Monthly Archives: May 2016

The Trouble with 401(k) Plans

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The 401(k) plan is now the primary retirement plan for employees in the private sector and Ted Benna isn’t happy.  Benna is regarded as the “father” of the 401(k) plan but now he calls his child a “monster.”

There are several problems modern with 401(k) type plans.

  1. They are too complicated. The typical 401(k) plan has dozens of investment options. These are often included to satisfy government regulatory demands for broad diversification.  For the plan sponsor, who has a fiduciary responsibility, more is better.  However, for the typical worker, this just creates confusion.  He or she is not an expert in portfolio construction.  Investment choices are often made when an employee gets a new job and there are other things that are more pressing than creating the perfect portfolio.  Which leads to the second problem.
  1. Employees are given too little information. Along with a list of funds available to the employee, the primary information provided is the past performance of the funds in the plan.  However, we are constantly reminded that past performance is no guarantee of future results.  But if past performance is the main thing that the employee goes by, he or she will often invest in high-flying funds that are likely to expose them to the highest risk, setting them up for losses when the market turns.
  1. There are no in-house financial experts available to employees. Employee benefits departments are not equipped to provide guidance to their employees; that’s not their function.  In fact, they are discouraged from providing any information beyond the list of investment options and on-line links to mutual fund prospectuses.  Doing more exposes the company to liability if the employee becomes unhappy.

What’s the answer?  Until there are major revisions to 401(k) plans, it’s up to the employee to get help.  One answer is to meet with a financial advisor – an RIA – who is able and willing to accept the responsibility of providing advice and creating an appropriate portfolio using the options available in the plan.  There will probably be a fee associated with this advice, but the result should be a portfolio that reflects the employee’s financial goals and risk tolerance.

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Passing $10 million to your heirs tax free

The new estate tax law includes a provision called “portability.”  It’s officially known as the “Deceased Spouse Unused Exclusion Amount.”

Portability allows married couples to capture two estate tax exemptions without having to rely on the A/B Trust plan discussed in previous essays.

An attorney should be consulted shortly after the death of a spouse to make sure that the deceased spouse’s exemption does not expire.

It’s convenient, and does not require separate accounts for A and B trusts.

It simplifies the tax life of the surviving spouse.

And it preserves the step-up in cost basis when the second spouse dies.

For more information, contact your estate planning attorney.

We welcome your inquiries.

Changes in tax law create problems for trusts – what to do now.

In our previous discussion of this issue we reviewed why so many estate plans included an A/B (or “spousal” and “family”) trust as a key provision of the plan.  It was a way of avoiding high estate taxes on modest sized estates.  However, when the tax laws were changed to increase the amount exempt from estate tax to $5.45 million per person (the current amount) it exposed some problems with these plans for people whose estates are under the exemption amount.

These are:

  • Inconvenience
  • Administrative costs
  • Capital gains taxes

Inconvenience:

Setting up two trusts requires establishing separate banking and investment accounts to hold the assets of each trust.

The surviving spouse may be allowed to use the income and assets in the “family” trust for health, education, maintenance and support but has to be careful that the heirs to the trust do not dispute the manner in which these assets are managed or dispersed. In the case of a blended family, this could cause problems.

Administrative costs:

Determining which assets go into the “family” and the “spousal” trust often requires the assistance of an attorney, a CPA or a financial advisor.

The income in the “family” trust requires a separate tax return and the tax rates on the two trusts are different.

This means that the surviving spouse may need expensive professional help for the rest of his or her life.

Capital gains taxes:

This can be the biggest issue of all.  When someone dies, the assets owned by the decedent have a step-up in cost basis.  This means is that if someone bought stock ABC many years ago for $1 per share and dies when the stock is worth $100, the new tax cost basis on ABC is $100.  If the heirs sell it for $100 there is no capital gains tax.   If it’s left to the spouse the spouse receives the stepped-up cost basis.  At the death of the spouse, the heirs receive a second stepped up cost basis.

Only assets left to the surviving spouse or to a “spousal” trust receive a stepped up cost basis at the survivor’s death.  Because the assets in the “family” trust never become the assets of the surviving spouse for tax purposes there is no second step-up in cost basis when the survivor dies.

