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May 7th, 2012
I come across investment bloopers all the time in my line of work – I’m a
Fee-Only (no products sold) Certified Financial Planner®. From what I can see,
many bloopers are a “perfect storm” – a combination of opportunistic product
sales combined with a lack of understanding by clients. How does this happen?
The standard of care by brokers and some advisors who sell products is a
“suitability” standard – not the better fiduciary standard that requires an
advisor to put a client(s)’ needs first. According to the “suitability”
standard, products are fine if they’re “suitable” for the client – but
“suitable” is a slippery slope that leads to investment bloopers.
Note: These investment bloopers are true; identifying information and
situations have been completely changed.
Blooper #4: Dan and Miranda don’t know how much their broker charges
them each year – and why he’s keen to recommend certain
investments:
Dan and Miranda have $2,000,000 of investment accounts with an advisor. They
don’t know anything about A, B and C mutual funds – they don’t pay attention to
the “A,” “B” or “C” alongside the name of each mutual fund holdings. Their
broker invested $500,000 in “A” shares – these generated up to $28,750 (5.75%)
in front-end commissions to the broker (note: fees were deducted from Dan and
Miranda’s initial pool of funds – they weren’t aware the initial $500,000 seed
money began at $473,750 because of the 5.75% front-end loads). Their broker
invested another $500,000 in “B” shares – they didn’t know B shares have a
surrender penalty so they’re stuck another 3 years and can’t move out of these
investments without penalty. Finally, their broker put the $1,000,000 balance in
”C” shares – these pay $10,000 each year to their broker (1% fee on $1,000,000
- again, fees are deducted from their net return so they don’t see or feel
them).
Conclusion: Pay attention to “A,” “B” and “C” designations mutual funds. Make
sure you understand what they cost you – brokers say they explain fees to
clients but this couple has no memory of having these explained to them.
Unfortunately, confusion about fees is very typical.
Blooper #3: Jerry has variable annuities he wasn’t aware he
owns:
Jerry has IRA accounts with a friendly advisor who sells products. Jerry told
the advisor he was worried about outliving his retirement assets. The advisor
agreed to “help provide a comfortable retirement” and explained these
investments are “safe.” Jerry didn’t really understand what he was signing but
he trusted his advisor.
When Jerry engaged an independent advisor to review his investments, he was horrified to discover he had purchased variable
annuities with surrender penalties! The advisor who sold these to Jerry did NOT
tell Jerry she earned a tidy $8,000 in commissions by putting him into $200,000
of variable annuities (4% commission on $200,000 = $8,000) and did NOT tell
Jerry these annuities would cost him 3% per year in fees that are deducted from
his investment return (= $6,000 per year on $200,000 – deducted from his
return).
Conclusion: Jerry was advised by his new independent advisor Jerry to exit
these variable annuities when the surrender penalty ends in 2014. Once he
unwinds these annuities in 2014, his funds remain in his IRA but now Jerry has
access to low-cost investment alternatives.
Blooper #2: Susan ended up in a hedge fund she doesn’t
understand:
Susan’s brother, a Fee-Only Certified Financial Planner® took a look at her
brokerage statement and discovered Susan had 25% of her investment portfolio in
an obscure hedge fund that has declined by more than 1/3 vs. her initial
purchase price. Susan will retire in 5 years – the broker obviously didn’t pay
attention to Susan’s comments that she can’t stomach much investment risk.
Conclusion: Susan confirmed this investment is free of surrender penalties;
she has decided to cut her losses due to the high risk. Since this position is
in a taxable account, Susan can “harvest” the investment loss (use it to offset
capital gains elsewhere — or carry over $3,000/year for the rest of her life).
If Susan retained this fund in her IRA, she would consider the pros and cons of
selling in consultation with an independent investment advisor.
Blooper #1: Janice and Bill don’t know what their ideal portfolio
should be (e.g. 40% stocks, 60% bonds/cash) and they don’t know how their
current portfolio is positioned:
Broker XYZ provided Janice and Bill with a patchwork of various investments.
They don’t understand what they’re invested in, and don’t know if their
portfolio is too risky for them. Janice checks the value on statements each
month and is pleased if the portfolio is “up” for the month. She trusts Broker
XYZ to handle things.
