oriented investments tend to have different characteristics than appreciation driven investments.  International funds add an extra level of risk in the fact that there is an exchange rate in play in addition to the underlying stock making then inherently more volatile. 

You needn’t go it alone; contact a financial planning professional.

Gain Distributions

When people prepare their taxes they are often surprised at the amount of gain that is on their 1099 from the mutual funds that they own.  I am often asked, "How can my mutual fund distribute gains in a down market?" 

The answer is evident if you look through the mutual fund to the underlying portfolio. The mutual fund portfolio manager will often build up cash heading into downward trending market and may have sold stocks that had accumulated gains over the life of the holding.  As the mutual fund manager attempts to accumulate cash in preparation for the down market these gains may be triggered.  These gains are accumulated over many years consequently the tax has been deferred for this same period.  This is especially the case with value funds that have low turnover ratios.

If you have a net loss in the fund then you can simply sell all of the fund by the end of the year and this negates the gains.  If you still have a net gain in the fund then this strategy does not work.  But you should consider yourself fortunate if you have a gain.

You should look at your mutual fund as a portfolio rather than just one investment. It provides a convenient way to diversify for the individual making smaller investments.  It has economies of scale that you may not get purchasing individual stocks as well as expert management, in most cases.  Mutual funds provide the best managers within their respective specialty. This is why I only use mutual funds.

I can explain this in greater depth just contact me.

Emergency Fund

The first thing that any planner worth his/her salt does for a client is to establish an emergency fund.  An emergency fund is made up of investments with liquidity and serves a multitude of purposes.   Among these is covering unforeseen expenses, satisfying deductibles, car repairs, and home repairs.

Benefits of having an emergency fund:

• Covering higher levels of deductible making insurance policies much more affordable. 
• It can be used to cover unforeseen expenses.
• As a source of liquidity when markets are too volatile to sell off investments.
• Used to cover loss of income due to extended medical leave or loss of employment.

A recent article I found in the Wall Street Journal stated that thirty-eight percent of the individuals surveyed weren't prepared to cover even a $500 car repair or a large medical bill.  This is a result of living paycheck to paycheck.  A good rule of thumb is to have three to six months of living expenses in reserve.  The fund is accumulated a little at a time. 

An Emergency fund should be kept in money market funds or as an alternate in short-term bond funds with low volatility investments.  

 

Charles Shearman is a Certified Financial Planner with 32 years experience as a financial planner.

www.prosperofp.com 

Buy Smart

    I have always had medical professionals as clients. One thing this has taught me is that being smart enough to pass med school doesn’t necessarily translate into financial intelligence. Doctors, as well as any professionals who have a steadily increasing salary at the start of their careers, can often make purchases that hurt their cash flow down the road once their income plateaus. This makes it all the more important to develop an emergency or “slush” fund early in your career no matter what your occupation. Then later in life, once your rainy day money has grown, the finer things are less of a strain on your bank account. The two main purchases that can set an individual up for financial distress are expensive cars and big houses. Making the right buys can lead to a life of comfort, if done correctly.

 

Fancy Cars 

 

When individuals jump up into the six figure income bracket one of the first things they want to do is buy an expensive new car. What they fail to realize is that when they drive their so called “investment” off the lot, it loses thousands in value immediately. Their new car will then continue to lose value until the wheels fall off. But Chuck, “How am I supposed to show off my financial superiority while I’m on the go?” It’s  simple. Buy used. Say you think you would look nice in a Mercedes-Benz SLK350. You’ve worked hard to bring in the money and its time to reward yourself. A new SLK350 costs over $55,000. A used last year model costs $36,000. Paying an extra nineteen grand for that “new car” smell seems quite ridiculous. Any other investment that declined in value by 35% its first year would make you furious. Even for individuals with more modest tastes, a Honda Civic loses four thousand in its first year off the lot which is still a 20% decrease. Do yourself a favor and let someone else be the sucker who has to unload their bad investment in a year’s time.

 

Living Large 

 

The other mistake many make is purchasing a house that is too big early in their careers. If your job is putting fat stacks in your slacks the worst thing you can do is tie yourself down to a house that will pull cash out of your pocket for the next fifteen to thirty years. We at Prospero Financial always push to develop a solid emergency account before purchasing an expensive home. Buying a less expensive home allows you to build that emergency fund faster.  You will then be able to make a larger down payment on your next home. This will give you more equity to build on. You will need 20% equity in the property in order to avoid private mortgage insurance and decrease your mortgage payment.

