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July, 2009:

Linksharing 7/12/2009

Jul 12th, 2009
by jblankenship.
3 comments

Once again, I’ve found several interesting blog posts among my colleagues that I feel compelled to share with you.

icy chain link fence by existentistTo start things off, Jeff “don’t call me Jan” Rose over at the “Good Financial Cents” blog wrote about the changes coming for Roth IRAs next year in the post Gone Daddy Gone – AGI Restriction For Roth IRA Conversion.  This is a good run-down of the specifics of this important change in the landscape – plus you’ve gotta appreciate a guy who can relate the Violent Femmes to the Roth IRA…

The next article for this week is from Jean Keener at Keener Financial Planning.  Jean wrote a very good article about your 401(k) options when you change jobs – a timely article, given the upheaval many folks are facing nowadays in the job market.

Aron Levin, on the “Gen Y – Retire Rich!” blog, brings us another timely article called Post #98 – Look at the Recent Numbers! (Bad Advice).  In this article, Aron points out how misleading the short term (reported!) numbers can be when making financial decisions, and cautions to use longer-term information to temper the short term.   Aron numbers each of his articles consecutively, as his blog is intended to be a sort of instruction manual to be followed in order.

This next one isn’t a blog entry but rather a magazine article I found – I wanted to share it with you nonetheless.  SmartMoney.com published the article An Interview With Burton Malkiel, by Lawrence C. Strauss, which I found very interesting.  Having followed Mr. Malkiel’s work for many years, it was interesting to read his thoughts on present activities in the markets – I think you’ll find it interesting as well.

David Csonka, on his interesting blog “I Hope To Retire Someday”, offers up an interesting word to the wise from an individual investor with his article Don’t Assume Somebody Is Monitoring Your Retirement Or Investment Accounts.  David is a Master’s student at FSU (Go ‘noles!), and he offers some very sage advice about his own journey through the perils of financial “stuff”  throughout his blog.

A friend and colleague of mine, Roger Wohlner, brings us the next entry, called Hellish Retirement Plans.  This is Roger’s review of a Forbes article (there’s a link in his article) which covers some nightmarish problems with retirement plans and what, perhaps, you can do about it.

Again this week, my friend Helen Maynard of Affine Financial Services brings us an interesting article – this time it’s the ins and outs of the choice of using an S-Corporation in a small business.  The article is Can an S corporation save me money?, and if you’ve ever pondered this question you need to read this article, pronto.

Last but certainly not least this week, a fellow Garrett Planning Network member Roger Streit brought forth an article, When Our Brains Short-Circuit, on his blog “The Passionate Planner”.  In this article Roger discusses recent research on how the human brain works, and how that impacts our decision-making processes, specifically with regard to long-term activities like investing.

I hope you enjoy these articles as much as I’ve enjoyed reading and relaying them to you.  If there are blogs or articles that you think I ought to read, please let me know in the comments!

The Obama IRA

Jul 9th, 2009
by jblankenship.
3 comments

buddha dog by SuperFantasticGuess who’s trying to horn in on Bill, Hymen, and David Lee by having an IRA named after him???

Well, not really, but the forced auto-enroll plan that is being bandied about as part of the sweeping financial services reform legislation does stand a chance to serve as a sort of legacy to BHO.  Here’s the plan in brief:

If an employer has 10 or more employees and does not presently offer a retirement plan, under the Obama IRA plan all employees would be automatically enrolled in a salary-deferral plan, starting with 3% of pay.  Supposedly there would be a default “conservative” portfolio, likely a money market or a target-date fund, into which the uninterested parties’ money would be funneled.  The employee would have the option to opt out or discontinue participation at any time, but they would have to make that choice explicitly – enrollment is the default.

While the idea of forcing people to begin saving for retirement seems heavy handed and big-brotherish, it’s clear that something must be done to get people involved in funding their own futures.  However, even though there are some benefits, this sort of plan has lots of problems.