Conclusion: Janice and Bill had a Fee-Only financial advisor review their
existing holdings, determine their risk tolerance, determine the kind of
portfolio that best funds their financial goals, weeds out inappropriate
investments and gets them on the right portfolio track. The advisor periodically
rebalances their investments so they stay on track.
Are you experiencing any of these investment bloopers? Get a 2nd opinion from
a knowledgeable financial advisor who doesn’t mix products with advice – a
Fee-Only advisor!
Copyright (C) 2012 by Eve Kaplan
Tags: A, B and C mutual fund loads, confusion about investing, fee transparency, variable annuities
Posted in Fee-Only Financial Planning, Investing, Investments | No Comments »
December 13th, 2011
How much money can you safely withdraw from your investments once you retire?
This is a subject of wide debate in the financial planning world as our country’s 78 million baby boomers start turning 65 this year. This “withdrawal rate” simply refers to how much you can tap from your investment assets to avoid running out of money before you die. The approach is designed to allow you to withdraw money each year while leaving your principal intact.
For example, if you start with $1,000,000 at retirement and withdraw 4% per year ($40,000), you skim a $40,000 annual gain off the top of your $1 million investment portfolio and always have the $1,000,000 principal until the end of your life. This implies the $1 million keeps growing by 4.2% each year (you need more than a 4% increase to return to $1 million).
Being able to live off interest while retaining your $1 million principal is valuable even if the purchasing power of your principal declines each year with inflation. In other words, your $1 million initial retirement account might only be worth the equivalent of $300,000 after 30 years, but having the equivalent of $300,000 is still a great financial cushion to help keep you from running out of money.
Unfortunately, we don’t live in the predictable world that facilitates an automatic 4% withdrawal rate because markets move up and down, tax rates change, your financial needs change and investments sometimes disappoint. You no longer can simply set the dial at e.g. “4% withdrawal per year” and be assured you won’t run out of money in 30 years.
Here are some things to consider, based upon recent research:
1. People are living longer and longer. It’s not overkill to assume you easily can live another 30 years if you retire at age 65.
2. You can’t control where markets will land the year you retire and begin tapping your investment nest egg. If you had a few bad years before you turn 65, you might start retirement with $900,000 instead of the $1 million you intended. How much you have at retirement also depends upon your portfolio mix in the years leading up to retirement. You should consult with a financial planner or investment specialist to determine your optimal mix.
3. Once you retire, you need to adjust your withdrawal rate “as you go” – depending upon how markets did the previous 3 years. The Wall Street Journal refers to this strategy as “the accordian strategy.” If the market hits a bear market bottom (note: this may not always be obvious), you trim your withdrawal amount by 25% for the coming 3 years. Michael Kitces, a planning strategist, recommends tracking the S&P 500 P/E (price earnings ratio) to determine if the market is overvalued, fairly valued or undervalued. On that basis, he increases or decreases recommended withdrawal rates within a 4.5% to 5.5% range. This approach has been effective in recent years when tested with a 60% stocks, 40% bonds portfolio.
4. Some specialists recommend an even lower withdrawal rate (as low as 2.5% for a moderately conservative 40% stocks/60% bonds portfolio). This means you withdraw $25,000 per year (2.5%) instead of $40,000 per year (4%). Of course we’re talking about pre-tax amounts.
5. One strategy at retirement is to set aside 3 years of cash reserves (what you otherwise would draw from your investments) so you always can suspend your annual withdrawals from your $1 million if markets hit the skids.
We haven’t discussed the fact that you need to pay taxes on what you withdraw (ordinary income tax rates if it comes from an IRA, or capital gains tax if funds come from an after-tax account). You may need significant other sources of income (social security, pensions, savings) to fund retirement. And then there’s the corrosive power of inflation; you need to withdraw more and more each year in order to keep pace with purchasing power. Finally, our example of $1 million doesn’t go very far toward covering retirement in more expensive parts of the country – you may need multiples of $1 million in addition to social security and a pension (if you’re lucky enough to have one).
As you can see, determining your ideal withdrawal rate is no trivial matter. If you’re calculations indicate you may be coming up “short,” alternatives include retiring later, adjusting your portfolio over time or spending less in retirement. It’s best to seek professional advice if you have doubts or concerns!
Copyright © 2011 by Eve Kaplan
Tags: withdrawal rates in retirement
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November 21st, 2011
by Eve Kaplan, Certified Financial Planner(R)
Do you – or someone you know – move in and out of investment holdings in order to “boost your return”? If you do, it’s worth considering the downside. Studies consistently show that market timing (you go into investments when they seem good, exit when they don’t) undermines your ability to make investment progress.
