The Social Security Administration has set the maximum taxable wage base for 2015 at $118,500. This represents an increase of $1,500 over the 2014 wage base of $117,000, an increase of 1.28%.
If you’re wondering about whether or not you need to do some financial planning, either on your own, using resources on the internet, or by hiring a financial planner, you might want to know what the benefits of financial planning are.
From my perspective of many years providing financial planning and advice to folks, there are three primary benefits of financial planning: Organization, Efficiency, and Discipline. We’ll talk about each of these in order.
One of the most important benefits of financial planning is ORGANIZATION. Statistics tell us that fewer than 25% of Americans know their financial net worth. In addition, (prepare to be astounded) the average individual’s credit card debt is over $8,000. Think about that for a moment…
We knew when Obamacare went into place that there would be new requirements for income tax filing, and one of the first to deal with is the health premium tax credit. This will require the use of a new form, Form 8962.
Health Premium Tax Credit
For this tax credit you will need to reconcile your advance credits that you have received in the form of reduced subsidized healthcare premiums.
When you signed up for health insurance through the ACA marketplace you had the opportunity to receive advance credit, depending upon your income, which reduced your premiums. When the tax year has been completed, you need to compare your Modified Adjusted Gross Income (MAGI) to the Federal Poverty Line (FPL) to ensure that your MAGI is between 100% and 400% of the FPL.
If your MAGI is greater than 400% (4 times) the FPL, you are not eligible for the premium tax credit. If you have received advance premium tax credit, you’ll need to pay it back. If it’s less than 400% of the FPL, you are eligible, but you’ll have to run the calculations to determine if you’ve received the appropriate amount of advance credit, too much, or too little.
Obviously if you have received too much credit, just the same as if your MAGI was greater than 400% of the FPL, you have to pay back the excess credit you’ve received. If you have received too little credit, this will reduce your other tax payable or increase your refund for the tax year.
These differences could occur if you’ve had a change in your circumstances during the tax year – change in family size, increase or decrease in family income, marriage, divorce, change of address, or change in employment status (gaining or losing eligibility employer-sponsored health coverage).
The last few weeks have shown that the market is certainly volatile. Once at a peak of over 17,000 the market has pulled back to just over 16,000. While this certainly makes for news (notice how I didn’t say interesting news) I wanted to give our readers a little perspective on why I (nor they) shouldn’t care.
First, when the news outlets, friends, family, etc. say “the market” they are generally referring to the Dow. The Dow Jones Industrial Average is made up of 30 companies (yes, only 30) and is a price weighted index, meaning that each component of the index is made up in proportion to its price. Thus a stock trading at $150 makes up roughly 10 times more than a stock trading at $15. Naturally, one stock can price can skew this average pretty significantly.
According to the Wall Street Journal, there are just over 5,000 public listed companies in the US market (as of February 2014). That’s 5,000 versus 30 in the Dow. In other words, 30 stocks is a terrible sample of the overall market. Additionally, the only time any investor should be worried about the Dow is if they own those 30 stocks only, and have no additional diversification.
I’m often amused when my students will mention in class what “the market” did on a particular day. Often, they are the ones telling me what happened and are surprised when I don’t know. I rarely check what the market has done nor could I care less. One student’s jaw dropped when I mentioned I hadn’t checked my Roth IRA balance in months. When they ask what the best investment is they are often shocked when I say human capital (investing in themselves) and paying down debt.
We’ve written about not worrying about the market in the past. As our readers know we recommend well diversified, index portfolios of stocks, bonds and other investments. We could care less about what the market is doing and encourage our clients and readers to do the same.
As we’ve mentioned before, focus on the things you can control (fees, expenses, debt) and worry less about what you can’t (the market, weather, Congress). And certainly don’t worry about 30 companies in price-weighted index. They’re hardly representative of the overall market.
Recently a colleague told me that he’d “give that a try”. I responded (tongue in cheek of course) “Try not. Do or do not. There is no try.” In case you don’t recognize it, that’s a line that Yoda gives to Luke Skywalker in the Star Wars “Empire Strikes Back” movie. Yoda was pointing out to Luke that if he simply “tries” to undertake the action, he will not succeed. I think it shows that Yoda would also suggest a low-cost index mutual fund for investing.
If you think back to the excellent article that Sterling wrote a few weeks ago, “Not All Index Funds are Created Equal”, Sterling used a particular load mutual fund as an example. The objective of the fund (paraphrasing here):
Seeks to match the performance of the benchmark…
Let’s analyze that objective. The “benchmark” in question is an index, in particular the S&P 500 index. And the term “seeks” can be interpreted as “tries”. So the fund tries to match the performance of the S&P 500 index. It is the act of “trying” that causes costs to go up. All that “trying” by the fund manager(s) costs money after all – there are yachts to buy don’t you know?