For example, it’s not clear just how the accounts would be set up – who is the custodian?  How does the employer handle the salary deferrals – this would be an additional cost to the employer, obviously, increasing the overhead on payroll administration.  Typically these small businesses do not have a full-time HR staff (think Mom & Pop Diner, for example), so the additional burden would likely fall to the bookkeeper – most likely the business owner herself.  Not only is the hassle of the salary deferral going to be a burden, but someone will have to choose the custodian, work out details on default choices, and monitor the custodian (make sure he’s not a Madoff).

In addition to the concerns about an increased burden on the small business owner, I’m concerned that the plan doesn’t quite go far enough to have a meaningful impact.  While a 3% deferral is a start, it’s hardly enough to begin to make a dent in the needs of a populace that is seriously under-prepared for retirement.  Here in Illinois the minimum wage recently increased to $8 per hour – which equates to an annual salary of approximately $16,000 per year (assuming a standard 2000-hour year).  3% of that is $480.  If the employee is a very young person with a 40-plus-year timeline, putting aside such a small amount will have an impact. If, however, the employee is within five or ten years of retirement, it just amounts to an annoyance, and quite likely the employee would opt out of the plan anyhow.

On top of the small amounts (which, admittedly, can be increased by the employee), the default investment choices are not as “safe” as you might think – a money market fund won’t hardly even keep up with inflation.

I think that to make this plan really work, the government-employee TSP plan should be opened up to allow meaningful, low-cost investment choices, along with a low-overhead plan which has a robust, standard administrative process already established.  This would reduce the burden on the business owner, as well as help the employee with easy-to-understand investment choices that would give them a chance to succeed in their retirement savings activities.

So that’s my opinion, what do you think?

Photo by SuperFantastic
(this reminded me of Dooce's poor, long-suffering
dog Chuck, who apparently is a former congressman)

TWO 5-year Rules for Roth IRAs

Jul 8th, 2009
by jblankenship.
No comments yet

In case the rules surrounding Roth IRAs weren’t confusing enough so far, there are actually TWO different 5-year rules that can apply to your Roth IRA account.

first ride on the bus by busymommy

5-Year Rule #1: The Account’s Age

In general, the first 5-year period begins on January 1 of the tax year when you established and first funded the account.  This 5-year rule is important in determining if any distributions you receive from the account are qualified.  In order to be qualified, a withdrawal must occur at least 5 years after that account establishment date (January 1 of the year you first funded the account).   In addition to the 5-year rule, one of the following conditions must also apply in order for your distribution to be considered qualified:

  • You are over age 59½
  • You are disabled
  • You (the account owner) are deceased
  • The distribution is for a qualified first home

See the IRS’ flowchart at this link in order to determine if your distribution is qualified.

5-Year Rule #2: Age of a Conversion

This 5-year period generally begins on January 1 of the year of a conversion to a Roth IRA from a traditional IRA or from a qualified retirement plan such as a 401(k).  Any amount that is attributable to such a conversion that was subject to taxation upon the conversion that is distributed before the 5-year period is complete would be subject to an additional 10% penalty tax applied to the distribution.  This would also include post-conversion earnings on those amounts that had been converted within the previous 5 years.  Possible exceptions to this rule are as follows:

  • You have reached age 59½.
  • You are disabled.
  • You are the beneficiary of a deceased IRA owner.
  • You use the distribution to pay certain qualified first-time homebuyer amounts.
  • The distributions are part of a series of substantially equal payments.
  • You have significant unreimbursed medical expenses.
  • You are paying medical insurance premiums after losing your job.
  • The distributions are not more than your qualified higher education expenses.
  • The distribution is due to an IRS levy of the qualified plan.
  • The distribution is a qualified reservist distribution.
  • The distribution is a qualified disaster recovery assistance distribution.
  • The distribution is a qualified recovery assistance distribution.

