12/17/2010 – with the passage of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, the rate changes formerly discussed in this article have been superseded.
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September, 2009:
It’s About to Become Cheaper To Be Single – Again
Six Important Facts About the American Opportunity Tax Credit
The IRS recently posted a tax tip (Tax Tip 2009-11) regarding the provisions of the American Opportunity Tax Credit, which was created as a part of ARRA 2009.
The six facts reported in the IRS notice are as follows:
- The American Opportunity Tax Credit, which expands and renames the existing Hope Credit, can be claimed for qualified tuition and related expenses that you pay for higher education in 2009 and 2010. Qualified tuition and related expenses include tuition, related fees, books and other required course materials.
- The credit is equal to 100% of the first $2,000 spend and 25% of the next $2,000 per student each year. Therefore, the full $2,500 credit may be available to a taxpayer who pays $4,000 or more in qualifying expenses for an eligible student.
- The full credit is generally available to eligible taxpayers who make less than $80,000 (single taxpayers) or $160,000 (married taxpayers filing jointly). The credit is phased out gradually for taxpayers with incomes above these levels.
- 40% of the credit is refundable, so even if the taxpayer owes no tax he can receive up to $1,000 of the credit for each eligible student as a refund.
- The credit can be claimed for qualified expenses paid for any of the first four years of post-secondary education. (The previous Hope Credit was available only to students in the first two years of post-secondary education.)
- You cannot claim the tuition and fees deduction in the same year that you claim the American Opportunity Tax Credit or the Lifetime Learning Credit. You must choose to either take the credit or the deduction, whichever is more beneficial to you.
Of course this changes the landscape of available tax credits and therefore the affordability of college for lots of folks. If your situation is such that tax credits could make the difference between going to college or not, you should probably talk your situation over with your tax advisor.
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How QDRO Impacts NUA
Don’t let the alphabet soup in the title put you off. If you’ve never come face-to-face with a QDRO you might not need to know this – but then again, the basic underlying premises are good information to understand…
First some definitions, just so we know what we’re talking about:
QDRO: Qualified Domestic Relations Order – this is a method for permitting distributions from a qualified retirement plan (not an IRA) in the event of a divorce. What happens is that, upon the decreed division of assets, if the retirement plan (such as a 401(k) or 403(b)) of one spouse is chosen as an asset to be divided and a portion given to the other spouse, a QDRO is issued. This QDRO allows the division to occur without penalty… otherwise, making a distribution from a qualified plan before age 59½ would result in penalty and possible taxation, as we all know. The QDRO provides a way for the receiving spouse to rollover the funds into an IRA of her own, without tax or penalty to either spouse.
NUA: Net Unrealized Appreciation – this is a special provision from qualified retirement plans that allows the employee to elect to treat company stock differently from all other assets in the plan when making a distribution from the plan. Essentially, you can pay ordinary income tax on the basis of the stock in your employer’s (actually former employer’s) company, and then place the stock in a taxable brokerage account, making any gains on the stock subject only to capital gains tax (rather than ordinary income tax, which could be much greater). The trick is that you can only do this maneuver one time, and the distribution must be in a lump sum of all your 401(k) account holdings. Everything in the account that is not company stock can be rolled over into an IRA and maintain tax deferral as usual. It’s critical to note that this can be the only distribution of funds from the account – if you were to roll over a small amount of funds in a previous year, you can no longer take advantage of the NUA provision.
QDRO and NUA
So the question comes up – if a QDRO distribution occurs for your account, and that distribution includes company stock: does this "bust" the employee’s ability to later have the company stock treated with the NUA privilege, since the rule states that the distribution must be a one-time single lumps-sum distribution?
(drum roll…) The answer is NO. A QDRO is a division of the account, and though technically a distribution has occurred, this distribution does not impact the remaining account’s ability to take advantage of the NUA provision. The employee can go ahead and, upon separation from service, perform the lump-sum distribution of the stock and rollover the remainder into an IRA and get the NUA treatment for the stock.
