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May, 2009:

Doing All The Right Things

I am diabetic.

100_8968-by-alishavThis is one of those situations we’re dealt with in life that requires changes – and paying attention to a lot of stuff we never wanted to pay attention to. Like eating right, exercising, taking appropriate meds, and monitoring and adjusting. It’s a lifestyle change.

What I’ve continued to notice is that, even when I do most of the right things – I exercise regularly, walking for 45 minutes a day, stay far, far away from sweets of any sort, take the right meds at the right times, and monitor things closely – I can still wind up with a high blood glucose level.

How can that be?  Well, it turns out that just staying away from sweets and sugars isn’t the whole answer – I also need to refrain from most starchy foods and have more proteins and vegetables in my diet.  Frustrating?  You bet.  Futile?  Of course not – I just need to do ALL of the right things.

So what does all this have to do with financial stuff?

Most folks are or were in a similar position with their investing and savings activities.  We thought we were doing the right things.  Turns out it was only most of the right things.  We were putting lots of money aside into our 401(k) and IRA plans, taking advantage of tax rules in our favor, spreading our money out among five, seven, nine different mutual funds, and well, keeping debt “in check”.

Unfortunately, just keeping debt in check isn’t the whole answer.  If we’re not prepared for a financial downturn with emergency funds, the debt situation can sneak up and cause lots of problems with our personal cash flow.  Many folks are experiencing this right now – and lots of formerly “in check” debt is coming dangerously close to getting way out of check.

Additionally, the idea of diversification needs to be better understood and applied.  Just because you’ve spread out your money among umpteen different funds, it won’t help a bit if all of those funds are subject to negative impact by the same economic factors.  To be properly diversified, a portfolio should include components that are not in any way related to one another – so that when an economic downturn affects the US domestic equity market, only that portion of our portfolio that is invested there is impacted.

The remainder of our portfolio, properly diversified into asset classes such as real estate, foreign and domestic bonds, foreign equity markets, commodities and the like, will have reacted differently to the negative impact in the domestic equity market and the overall effect is lessened dramatically.

Granted, even the best diversification strategy would not have kept you from experiencing paper losses during the economic downturn we experienced in the fall of 2008 – but your overall result would have been much better than most folks saw, and you would be much closer to “whole” at this stage. Frustrating?  You bet.  Futile?  Of course not – we just need to continue to do ALL the right things.

One last parallel with my health situation to our financial situations – continuous monitoring and adjusting is necessary, as is patience.  As I mentioned before, I need to check my blood glucose level regularly and make adjustments to my diet and such to help ensure that I’m staying within manageable levels.  Oftentimes it gets frustrating because I believe I’ve done all the right things and my level is still off.  Then I’ll realize that maybe I didn’t exercise quite as much that particular day or perhaps I ate something I shouldn’t have.  No matter, it’s passed by, the only thing that can be done is to resolve to do it right for the next day.

This is what we’ve got to do, now, in our financial lives.  Continue doing all of the right things we were doing before, and make those changes and adjustments that we need to make (diversify appropriately, eliminate debt, have emergency funds, don’t buy more than you can really afford – of anything), and monitor the outcome.  And be patient.  Too many folks nearing retirement are looking at their account balances and figuring now is the time to make aggressive investment choices in order to “catch up”.  There is another way to catch up, a much more assured way:  put more money into a properly-diversified portfolio.  Work a little longer than you expected.  It’s not fun, it’s not what you had in mind, but it’s necessary for you to be able to face retirement with a healthy source of income.

If you have additional ideas on this subject, I’d be happy to hear from you – leave a comment!

Age 70½ RMD Rules

give-us-this-day-by-mr-krisAs you are likely well aware, once you reach age 70½ you’re required to begin taking a minimum distribution from your IRA and/or qualified retirement plans.  There are several things you need to know about these distributions, so that you don’t make any mistakes.  Listed below are some of the more important rules – but keep in mind that these RMD rules are only for the original owner of the account, not for a beneficiary of an inherited account.

