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Money Matters
Are You Contributing Enough to Your Retirement Plan
If you are one of the millions of Americans who contribute to a defined contribution retirement plan, there are two reasons to rethink the level of your contribution for 2012.
The first is that it is well established that contributing less than 10% of your salary diminishes your chance for meaningful retirement income. If you are not maxing out the annual deferral limits, review the level of your current deferrals. If it is less than 10%, implement a strategy to raise the percentage that goes to your retirement account.
If you don’t recall your current deferral percentage, ask your HR department. An alternative is to look at your pay stub and divide the amount of your retirement account contribution by the total pay for the pay period.
Let’s say that your current deferral percentage is 6% but you don’t feel that you can afford to put 4% more into your retirement with the house payment and your other bills and expenses.
One strategy would be to raise your contribution 1% in January and then raise it 1% again in January in each of the following three years. You would be increasing your contribution a reasonable amount without the financial hit of jumping it up all at one time.
Another method of increasing your contribution would be take one-half of your next raise as increased income, and defer the other half to your retirement plan.
The second reason to revisit your level of contribution is that the limits are about to be raised. These changes will impact only those that max out the deferral amounts, which tend to be doctors, attorneys, engineers, business owners, or executives.
On October 20, 2011 the Internal Revenue Service announced cost of living adjustments affecting dollar limitations for pension plans and other retirement-related items for Tax Year 2012. The changes were triggered because the increase in the cost-of-living index met the statutory thresholds.
| 401k Plan Limits for Plan Year | 2012 | 2011 |
| 401k Elective Deferrals | $17,000 | $16,500 |
| Annual Defined Contribution Limit | $50,000 | $49,000 |
| Annual Compensation Limit | $250,000 | $245,000 |
| Catch-Up Contribution Limit | $5,500 | $5,500 |
| Highly Compensated Employees | $115,000 | $110,000 |
| Non-401k Related Limits | ||
| 403(b)/457 Elective Deferrals | $17,000 | $16,500 |
| SIMPLE Employee Deferrals | $11,500 | $11,500 |
| SIMPLE Catch-Up Deferral | $2,500 | $2,500 |
| SEP Minimum Compensation | $550 | $550 |
| SEP Annual Compensation Limit | $250,000 | $245,000 |
| Social Security Wage Base | $110,100 | $106,800 |
Given the importance of saving for your retirement, combined with changes in the deferral limits for defined contribution retirement plans, it’s prudent to rethink your level of contribution, and take as much advantage of your plan as possible.
5 Key Estate Planning Documents to Help Avoid Family Conflicts
This week is National Estate Planning Week. The hope is to raise awareness as to the importance of having the proper estate planning documents to protect you, your family and your assets. An added bonus is to decrease family strife and discourse at the time of serious illness or death.
Below is a review of the documents you may need to be sure your desires are legal and clear, hence minimizing conflicts and confusion in your family.
The Advanced Health Care Directive is a specific form that lists your healthcare preferences to be used only at a time when you cannot communicate your wishes. It puts your family, doctors and hospitals on notice as to the types of treatments/tests/care you would or would not want. It also lists those empowered to make health care decisions on your behalf should you not be able to express your desires. Everyone over the age of 18 should have this form completed.
The office of the Attorney General of California has excellent information on this topic including a sample form
Power of Attorney for Asset Management appoints those that you trust to handle your financial affairs. The form also lists those areas in which you allow the individual to assist you. Having completed this form can be very important in avoiding conservatorship should you become incapacitated. An immediate or durable power of attorney allows your agent to immediately act on your behalf. A springy power-of-attorney goes into effect only when you are incapacitated. It would be important to talk to your attorney and make sure you receive the form that is most appropriate for your situation.
HIPAA Release Form. Several years ago the federal government passed a law to help protect our health care information. In doing so, it made it more difficult for our family members or trusted individuals to deal with health insurance matters at a time of our incapacitation. By having this special form completed ahead of time you allow those individuals named in your advanced health care directive and or power of attorney for asset management to have access to healthcare information to deal with insurance matters on your behalf at a time when you cannot do so.