Now, if you’re really astute, the last paragraph made you think of another question (it’s okay to admit it if you aren’t tax-geeky enough to have thought of this question): Can the ex-spouse (the one receiving a split of the employee’s plan) elect NUA treatment of any stock that was included in his portion of the account?
(drum roll…) The answer is a qualified YES. The qualification is this: As long as the rest of the account is eligible to be distributed (to include NUA treatment), the QDRO’d portion of the account can also take advantage of this provision.
In other words, although the ex-spouse of the employee could roll over the QDRO’d qualified retirement plan into an IRA at any time, if the account contains appreciated employer stock (stock of the former spouse’s employer) – it may be in the best interest of the receiving spouse to wait until the employee reaches age 59½ or leaves employment (termination or retirement), so that she can take advantage of the NUA provision. Otherwise, any rollover will squash this option forever.
Example
Here’s a quick example to illustrate: Dick and Jane are divorcing. Dick has a 401(k) plan with his employer, including some stock in his employer. Part of the divorce includes a QDRO to give Jane half of the 401(k) plan.
Once the QDRO is completed, Dick still has his original 401(k) account (albeit diminished by half), and Jane has an account in the plan of equal size. Jane can rollover those funds into an IRA at any time, if she chooses, without penalty. However, since the account holds highly appreciated company stock, in order to qualify for NUA treatment, she must maintain the account in the 401(k) plan until Dick terminates employment, retires, or reaches age 59½. At that time, she can pull the lump-sum distribution for NUA treatment and rollover the rest into an IRA. Dick can elect NUA treatment for his account when he terminates employment or retires.
Now you may be wondering about that picture… the button is the prize that a person gets when in a seminar with Natalie Choate, the renowned IRA expert – if you happen to ask a question that she is unable to answer. I asked the above questions of Mrs. Choate recently and received the button. No disrespect for her whatsoever – as an admirer of her work, I am proud of the button and wanted to share it here.
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Special Rollover Allowed (in 2009 only)
Admittedly, this is likely a small group: folks who are required to take RMD’s in every other circumstance, but for 2009 were given a holiday from RMDs due to WRERA 2008 – but still went ahead and took the distribution for this year… and now they want to put it back.
The IRS must think it’s a fair large group, because they’ve put out a special notice – Notice 2009-82 for you IRS geeks out there (okay, I resemble that) – to deal with this subject.
The deal is this: if you’re in that group mentioned above, you can roll your distribution back into the same or another IRA (or other qualified plan), as long as you do it before November 30, 2009 (rather than the usual 60 days). This is a nice feature, although I really doubt if there’s that awful many folks who will fit the circumstances.
The Kicker
Here’s the kicker, though: this special rollover applies ONLY to the REQUIRED Minimum Distribution. So if you were required, based upon your Table I or Table III values, to take out $10,000 this year (were it not for the RMD holiday), and you actually took out $15,000, you can only rollover $10,000 (unless you get it done within 60 days, as per normal circumstances).
The Second Kicker
The second kicker is that, if you took that $10,000 in equal quarterly installments, since you’re restricted to one (1) "rollover" per year, you can only roll one of those payments back into your IRA. If you took the distribution from a qualified plan, such as a 401(k) or 403(b), you can roll the all of your RMD payments (but just the RMD, no more) into an IRA.
All is not lost if you took money from an IRA in multiple payments: you could still put the extra funds into a Roth IRA before 11/30/2009, with the amounts being taxed, but now they are in your Roth IRA (as long as all other eligibility rules are met, such as MAGI less than $100,000 and you don’t file your taxes as Married Filing Separately).
So anyhow, if you’re in this slice of folks, there’s some leniency by the IRS in letting you undo the distribution for this year, as long as you get it done before the end of November.
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Health-Care Reform
Confused by the ongoing health-care reform debate? If so, you’re not alone. With multiple bills and proposals in play, it’s often hard to get a grasp on even the most basic elements of the discussion. While the outcome of the debate is uncertain, here are some of the major issues that are being discussed.