Consider the fact that retail (individual) investors typically flee from markets when the bad news already is reflected in prices, and typically try to climb back in when prices already have moved higher. Instead of buying low, selling high, individual investors tend to do the opposite.
I have an excellent graph that illustrates this point – but I’m not able to overcome technical difficulties and print it here (very irritating!)…so I’ll ask you to use your imagination. As you know, the market fell out of bed in September 2008 (good-bye Lehman Brothers, hello imploding mortgage market). The graph I can’t post shows a steady outflow of individual money in mutual funds as the S&P 500 hit bottom (March 2009) and continued to rise into 2011. As the market is rising, individual investors continue to bail out of stocks.
So who’s driving the market higher? It’s often institutional money (pension funds, professional money managers) who have clients with staying power. This institutional money effectively works to block the natural tendency toward panic selling The proxy for this staying power is Dimensional Fund Advisors but it could be any institutional investor who didn’t try to “market time.” (full disclosure: I use Dimensional Fund Advisors mutual funds for my assets-under-management clients).
Here’s another example of the damage others inflicted on their investment returns when they tried to time markets. Remember the Fidelity Magellan Fund? This fund returned a stellar 29% per year (1977-1990) under Peter Lynch’s tenure but Lynch apparently once said he felt more than half of the Magellan Fund shareholders lost money, based upon fund inflow/outflows. By now you must know the reason why… Smart money doesn’t exit when the going gets tough – it rides problems out, continues to invest for the future and racks up a better return over time.
Copyright © 2011 by Eve Kaplan
Tags: financial investing, investment returns, investment timing, market underperformance, trying to beat the market
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August 25th, 2011
by Eve Kaplan, CFP(R) Practitioner
Imagine you’re on a train headed for California. You know the train ride will take some time. You know the train will slow or stop at stations, accelerate to a certain speed, ascend to higher elevations, descend again and hit some switchbacks.
You plan on riding all the way to California, but you get motion sickness when you hit a series of switchbacks and you feel the train descending rapidly. Do you: 1) continue your journey or 2) jump from the moving train mid-way?
I hope you answered “continue my journey” and didn’t say “jump from a moving train”! Or should I say – I hope you stick with your investment strategy and don’t bail (panic) by selling into lower markets when they begin to decline?! Because – like all journeys – investing in stocks (US, overseas markets) is not always smooth. However, stocks can get you to your destination: a nest egg that carries you through retirement.
Why not bail on stock markets when you hit a rough patch? For one, it may be easy to exit the market (jump from the train) but how do you get back on board? One of my investment rules of thumb is – don’t do what your gut tells you to do. When markets become choppy, volatile and uncertain, there’s certain to be an overabundance of negative news in the media. If you actually listen to it, your gut feeling will tell you “jump from the train!” But that’s exactly the wrong thing to do, at the wrong time, for the wrong reason.
Here are some things to ponder before you consider jumping from any train:
1. You will have a smoother ride if your portfolio is prudently constructed and well diversified. Exposure to various stock markets (US large, mid and small, international developed, emerging, growth and value) reduces the pain of hitting a speed bump. Add various types of bonds, commodities, real estate investment trusts and alternative investments, and your ride is relatively smooth.
2. Occasionally this system breaks down (e.g. during the 2008 meltdown) and it seems like there is no save place to hide. That experience is temporary because the benefits of diversification resurface.
3. If you live into your 90s, you may have 20-50 more years on your train ride. It makes no sense to jump from a moving train (react to the market short-term) if you’re in it for the long haul.
4. Studies show individual investors typically earn a fraction of their promised rates of return because they hop in and out of holdings –usually at the wrong time. Poor timing means they rack of transaction fees and end up “buying high and selling low.”
5. Rebalancing your portfolio (selling outperforming investments, buying more underperforming investments) can contribute to a smoother ride (better return). If your model portfolio is 60% stocks/40% bonds now, and market movements change this to 55% stocks/45% bonds, consider gradually buying more stocks/selling more bonds until you get back to your optimal 60% stocks/40% bonds portfolio.
