As you put a plan together, watch out for these common myths.

Myth No. 1: I can postpone saving now and make it up later

Reality: This is very hard to do.

If you wait until–fill in the blank–you buy a new car, the kids are in college, you’ve paid off your own student loans, your business is off the ground, or you’ve remodeled your kitchen, you might never have the money to save for retirement.

Bottom line–at every stage of your life, there will be competing financial needs. Don’t make the mistake of thinking it will be easier to save for retirement in just a few years. It won’t.

Consider this: A 25 year old who saves $400 per month for retirement until age 65 in a tax-deferred account earning 4% a year would have $472,785 by age 65. By comparison, a 35 year old would have $277,620 by age 65, a 45 year old would have $146,710, and a 55 year old would have $58,900.

Note: This is a hypothetical example and is not intended to reflect the actual performance of any specific investment.

Why such a difference? Compounding. Compounding is the process by which earnings are reinvested back into a portfolio, and those earnings may themselves earn returns, then those returns may earn returns, and so on. The key is to allow enough time for compounding to go to work–thus the importance of starting to save early.

Now, is it likely that a 25 year old will be able to save for retirement month after month for 40 straight years? Probably not. There are times when saving for retirement will likely need to take a back seat–for example, if you’re between jobs, at home caring for children, or amassing funds for a down payment on a home.

However, by starting to save for retirement early, not only do you put yourself in the best possible position to take advantage of compounding, but you get into the retirement mindset, which hopefully makes you more likely to resume contributions as soon as you can.

Myth No. 2: A retirement target date fund puts me on investment autopilot

Reality: Not necessarily.

Retirement target date mutual funds–funds that automatically adjust to a more conservative asset mix as you approach retirement and the fund’s target date–are appealing to retirement investors because the fund assumes the job of reallocating the asset mix over time. But these funds can vary quite a bit. Even funds with the same target date can vary in their exposure to stocks.

If you decide to invest in a retirement target date fund, make sure you understand the fund’s “glide path,” which refers to how the asset allocation will change over time, including when it turns the most conservative. You should also compare fees among similar target date funds.

Myth No. 3: I should invest primarily in bonds rather than stocks as I get older

Reality: Not necessarily.

A common guideline is to subtract your age from 100 to determine the percentage of stocks you should have in your portfolio, with the remainder in bonds and cash alternatives.

But this strategy may need some updating for two reasons. One, with more retirements lasting 25 years or longer, your savings could be threatened by years of inflation.

Though inflation is relatively low right now, it’s possible that it may get worse in coming years, and historically, stocks have had a better chance than bonds of beating inflation over the long term (though keep in mind that past performance is no guarantee of future results).

And two, because interest rates are bound to rise eventually, bond prices could be threatened since they tend to move in the opposite direction from interest rates.

Myth No. 4: I will need much less income in retirement

Reality: Maybe, but it might be a mistake to count on it.

In fact, in the early years of retirement, you may find that you spend just as much money, or maybe more, than when you were working, especially if you are still paying a mortgage and possibly other loans like auto or college-related loans.

Even if you pay off your mortgage and other loans, you’ll still be on the hook for utilities, property maintenance and insurance, property taxes, federal (and maybe state) income taxes, and other insurance costs, along with food, transportation, and miscellaneous personal items.

Wild card expenses during retirement–meaning they can vary dramatically from person to person–include travel/leisure costs, health-care costs, financial help for adult children, and expenses related to grandchildren.

Because spending habits in retirement can vary widely, it’s a good idea as you approach retirement to analyze what expenses you expect to have when you retire.

Copyright 2013 Forefield Inc.

A variety of factors has transformed what once had been a reasonable expectation of some inherited wealth to a concern that parents will have enough money to provide for their well-being in their later years.

Longevity

First and foremost, we’re living longer. According to the Social Security life expectancy tables, men and women who have reached age 65 can expect to live into their 80s. It is not uncommon for individuals to live 25 years or longer in retirement.