Required Minimum Distribution Rules

Special Exception for 2009 – for calendar year 2009, Required Minimum Distribution (RMD) rules are waived, so no distribution is required in 2009.  If your 70½ year was during 2008 you are still required to take your distribution for 2008 calendar year before April 1, 2009.  If you turn age 70½ during 2009 you will not be required to take a distribution before April 1, 2010, however, your first RMD will be required by December 31, 2010.

Calculation of RMD -

  1. You must have your account balance from the end of the calendar year prior to the year for which the distribution is being calculated.  Any additions or withdrawals after December 31 of the previous year are not included in this balance, even if an addition is for the previous calendar year.  Also, any “in flight” rollovers or recharacterizations that effectively would impact the end of year balance are included (or excluded) in the balance as applicable.
  2. You must learn your distribution period, which can be found in Table III, using your age at the end of the current year (not the previous year).
  3. Divide the balance from #1 by the distribution period found in #2.  This is your RMD for the current year.
  4. For each subsequent year, go back through #1 for a new balance at the end of the prior year, then go to the table from #2 to get a new distribution period, and do the math.

More Than Minimum – for any year in which you withdraw more than the RMD amount you are NOT allowed a credit against future year RMD.  The result is that your balance at the end of the current year would be less, so future RMD would be resultingly a little less, but not by the amount of extra you received.

No Rollovers or Conversions of RMD Amounts – Although you’re allowed to rollover or convert IRA funds after age 70½, you can not rollover or convert the amount attributable to your RMD for the year.

Multiple Accounts – For the purposes of calculating RMD, the IRS considers all traditional IRAs owned by one individual as one aggregate IRA.  This means that you can determine your RMD by adding together the balances of all your trad IRA accounts at the end of the prior year, and then taking your RMD from any one account (or as many accounts as you wish) as long as it totals at least the RMD for that year.  Other qualified retirement plans such as a 401(k) must be treated separately – that is, RMD must be calculated only on that account and distribution received from only that account.

Multiple Payments – You are allowed to take from as little as one to as many payments as you wish from your IRAs, as long as they add up to the RMD for the year.

Photo by Mr. Kris

Non-Spouse Rollover of Inherited IRA or Plan

750-year-old-gija-jumulia-by-sridgwayWhen you inherit an IRA from someone other than your spouse, you are able to take advantage of certain protections or deferrals of tax inherent in the IRA, but you are somewhat restricted in your actions with the account.  These rules also apply to a spouse who has elected NOT to treat the inherited IRA as his own IRA.

Restrictions

Specifically, you are not allowed to treat the IRA as your own – in other words, the account can only be re-titled as an inherited IRA.  This means that you can move the account to another custodian (via trustee-to-trustee transfer only) or leave it at the same custodian, and change the title to read as “John Doe IRA (Deceased January 1, 2009) FBO Janie Brown” or something very similar.

In addition to the restriction on titling, the IRA beneficiary must begin taking Required Minimum Distributions (RMD) as described below:

  • If the owner of the account died on or after his Required Beginning Date, which is generally April 1 of the year following the year in which he reached age 70½, the RMD is based on the longer of: 1) the owner’s life expectency¹; 2) the beneficiary’s life expectency¹; 3) the oldest of multiple beneficiaries’ life expectency¹ (if more than one beneficiary).
  • If the owner of the account died before his Required Beginning Date, the RMD is based upon the beneficiary’s life expectency¹ or the life expectency¹ of the oldest beneficiary if there are more than one beneficiary.

The Designated Beneficiary

The designated beneficiary is generally determined on September 30 of the year following the year of the death of the plan owner.  In order to be named the designated beneficiary, an individual must be named on the plan documents as of the date of death (no changes can be made after death).  If any person named in the plan documents as beneficiary but is no longer a beneficiary as of September 30 of the year following the year of death, that person will not be considered when determining the designated beneficiary.  This could come about if one of the original beneficiaries chose to disclaim entitlement to the account.

If an individual who is a beneficiary as of the owner’s date of death dies prior to September 30 of the year following the year of death, that individual is still considered to be the beneficiary, rather than any contingent beneficiaries.  The deceased beneficiary’s estate would receive the account and her age would be used for determining distribution.