If you work with a good investment advisor/financial planner, you’ll have someone prevent you from following your gut reaction to “jump from the train.” If you don’t work with anyone, consider utilizing professionally managed portfolios at Vanguard, Fidelity, T. Rowe Price, etc. Once you find the portfolio that’s right for you, stick with it through market turbulence. Having your investments rolled up in a one-stop-shop will help you avoid the temptation of jumping from the moving train.
Copyright © 2011 by Eve Kaplan
Tags: asset class diversification, dos and donts in investing, investing dos and donts, long-term investment planning, market timing, market volatility, rebalancing, staying the course in investing
Posted in Investing, Investments, Retirement Planning | No Comments »
June 7th, 2011
by Eve Kaplan, CFP® Practitioner
People are programmed to follow crowds because it helps our survival. If you see a crowd running in the same direction, you’re likely to follow it since “it must know something.” Doing so could save your life.
What about following the crowd when it comes to investing? Studies show the “wisdom of the crowds” becomes a liability in the investment world. This is true not only during bubble times, but during ordinary times, too.
During bubble times, extensive research underscores the wisdom of heading in the opposite direction when everyone is enthusiastic about something. Joseph Kennedy is said to have cashed out his stock market positions in 1929 when he heard a shoeshine boy giving stock tips. There are many similar stories – from tulip mania in the Netherlands to the 2001 Nasdaq crash. When everyone is excited about an investment, that’s a good sign to “get out early” and avoid running further with the crowds.
But more often than not, we’re not necessarily in the midst of a growing bubble. During these so-called “ordinary times,” data also indicate the crowd is more often wrong than right when it comes to investments. The Economist investigated Morningstar fund flow data and performance statistics in the US in order to determine if investor crowd wisdom paid off. Specifically, the Economist was looking to see if it paid off to invest money into something that already had done relatively well the previous year (something that already had a “good buzz.”) Looking at the most popular investment sector (that beat the average sector by more than 2 percentage points the previous year), the popular sector subsequently lagged the average by under 3 percentage points as investors continued to pour money it. Multiple test runs indicated the herd mentality was wrong approximately 60% of the time. 60% may not seem like a lot, but that’s hugely significant when compared with random statistical outcomes.
How about using “wisdom of the crowds” behavior as a contrarian indicator? The numbers seem to indicate that “pariah” or out of favor funds do better than popular sectors, but do not exceed average returns.
You’ve probably often heard the disclaimer “past performance is no guarantee of future performance” in mutual fund literature. Investment gurus frequently remark that past outperformance of mutual funds does not continue indefinitely due to mean reversion. In other words, an investment that did relatively well in the past likely will not continue to do so in the future. Investors typically get very enthusiastic about something after it’s done well, and end up “buying high, selling low.”
The reversion to the mean phenomenon can be seen as yet another reason to stick to “passive” (index-based) investing since data show it’s difficult to outperform a market on a consistent basis through active management. By some measures, approx. 75% of mutual funds who actively attempt to outperform a benchmark end up underperforming (doing less well).
Volumes have been written about these subjects so I’ll end here by touting portfolio diversification. Even pundits were skeptical after the 2008 crash about diversification since all assets fell together and there was no safe place to hide. However, diversification always reasserts itself and remains the cornerstone of prudent investing. Diversification simply means having exposure to many different assets classes (different types of bonds, different types of stocks, alternative investments) to smooth growth and lower volatility. The right mix of different assets is something your advisor can design for you. If you don’t have an investment advisor, there are some online tools that give you some ideas about ways to increase your diversification and simultaneously lower your risk.
Copyright © 2011 by Eve Kaplan
Tags: contrarian investing, diversification, passive investing, reversion to the mean
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May 1st, 2011
By Eve Kaplan, CFP®
Here’s an easy to way to fix 2 investment mistakes. I detailed both at a recent workshop at the Berkeley Heights Public Library on April 6. Both mistakes are very simple ways to get you started with your Spring Cleaning investment project: 1) consolidate your scattered investment accounts into several holdings and 2) confirm your holdings are diversified by weeding out overlapping positions.S
Scattered holdings is like hanging your clothing in closets throughout the house (plus having some of it packed away, out of sight). Imagine dressing for a formal occasion, but running from closet to closet to piece together your outfit. It’s the same with financial accounts. If you have accounts scattered all over the place, it’s very hard (often impossible) to understand what you’re invested in, and where all your money is located. If you don’t know where your money is, you can’t minimize taxes (by knowing how much is taxable vs. tax-deferred). You also can’t know or remember what you have where, what should be rebalanced (positions brought back to your optimal asset allocation levels), etc. Scattered holdings are the enemy of good financial planning. Here are some guidelines for the number of places you should hold investments:
1) one current 401(k) or 403(b) plan per person (take all previous employer 401(k) and 403(b) plans and roll them into an IRA).