Living longer means paying for living expenses over a longer period of time. This sometimes results in stretching savings past their breaking point. Children of older parents often find themselves worrying about whether they will have to provide financial support for their aging parents.

Rising health-care costs

Another consequence of living longer is the likelihood of spending more on medical care as we age. And health-care costs are rising at a rate that outpaces inflation. While Medicare covers some of these expenses, it doesn’t cover all of them.

Also, there are co-payments, deductibles, and premium costs for Medicare Parts B and D as well as Medigap insurance. Out-of-pocket medical expenses paid over a longer period of time can deplete savings.

Investment risk

Fewer retirees are able to rely on employer pensions for income. Accordingly, many seniors are depending on stock market returns from their investments to finance their retirement income needs while exposing their savings to the risk of loss due to market volatility.

Coupled with the prospect of reduced savings due to market risk is the fact that most retirement savings are invested in qualified plans such as 401(k) accounts and IRAs.

Withdrawals from these accounts are typically taxable as ordinary income, further reducing their net value to the account holder, meaning more has to be withdrawn to cover any tax owed.

I’m spending my kid’s inheritance

Preserving and protecting assets for the primary purpose of passing that wealth on to subsequent generations is not as important a goal as it once was, and for many retirees, it’s not a goal at all.

We often see members of the older generation passing wealth to their children and grandchildren during their lives by providing a down payment for a home or helping with college expenses, for example.

On the other hand, the decline of employer pensions, increasing cost-of-living expenses, and dwindling savings often force retirees to rely on assets that otherwise may have been earmarked for inheritance.

Life insurance policies may be cashed in or sold, and home equity might be accessed through loans or reverse mortgages.

What does all this mean for you?

While you may have expected or hoped for an inheritance from your parents, instead you may find yourself having to help provide for their financial support. It’s best to prepare for this possibility by talking to your parents about the provisions they’ve made for the future.

Find out whether they have adequate income and savings. Have they prepared for the potential of long-term care expenses? Gaining as much information as possible about your parents’ finances may help you prepare for their future needs as well as your own.

Not getting the inheritance you may have anticipated means you’ll probably have to rely on your own savings for your retirement.

So save as much as you can, or you may find yourself relying on your children for your financial support in your later years.

Copyright 2013 Forefield Inc.

Contribute as much as possible

The more you can save for retirement, the better your chances of enjoying a comfortable retirement.

If you can, max out your contribution up to the legal limit ($17,500 in 2013, $23,000 if you’re age 50 or older). If you need to free up money to do that, try to cut certain expenses. (Note: some plans limit the amount you can contribute.)

Why invest your retirement dollars in a 401(k) plan instead of somewhere else? One reason is that your pretax contributions lower your taxable income for the year.

This means you save money in taxes immediately when you contribute to the plan–a big advantage if you’re in a high tax bracket. For example, if you earn $100,000 a year and contribute $17,500 to a 401(k) plan, you’ll only pay federal income taxes on $82,500 instead of $100,000.

Another reason is the power of tax-deferred growth. Any investment earnings compound year after year and aren’t taxable as long as they remain in the plan.

Over the long term, this gives you the opportunity to build an substantial sum in your employer’s plan. (Your pretax contributions and any earnings will be taxed when paid to you from the plan.)

Consider Roth contributions

Your 401(k) plan may also allow you to make after-tax Roth contributions. Unlike pre-tax contributions, Roth contributions don’t lower your current taxable income so there’s no immediate tax savings. But because you’ve already paid taxes on those contributions, they’re free from federal income taxes when paid from the plan.

And if your distribution is “qualified” (that is, the distribution is made after you satisfy a five-year holding period, and after you reach age 59½, become disabled, or die) any earnings are also tax free.

If your distribution isn’t qualified, any earnings you receive are subject to income tax. A 10% early distribution penalty may also be imposed if you haven’t reached age 59½ (unless an exception applies).