A Will is the method that many people use to transfer their assets upon their death. These are relatively inexpensive to acquire but in most cases will result in probate which can be time-consuming and expensive. For many people who own real estate or have more than just modest assets, may be better served by having a Living Trust. Even those individuals having a living trust still need a will.
A Living Trust is the preferred method of transferring assets upon death for many people. When assets are transferred via the trust there is more confidentiality, less cost, more flexibility with distribution, faster distribution and your wishes are less likely to be contested than with a “probated will”. For those with a lot of wealth, the trust might also provide some estate tax benefits. The downside to the trust is that they are a little bit more expensive to create and maintain.
If you have the trust, is important to make sure that trust is properly funded. All real estate should be transferred to the trust as well as savings accounts, mutual funds and other investments. Assigning your personal property to the trust and having the proper document allows the trustee to distribute your personal property those that you list thus helping to avoid conflicts within the family when you’re gone.
You should always consult with an attorney who specializes in estate planning to make sure you have the correct estate planning documents for your situation. Do not rely on the Internet or from the sale of products such as from Suze Orman to create your own trust document.
Do yourself and your family a favor and make sure you have the proper estate planning documents now thus avoiding the family issues that can be caused by your lack of planning.
Refinance Your Home Loan Now
The mortgage payment is one of the biggest items in most homeowners’ budgets. A smaller payment means more to spend elsewhere.
Interest rates on home loans are at the lowest level in 60 years. This is an opportunity to save on interest payments and use the saving to finance other goals.
Consider a homeowner who has a mortgage of $250,000 with a current interest rate of 5.5%. The monthly payment would be $1,419 a month. If, however, the loan was refinanced to current levels of 4.2%, the payment would be $1,222 a month. This is a savings of $2,364 a year. That saved money could be used for retirement, for kids’ education, or other budgetary needs.
Mortgage rates are lower now because investors are seemingly worried about the US economy. More people are investing in US Treasuries. Mortgages tend to track the yield of the 10-year Treasury note, which is close to an all-time low.
There are factors to consider when refinancing other than the rates. You should talk to your mortgage banker about the cost of the refinance, which is typically referred to as “closing costs.”
Other considerations are going to a 15-year loan rather than 30-year, which has even lower rates. This could be important if you are over the critical age group of 45 to 50, since having a mortgage in retirement stretches the retirement dollars.
Another option is refinancing your home to a 30-year loan but continuing to make your current payment. The net result is that the loan would be paid off in a shorter time period but with the flexibility of paying less when cash is short.
This may be “the best time ever” to refinance your mortgage. It would be worth your while to consider the benefits now rather than in a month or two
Why You Need a Second Opinion on Your Portfolio
You’re mired in a world of splitting headaches and chronic stomach pain. You know something is wrong, yet after a checkup you’re told that everything is fine. Most of us would be inclined to seek out a second opinion. However, given the above encounter was with your financial advisor pertaining to your investment plan as opposed to a doctor regarding your health, many simply continue on with an inadequate financial blueprint that will likely guide their retirement years to an early grave. It’s critical you take as much care to ensure long lasting financial health as you do your physical health.
Given the economic woes and market turmoil we’ve endured as of late, now is an ideal time to procure a second opinion. Here are some things to keep in mind when seeking out such advice:
Be Aware
The landscape has become increasingly confusing for the public over the years as the lines between various financial professionals has become blurred. We now have some CPAs and attorneys selling investments and insurance professionals positioning themselves as financial advisors. Furthermore, some advisors represent Broker Dealers (Merrill Lynch, Morgan Stanley Smith Barney etc.) and operate under a suitability standard, while others known as Registered Investment Advisers (RIA) are held to the higher fiduciary standard.
As a result, it’s confusing to know where to go for a second opinion. Many publications have recommended seeking out a Registered Investment Advisor for an unbiased second opinion. To find one near you check out NAFPA or Garrett Planning Network.