Why These Rules Are Important: Distribution Ordering Rules

These two rules come into play when considering the order in which distributions are attributed.  The IRS has specific rules determining just which money is coming out of your account and how it is to be treated, depending on if it’s qualified or not.  The order of distribution is as follows:

  1. Regular contributions
  2. Conversion and rollover contributions, on a first-in, first-out basis, meaning that the total of conversions and rollovers from the earliest year come out first.  These conversions and rollovers are further sorted as follows:
    1. Taxable portion (that portion that was taxed during the conversion or rollover)
    2. Non-taxable portion
  3. Earnings on all contributions

It should be noted that, in determining the amounts for #2 (conversion and rollover contributions) that certain aggregation rules apply:

  • Add all distributions from all your Roth IRAs during the year together.
  • Add all regular contributions made for the year (including contributions made after the close of the year, but before the due date of your return) together. Add this total to the total undistributed regular contributions made in prior years.
  • Add all conversion and rollover contributions made during the year together. For purposes of the ordering rules, in the case of any conversion or rollover in which the conversion or rollover distribution is made in 2008 and the conversion or rollover contribution is made in 2009, treat the conversion or rollover contribution as contributed before any other conversion or rollover contributions made in 2009.

Of course, the regular contributions can always be taken out of the account tax free (no 5-year rule applies).  After that, your two 5-year rules kick in on the rest of the types of funds in your account.

Photo by busymommy

Changes to Student Aid 7/1/2009

Jul 7th, 2009
by jblankenship.
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Every year on July 1, annual changes come into play in the education aid arena, and this year is no exception, with lots of changes.  As of July 1, 2009, several changes for Student Financial Aid went into effect.  Highlights are:

student in class by foundphotoslj

  • Increase in maximum Pell Grants to $5,350.  The old maximum amount for Pell Grants was $4,700, a number increased by the College Cost Reduction and Access Act (CCRAA) and the American Recovery and Reinvestment Act (ARRA).  The minimum Pell grant has been increased – in the past the minimum was $400, and now the minimum has been pegged at 10% of the appropriated maximum… so, to really confuse matters, the “appropriated maximum” for 2009-2010 is $4,860, with a CCRAA addition of $490 to all Pell awards (hence the maximum reported above of $5,350).  What this means is that the effective minimum for school year 2009-2010 is $976, which is $486 (10% of appropriated maximum) plus the CCRAA addition of $490.
  • New Subsidized Stafford Loans have a rate of 5.6%, on up to $5,500 (up from $3,500). This is the second of four annual cuts to the rate on these loans, which will continue until the rate reaches 3.4% in 2011.
  • Old loans are pegged to the 91-day T-Bill auction rate.  For now, that rate is an amazingly low 2.48%.  This applies to loans made before June 30, 2006 and after July 1, 1998.
  • Stafford Loan upfront fees have dropped to 1.5% from 2%.  If insurance is not added to the loan, the upfront fee is now as low as 0.5%.
  • New Income-Based Repayment program (IBR) is available to folks who are already paying back their loans.  This program caps borrowers’ monthly loan payments at 15% of their discretionary income (that is, 15% of what a borrower earns above 150% of the poverty level for their family size).  Any current or future borrower whose loan payment exceeds 15% of his or her discretionary income is eligible.  After 25 years in the program, the borrowers’ debts will be completely forgiven.  Borrowers with high debt or low-paying jobs are most likely to benefit from the program.  IBR applies to all federal loans made to students, including Stafford, Grad PLUS or consolidation loans, but not loans made to parents.  Perkins loans are also eligible if a borrower consolidates them into a FFEL or Direct loan.
  • Competitive Loan Auction Pilot Program, which was scheduled to begin on July 1, has been canceled due to lack of interest from FFELP lenders.
  • Sex offenders are no longer eligible to receive Pell Grants.
  • Due to the implementation of IBR, the old 20/220 ratio will no longer be in effect.  Under this old plan, a student could qualify for economic hardship deferment on their loans if they 1) are employed full time; 2) have an education loan debt burden equal to or greater than 20% of their monthly income; and 3) have an income minus debt burden that is less than 220% of the greater of the minimum wage rate or the federal poverty line for a family of two. This could be extended if HR 1615, Medical Economic Deferment for Students Act is passed.
  • The Higher Education Opportunity Act (HEOA) provides for maximum Pell Grant eligibility to a student whose parent or guardian was a member of the Armed Forces and died as a result of performing military service in Iraq or Afghanistan after 9/11/2001, provided that the child was under 24 years of age or was enrolled in college at the time of the parent or guardian’s death.
Photo by foundphotoslj