Capture the full employer match

Many employers will match all or part of your contributions. If you can’t max out your 401(k) contributions, you should at least try to contribute as much as necessary to get the full employer match.

Employer matching contributions are basically free money. By capturing the full benefit of your employer’s match, you’ll be surprised how much faster your balance grows. If you don’t take advantage of your employer’s generosity, you could be passing up a significant contribution towards your retirement.

Access funds if you must

Another beneficial feature that many 401(k) plans offer is the ability to borrow against your vested balance at a reasonable interest rate. You can use a plan loan to pay off high-interest debts or meet other large expenses, like the purchase of a car.

You typically won’t be taxed or penalized on amounts you borrow as long as the loan is repaid within five years. Immediate repayment may be required, however, if you leave your employer–if you can’t repay the loan, you may be treated as having taken a taxable distribution from the plan.

And remember that when you take a loan from your 401(k) plan, the funds you borrow are generally removed from your plan account until you repay the loan, so you may miss out on the opportunity for additional tax-deferred investment earnings. So loans (and withdrawals if available) should be a last resort.

Evaluate your investment choices

Choose your investments carefully. The right investment mix could be one of your keys to a comfortable retirement. That’s because over the long term, varying rates of return can make a big difference in the size of your 401(k) plan account.

Copyright 2013 Forefield Inc.

A storm or other natural disaster could destroy your home, business, or workplace and put you in financial straits, but there are things you can do both before and after the event to help you recover quickly.

Pre-disaster

Create a financial emergency kit.

Put together a kit that contains some cash and checks, a list of important contacts (e.g., your insurance agent), and copies of important documents, including identification cards, birth and marriage certificates, insurance policies and inventories, wills, trusts, and deeds.

Make sure your kit is stored in a safe, secure place in your home, is easy to reach and carry, and is both waterproof and fireproof. You’ll want to stash enough cash (or a credit card) to pay for immediate expenses such as gas, food, and lodging.

Tip: While you’re at it, you might also want to keep your most precious items in the kit, such as your special photos and family heirlooms.

Protect your assets.

Take some commonsense precautions to safeguard your home, business, car, boat, and similar assets against damage from wind, water, fire, or other risks.

For example, install an emergency generator and paperless drywall, keep loose objects (e.g., grills and patio furniture) secure, cut down overhanging tree limbs, park your car in a garage, and invest in storm windows, doors, and shutters.

Take inventory.

Create and maintain an inventory of your valuables, including appliances, electronics, furniture, clothing, jewelry, and artwork. Record models and serial numbers, and take pictures or a video of the items. This will help when it comes time to file insurance claims and purchase replacements.

Check your insurance coverage.

Make sure your insurance policies (e.g., homeowners, auto) include all the coverage you need, and understand that damage caused by natural disasters may not be covered under general types of policies. You may need to consider buying separate coverage for hurricanes, floods, earthquakes, or other disasters.

Consult your insurance agent to determine whether you have adequate coverage given the likelihood of such events occurring in your area.

Post-disaster

In the immediate aftermath, proceed with caution.

While the disaster may have passed, health and safety hazards still may exist. Be aware that any building you’re in, including your home, may not be structurally sound, so carefully look for any apparent damage.

Also, report contamination from spills of oil, gas, chemicals, or any hazardous substance.

Assess your property for damage.

Take pictures of damaged areas both inside and outside your home, including trees, landscaping, and yard structures such as sheds.

File insurance claims immediately.

Contact your insurance agent and file claims as soon as possible. The quicker you do so, the sooner you can get back on your feet.

Protect your income.

If you end up out of work, take advantage of any employee assistance programs that your employer may offer. Seek unemployment compensation from your state and ask about special job considerations for disaster victims.

Find out if special unemployment benefits are available through the Department of Labor.

Get help from emergency sources.