Required Minimum Distribution (RMD) Rules

It is important to note, the following RMD rules apply:

  •  you’re allowed to spread the distribution out in monthly, quarterly, or any schedule of payments as long as it’s at least annually; 
  • if you’re the beneficiary of more than one IRA, you must determine the RMD for each IRA individually, although you may total the RMDs and take the amount from a single account if you wish; as well as
  • if you receive more than the minimum required in any one year, you do not receive “credit” against future distribution requirements.

Multiple Beneficiaries

If there are multiple beneficiaries of a single account, and all of the beneficiaries are individuals (not trusts), as indicated earlier, the beneficiary with the shortest life expecency¹ is used to determine RMD for the account.  If an account is split into separate accounts with separate beneficiaries prior to the death of the owner, each account is treated separately with regard to inheritance rules, not aggregated.

Trust as a Beneficiary

If a trust is the named beneficiary, on September 30 of the year following the year of the death of the owner, the beneficiary(s) of the trust will become the designated beneficiary(s) of the IRA as long as the following are true:

  1. The trust is a valid trust under estate law, or would be but for the fact that there is no corpus.
  2. The trust is irrevocable or will become irrevocable by terms, upon the death of the owner.
  3. The beneficiary(s) of the trust are specifically identified from the trust document.
  4. The IRA custodian or trustee has received documentation of the trust by October 31 of the year following the year of the owner’s death.

If the beneficiary of the trust is another trust, as long as the second trust meets the requirements above, the beneficiary(s) of the second (or subsequent) trust will become the designated beneficiary(s) of the IRA.

Footnotes:

¹ Life expectency is generally determined in these cases by the IRS Single Life Table, also known as Table I, which you can find by clicking this link.

Photo by sridgway

What Is It That You Want To DO?

Note: Taking a little break from tax law and retirement planning for the day…

One of the questions that I often ask folks as we’re working on financial matters is – “what is it that you want to DO?”  And in this case, DO is properly capitalized, because the context of the question is with regard to life.  “What is it that you want to DO in your life?”

purpose-by-sidewalk-flyingDeep down, we all have the desire to matter.  We want to, in some way, create a legacy of our life, so that this time we’ve spent here doesn’t seem like a waste of time.  Not that what we do every day – caring for our families, performing our job, etc., is a waste of time.  But if we’re not cognizant of a greater purpose for our life, oftentimes life seems unfulfilled.  It doesn’t have to be grandiose, we all have our little corners of the world that we can impact in a positive way that will leave a legacy long after we’re gone.

Believe me, I’m not in any way saying that I have all the answers.  In fact, I have quite a few questions that you might want to ask yourself as you consider just “what is it that you want to DO?”.  These questions are primarily from a financial standpoint (duh, financial planner, remember?) but have a greater reach, as in how money interplays with your aims for your life.

  • How would you describe your relationship with money?  Is it a means to an end, or is it the goal you’re aiming toward?  If you answered the latter, what are you going to do with the sum of money when you get it?
  • What in your life brings meaning to your existence?  It may be volunteer work, your job, or just being with your family.  How would a drastic reduction in your financial situation, such as loss of a job, impact your meaningful activities?  Would a dramatic improvement in your financial situation, such as winning the lottery, lead to a more meaningful life?
  • If you’ve got an idea of what you’d like to accomplish in your life to leave a legacy, how does money affect your ability to do “your thing”?  Are you doing those things now – that is, making those contributions – that will help to leave the impact you’re hoping to leave on the world?
  • Quite often, it is said, that we don’t really get to know our personal strengths until we’ve faced adversity.  If you’ve suffered a financial setback, what personal attributes do you have that you can use to help you deal with the situation and get yourself (and your family) through the crisis?
  • As you consider your personal values, is there anything that you’re lacking?  Is it possible that we have too much “stuff” in our lives that keeps us from truly appreciating and evoking our values?
  • Consider the above questions again, only substitute time for money in the question… and then do it again, substituting talents.