Be Thorough
Once you have a handful of possible candidates, spend time reading their websites and understanding their process, experience and qualifications (CFP, CFA etc.). Just as you would want to know where your surgeon went to medical school, completed residency, and the various designations and licenses they hold, you should want to know what makes a financial advisor qualified to give a second opinion on your financial health.
Be Clear
During your initial meeting with an advisor, have a clear understanding of what you want and what you’re going to ask as to the advisor’s qualifications.
With respect to the second opinion you will want to ask:
- What am I getting? Ask to see a sample report of what you will be provided.
- How is this different? Request to have a side by side comparison of what you currently have and what will be recommended.
- How am I charged? Have a clear understanding how the advisor is compensated for the advice, preferably in writing. Some advisors will simply charge a set fee, others will charge by the hour, while others won’t charge at all. As we know, nothing is free. Those that don’t charge for the actual plan or advice will expect to be compensated by the plan implementation, therefore possibly leading to advice that is not completely unbiased.
Be Open
Just as you wouldn’t expect a doctor to perform surgery or prescribe medication without knowing your medical history, you can’t expect to get quality financial advice if you are not willing to disclose your private information. Although maybe you’d rather not tell them about your 500 shares of Apple (AAPL) in fear they may suggest you liquidate, you would be doing yourself a disservice and hindering your plan. Transparency on the part of both the client and the advisor should be the foundation of any successful working relationship.
Be Patient
Your financial diagnosis and plan, when approached properly, should take time – typically a several meeting process. And once your new plan is in place (or your existing plan is confirmed) the real test of patience begins. As with your health, an annual checkup is a must.
Whether your pain and suffering is physical or financial, it’s prudent to get a second opinion.
What to Ask Your Potential Financial Advisor
In these crazy times of volatile stock prices, low interest and changing economics, making good financial decisions is not easy. Using the services of a financial advisor can greatly help but finding a great advisor is not easy. Knowing what to ask of a perspective advisor is often helpful. However, all published advice is not accurate.
In the July 2011 edition of Money Magazine (page 69), senior writer George Mannes suggests that as part of the vetting process for selecting a perspective “trusted” financial advisor or planner, you ask for some names of clients that you can talk to about the advisor. The Wall Street Journal, CNN Money, and even Liz Davidson and Susan Bradley, who are contributors to Forbes.com, also make this suggestion.
While these credible sources are all well meaning, they are missing the boat by suggesting that a financial advisor or financial planner give the shopper some names of current or past clients for at least 3 reasons:
- First, and for simple common sense reasons, the process is unreliable and can be very misleading. Let’s say that the advisor had worked with 100 clients. 97 of the clients felt the advisor was terrible. Three of the clients thought the advisor was great. The advisor would obviously know the feelings of the clients and would only give out the contact information for the three happy clients. This would be misleading which is why the SEC prohibits testimonials.
- The Security and Exchange Commission (SEC) prohibits the use of testimonials since it is felt they can be misleading. SEC Rule 206(4)-(1)(a)(1) in general states that it is fraudulent, deceptive, or a manipulative act, for any Registered Investment Adviser (RIA) to directly or indirectly, publish, circulate, or distribute any testimonial of any kind concerning the investment adviser. On the other hand, stockbrokers and insurance agents can give out names of clients because they are not RIAs who are held to the higher standard.
- Most RIAs have a Privacy Policy Statement for their office, which states that the office does not release information about its clients for any reason. Not abiding by the privacy policy statement would contradict form ADV and would be a violation of either state or federal law.
It is for these reasons and possibly others that the following organizations do not recommend asking for references: Forbes.com, Kiplinger, CFP® Board of Standards, NAPFA, Garrett Planning Network, and About.com.
Many organizations and writers suggest asking the following meaningful questions of a would-be advisor:
- Are you a Fiduciary, and do you accept fiduciary responsibility in writing? (This is what you want)
- Do you sell clients products such as insurance and investments? (If they say yes, how will you know that their advice is in your best interest — or that of the seller who gets the commission? Avoid sales people.)