If you need immediate financial help, disaster relief funds and special programs (for example, housing assistance) may be available through the Federal Emergency Management Agency (FEMA) or your state and local governments, as well as the American Red Cross, United Way, Salvation Army, social services, and local churches.

Consider available tax breaks.

Tax law allows taxpayers to deduct certain unreimbursed casualty losses in the year in which they are incurred, subject to certain limitations. In certain presidentially declared disaster areas, individuals can claim the loss (again, subject to certain limitations) in the prior tax year by filing an amended return.

Moreover, special relief (for example, bonus depreciation for business property) may be granted in the case of specific disaster events. Be sure to consult your tax professional about any tax relief that may be available to you.

Get legal help, if necessary.

If you experience legal difficulties, you may want to consider hiring an attorney who specializes in the complex area of natural disaster law.

Don’t ignore the stress.

Surviving a natural disaster can be a very stressful situation. Don’t hesitate to ask for help from family and friends. If you have young children, they may be upset about damage to their home and belongings. Be patient and try to explain what’s happened and how you’re going to try to get back to normal as soon as possible.

Copyright 2013 Forefield Inc.

“He is not here; he has risen, just as he said. Come and see the place where he lay.”
– Matthew 28:6

The new tax, known as the unearned income Medicare contribution tax, or the net investment income tax (NIIT), took effect on January 1, 2013.

Who must pay the new tax?

The NIIT applies to individuals who have “net investment income,” and who have modified adjusted gross income (MAGI) that exceeds certain levels (see below; estates and trusts are also subject to the new law, although slightly different rules apply). In general, nonresident aliens are not subject to the new tax.

Filing Status MAGI over …
Single/Head of household $200,000
Married filing jointly/ Qualifying widow(er) $250,000
Married filing separately $125,000

What is MAGI?

For most taxpayers, MAGI is simply adjusted gross income (AGI), increased by the amount of any foreign earned income exclusion.

AGI is your gross income (e.g., wages, salaries, tips, interest, dividends, business income or loss, capital gains or losses, IRA and retirement plan distributions, rental and royalty income, farm income and loss, unemployment compensation, alimony, taxable Social Security benefits), reduced by certain “above-the-line” deductions (see page one of IRS Form 1040 for a complete list of adjustments).

Note that AGI (and therefore MAGI) is determined before taking into account any standard or itemized deductions or personal exemptions. Note also that deductible contributions to IRAs and pretax contributions to employer retirement plans will lower your MAGI.

What is investment income?

In general, investment income includes interest, dividends, rental and royalty income, taxable nonqualified annuity income, certain passive business income, and capital gains–for example, gains (to the extent not otherwise offset by losses) from the sale of stocks, bonds, and mutual funds; capital gains distributions from mutual funds; gains from the sale of interests in partnerships and S corporations (to the extent you were a passive owner), and gains from the sale of investment real estate (including gains from the sale of a second home that’s not a primary residence).

Gains from the sale of a primary residence may also be subject to the tax, but only to the extent the gain exceeds the amount you can exclude from gross income for regular income tax purposes. For example, the first $250,000 ($500,000 in the case of a married couple) of gain recognized on the sale of a principal residence is generally excluded for regular income tax purposes, and is therefore also excluded from the NIIT.

Investment income does not include wages, unemployment compensation, operating income from a nonpassive business, interest on tax exempt bonds, veterans benefits, or distributions from IRAs and most retirement plans (e.g., 401(k)s, profit-sharing plans, defined benefit plans, ESOPs, 403(b) plans, SIMPLE plans, SEPs, and 457(b) plans).

Net investment income is your investment income reduced by certain expenses properly allocable to the income–for example, investment advisory and brokerage fees, investment interest expenses, expenses related to rental and royalty income, and state and local income taxes.

How is the tax calculated?

The tax is equal to 3.8% of the lesser of (a) your net investment income, or (b) your MAGI in excess of the statutory dollar amount that applies to you based on your tax filing status. So, effectively, you’ll be subject to the additional 3.8% tax only if your MAGI exceeds the dollar thresholds listed in the chart above.