For example, if ABC is put in the “family” trust with a stepped up cost basis of $100 and the stock is worth $200 per share when the surviving spouse dies, the heirs have to pay a capital gains tax of $100 ($200 – $100 = $100) when they sell.  If it had been left to the surviving spouse, the capital gain tax would have been avoided.

If the estate plan documents were prepared when the exemption was much lower, the result could be an actual increase in cost and increase in taxes rather than a tax saving.  It may be time to meet with your attorney and bring your estate plan up to date.

In our next essay we will briefly look at ways to increase the amount that can be left estate tax free to over $10 million.

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Changes in tax law create problems for trusts

The Federal Estate Tax was created in 1916 to help pay for World War 1.  The tax is levied on everything you own or have interests in at your death.  At first, it did not apply to many people but inflation and prosperity began taking its toll.  From 1987 to 1997 the government tax on estates over $600,000 was 55%.

By then, many people who owned a nice home and had savings and investments became worried that a lot of their money want going to go to the government rather than their heirs.  Each person has his or her own exemption.  A married couple has two exemptions.  However, if one died, leaving everything to the spouse, the surviving spouse only had one exemption left.

The legal profession came up with an answer: the A/B Trust otherwise known as the “spousal” and the”family” trust.  Under current law, you can leave an unlimited amount of money to your spouse free of tax.  But you can leave up to $600,000 to a trust that your spouse can use for his or her benefit but is not legally their property.  This is known as the “family trust.”  The rest goes directly to the spouse or to a “spousal trust.”

Then when the surviving spouse dies, the heirs inherit both the “family trust” assets ($600,000) and the surviving spouse (or “spousal trust”) assets up to the $600,000 limit – for a total of $1,200,000 free of federal estate tax.

At a tax rate of 55%, that saves the heirs a whopping $330,000 in taxes.  Everyone thought that was a great idea.  Many estate plans and trust documents were prepared with these issues in mind.  There were some drawbacks with these plans but the estate tax savings overwhelmed all other considerations.

Beginning in 1988 the amount of the exemption that could be passed on to non-spousal heirs was gradually increased.  In 2000 it went to $1,000,000 and for one year – 2010 – there was no estate tax at all.  In 2012 the law was changed and the limit was raised to $5 million and indexed for inflation.  In 2016 the estate tax exemption is $5.45 million and the estate tax rate is 40%.

This means that a lot fewer people will be subject to the estate tax and now are faced with the negative aspects of this approach to estate planning. These include

  • Inconvenience
  • Administrative costs
  • Capital gains taxes

We will address these issues in our next essay.

Questions?  Call us.

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Single Women and Investing

Women are in charge of more than half of the investable assets in this country.  A recent Business Insider article claims that women now control 51% of U.S. wealth worth $14 trillion, a number that’s expected to grow to $22 trillion by 2020.

Single women, whether divorced, widowed, or never married, have been a significant part of our clientele since our founding.  Widows that come to us appreciate that we listen and take time to educate them, especially if their spouses managed the family finances.  Once their initial concerns are alleviated they’re often terrific investors because they are able to take a long-term view and don’t let short-term issues rattle them very much.

Unfortunately, we have had women complain to us that other advisors that they’ve had in the past did not want to discuss the details of their investments and the strategy employed. Other women have come to us with portfolios that were devastated by inadequate diversification.

Our female clients are intelligent adults who hire us to do our best for them so that they can focus on the things that are important to them.  We are always happy to get into as much detail on their portfolios as they require.  Our focus on education, communication, diversification and risk control has led to a large and growing core of women investors, many of whom have been with us for decades.

Our book, BEFORE I GO, and the accompanying BEFORE I GO WORKBOOK, is a must-have for women who are with a spouse that handles the family finances.  Men who have always handled the family finances should also grab a copy and fill out the workbook.  If something were to happen to them, it would be a tremendous relief to their spouse to have such a resource when taking over the financial duties.  The first three chapters of our book are available free on our website.

We welcome your inquiries.

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Planning to Retire Someday? Start Planning Today!

Americans want help with financial planning.

A recent survey showed that most Americans don’t want to do their own financial planning but they don’t know where to go for help.  60% of adults say that managing their finances is a chore and many of them lack the skills or time to do a proper job.

The need for financial planning has never been greater.  For most of history, retirement was a dream that few lived long enough to achieve.  In a society where most people lived on farms, people relied on family for support.  Financial planning meant having enough children so that when you could no longer work, if you were fortunate enough to reach old age,  you could live with them.