Pretty sure we haven’t resolved anything here today – but hopefully some of the questions I’ve asked have sparked you to action (or at the very least, deep thought).  Because the actions we take in our lives are our only way to create that legacy – so that in the end we can look back on our life and feel satisfied that we’ve done our best.  That’s what it’s all about, right?

Take care, jb

SGLI Payment Rollover to Roth or ESA

hero-by-mikeensorIntroduction

On May 20, 2008, Congress passed H.R. 6081, the Heroes Earnings Assistance and Relief Tax Act (the HEART or Heroes Act), which was signed into law by President Bush on June 17, 2008. One of the major provisions related to retirement accounts (IRAs and qualified accounts) is the ability to rollover SGLI (Serviceman’s Group Life Insurance) payments to a Roth IRA or a Coverdell ESA.

Contributions of military death gratuities to Roth IRAs and Coverdell ESAs

The Act permits an individual who receives a military death gratuity or Servicemembers’ Group Life Insurance (“SGLI”) program payment to contribute the funds to a Roth IRA, or to one or more Coverdell education savings accounts.

Such contributions will be treated as rollover contributions to the Roth IRA or Coverdell ESA accounts, not subject to normal income or contribution limits. The maximum amount that can be contributed to a Roth IRA or one or more Coverdell education savings accounts in the aggregate under the provision is limited to the sum of the gratuity and SGLI payments that the individual receives.

In the event of a subsequent distribution from a Roth IRA that is not a qualified distribution or a distribution from a Coverdell education savings account that is not a qualified education distribution, the amount of the distribution attributable to the contribution of the military death gratuity or SGLI payment is treated as nontaxable investment in the contract. This provision is generally effective with respect to payments made on account of deaths from injuries occurring on or after June 17, 2008.

In addition, the provision permits the contribution to a Roth IRA or a Coverdell education savings account of a military death gratuity or SGLI payment received by an individual with respect to a death from injury occurring on or after October 7, 2001 and before June 17, 2008 if the individual makes the contribution to the account no later than June 17, 2009.

Action Now

If, heaven forbid, you happen to have received SGLI payment or military death gratuity as described above with respect to a death that occurred between October 7, 2001 and  June 17, 2008: first of all, God Bless You and your family for the sacrifice you’ve endured. I can’t say enough how deeply we feel for you.

On a second, far less important note, you have until June 17, 2009 to rollover those benefit funds into an ESA or Roth IRA.  This could make a profound difference for your taxes in the future. For SGLI or military death gratuity payments due to a death that occurs (or occurred) after June 17, 2008, you have one year to make the rollover.  As always, if you have questions, talk to your financial advisor – she should be able to help you out with this.

Photo by mikeensor

Credit Card Industry Reform

credit-card-roullete-again-by-moacirpdsp

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By now you’ve likely heard about the reforms planned for the credit card industry.  Mr. Obama has come in and saved the day for us poor, disheveled credit card users.  Why, we’re all going to benefit from these changes… right?

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Wrong (or at least that’s how I’m reading it).

So here are the major tenets of this legislation:

  • cc companies must give 45 days’ notice before increasing rates on an account
  • new limits on the penalties and fees that the cc company can charge
  • an account must be 60 days behind in payments before the cc company can increase rates
  • after 6 months at an increased rate (due to late or non-payment) if the account has maintained good standing, the rate can be reduced

What’s not said in this legislation is how the cc companies are going to pay for this imposed largesse.  How about:

  • new, higher annual fees just to have an account
  • reduced “grace period” – possibly even eliminated, meaning that if you use a credit card, you are charged interest from the date of purchase, rather than the date of the bill
  • other unknown ways to spread the cost of credit from the users abusers of credit to the folks who pay their bill in full each month

Now, I guess this isn’t necessarily wrong or bad business.  After all, the folks that pay their credit card bill in full every month have been the beneficiaries of a “float” – that is, essentially you’ve got free money to work with for 28 to 30 days.  So, even though we’ll experience relative depravation when this goes away, it’s not like it’s a God-given right of ours to have free short-term financing.