- What is your training and Certifications? (CFP®, CFA® AIF® are some of the best.)
- How long have you been working as a financial Advisor/Planner? (The longer the better.)
- Do you have any financial ethics violations?
- What are the services that you offer? (Make sure the planner provides what you are looking for.)
- What is the age range and economic situation of your clients, and what is your ideal client? (They should be people like you.)
- The field of financial planning is broad. What are your strong points and what do you refer out to others most often?
- How long do you plan to be in business and what is your exit strategy? (It is not wise to start the process with someone who is planning to retire in 1 year.)
- Will you give a written fee estimate for the services requested? (This should be “yes”!)
To find perspective financial advisors near you, go to the National Association of Personal Financial Advisors NAPFA.org or GarretPlanningNetwork.com
A Basic Guide to Americas Most Common Income Taxes
As a teenager I worked in an ice cream store. There were 31 flavors, so I think you know which store in which I worked. My problem with ice cream is I like all the flavors. That is not the case with the different flavors of income tax.
The most common flavor of income tax is Fully Taxable. The sources of income subject to full tax are wages, bonus, business income, partnership income, bank account interest, alimony, pensions and rent that you might receive. The tax rates are 10%, 15%, 25%, 28%, 33% and 35% depending on your total income. With the current financial status of this country, it’s pretty clear that these income tax rates will be going up at some point in the future.
The second flavor of income tax that’s better than the full tax flavor is deferred tax. This includes traditional IRA’s, 401K, 403B 457 and a few others. It depends on the type of employer as to which type plan is offered but regardless to the plan they all provide the same feature. They allow employees to defer income until the retirement years when you might be in a lower bracket. With this flavor of tax you don’t pay now you pay later when you take the money out.
The third tax flavor is preferred tax status. Many of you who are retired do have this preferred tax on your Social Security benefits. If you’re in a low income tax bracket you pay no tax on your Social Security benefits. If you have some additional income you could tax on up to 85% of your benefits. Some of you might be old enough to remember the government’s previous promise never to tax Social Security benefits.
Another type of preferred flavor is that of long-term capital gains. If you invest in stocks or other types of investments and hold it for longer than one year, sell the item and reap a profit, you pay less than ordinary income. If you are in a low tax bracket would pay zero tax and in higher brackets long-term tax rates are 15% which is honestly preferred to the higher rate of fully taxable.
A perpetual tax flavor favorite is tax-free. The income from municipal bonds is what most people think of when they think of tax-free income. There are however many other sources of tax-free money. When someone gives you a gift, there is no tax due. If you receive an inheritance, there is no tax due. Life insurance payouts are income tax-free. When a couple sells their home, there is no income tax up to $500,000. Child support is tax free to the recipient. Roth IRA withdrawals are tax-free. Health Savings Account withdrawals are income tax free as long as you use it for a qualified expense. 529 plan with drawls for college education are tax-free when the proceeds are spent on qualified expenses.
The fifth flavor is not bad but is not great. It is when there is no tax due because the income is below the taxable threshold. On one hand its good because no tax is due. Yet it is not so desirable in that there may not be adequate resource to fund current needs and save for the future.
The last flavor of tax is the Alternative Minimum Tax. The Federal government invented this particular flavor years ago for the purpose of making sure the “wealthy” pay their “fair share”. When the legislature wrote this rule they did not index the law for inflation. As a result, years later, it is impacting many middle-income taxpayers. Unfortunately, our lawmakers don’t have the time to eliminate this flavor from our ice cream shop oh I mean tax code.
As a financial planner as well as a taxpayer, my favorite flavor is tax-free, followed by tax preferred then tax-deferred. I have to put up with fully taxable but I personally have never had to taste Alternative Minimum tax. What are your favorites, if any?