Example: Sybil, who is single, has wages of $180,000 and $15,000 of dividends and capital gains. Sybil’s MAGI is $195,000, which is less than the $200,000 statutory threshold. Sybil is not subject to the NIIT.

Example: Mary and Matthew have $180,000 of wages. They also received $90,000 from a passive partnership interest, which is considered net investment income. Their MAGI is $270,000, which exceeds the threshold for married taxpayers filing jointly by $20,000. The NIIT is based on the lesser of $20,000 (the amount by which their MAGI exceeds the $250,000 threshold) or $90,000 (their net investment income). Mary and Matthew owe NIIT of $760 ($20,000 x 3.8%).

Note: The NIIT is subject to the estimated tax rules. You may need to adjust your income tax withholding or estimated payments to avoid underpayment penalties.

Health-care reform legislation passed in 2010 included a new additional 0.9% Medicare tax on wages, compensation, and self-employment income over certain thresholds. This new tax also took effect on January 1, 2013. The 0.9% tax does not apply to income subject to the NIIT. So while you may be subject to both taxes, the taxes do not apply to the same types of income.

Copyright 2013 Forefield Inc.

And not a moment too soon: the $233 billion (with a “b”) fund has a recent performance record that can only be called abysmal
(Forbes article: CALPERS returns 1% for fiscal year).

None of this is terribly surprising: the quest for outperformance is a roll of the dice and an expensive one.  The only sane strategy is to not play that game, but instead, diversify
appropriately according to your goals and situation, keep your costs low, and ignore the charlatans (ie, the “consultants” who have previously been advising CALPERS) who promise “pie in the sky” returns.

CALPERS, if you are listening: I’ll help you craft and implement such a strategy and certainly at a much lower cost than you are used to paying (one would think that $233 billion would get you the best financial adviser money can buy but apparently not!)

Read the whole story:  Investment News/Passive investing: if it’s good enough for CALPERS…

This is notable for several reasons:

1) Many surveys that have been conducted in the wake of the Bernie Madoff scandal indicate that investors’ number one fear is no longer “running out of money” (as it was for many years), but is now “getting ripped off by my financial adviser.”

2) The SEC has rightly changed its emphasis from less relevant matters to the the one which can potentially cause the most harm (ie, while incompetency is certainly a bad thing, fraud and embezzlement is worse).

While I certainly understand and appreciate the prevailing business model of most investment advisers, I have chosen a different path; one which uses straightforward but advanced technology to allow clients easy and accurate implementation of my investment recommendations WITH my help but WITHOUT any delegation of power of attorney, trading authority, or any other access that even resembles custody.

This business model keeps my compliance burden low and my client’s fears to a minimum.

Okay, I’ll get off my soapbox now (for the moment anyway).

It also permanently extended portability of the gift tax and estate tax applicable exclusion amount between spouses. However, it also increased the top gift, estate, and GST tax rate to 40% starting in 2013. A number of other provisions were also permanently extended.

Top gift, estate, and GST tax rate

In 2012, there was a 35% top tax rate for gift, estate, and GST taxes. It was scheduled to increase to 55% in 2013. ATRA 2012 provides a permanent 40% top rate, starting in 2013.

Applicable exclusion amount

You have an applicable exclusion amount that can protect a certain amount of property from the federal gift tax and estate tax. The basic exclusion amount was $5,120,000 in 2012 ($5 million as indexed for inflation), but was scheduled to drop to $1 million in 2013. ATRA 2012 permanently extends the basic exclusion amount at $5 million as indexed for inflation.

Portability of exclusion

The estate of a person who died in 2011 or 2012 could transfer the decedent’s unused applicable exclusion amount to his or her surviving spouse, who could use the unused exclusion, along with his or her own basic exclusion amount, to shelter property from gift and estate tax (referred to as portability). The provision was scheduled to sunset in 2013. ATRA 2012 has permanently extended the portability provision.