Maybe I’m just cynical, but I expect this legislation to cause more folks to stop using credit cards and begin using cash and/or debit cards, at least until the fees start moving to those items as well.  Cash is more costly (in the long run) to handle, so the trickle-down effect will be an increase in overhead, more than likely.

What do you think?  Leave a comment!

Creditor Protection for Retirement Plan Assets

In this day and age with bankruptcies on the rise, quite often this question comes up:  are my retirement plan assets protected from creditors? And of course, there are two ways you can take this – are the assets protected from creditors of my employer; and are the assets protected from my personal creditors?

protection-by-hryck

Employer Creditors

Your qualified retirement plans (401(k), 403(b), etc.) are always protected from creditors, in the event that your company should declare bankruptcy.  The same is true for traditional qualified pension plans.  However, with certain nonqualified retirement plans, there is a strong possibility that these assets could be accessed by your employer’s creditors in the event of a bankruptcy.

These plans are often called executive compensation, rabbi trust, deferred compensation, or supplemental retirement savings (among many other terms).  The key here is that these accounts are “non-qualified”, and as such are not protected by the ERISA law.  These accounts are very often open to access by creditors, so be aware of this if you’re a participant in such an account.  Check with your HR department if you’re unsure if your retirement account(s) are qualified (and thus protected by ERISA) or not.

IRAs, being individual accounts totally separate from your employer (unless you’re self-employed) are not considered in any way the assets of your employer.  If you are self-employed and are not incorporated in some fashion, depending upon your state law, some of your IRA assets could be at risk, depending upon the state that you live in, and the balance of the account (see below).

Personal Creditors

In general, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) provides that both traditional and Roth IRAs derived from contributions are protected from creditors up to $1 million.  This protection only applies to bankruptcy, not to other judgments, and as such state law applies for all other situations.  The level of creditor protection varies widely by state.  For more up-to-date information on the protection within your state, click this link.  Rollover (including, if you’ve been paying attention, trustee-to-trustee transfer) amounts from employer plans, SEP or SIMPLE IRAs have unlimited protection from creditors.

There are cases, as illustrated recently in a case that was decided in 2007, where an inherited IRA with a revocable trust as the beneficiary became available to the decedent’s creditors.  This case was in the state of Kansas, so other states may have differing laws, this was just an example.  The way to resolve or avoid this is to use an irrevocable trust as the beneficiary and use discretionary and spendthrift clauses within the trust as protection.  Otherwise, naming an individual (or individuals) as the IRA beneficiary(s) would avoid this problem as well.

Further problems develop in the inherited IRA spectrum due to the fact that most state courts do not consider an inherited IRA to be a “retirement account”, since the owner (the beneficiary of the decedent) is currently receiving an income from the account.  This is important because retirement accounts are specifically protected from creditors (due to BAPCPA).

Closing

So, even though the IRA has somewhat fewer protections against creditors versus the employer plans, if you’ve left the employer this shouldn’t be the reason to leave funds in the old account.  An IRA account can be considerably more flexible, easier to access, and (likely) lower in cost overall.  If protection against creditors is a great concern, umbrella liability and/or malpractice insurance could be used as a low-cost alternative.

Photo by Hryck.

7 Mistakes With Stretch IRAs

exercise-stretch-discuss-by-filtranThe stretch IRA, when implemented properly, can be one of the great vehicles for transferring wealth to your heirs, maintaining the tax-deferred status until much later.  The problem is that there are some very specific terms that must be met in order to achieve the stretch – and if you screw it up, there’s definitely not a do over in most of these cases.

Ground Rules

First, let’s run through the specifics that make up a stretch IRA situation.  When an IRA account owner dies, the beneficiary(s) are eligible to re-title the account(s) as inherited IRAs in the name of the deceased owner, and then begin taking Required Minimum Distributions based upon the beneficiary’s age – rather than having to take the entire sum all at once and pay tax on it, or the onerous five-year distribution rule that can come into effect if things aren’t done properly. (more on the specifics of the Stretch IRA can be found in this article.)