So anyhow, if our objective as investors is to match the performance of the benchmark, why not invest in the benchmark via a low-cost index fund rather than in a fund that wastes a lot of effort (and money) “trying” to match the benchmark?
I think Yoda would heartily approve.
M. Barton Waring does an excellent job in his book Pension Finance. The book essentially covers what’s wrong with the way conventional accountants and actuaries think using conventional math and accounting practices to justify the payments (or lack thereof) funding corporate and municipal pensions.
A concept talked about at length in the book is the idea of long-term average returns and how many pension actuaries rely on them to determine funding. Mr. Waring would argue that there is too much reliance on the long term average returns thus allowing pension actuaries to fund their pensions with less money due to assuming higher rates of return.
Instead, one of the areas that may help the crippling pension system in the US is to get realistic about long term returns and use a combination of a smaller returns, and bigger contributions (among others).
The book is heavy on the analytic side (great for our quant readers) but offers substantial insight in plain English on what led to the current pension crisis while offering a mathematically possible solution that relies on real numbers and not hypothetical long term average returns.
- See a lawyer and make a Will. If you have a Will make sure it is current and valid in your home state. Make sure that you and your spouse have reviewed each other’s Will – ensuring that both of your wishes will be carried out. Provide for guardianship of minor children, and education and maintenance trusts. If you have divorced and remarried, make sure that your retirement account beneficiary designations are up-to-date reflecting your current situation.
- Pay off your credit cards. Forty percent of Americans carry an account balance on their credit cards or other personal credit – this is not good for your financial future. Create a systematic plan to pay down your balances. Don’t fall into the “0% balance transfer game” as it will hurt your FICO score. Credit scores matter not only to credit card companies but to insurance companies and future employers as well; you can avoid an unpleasant increase in your insurance rates by managing your credit wisely.
- Buy term life insurance equal to 6-8 times your annual income. This is primarily true for younger folks who have financial obligations to cover with future income. Most consumers don’t need a permanent policy (such as whole life or universal life). Also consider purchasing disability insurance; think of it as “paycheck insurance.” Stay-at-home spouses need life insurance, too! Note: Each family’s needs are different. Some families have a need for other kinds of life insurance, so you should review your situation carefully with an insurance professional (preferably two or more) before making decisions in this area.
- Build a 3 to 6 month emergency fund. This helps you to keep from having to charge up your credit cards when life’s emergencies strike. In the interim, before you’ve built up your fund, you can establish a home equity line of credit before you need it – this can take the place of part of your emergency fund.
- Don’t count on Social Security too much. Since the projections show that in the future the most that can be paid out for Social Security obligations is around 77%, you should adjust what you expect to receive – especially if you are age 50 or younger. Make up for this by funding your IRA each and every year. If you don’t fund these accounts annually, you lose the opportunity to increase your tax-deferred savings. Fund a Roth IRA over a traditional IRA if you qualify.
- If offered, contribute to your 401(k), 403(b) or other employer-sponsored saving plan. Just the same as with your IRA, if you don’t take advantage of the opportunity to defer funds into these savings vehicles, you lose the opportunity. In addition, if you don’t participate in the plan, you lose the chance to receive the matching funds from your employer.
- Use your company’s flex spending plan to leverage tax advantages. If you don’t use your flex plan annually, you lose the opportunity – and the tax advantages – for that year.
- Buy a home if you can afford it. Maintain it properly. Build equity in your property. You’ll have much more to show for your money spent than a box full of rental receipts! This is also about more than your financial future – studies show that home ownership adds to peace of mind and improved quality of life.
- Use broad market stock index funds to reduce risk and minimize costs. Indexes are a simple way to diversify, and they can have very low costs but you have to pay attention to make sure you’re getting a low-cost index. Diversification reduces risk of single securities (see #10) and reducing costs is one of the best things you can do to improve your overall investment results. If you have limited options, for example in your 401(k) plan, make sure that you diversify across a broad spectrum of options.
- Don’t over-weight in any one security, especially your employer’s stock. As a rule of thumb, keep exposure to any single stock to less than 5% of your overall portfolio. If you over-expose to a single stock and that company goes bankrupt, you’ve lost a significant portion of your portfolio. It can happen easily, history is littered with good companies that went bad.
I have two daughters and it has given me the pleasure of seeing them grow up and get excited about even the little things like chasing butterflies or finding a lucky penny. My kids find lucky pennies all the time. In fact, they find lucky coins all over the place. Some are by chance as we’re walking down the sidewalk and other times it’s a lucky coin that I may place in an inconspicuous place so they stumble upon it and find it (sometimes it’s fun creating luck for my kids).
Whether they find the coin by luck or otherwise, it gives me a great opportunity to teach them. After the excitement of the find goes away, they get even more excited when I ask, “Where should we put that lucky coin?” With glee they almost always reply, “In the piggy bank!”