The industrial revolution took people away from the farm and into cities.  Life expectancy increased.  In the beginning of the 20th century life expectancy at birth was about 48 years.  Government and industry began offering pensions to their employees.  Social Security, which was signed into law in 1935, was not designed to provide a full post-retirement income but to increase income for those over 65.

For decades afterward, retirement planning for many Americans meant getting a lifetime job with a company so that you could retire with a pension.  The responsibility to adequately fund the pension fell on the employer.  Over time, as more benefits were added, many companies incurred pension and retirement benefit obligations that became unsustainable.  General Motors went bankrupt partially because of the amount of money it owed to retired workers via pension and health obligations.

As a result, companies are abandoning traditional pension plans (known as “defined benefit plans”) in favor of 401(k) plans (known as “defined contribution plans.”) This shifts the burden of post-retirement income from the employer to the worker.   Instead of knowing what your pension income will be, employees are responsible for investing their money wisely so that they will have enough saved to allow them to retire.

In years past, people who invested some of their money in stocks, bonds and mutual funds viewed this as extra savings for their retirement years.  With the end of defined benefit pension plans, investing for retirement has become much more serious.  The kind of lifestyle people will have in retirement depends entirely on how well they manage their 401(k) plans, their IRAs and other investments.

Fortunately, the people who are beginning their careers are recognizing that there will probably not be pensions for them when they retire.  Even public employees like teachers, municipal and state employees are going to get squeezed.  Stockton, California declared bankruptcy over it’s pension obligations.  The State of Illinois’ pension obligations are only 24% funded.  Other states are facing a similar problem.

In fact, many Millennials we talk to question whether Social Security will even be there for them.  They also realize that they need help planning.  Traditional brokerage firms provide some guidance, but the average stock broker may not have the training, skills or tools to create a financial plan.  Mutual fund organizations can offer some guidance but getting personal financial guidance via a 800 number is not the kind of inpersonal relationship that most people want.

But there is an answer.  The rapidly growing independent RIA (Registered Investment Advisor) industry offers the kind of personal guidance that people want to help them create and execute a successful financial plan that will take them from work through retirement.  Many RIAs are also Certified Financial Planners (CFP™).  Many are fiduciaries who put their clients’ interests ahead of their own.  Dealing with a local RIA is like dealing with a family friend who’s can act as your personal financial guide.

For more information, and a copy of our book Before I Go, contact us.

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Keeping Your Eye on the Ball

Investors face a fire-hose torrent of information every day.  Determining what’s important and what’s irrelevant is critical.  Projections of doom and gloom are interspersed with promises of fabulous wealth if only we invest in a certain way.  99% of it is useless or even counter-productive, meant to entice the unwary investor to chase after chimeras that are simply not real.

Today’s issue of First Trust’s Monday Morning Outlook:

Honest question: How much time does the Apple Inc. Board of Directors spend debating whether the Federal Reserve will hike rates once or twice more in 2016?  We don’t really know the answer, but we would guess the best answer is zero.

Now, how much time does CNBC spend debating this question, along with potential actions of the Japanese and European Central Bank?  Answer: Way, way too much.

Business news should cover business, not government, but somehow, over the years, people have been led astray and many now think actions by the government are more important than actions of businesses and entrepreneurs.  Nothing could be further from the truth…

So, while the TV debates between day traders rage on, it doesn’t really matter whether the Fed lifts rates in June, or not.  The difference between a 0.5% and 0.75% federal funds rate matters little to corporate America and entrepreneurs.  In fact, higher rates will most likely make money more available, not less.  If the Fed really wanted to tighten policy, it would get rid of all excess reserves, but it won’t.  So, we suspect a symbolic rate hike in June, no matter what the talking heads’ endless debates about the matter suggest.

As investors we want to follow the lead of Boards of Directors, not the lead of what passes for business journalism these days.  No matter what they say, it is the entrepreneurial class that drives economic activity, not the government.

After all, Greenspan, Bernanke and Yellen have never pulled all-nighters drinking Red Bull and writing Apps for the iPhone.  That’s what changes lives, not quarter point rate hikes.

Professional investors have learned the difference between meaningful information that has a real impact on portfolios and simple distractions.  If you are interested in seeing how this process works, contact us.

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