2) No more than 2 brokerage house accounts per individual or couple (e.g. TD Ameritrade, Fidelity, Vanguard). Some folks have a checking account at one brokerage house, but most or all their holdings at another. That’s OK, but preferably no more than 2 accounts.
Having money spread across several brokers to “see how each of them is doing” makes no sense. That means no single broker or advisor can see everything you’re invested in – so they invest on your behalf with blinkers on.
3) No more than 2 banks for CDs, checking and savings – per individual or couple. You may have some CDs at one bank, but use another for checking/savings. That’s OK – but preferably no more than 2 banks.
4) If you have annuities and no surrender penalties, these should be consolidated (rolled over, using a 1035 exchange) to low cost, no load annuities with one annuity provider.
5) We haven’t discussed insurance and other financial documents, but the fewer insurers and policies you have, the better.
Let’s turn to another area that’s a perfect target for Spring Cleaning: having an excessive number of mutual funds that may be redundant in content – and end up giving you asset class concentration instead of diversification.
Everyone should have the right portfolio mix of these basic asset classes: short- and intermediate bonds (possibly municipal, corporate and global), large, mid and small cap US stocks, international developed stocks, emerging markets, commodities and REITs. The appropriate weighting of each asset class is determined by your risk tolerance, income and/or growth needs, etc.
How do you know if your mutual fund holdings overlap? You likely won’t be able to tell if they just by looking at the name alone. Here’s what I mean:
Do you know what Janus D (JANDX) invests in? How about Fidelity Contrafund (FCNTX)? (answer: they both invest in US large cap growth stocks). How about Janus Triton D (JANIX) and Catalyst Value Cl A (CTVAX)? (answer: they both invest in US small cap stocks). If you subscribe to Morningstar, Quicken or other investment programs, X-ray functions allow you to enter mutual fund holdings to determine the extent of the overlap.
These are just 2 tips – briefly described – to Spring Clean your investments. Knowledge is power, so this type of Spring Cleaning is essential and not optional.
Copyright © 2010 by Eve Kaplan
Eve Kaplan is a Fee-Only Certified Financial Planner in Berkeley Heights. Kaplan Financial Advisors is a Registered Investment Advisor in New Jersey and New York. Her firm provides financial planning for individuals, and 401k/403b plans for companies. She can be reached at 908-898-0549 or www.kaplanfinancialadvisors.com.
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Tags: investments, mutual funds, portfolio allocation
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April 1st, 2011
Spring Clean Your Way to Investment Success!
By Eve Kaplan, CFP® Practitioner
I’m going to suggest two things are possible in the next several months:
1) the relentless cold, snow and ice will become a fading memory and
2) it’s possible to Spring Clean you way to a better investment life – based upon advice from a sage Wall Street veteran.
I’m taking my cue for Spring Cleaning from a prominent figure in the financial planning world: Gordon Murray. Mr. Murray, a Wall Street veteran and recent Dimensional Fund Advisors consultant, passed away recently from brain cancer. Gordon decided to cease treatment for his terminal cancer last June. He dedicated the last months of his life to writing a book (with his financial advisor, Daniel Goldie) called “The Investment Answer.” The book was completed before Gordon passed away – allowing him to see this project to fruition.
Gordon embraced simple ideas that could benefit the investment lives of all Americans. The book is simple and elegant. After more than 25 years on Wall Street, it manages to boil things down to 5 simple principles that can have a far-reaching effect on your investment life.
Here are the 5 decision points Gordon Murray recommends you embrace:
1. Hire an advisor who earns fees from you, not from mutual fund or insurance companies (Daniel Goldie works that way – not by coincidence). The thinking here is that commission-based advice-giving can never be as objective as advice that puts your needs before those of the advisor. It’s very hard to give objective advice when an enticing commission lurks behind the scenes.