Keep in mind that these stretch rules apply to both Traditional and Roth IRAs – even though Roth IRA owners are not subject to RMD, their beneficiaries are.

7 Mistakes

What we’re here to discuss are the some of the common mistakes that can be made when attempting to stretch an IRA.

  1. Not properly titling the account – if the account is set up in the name of the non-spouse beneficiary, the funds would be immediately taxable and the IRA would be distributed.  There’s no remedy to this one, the account has to be titled as “John Doe IRA (Deceased January 1, 2009) FBO Janie Brown” or something very similar.
  2. Doing a “rollover” – while it may seem like an issue of semantics, there is a technical difference between a direct trustee-to-trustee transfer and a rollover.  The trustee-to-trustee transfer is self-describing; a rollover is when the beneficiary receives a payment made out in his own name, which he then deposits into an IRA.  A rollover is disallowed in attempting to set up a stretch IRA – you must always do a direct trustee-to-trustee transfer.
  3. Neglecting timely transfer – sometimes estates can be tied up for years getting everything sorted out.  IRAs and 401(k) plans should not have this sort of problem, as generally there is a specific beneficiary or beneficiaries designated on the account documentation.  It is critical that the funds are transferred into a properly titled account before the end of the year following the year of the deceased owner’s death – otherwise the stretch IRA option is lost, and the funds will have to be paid out via the five year rule.
  4. Failing to take RMD for year of death – if the IRA owner dies after his RBD, a Required Minimum Distribution must be taken for the year of his death, and can not be included in a transfer to an inherited IRA.  This one can cause some hiccups, but in general can be resolved if caught in a timely fashion by taking the distribution in the name of the decedent and paying the applicable penalties for excess accumulation.  If the amount is transferred to the inherited IRA and isn’t caught quickly, it could negate the stretch altogether, causing big tax bills.
  5. Missing or neglecting RMD payments – if the beneficiary forgets to take the Required Minimum Distribution payment in a timely fashion, technically the five-year rule could kick in, requiring that the entire balance is paid out within five years, rather than the beneficiary’s lifetime.  However, it is possible to recover from this mistake, according to the outcome of a Private Letter Ruling (PLR 200811028, 3/14/2008).  What happened in this case was that the beneficiary neglected to take two years’ worth of RMD, and then corrected her mistake in the third year, taking all three years’ worth of RMD, followed by paying the penalty (50%) on the missed two years.  The IRS ruled that the failure to make these distributions in a timely fashion does not require that the five year rule apply – and since she maintained the appropriate distributions, caught up on the “misses” and paid the penalties, she is allowed to continue stretching the IRA over her lifetime. Interestingly, this particular PLR is the first place where the stretch IRA was determined as the default rather than the five-year rule, breaking ground for this to be the case across the board, unless the plan’s provisions require the five-year rule.
  6. Not properly designating the beneficiary(s) – IRS regulations state that the beneficiary must be identifiable in order to be eligible for the stretch provision.  This means naming an individual or individuals as specific beneficiaries on the account forms, or designating a proper “see through” trust (with specific beneficiaries named) as the beneficiary.  The account form can not have something ambiguous like “as stated in will” – since this does not name an identifiable beneficiary.  In addition, if the original IRA beneficiary is a trust and any beneficiary of the trust is not a person, then the stretch IRA provision is lost for all beneficiaries.
  7. Transferring the balance to a trust – if a qualified “see-through” trust is the beneficiary of the IRA, the balance of the funds in the IRA are NOT transferred to the trust – but rather the IRA is transferred directly to a properly-titled inherited IRA, and then RMDs are taken from the IRA and paid to the trust.  According to the trust’s provisions, the payments are then made to the trust beneficiary(s).  If the payments are simply passed through the trust to the trust beneficiary(s), then each beneficiary will be responsible for any tax on the distribution.  If the funds are accumulated in the trust, they are taxable to the trust (to the extent that they exceed $10,700 in income).