GST tax exemption

You have a GST tax exemption that can protect a certain amount of property from the GST tax. The GST tax exemption was $5,120,000 in 2012 ($5 million as indexed for inflation), but was scheduled to drop to $1 million (as indexed for inflation) in 2013. ATRA 2012 permanently extends the GST tax exemption at $5 million as indexed for inflation (it is $5,250,000 in 2013).

State death taxes

In 2012, your estate could take an estate tax deduction for death taxes (estate tax or inheritance tax) paid to a state. In 2013, it was scheduled to change back into a credit for state death taxes, as available back in 2001. However, ATRA 2012 permanently extends the deduction for state death taxes.

Conservation easement exclusion

An estate tax exclusion is available for qualified conservation easements. In 2012, the exclusion was generally available if the property was located anywhere in the United States. In 2013, the exclusion was scheduled to be available, as in 2001, only if the property was located within a limited number of miles from a National Wilderness Preservation System or an Urban National Forest. ATRA 2012 permanently extends the provision that the property can generally be located anywhere in the United States and the mileage requirements do not apply.

Estate tax deferral for closely held business

Where the value of a closely held business exceeds 35% of the value of the adjusted gross estate, payment of estate tax attributable to the business can be deferred for up to 5 years and then paid in installments over 10 years, all at favorable interest rates. In 2012, a closely held business could have 45 partners or shareholders. In 2013, the permissible number of partners or shareholders was scheduled to drop to 15, as in 2001. ATRA 2012 permanently extends the provision allowing up to 45 partners or shareholders.

Copyright 2013 Forefield Inc.

Many people have been saying (for quite a long time actually) that because interest rates are so low, that bonds are a very bad investment at present.  Is that true?

In Taking a long view of bonds by Craig Israelsen (Journal of Indexes, March/April 2013), the author compares the performance of stocks, bonds, and cash during two periods of history, one during which interest rates rose (1948-1981) and one during which interest rates fell (1982-2011).

During the 34-year period of rising interest rates, a nondiversified all-bond portfolio averaged 3.83 percent per year, whereas during the last 34 years, it would have produced an average annualized return of 8.98 percent.

Furthermore, cash (as represented by the three-month T-bill) averaged 4.49 percent during the 34-year period of rising interest rates, and 4.88 percent during the 30-year period of declining interest rates.

Interestingly, U.S. stocks (represented by the S&P 500 Index) performed essentially the same during both periods. From 1948 to 1981, when interest rates were rising, the S&P 500 Index had an annualized return of 11.00 percent. During the recent 30-year period of declining interest rates, the S&P 500 Index generated a 10.98 percent annualized return.

If the story ended there, we might conclude that the bond bears are correct.  The story doesn’t end there, though…

A four-asset portfolio that allocated 40 percent to large U.S. stocks, 20 percent to small U.S. stocks, 30 percent to bonds and 10 percent to cash (with annual rebalancing) generated an annualized return of 9.52 percent during the 34-year period when interest rates were rising, and a 9.96 percent annualized return during the last 30 years in which rates were falling. There was a modest difference of 44 basis points between the two time frames.

I am also reminded of a great research article by Vanguard, dated 08/04/2010, “Risk of loss: should investors shift from bonds because of the prospect of rising rates?” in which several very important counterarguments are offered:

• Difference of severity between stock and bond bear markets
• Yield curve flattening
• Previous periods of extended low interest rates

Notably, bond investors have done quite well over the last 2 1/2 years since that piece was published.  Ditto since the time the Fed lowered short-term rates to nearly zero.

Conclusion:  there’s no gaming the system.  Relatively speaking, bonds may not offer the same high returns that they have over the most recent lengthy falling interest rate environment, but that doesn’t mean you should bet the farm by ditching your bonds either.