2. Divide your money into a number of buckets: stocks & bonds, big & small, value & growth. I would add here that a large majority of investors – when in doubt – are well-served by a 60/40 stocks/bonds portfolio. I also would add that the Dimensional Fund Advisors bias favors small over big, and value over growth. 80+ years of investment data underscore the fact that small is better than big, and value outperforms growth.
3. Divide your money further into domestic and foreign buckets. Your home currency is the US dollar and that won’t change unless you plan on retiring in a foreign country. That said, the US percentage of global stocks is shrinking as other markets and economies outpace US growth. You want to consider holding global bond mutual funds, and having sufficient international exposure – directly through international and emerging market mutual funds, and indirectly through large US conglomerates who sell around the world (e.g. Coca Cola and Caterpillar).
4. Decide if you want to invest “actively” or “passively” through mutual funds. I will add here that I’m a former fund manager who embraced active management (stock picking) at the time, but I’ve converted to the passive approach. The passive approach doesn’t aim to do better than markets (and, by adhering to an index, typically doesn’t do worse, either). Costs are lower and some studies show passive investing beats the pants off active management, net of fees.
5. Rebalance regularly. This means you sell your winners (prune them back) and buy more losers. This strategy means you’re one step ahead of most individuals, who bolt for the door when things get bad, and crowd into something near its top. It means you go against your gut reaction (which tells you to buy something when it’s often too late, and sell something when it already has fallen).
If you don’t think you have the discipline to follow Gordon Murray’s 5 simple steps on your own, consider Step 1 (hiring an advisor who earns fees from you) as your starting point.
Spring Cleaning your investment life means you clear out the extraneous clutter, junk expensive or unattractive investments and streamline everything so it’s consistent with your risk tolerance. Doing this sooner – rather than later – means you can get to the goal line (the end of your life) and accomplish everything you need to do that costs money.
Eve Kaplan is a Fee-Only Certified Financial Planner in Berkeley Heights. Kaplan Financial Advisors is a Registered Investment Advisor in New Jersey and New York. Her firm provides financial planning for individuals, and 401k/403b plans for companies. She can be reached at 908-898-0549 or www.kaplanfinancialadvisors.com.
Tags: investments, mutual funds, portfolio allocation
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January 1st, 2010
Advanced Roth IRA Conversion Techniques
By Eve Kaplan, CFP® Practitioner
Interest in Roth IRA Conversions is heating up as we approach 2010. Last month another financial advisor, Michael Wattick, gave a good overall summary of Roth IRA conversion basics. I’ll address more advanced Roth IRA conversion techniques in this article that are attractive to higher net worth individuals in a 40% combined (federal, state, local) tax bracket.
To recap on Roth IRA Conversion basics, 2010 offers a unique opportunity to convert a tax-deferred IRA to a Roth IRA – regardless of income level. The tax bill you owe by converting a tax-deferred IRA to a Roth IRA can be split 50/50 over 2011 and 2012. Further, conversions can be partial and taxes can be paid by tapping the IRA (although it makes better tax sense to pay taxes from another account). Conversions make sense if you don’t need the IRA in retirement and want to gift it. If you do plan on tapping your Traditional IRA, a Roth Conversion makes sense if you anticipate being in an even higher tax bracket in retirement. However, you need to pony up money for taxes now and conversion isn’t attractive if you plan on gifting your IRA to charity.
Have you ever test-driven a car? You can test-drive a Roth IRA conversion and have up to 22.5 months to see if it makes sense for you or not. This advanced Roth IRA Conversion technique only makes sense if you have larger IRA accounts (300K+) since you need to get a financial planner involved to help you with the ins-and-outs:
-Rita” is in a 40% tax bracket; she has a 500K traditional IRA
-Rita wants to limit her tax liability to 40K taxes on the 2010 Roth IRA conversion and she wants to pay 40K in 2010 because she’s afraid tax rates will be higher in 2011 and 2012.
- Rita converts her 500K Traditional IRA, splitting it into 5 100K Roth IRAs on Jan 2, 2010:
a) 100K domestic large caps
b) 100K domestic small cap
c) 100K international stocks
d) 100K emerging market stocks
e) 100K hard asset stocks
-Rita pays 40K taxes on April 15, 2011 and requests an automatic filing extension until 10/15/2011.
- Rita’s Roth IRA conversion can be reversed (she can “recharacterize”) to a Traditional IRA anytime up to Oct 15, 2011 if she changes her mind about the conversion.