Linksharing 7/5/2009

Jul 5th, 2009
by jblankenship.
1 comment

links are fun by ingermaaike2I think I’ll keep up with this activity, sharing links to others’ blog entries that I found compelling over the past week or so – just don’t hold me to a schedule, I can’t promise that I’ll always have time to do this…

Last week I found this blog post from Kevin O’Reilly (a member of Garrett Planning Network) of Foothills Financial Planning on his excellent blog called Many Things Finance.  Kevin underscores, with support from a recent TD Ameritrade study, that most folks in the investing public do not understand when they are or are not being treated appropriately by “advisors”.  As we’ve discussed here before, the only way to ensure that the advisor is working in your best interest is to make certain that the advisor is a fiduciary.  A stockbroker who is not a CFP® practicioner is not a fiduciary.  The best you can hope for is that the recommendations you get from this person are “suitable” for someone like you – but not explicitly in your best interests.

Keeping with that theme (I think the Madoff sentencing had a profound influence on us!) my colleague and friend Jeff “don’t call me Jan” Rose of Alliance Investment Planning Group wrote a very good, easy-to-follow article about how to do a background check on your financial advisor on his blog, “Good Financial Cents”.

Lon Jeffries, a Fee-Only Financial Planner and Fiduciary who writes in a blog called Independent Fee Only Financial Planner and Retirement Advisor, wrote an interesting article on the common question about a preferred stock – is it a stock, or a bond?

And my friend Helen Maynard at Affine Financial Services wrote an article about title insurance – and while Helen admits up front that this is a real yawner of a topic, this is the very sort of thing that we should review carefully when trying to determine if it makes financial sense to spend money on.

Fellow Garrett Planning Network member Kristine McKinley over at Beacon Financial Advisors reminds us that “It’s Summertime – Time for a Midyear Financial Checkup“, a fact that we all tend to overlook as we fill up our available time with ballgames, cookouts, and time spent with family and friends.  It doesn’t have to take over your life, but taking time out from the rest of the distractions can help to keep your finances on track through the years.

Last but certainly not least, yet another fellow Garrett Planning Network member Jean Keener (master of the french horn, not the pan flute as was previously incorrectly reported) of Keener Financial Planning writes about “Estate Planning Opportunities in a Down Market“.  Jean walks us through some of the benefits that can be achieved in your estate planning process during these otherwise difficult financial times, pointing out the silver linings we might have otherwise missed.

That’s all for this week…

Photo by ingermaaike2

Hidden Costs to 401(k) Plans and Who Pays Them

Jul 4th, 2009
by jblankenship.
No comments yet

hide and seek by Faithful ChantI recently came across this article in WSJ that brought out some of the more interesting reasons that the 401(k) Fee Disclosure legislation is important…  There are two bills under review, one in the House (HR 1984) and one in the Senate (S 401), which aim to improve disclosure of fees within 401(k) plans.  These two bills also address the issue of the qualities that are appropriate for folks who are providing advice to plan participants – which I wrote about in this article.  A brief summary of the WSJ article follows:

It should not come as a shock that there are certain costs involved in maintaining a 401(k) plan – there is a degree of back office activity, such as signing up participants, tracking accounts, maintaining changes to accounts, distributing statements, and the like.  In addition, the plan administrator must provide certain reports to the government, along with required annual reports for participants (that annual Summary Report, written on tp, that you get in the mail once a year and promptly toss in the trash), as well as reports to the management of the sponsoring company on plan participation rates and such.

You would likely expect to share in the cost – after all, it’s benefiting your account, right? – and it seems like that sharing should be based on your account balance or at best evenly distributed among all participants.  However (and there’s always a however in life)… depending upon your fund choices, you may be paying more toward those back office activities than the guy in the cubicle next to you.

Turns out, the more inherent fees in an investment choice, the greater portion of the overhead you’ll be taking on (in general).  If you’re in a money market account or (shockingly) the company stock, you might not pay any overhead.  If you are in a managed mutual fund, you could be paying as much as 0.6% in annualized overhead fees.  As with most things surrounding 401(k) fees, it’s not very clear just how these costs are allocated – and quite likely not very fair in the long run.

Hopefully the Fair Disclosure legislation will find appropriate legs and make its way to law, giving us all a much-needed view into the costs of our plan choices.  Well, we can hope, right?