 As unpredictable as the housing market is, you want to make sure that your house and property are sellable when the time comes. Choosing your neighborhood wisely can make a huge difference in the future. Picking the right house in that neighborhood can be just as important. The most expensive house in a neighborhood will be the hardest to sell. When prices in housing go up your palace might increase in value, but a home is worth nothing if there’s no one to buy it. The cheapest house in the neighborhood can be just as tough. Look for a home that is in the upper middle price range for the neighborhood you are moving into and you will have made a safe choice if you ever need to liquidate the property. Lastly, when  it comes time to sell a house, you need to leave yourself at least six months time to keep from leaving money on the table. Selling a home can be profitable, as long as you make smart decisions along the way.

Related articles

The Millennial Home Buying Guide

Should You Buy a New Home or Older Home?

Not Ready To Retire Yet?

 I was looking around my networking group and it seemed to be made up of a large group of people on their second or third careers due to company downsizing. They probably had a retirement plan, 403(b) for not-for-profit entities or 401(k) for any other entities, after leaving a previous employer.  They may be spending this to maintain their lifestyle and that's probably alright as long as that doesn't go on for very long. It is better to reduce your lifestyle then drain your retirement plans.  You not only don’t have the money for the retirement years you also don’t get the growth on that money that you withdraw from these accounts.   

Not only do you pay tax on the withdrawls but this can be doubly bad if you're paying tax penalties on an IRA or 401(k).  The IRS may charge a 10% premium to withdraw funds.  This is if you haven't reached the age of 59½.  There are several exceptions to the age 59½ rule. Even if individuals receive a distribution before they are age 59½, they may not have to pay the 10% additional tax if they receive a distribution from a retirement plan (other than an IRA) after leaving a job and are age 55 (age 50 for qualified public safety employees).  Or they are receiving a series of distributions in equal payments based on your life expectancy.  These are not the only exceptions but those most likely to apply.    

Another way to avoid the 10% penalty is to prove hardship. A retirement plan may (but is not required to) allow participants to receive hardship distributions. A distribution from a participant’s elective deferral account can only be made if the distribution is because of an immediate and heavy financial need, and limited to the amount necessary to satisfy that financial need.  

You should consult your tax Advisor before you undertake this.

Not to Late For an IRA!

If you have not made your individual retirement account (IRA) contributions it's not too late unless you have already filed your tax return. The deadline is the earlier of which you file your tax return or April 15. 

Contribution Limits

The contribution limits for IRAs for tax year 2012 are $5000 plus an extra $1000 for a total of $6000 if you were over age 50.  If you're doing a Roth IRA not concern yourself with the deductibility since the contributions are not deductible anyway.  However if you are doing a traditional IRA the deductions are phased out between $92,000 and $112,000 of  AGI if you are married and either you or your spouse have a reirement plan at work.  Beyond $112,000 you can't deduct it anyway and you probably should do Roth IRA.  If you and your spouse are not covered by a retirement plan you can take a full deduction up to the contribution limits. 

For tax year 2013 the contributions are increased to $5,500 or $6,500 if you're over 50. This is per individual So it can make for an Inexpensive retirement plan.  A Roth IRA is still worth doing because your growth is not taxable and when you take it out it is not taxable.

This provides some food for thought.  You should probably go on the IRS website to get the full details.

Black Monday Revisited

Volatility

With the volatility of this market I'm reminded of the October 19, 1987 decline of the market referred to as “Black Monday”. This one was not as severe from a points standpoint it was from a percentage standpoint. The market plummeted 500 plus points which in itself doesn't seem like much but it represented over 22% of the market. Two hundred points up or down seems like an average day. Imagine getting up and your portfolio is worth three quarters of what it was the day before. Some important safeguards came into play after this debacle. For example computerized trading, was supposed to protect the big pension traders from losses, but had the opposite effect. When this type of thing happened it contributed to this kind of downfall. Today computer trading is suspended after the market moved fifty points.

Federal Reserve

The new chairman of the Fed Alan Greenspan in his first year wisely thought to loosen the money supply as opposed to what happened in the 1929 Depression in which case they thought that was wise to tighten the money supply thus causing the Depression. So the resulting rollercoaster ride we have been through in this year does not compare to the large downturn that was experienced in the past. The volatility of the market although big in points is minimal in percentage. The market should be positive for the year in results and no-harm-no-foul in percentage and volatility.

So as Christmas approaches we should be thankful for the little things that are available to us and Ben Bernanke should be thankful that he's not facing the same thing as Greenspan faced in his first year.