I feel parents can teach their kids about money even if it’s starting with something as small as a penny. From lucky coins to birthday money it’s OK to teach your kids about saving a little bit, giving a little bit and spending some as well. I don’t think there’s too-young an age to start doing this. And by starting early, your kids will get excited about saving and this can potentially be less burdensome if they were to try at say – age 21.
Some readers may question how they can teach their kids about money or even feel that they can’t be effective teachers since they may not be as financially stable or literate as they would like. They needn’t worry. It’s an excellent way for parents to learn with their kids and they can both enjoy the benefits of working together. Parents can learn and then teach by example and simultaneously show their kids how to save.
As kids grow up, parents can then teach them how to save from the piggy bank to the savings account and even investments such as stocks, bonds and IRAs. Having been taught the basic fundamentals of just saving and not spending all their money, kids can learn the value of investing, and the miracle of compound interest.
Finally, teaching your kids about money ultimately empowers them to control their money, and not have their money control them. They’ll grow up seeing money as a tool, as a currency, and as an asset they can accomplish great things with – not as a conundrum, enigma, or something to worry or argue about – or worse, something they fear.
Recently the IRS issued a Notice, 2014-54, which details some information regarding the allocation of pre-tax funds from a qualified plan (such as a 401(k) plan) into a Roth IRA. This is a clarification of a question that has been on the minds of folks in the financial services industry for some time, and it’s a good result. Now the question becomes: does this help to clarify NUA basis allocation strategies?
What I find interesting about this Notice is that this is the first time that the IRS has used this interpretation of the rules referenced specifically in IRC Section 402(c)(2), which is the code section I’ve referenced before regarding allocation of basis for Net Unrealized Appreciation (NUA) treatment for employer stock. (See more information in this most recent article NUA Allocation Twist – Not as Easy as it Looks.) The problem (outlined in the article) has been that plan administrators are unwilling to attempt applying the allocation of basis in an NUA transaction because there has never been any guidance from the IRS on such an allocation of basis. Notice 2014-54 may be the first step toward such guidance.
I’ve sent queries to the best minds I know in the retirement plan law universe to get additional insights into this concept – and as yet have not received a confirmation either way. I think this is a step in the right direction, but don’t get too excited yet.
I’ll keep you posted.
When saving and investing for retirement many folks as well as advisors helping those folks plan save and invest for retirement generally will have the conversation that includes how much they can save per month or year, how much they need at retirement and how long they have to save until retirement.
Essentially, all of the ingredients in the previous paragraph boil down to a phrase mentioned many times in financial planning classes as well as courses in finance, investing and business: the time value of money.
The time value of money helps individuals and businesses figure out how much they need to save, earn, and spend in order to achieve certain financial goals. What it boils down to is what is a dollar worth, if not spent today, and instead invested and allowed to grow for tomorrow (the future).
Since there’s been an appreciable run-up in stocks over the recent past, now may be a good time to reallocate your investment allocations in your retirement plans and other accounts. You’ve probably heard of reallocation before – but what does it really mean?
Reallocating is the process of changing your current mix of investments to a different mix. It could be that you’ve changed your risk assessment and wish to have more stock and fewer bonds, vice versa, or your investments have grown in some categories from your original allocation and you need to get the mix back to where you started.
At any rate, reallocation is a relatively simple operation, and research tells us that it is important to reallocate regularly, such as on an annual basis. Below are five steps that you can use for a simple reallocation in your accounts.
Reallocation in Five Steps
1) Reallocating, sometimes referred to as “rebalancing”, requires taking a look at your overall investment portfolio. You need to bring together all of your different investment and savings account statements and review the allocation, comparing to your goal allocation. You might put this information on a spreadsheet on your computer, or just on a sheet of notebook paper.
For some people, this could take quite a while – if you have several bank accounts, retirement plans, maybe a brokerage account or two, and then some savings bonds, for example, it can take quite a while to pull all of this together. This may be one reason why folks don’t bother with reallocation. Believe me, it’s worth every minute of effort! Without reallocation, some components of your investment assets can become too large of a part of your investments, changing the risk structure of the portfolio.
So anyway, go ahead and pull all of the account information together.
2) Once you’ve done this, break down your overall retirement portfolio into three categories – cash, bonds, and stocks. For our purposes, you should consider bond mutual funds, individual bonds, and preferred stocks in the “bonds” category. Likewise, consider individual stocks and stock mutual funds in the “stocks” category. Real estate or other non-stock and non-bond investments should be considered as a fourth category, if you have any those.
3) Now that you have the categories split up, add up each category of items separately, and divide that amount by the overall total. This will give you your current ratio.