Photo by Faithful Chant

60-day Rollover Waivers

Jul 2nd, 2009
by jblankenship.
No comments yet

Otis Day and the Knights.

There are all sorts of problems that can crop up when attempting to complete a 60-day rollover of qualified funds to an IRA.   Sometimes you can be granted an automatic waiver of the 60-day rule, but only if all of the following apply:

  • The financial institution receives the funds on your behalf before the end of the 60-day rollover period.
  • You followed all the procedures set by the financial institution for depositing the funds into an eligible retirement plan within the 60-day period (including giving instructions to deposit the funds into an eligible retirement plan).
  • The funds are not deposited into an eligible retirement plan within the 60-day rollover period solely because of an error on the part of the financial institution.
  • The funds are deposited into an eligible retirement plan within 1 year from the beginning of the 60-day rollover period.
  • It would have been a valid rollover if the financial institution had deposited the funds as instructed.

If the above conditions do not apply, you can still request a ruling from the IRS, called a Private Letter Ruling (PLR), if you still think your circumstances merit the inclusion of your rollover even though it was beyond the 60-day period.  There is a $3,000 fee for requesting the PLR.

When making a determination on your request, the IRS will consider all of the following details:

  • Whether errors were made by the financial institution (other than those described under ”Automatic waiver”, earlier),
  • Whether you were unable to complete the rollover due to death, disability, hospitalization, incarceration, restrictions imposed by a foreign country or postal error,
  • Whether you used the amount distributed (for example, in the case of payment by check, whether you cashed the check), and
  • How much time has passed since the date of distribution.

If you are planning to request a PLR, keep in mind that the costs can be quite high.  In addition to the earlier-listed $3,000 user fee, the cost for a tax attorney to prepare the request can be anywhere from $3,000 to $10, 000 and more, depending upon the complexity.

Once again, the problems you find with the 60-day rollover highlight the benefit of doing the relatively painless trustee-to-trustee transfer.

IRS Private Letter Rulings, Revenue Rulings and Revenue Procedures

Jul 1st, 2009
by jblankenship.
No comments yet

private property by mollybobThe IRS has a couple of different ways that guidance is provided, called Private Letter Rulings and Revenue Rulings.  These rulings can be very important when determining if a particular position is valid in the interpretation of the IRS.

A Private Letter Ruling (PLR) is a written decision by the IRS in response to a specific individual’s request for guidance, as it relates to that individual’s specific situation.

Private letter rulings are only binding on the IRS and the requesting individual, and as such can not be cited as precedent for other cases, although they do give insight as to what the IRS’ position may be on a particular situation.  Often, the IRS will take the information from a PLR and redact it for use as a Revenue Ruling, which is guidance for all taxpayers and can be cited as a precedent.

PLR’s have a cost associated with them:  generally you must have a tax attorney prepare the request for you, which may cost anywhere from $3,000 to $10,000 depending upon the complexity of your case, and then the IRS charges a fee for delivering the PLR.

This fee used to be fairly innocuous, but in 2006 was increased to $9,000 for most requests, and as much as $3,000 for a simple 60-day rollover ruling – a standard sort of ruling that used to cost only $95.  Formerly, the highest fees were $2,750, which was often reduced to $625 if the requestor’s income was less than $250,000.  Certain 60-day rollover activities are only allowed once a PLR has been issued – when you for whatever reason are not able to complete the rollover within the 60-days and it’s not due to an automatically-approved reason.

Revenue Rulings, on the other hand, are administrative rulings that explain how the IRS applies the law to specific factual situations.  As indicated previously, these rulings are for all taxpayers, and are published in the Internal Revenue Bulletin and the Federal Register.

Revenue Procedures are statements of procedure, rather than application of law (as in Rulings) – such as methods for filing and instructions.  An example of the difference between a Revenue Procedure and a Revenue Ruling would be:  A Revenue Ruling provides guidance on what items may be deducted as a part of your itemized deductions on Schedule A, such as the definition of unreimbursed employee business expenses; while a Revenue Procedure explains how those deductions are treated, such as Miscellaneous deductions in total are subject to a 2% floor.

Photo by mollybob
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