Obviously this isn’t an exhaustive list, but rather a sampling of some of the more common sorts of errors that folks make when attempting to set up a stretch IRA. Done properly, this sort of arrangement can turn an IRA of a sizeable amount in your lifetime into a very significant legacy to your heirs.  Proper setup is very important – get a professional to help you with it if you are confused by how this works!

Photo by filtran

Fiduciary Standard for All Advisors?

dog-in-suit-by-matt512There has been a raging debate going on in the financial advisory world.  You see, there are two primary governing bodies for folks in the financial services business:  the Securities Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).  There are others, literally dozens, but these are the two primary governing bodies.

The Players

The SEC, an arm of the US federal government, has regulatory authority over Registered Investment Advisors (RIA) and Investment Advisor Representatives (IAR) who provide investment advice pursuant to the Investment Advisors Act of 1940 (the ’40 Act).  These folks are advice-givers first and foremost, and are held to a fiduciary standard.

FINRA, on the other hand, is a Self-Regulatory Organization (SRO) which regulates Registered Representatives of brokerage companies, among others.  The people in this group are brokers, sellers of products first and foremost.  Members of FINRA are held to a suitability standard.

The SEC was  created in 1934 with the passage of the Securities Exchange Act (the ’34 Act) created in 1934 and FINRA’s predecessor, the National Association of Securities Dealers (NASD), was created in 1939 due to some amendments made to the ’34 Act.  The prime reason I’m giving you this history is to show you just how long the tail can be for legislation passed during times of national economic crisis – these organizations have been operating for 70 and 75 years following their creation in response to situations that developed prior to the (and some believe had direct cause for) the Great Depression.  Legislation that is being considered today could have similar monumental impact.

But enough history for now – there are literally tons of nuances to consider throughout the history of these two organizations, but the question at hand is the standard to which folks in the financial services sector are held.

Definitions

Fiduciary Standard – A fiduciary is someone who has undertaken to act for and on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence.  A fiduciary duty is the highest standard of care at either equity or law. A fiduciary is expected to be extremely loyal to the person to whom he owes the duty (the “principal”): he must not put his personal interests before the duty, and must not profit from his position as a fiduciary, unless the principal consents. The word itself comes originally from the Latin fides, meaning faith, and fiducia, trust. (from Wikipedia)

Suitability Standard – brokers are required to: 1) know their clients’ financial situations well enough to understand their financial needs, and 2) recommend investments that are suitable for them based on that knowledge. Brokers are not required to provide upfront disclosures of the type provided by investment advisers, including, but not limited to their conflicts of interest.

The Debate

Financial planners, financial advisors, etc. (for there are many names by which advisors call themselves) are not per se regulated by one standard or another, but rather it depends upon the situation.  Certified Financial Planner™ practicioners (CFP®) are held to a fiduciary standard by the Certified Financial Planner Board of Standards, while most other credentials do not carry such a standard requirement.

It is apparent that the suitability standard is a portion of the fiduciary standard: if a person is operating as a fiduciary, putting the client’s interests first, then investments recommended are by definition suitable to the client’s situation.  The industry recognizes that there is a lot of confusion in the way things are presently laid out, and are working toward a single standard for both types of advisors.

Folks presently held to the suitability standard argue that the fiduciary (often referring to this as the “f-word”) standard is aspirational in nature, where the suitability standard is very clear and direct.  On the other side of the spectrum, those held to the fiduciary standard believe that the inclusion of the FINRA brokers in this standard would serve to dilute the standard – that there would be “degrees” of fiduciary standard to which some folks would be held, while still claiming the mantle.

This is particularly newsworthy as recently the head of FINRA indicated that he thought there should be a single standard, and that he thought the fiduciary standard was the appropriate direction.

The Real Question

The burning question in my mind is this: from the consumer point of view, do you care?  Did you even know about these two standards in the first place?  Did you know that when you go to a brokerage and ask for advice, that the primary standard to which the advisor is held is to ensure that whatever they have for sale is in some way suitable to your situation even if it’s not necessarily in your best interest?  For example, it is entirely possible for a broker to consider a high-cost annuity suitable to your situation, even though it’s not necessarily in your best interest.