4) The next step is a little more difficult. It requires you to think about what kind of “split” you’d like for your investments. For each individual, this split will be a little different. There are rules of thumb that you could use, but in the end, this split is a personal decision for you to make. Generally speaking the more that you have allocated to stocks, the more risky your portfolio is. So, a 60% stock/40% bond portfolio is more risky than a 50% stock/50% bond portfolio, generally speaking.
Some of the factors that you need to consider are your age, the number of years until retirement, your health, and the same factors for your spouse. In addition, consider your children’s education expenses, as these often cut in to the amounts available for your retirement.
Bear in mind that this split ratio will be a number that will change as time passes. For example, a person at age 25 may have a ratio of 90% stocks, 5% real estate, and 5% bonds. When this person reaches age 40, they might wish to have a lower-risk exposure, so they have changed their ratio to 70% stocks, 20% real estate, and 10% bonds. As this example individual nears retirement age, say around age 55, the ratio might adjust to 50% stocks, 20% real estate, and 30% bonds. (Note: these ratios are only for example and are not a recommendation. As stated earlier, each individual should determine the appropriate ratio for his or her own personal situation.)
A cash allocation is for those funds that you have a short-term need for. You might have college expenses to be paid from this fund, or perhaps you’re in retirement and need to money for living expenses. This money that is earmarked for use within say, five years, should not be exposed to the stock and bond market risk like your other long-term funds.
5) Once you’ve determined the ratio that works best for you, compare it to the real ratio that we calculated in step 3 above. All you have left to finish your re-allocation is to adjust your current holdings to match the ideal ratio that you’ve come up with for yourself.
Most retirement plan websites have a facility or toolset that allows you to do this re-allocation quite simply. If that’s not the case for your plan, simply determine which of your holdings that you need to buy and/or sell in order to make your allocation match the ratio that you’ve decided upon for yourself.
Note: If you have a mix of tax-deferred accounts and taxable (non-IRA accounts), you’ll want to be careful if you’re selling any positions in the taxable accounts as this can generate capital gains taxation depending upon your circumstances. This can be a nasty surprise come tax time if you’re not careful about it. Try to offset capital gains with capital losses in other holdings or accounts, or perform any sales of appreciated holdings within your tax-deferred accounts alone.
And you’re done! That was actually pretty painless, wasn’t it? This process will be much easier next time around (it should be done once a year, by the way) since you’ve already gone through it once. You’re on your way to financial independence, believe it or not!
If you’re finding this a little more complicated than you feel you can work out on your own, hire a financial advisor to assist you with the task. A fee-only financial advisor will assist you with this kind of task without trying to sell you investments. If you need some assistance in reallocating your investment account, especially if it’s your employer-sponsored retirement account, a fee-only advisor is your best bet.
If you’ve ever planned for a day out, picnic, family day or relaxing day outside chances are you turned on your TV, radio or grabbed your smartphone app and got an idea of what the weather was going to be for the day of your trip.
When you looked you got a prediction, based on the probability of what the weather patterns have shown in the past and you got an idea of what your day would look like. And sometime in your life, what was predicted to be a bright sunny day was laden with storm clouds, rain and gloom.
Trying to predict the market is like predicting the weather, only more confusing, more expensive, and less likely to get your desired outcome.
Read any financial column or blog and chances are the writers (including yours truly) have advocated that readers save their income, reduce expenses and get rid of debt. Sometimes this valuable information can get interpreted as you can never spend any money on yourself for little things here and there such as a meal out or grabbing a movie with a friend.
These little things can help keep you on track for your bigger savings targets by allowing you a bit of autonomy and a chance to enjoy the money you’re working hard to earn and save.
Think of it this way: let’s say someone is going on a diet and they absolutely refuse to eat any type of sweet, junk food or anything that would keep them from getting to the proper fitness level or weight they are looking to achieve.
What can (and usually does) happen is by denying themselves even the smallest little treat or dessert they eventually cave in and break their diet and binge eat on sweets, junk food, etc., often ending in a worse situation than they started.
The same can happen if we deprive ourselves the pleasure spending a little something because we want to. If we deprive ourselves too long, we can binge spend and completely lose sight of our goals or worse, be tempted to swipe the credit card to make up for the deprivation.
Now, this isn’t a green light to simply spend, it’s more of a cautionary yellow that says it’s ok, but don’t spend out of control.
There has been a rash of phone scams going on this year – scammers posing as IRS agents that is. I haven’t personally received any of the calls, but I’ve had calls from several clients who have gotten these calls.
They can be very disconcerting, to say the least. In the typical phone scam, the caller contacts you out of the blue, and seems to have information about your home address, or bank, or other somewhat personal information. They then tell you that you owe a pile of taxes and you have to pay up now or the local police will be on the way to see you. They will readily take your credit or debit card information right now, over the phone.
The flip side is that they’ll say you have a refund coming and will ask for your bank account information so that they can transfer it to you, right away!