Universal vs. mandatory coverage
One of the main goals of health-care reform is to make affordable health coverage available to all Americans. To help provide coverage to individuals and families who can’t afford it, most of the proposals provide assistance in various forms, including new tax credits, an expansion of eligibility for Medicaid, and insurance premium subsidies.
In fact, most of the major proposals currently being discussed actually require individuals to obtain health-care coverage (i.e., “mandatory” coverage). Under these proposals, individuals who refuse to get coverage would pay a financial penalty. Similarly, employers would be required to offer health-care coverage or pay a fine.
The “public option”
One of the most significant areas of debate centers on the so-called “public option.” The term “public option” generally refers to the establishment of a government-run health-care plan that would compete with private insurers and provide coverage to millions of uninsured Americans. There has also been some discussion of establishing health-care cooperatives (nonprofit organizations that would be completely independent of the federal government) as an alternative to a government-run health-care plan.
Paying for reform
The costs associated with most of the health-care reform proposals being discussed are significant. The nonpartisan Congressional Budget Office (CBO) estimates that the legislation currently being considered in the House would cost more than $1 trillion over ten years, with a corresponding increase to the federal deficit over that period of time exceeding $200 billion. To help pay for health-care reform, reductions in Medicare spending are built into the House bill. Other proposals to raise revenue include raising taxes on high-income families, and taxing high-end health plans.
In his address to Congress on September 9, 2009, President Obama proposed a health-care reform plan he estimated would cost $900 billion over ten years, and pledged that he would not sign legislation that increased the deficit. The President described a plan in which savings within the current health-care system paid for most of the cost, with at least a portion of any shortfall paid by charging insurance companies a fee for their most expensive policies.
An evolving landscape
There are, of course, many specific provisions being discussed that we haven’t mentioned here, and not all of them are controversial. For example, any health-care reform legislation is likely to tackle some of the current issues relating to pre-existing conditions. The entire discussion is evolving very quickly, however, with new proposals and ideas coming into play daily. The legislation that emerges will affect all of us in one way or another, so it’s important to stay informed.
Tuition and Fees Deduction Expiring At The End Of 2009
12/17/2010 – with the passage of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, the rate changes formerly discussed in this article have been superseded.
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Change Coming For the Child Tax Credit in 2011
12/17/2010 – with the passage of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, the rate changes formerly discussed in this article have been superseded.
Photo by Pink Sherbet Photography
Why We Use Timber in an Investment Portfolio
Continuing with the series we started some months ago, today we’ll talk about why Timber is a viable and important asset class to include in your portfolio. If you’ll recall, in previous discussions we talked about Real Estate as an asset class, and then we discussed the merits of Commodities as a broad asset class for your portfolio. Timber is an asset class that is not well-represented in the broad Commodities indexes, and (at least as of this writing) there is no index fund tracking what is considered the benchmark for the US-based timber industry, the National Council of Real Estate Investment Fiduciaries (NCREIF) Timber Index.
Timber as an Asset Class
Timber is typically not well-represented in other Commodities indexes. The nature of timber as an asset doesn’t lead it to treatment the same as most other commodities, due to its unique 3-part return generating process. Returns are generated by 1) cutting and selling the timber itself; 2) increases in demand for timber, which tends to follow the growth of the GDP; and 3) inflation in the cost of timber, which over time has tended to slightly out-pace inflation in the general economy. Capital appreciation in the timber asset class is generated by the increases in the value of the underlying land, plus the natural growth rate of the trees.
The risks associated with the asset class include primarily demand-side risks. Since supply-side inputs are primarily “free”: sun, soil, and water; risks in generation of the product are relatively small. In the management of the product there are costs and minor risks – that of land management, lease and/or other acquisition costs and taxes, and the risks of climate change, fire damage, and other biological damage. These management risks are deemed to be relatively small (much less than 1%).
On the other hand, the demand-side risks are many: demand for lumber can vary dramatically with the economic cycles, but some demand is always present. In addition, if the volume of available finished product is too great for the demand, price volatility can be present to erode returns.