A Hot Investment Recommendation
Recently in a social situation, I was introduced to a physician. In the course of the conversation she realized I was a financial planner and investment fiduciary and she asked the common question “What would a be a good investment for me in these turbulent economic times?”
The physician appeared to be somewhat taken back when I answered “I have no idea what would be a good investment for you.” Her question would be like me asking her, “What would be a good drug for me to take?”
A doctor would not prescribe a medication without taking a case history, performing tests, making a diagnosis and consider the treatment options in light of other medications.
A financial planner or investment advisor should go through a series of similar steps before making an investment recommendation. The following is an outline of the steps.
- Understanding the client
The advisor must understand the client’s current financial situation including liabilities and income, as well as their goals, aspirations and dreams. The financial capacity for risk as well as the clients’ mental outlook for risk needs to be understood by the advisor and the client. - Analysis of current investments
The next step would be to the current asset allocation and the investments in each category. Appropriate investments should be retained while others may need to be liquidated taking taxes into consideration. If a client had 80% of their assets in growth equities adding Netflix, Apple, Google, Microsoft or even Wal-Mart Stores or would not be appropriate since the portfolio is already grossly out of balance. - Investments going forward
First a determination of appropriate asset classes for the individual is made. As an example with a low interest rate environment adding long bonds may not be appropriate when interest rates go up. The appropriate mix of these different asset classes is then determined. Sometimes an optimization program is utilized to determine which mix of asset classes gives the highest projected return for the minimum risk taken. A plan should be developed and expressed in what is known as an Investment Policy Statement.
When picking the funds that go into the different asset classes, many investors fail to heed the SEC’s warning published in all prospectuses, which states, “Past performance is not a good indicator of future performance.”
Selecting investments should be based on Generally Accepted Investment Principles. These would include: an investor cannot pick the return but can only choose the level of risk, One cannot accurately predict the market, Diversification lowers risk, Invest to be on the Efficient Frontier and low cost investments can improve performance vs. high costs.
The take away for the Dr. and for the public in general is that there is no one HOT investment that is right for every one and that an appropriate investment recommendation is not made lightly.
Michael Chamberlain CFP® AIF®
Sacramento/Santa Cruz/Campbell
Are You a Victim of Illegal Investment Advice?
It is all too common: an insurance salesperson who comes to your home after you attend a free seminar or a bank employee recommends that you cash out some or all of your stocks, bonds, or mutual funds and purchase an annuity. In doing so, they have broken the law and may not even be aware of it.
The Investment Advisers Act of 1940 is a United States federal law that was created to regulate the actions of those giving investment advice for compensation as means to protect the public.
The Act defines an “investment adviser” as anyone who, for compensation engages in the business of advising others about the value of securities or the advisability of investing in, purchasing, or selling securities.
Therefore, when an insurance salesperson or bank employee suggests that you sell some of your investments to buy their annuity, they are technically giving investment advice, and are required to be licensed to provide that advice.
Recommending that you buy the annuity is not illegal under the Act because fixed annuities and indexed annuities are not considered investments. They are insurance contracts. It is the suggestion or advice to sell your stocks or mutual funds that is the illegal act.
To give investment advice, one needs to be licensed as a Registered Investment Advisors. RIA’s have a legal obligation to always recommend what is in the best interest of the client, disclose all relevant details, and avoid conflict of interest. This is the fiduciary standard.
Investment advice can be provided by a non-RIA’s under two exemptions:
- Advice associated with offering investments for sale can be given via a Broker Dealer representative. However, these sales folks currently operate under the “suitability standard” which does not have the same legal safeguards that you have when using a RIA.
- CPAs and attorneys are exempt when providing advice in the normal course of their work and do not hold themselves out as an Investment Advisor.
Please note that an insurance license DOES NOT allow for any advice to by given to buy, sell or hold a stock, bond, mutual fund or ETF under any circumstances.
Unfortunately, seniors are often the victims of this illegal investment advice. The result can be increased income taxes from the sale of highly appreciated investments, being locked into an annuity contract for a long period of time, having to pay a penalty to get all of your money back, or having a contract that fails to live up to the sales pitch.