-Why would she change her mind? If her domestic large cap, domestic small cap and hard asset stock IRAs all appreciated during that 22 ½ month period, she could keep them as is (and merge the 3 to reduce paperwork). She’ll enjoy this appreciation tax-free in the future.
But perhaps her 100K emerging market stocks and 100K international stock holdings declined in value to 80K each. It makes good tax sense for her to “recharacterize” these back to Traditional IRAs by October 15, 2011. Assuming they continue a sub-par performance, she’ll have smaller IRAs to tap in retirement but also a smaller tax bill.
-Rita files her tax return for 2011 and gets a refund for taxes she paid on the 2 x 100K Roth IRA conversions she ultimately decided to “recharacterize” back to Traditional IRAs.
Sound complicated? There’s a fair amount of paperwork here which can’t be taken lightly – but this kind of strategy can make good sense for more sophisticated investors in higher tax brackets.
Copyright © 2009 by Eve Kaplan
Eve Kaplan is a Fee-Only (no products sold) Certified Financial Planner in Berkeley Heights. Kaplan Financial Advisors is a Registered Investment Advisor in NJ and NY. She can be reached at 908-898-0549 or www.KaplanFinancialAdvisors.com
Tags: investment techniques and Roth IRA conversions, roth IRA conversions, tax consequences of roth IRA conversions
Posted in Investing | No Comments »
November 1st, 2009
Advanced Roth IRA Conversion Techniques
By Eve Kaplan, CFP® Practitioner
Interest in Roth IRA Conversions is heating up as we approach 2010. Last month another financial advisor, Michael Wattick, gave a good overall summary of Roth IRA conversion basics. I’ll address more advanced Roth IRA conversion techniques in this article that are attractive to higher net worth individuals in a 40% combined (federal, state, local) tax bracket.
To recap on Roth IRA Conversion basics, 2010 offers a unique opportunity to convert a tax-deferred IRA to a Roth IRA – regardless of income level. The tax bill you owe by converting a tax-deferred IRA to a Roth IRA can be split 50/50 over 2011 and 2012. Further, conversions can be partial and taxes can be paid by tapping the IRA (although it makes better tax sense to pay taxes from another account). Conversions make sense if you don’t need the IRA in retirement and want to gift it. If you do plan on tapping your Traditional IRA, a Roth Conversion makes sense if you anticipate being in an even higher tax bracket in retirement. However, you need to pony up money for taxes now and conversion isn’t attractive if you plan on gifting your IRA to charity.
Have you ever test-driven a car? You can test-drive a Roth IRA conversion and have up to 22.5 months to see if it makes sense for you or not. This advanced Roth IRA Conversion technique only makes sense if you have larger IRA accounts (300K+) since you need to get a financial planner involved to help you with the ins-and-outs:
-Rita” is in a 40% tax bracket; she has a 500K traditional IRA
-Rita wants to limit her tax liability to 40K taxes on the 2010 Roth IRA conversion and she wants to pay 40K in 2010 because she’s afraid tax rates will be higher in 2011 and 2012.
- Rita converts her 500K Traditional IRA, splitting it into 5 100K Roth IRAs on Jan 2, 2010:
a) 100K domestic large caps
b) 100K domestic small cap
c) 100K international stocks
d) 100K emerging market stocks
e) 100K hard asset stocks
-Rita pays 40K taxes on April 15, 2011 and requests an automatic filing extension until 10/15/2011.
- Rita’s Roth IRA conversion can be reversed (she can “recharacterize”) to a Traditional IRA anytime up to Oct 15, 2011 if she changes her mind about the conversion.
-Why would she change her mind? If her domestic large cap, domestic small cap and hard asset stock IRAs all appreciated during that 22 ½ month period, she could keep them as is (and merge the 3 to reduce paperwork). She’ll enjoy this appreciation tax-free in the future.
But perhaps her 100K emerging market stocks and 100K international stock holdings declined in value to 80K each. It makes good tax sense for her to “recharacterize” these back to Traditional IRAs by October 15, 2011. Assuming they continue a sub-par performance, she’ll have smaller IRAs to tap in retirement but also a smaller tax bill.
-Rita files her tax return for 2011 and gets a refund for taxes she paid on the 2 x 100K Roth IRA conversions she ultimately decided to “recharacterize” back to Traditional IRAs.