This debate means a lot to folks in this industry, and I think it’s pretty clear what you’d probably like, but I just wondered if you care enough to comment on it.

Photo by matt512

Making an Income For Yourself, Part 2

In Part 1 of this series, we talked about the initial steps you need to take as you plan your income stream, especially in retirement.  In this second section we’ll talk about how to develop an income stream from your assets.

But first, we need to get an understanding of just how much income we’ll need.  In the example that we started with in Part 1, the expenses totaled at $2,975 per month, and our income from pension, Social Security, an annuity, and rental income totaled $2,000, leaving us with an unmet need of $975 per month, $11,700 per year.

sustain-ability-by-gaborbaschAlso, earlier in Part 1, we totaled up all of our investment accounts: IRAs, 401(k)s, taxable accounts, savings accounts, and the like.  Time to put those calculations to work.  As a general rule, which we can address further at another time, you can usually count on being able to withdraw up to 4% of your portfolio per year, and as long as the investments are properly diversified, this rate of withdrawal should sustain over your lifetime.  (Keep in mind that this is only a general rule of thumb and each individual’s situation is different, requiring review of risk tolerance and year-by-year investment experience.)

Sustainable Withdrawals

So if we use a 4% rate of withdrawal, we need to have approximately $292,500 in investments in order to generate the additional income stream that we calculated earlier ($11,700/year).  We get this number by dividing the needed income by the withdrawal rate ($11,700/4% = $292,500).  Simple enough, right?

Let’s say you indeed have a total of $300,000 in your accounts.  For now, we won’t get into which account to draw from first, let’s assume that you’re over age 59½, and that all funds are available to you for withdrawal.  Furthermore, we’ll assume that none of your funds are in Roth-designated accounts (but taxes are not considered in this example).

The Portfolio

How does one concoct a portfolio that will provide the required income stream, while at the same time generates growth and protects the principle?  Start with the amount required in income – this amount goes into a money market account with checking privileges.  Secondly, a similar amount, representing the following year’s income needs, is invested in short-term Treasury bonds of 1-3 year duration.  This has covered the investment of a total of $23,400 of your portfolio.

The remainder of your funds, $276,600, should be invested in a broadly-diversified portfolio, approximating no more than a 50% exposure to equities, and including domestic and foreign debt instruments, commercial property (in the form of REITs), and various commodities, in order to ensure that the portfolio is well rounded and contains enough non-correlated asset classes to protect your capital.

Each year, as you need the funds, you draw from the money market account.  At the end of the year, you replenish that account with the proper amount for the coming year – if necessary from the short-term Treasury holdings, but most likely from income/dividends generated by the remainder of the portfolio.  In years of lean growth, more will need to be drawn from the short-term portfolio, but in years with more growth, the “investment” portion of your portfolio will grow and should outpace inflation.

But There’s Not Enough!

The question comes up though – what if you didn’t have a portfolio of $300,000 (from our example)?  What if the portfolio only amounts to $100,000?  The sad truth is that you’ve got some tough decisions to make… Maybe you will need to delay retirement for several years in order to build up your portfolio.  Another option would be to take a part-time job that pays at least your “unmet” amount after tax for several years, in order to make up the difference.

You may have to look long and hard at your expenses and make some dramatic cuts to your lifestyle goals.  Maybe it would make sense to downsize your home, assuming that you have equity built up, and thereby use some of the excess cash to bolster your investment funds.

Oooh, but not an annuity!

There is one option that may sound very tempting at this point, especially if you’re much closer to the full amount required from your calculations, but still just a bit short – an immediate annuity.  Under one of these plans, you are trading flexibility and a considerable amount of expense for a guarantee that you’ll always have an income stream – even if it’s a little less than you had planned for originally.  The expense amounts to anywhere from 2% to 3% of your portfolio, and the flexibility is huge: if you decided that instead of the lifetime income you’d prefer to make a large charitable gift (perhaps a health issue has developed) – you’ve pretty much lost that option if you’re stuck in an annuity.

Photo by gaborbasch