Getting help when you are a victim of illegal investment advice can be difficult. Some governmental agencies are strapped for resources and never properly investigate a complaint. Police may not understand the significance of the 1940 Act. Many folks do not know where to go for help.
Complaints can be sent to the Securities and Exchange Commission but many times are a matter for a State agency. Another alternative is to talk to an attorney who specializes in senior abuse or security law violations.
Many financial services companies have been sued for questionable annuity sales including LPL Financial, AIG and Washington Mutual, Allianz, Bank of America, National Western Life Ins. Co.,
If you, a parent, or friend had an insurance salesman recommend that stocks, bonds, or mutual funds be sold to buy their annuity or indexed annuity, there can be legal recourse against the agent and the insurance company. One client that I referred to an attorney, received a $50,000 settlement as a result of an improper annuity sale.
Additional information on avoiding financial abuse with annuity sales may be viewed here.
Michael Chamberlain CFP® AIF®
Busting 5 Financial Myths
Perhaps you have seen the Discovery Channel television program “Myth Busters.” Adam Savage, Jamie Hyneman, Kari Byron, Grant Imahara, Tory Belleci go about proving whether myths are true or not. Unfortunately they have not tackled any financial myths, of which there are plenty. This post will address 5 such myths and perhaps motivate the TV show to address other financial misunderstandings.
- “Dollar Cost Averaging will increase my return.” Sorry folks, dollar cost averaging can make you feel more comfortable about investing into the markets, however there is no evidence to justify the belief that it will increase your return. A primary reason is that the stock market rises more often than it falls so the sooner you have more into the market, generally the higher return you will have. This is particularly true when you are investing over long periods of time.
- “Picking the right investment is the main factor to high returns.” Sorry…Wrong again. Several studies over time have shown that having the proper asset allocation (mix of investments, stocks, bonds, and cash) that is appropriate for your goals, time frame, risk tolerance, and risk capacity is responsible for a majority of your portfolio return. Trying to pick the next “big thing” or the “right” investment is very difficult hence the SEC states, “Past performance is a poor indicator of future performance.”
- “I don’t need to worry about long-term care costs because Medicare will pay for it.” This is perhaps one of the biggest myths ever. Medicare will pay for skilled nursing care but only for a limited time frame. The vast majority of nursing care costs are custodial in nature and Medicare specifically excludes this type of care. You are on your own for this cost. Don’t look for the government to help unless it is through the Medicaid program for the indigent.
- “It’s always best to roll your 401(k) at retirement into an IRA.” Not true but it could be in some cases. Unfortunately, many companies like Fidelity encourage employees to roll over their 401(k) to an IRA when leaving an employer. When doing so the employee loses some asset protection if sued and the ability to borrow from the 401(k). Many 401(k) plans have very good choices available at a very low cost and should be retained. In some cases, the 401(k)’s don’t give you enough diversification of investment choice or have high fees, and going to a no-load IRA would be a better choice. Understanding all the differences is important. If you are unsure, get unbiased advice from someone who will not profit from the advice, such as a fee-only planner.
- “Actively managed mutual funds have higher returns than index funds.” This myth has two sides. If you believe economists, college professors, and Nobel Prize winners, over time, index funds (passively managed) provide higher returns than the majority of actively managed mutual funds. If you tend to believe stockbrokers, Wall Street, Banks, and big for-profit companies (all of whom are trying to make money off your investments), you may believe actively managed mutual funds do better. Granted, some actively managed funds beat the index in the short run but no one knows which funds those will be until after it has occurred. Actively managed funds have higher trading and management costs and can incur more income taxes. As a result, passive index funds do better over the long term most of the time.
Do you have a financial myth that you would like confirmed or busted? Just ask! Send your questions to mike@chamberlainfp.com
Michael Chamberlain CFP® AIF®
This article is for informational purposes and should not be taken as legal, tax or investment advice.