Sound complicated? There’s a fair amount of paperwork here which can’t be taken lightly – but this kind of strategy can make good sense for more sophisticated investors in higher tax brackets.
You can find out more about this by attending my free “Staying Ahead of the Curve: Key IRA Conversion Strategies for 2010″ workshop at the Berkeley Heights Public Library on Sunday, November 8 (3-4 pm). See my advertisement for more information.
Eve Kaplan is a Fee-Only (no products sold) Certified Financial Planner in Berkeley Heights. Kaplan Financial Advisors is a Registered Investment Advisor in NJ and NY. She can be reached at 908-898-0549 or www.KaplanFinancialAdvisors.com
Tags: roth IRA conversions, tax consequences of ira conversions
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October 1st, 2009
Variable Annuities – Uses and Abuses: Part 2
By Eve Kaplan CFP®
Last month we fired an opening shot at Variable Annuities to highlight their uses and abuses. We’ll continue this discussion this month by looking at them in greater detail.
To summarize, I mentioned last month why so many annuities get sold (very profitable, for one) and why so many people buy them without understanding them well. Annuitants (annuity holders) I meet never seem to know they’re getting their hands tied to an expensive investment that unnecessarily restricts their freedom of choice and doesn’t protect them as much from the market as they think.
Variable annuities just aren’t the “quick fix” for retirement some annuitants think they are.
Let’s review in detail some of the pros and cons re: variable annuities:
Pros:
1. Any annuity takes taxable income and converts it to tax-deferred income (note: this is redundant if the IRA is put into an annuity). This is good if you’re in a high tax bracket now, don’t need the money now and expect a lower tax bracket when you draw your annuity.
2. Some variable annuities (expensive ones with bells and whistles) provide downside protection in stock markets. This certainly was helpful this past year. However, the underlying expenses are quite high for this type of “portfolio insurance” (and a lot steeper than they used to be since September 2008). Insurers got burned by the market collapse that began last September, so the protection is less generous and/or costs have risen for protection.
Cons:
1. Converting money to a tax-deferred status means you lose the ability to make use of a loss by offsetting it against gains in your taxable portfolio. Further, you lose the right to deduct an additional 3K/year of excess losses each year. If you’re in a 33% tax bracket, that’s like losing an extra 1K per year.
2. The present value of the annuity (a stream of payments for the rest of your life) is higher if you live longer. But variable annuities invest in unpredictable things (stock markets) so the stream of income is unpredictable, too (unless you previously bought the ‘bells and whistles’ annuity). The annuity may have no value if you pass away unless you purchase additional features that pass initial investments to your estate.
3. Locking up money in any annuity means you can’t readily tap the funds if you suddenly need your funds in a hurry.
4. Variable annuities can confine you to an unattractive, expensive investment selection. You’d lost the freedom to roam widely and find the best and most cost-effective investments.
5. School teachers are thrown to the wolves in many 403b plans – these annuities confusingly are billed as “tax-sheltered” investments (giving the impression tax is avoided altogether).
6. One of the worst offenses is putting IRA (already tax-deferred money) into an annuity. Putting IRA into an annuity can be likened to putting a refrigerator inside another refrigerator.
As you can see, the “cons” outweigh the “pros.”
I use annuities sparingly through a network of annuity providers I trust. I prefer fixed annuities – especially inflation-protected annuities that retain purchasing power. And charitable annuities (typically fixed) bestow tremendous tax benefits, secure some income for life and allow the annuitant to gift the balance to a charity of choice.
Financial planning should encompass all aspects of a person’s financial world: insurance, estate planning, education planning (if relevant), investments and tax planning. When done right -without the intrusion of product sales compensating the planner – clients have powerful plans to the end of their lives. The alternative is a quick fix annuity sale by an advisor or broker who usually bypasses a detailed, in-depth analysis of the person’s financial needs.
Again – the expression Caveat Emptor (“buyer beware”) is a good adage when you purchase anything —including a variable annuity.
Copyright © 2009 by Eve Kaplan
Eve Kaplan is a Fee-Only (no products sold) Certified Financial Planner. Kaplan Financial Advisors, LLC is a Registered Investment Advisor in NY and NJ. She can be reached at 908-898-0549 or www.kaplanfinancialadvisors.com
Tags: abusive practices in variable annuity sales, negative aspects of variable annuities, variable annuities
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Eve Kaplan, CFP®