Over the past 40 years, depending upon the benchmark in use (I used the Hancock Global Timber Index), the yield on timber as an asset class was in excess of 9%, with a standard deviation of roughly 12.5%. Recent calculations of future returns for timber indicate anywhere from a 6% to a 7.5% return for the near term. Longer term calculations quickly become invalid due to the dependency upon the global GDP estimations.
And lastly, given the compelling return predictions, one of the critical factors that we look for when choosing additional asset classes to invest in is low correlation to the remainder of our portfolio. In this case, timber fits the bill quite well – when compared to fixed income, equities, foreign equities, other commodities, and foreign-currency bonds, the correlation falls well below .25. This means that, for example, any movement (positive or negative) in the underlying value of our timber proxy has historically reflected other asset class movements at less than a 25% rate. In other words, if the domestic equities asset class experienced a 10% correction, historically speaking, you would expect less than a 2.5% “reflective” correction in the timber asset class.
So, all in all, it seems to make a great deal of sense to have a small exposure in our portfolios to Timber as an asset class when seeking additional non-correlated returns beyond the more common asset classes. Timber is not always present in the portfolios that I develop, but it is quite often included, for the reasons stated above.
Expiring Tax Provisions From ARRA 2009
Earlier this year, the American Recovery and Reinvestment Act (ARRA 2009) was passed, and it contained quite a few tax incentives that were only good for this year. Since we’re coming down to the last three months of the year, I thought it would be appropriate to highlight those provisions that will be expiring this year. Click on the title link for each section to be taken to the original article I wrote about the provision.
First-Time Homebuyer Credit
This provision expires on December 1, 2009*. This is a credit of up to $8,000 on either an original or amended 2008 tax return, or a tax return filed for 2009 – but the purchase must be closed by December 1, 2009. To be eligible, you must not have owned a principal residence during the past three years prior to the purchase date of the new home. Further, this deduction is phased out for MAGI above $75,000 for singles, $150,000 for married individuals.
* Note: this provision has been extended through September 30, 2010. See this post for details.
New Vehicle Purchase Incentive
State and local sales tax are deductible on the purchase of new cars, light trucks, motor homes, and motorcycles. The deduction is limited to the tax on up to $49,500 of the purchase price of each qualifying vehicle. The MAGI phaseout for this credit is at $125,000 for singles and $250,000 for married filing jointly. This provision expires on January 1, 2010.
Reduced Withholding
The “Making Work Pay” Credit lowered withholding tax for most employed individuals earlier this year. This provision is set to expire on December 31, 2009. The important point of this provision is that if your tax situation is somewhat complicated – for example, if you have more than one wage-paying job, both spouses in the household work, or if you can be claimed as a dependent by another taxpayer – you should review your withholding now to determine if you’ve had enough withheld throughout the year. Otherwise, you could inadvertently have an underpayment penalty, receive a much lower refund than you expected, or possibly even owe taxes when you anticipated a refund.
The Richest Man in Babylon: Summary, Pt 9 of 9
This article is Part Nine, the final portion of our series of the lessons from George S. Clason’s bestseller The Richest Man in Babylon. Did I just hear a collective “FINALLY!”? If you’d like to go back to the beginning and catch up on the earlier lessons, you can start with the first article in the series by clicking this link.
The Luckiest Man in Babylon
In this final chapter, Clason ties all the lessons together with the story of Sharru Nada, a rich merchant, who tells his young companion, Hadan Gula, the grandson of his business partner, the story of how his grandfather had become such a successful merchant.
In a nutshell, the grandfather and Sharru Nada had each found themselves in dismal financial straits. Learning from one another and from listening to the successful people around them, each applied the lessons we’ve discussed throughout this series. With time, effort, patience and discipline, each man gradually improved his situation. Times arose where they were able to help one another out, and eventually they became business partners, successful in every venture they undertook. (Honestly, read the book if you want the whole story – it’s a good, quick read – you’ll not regret the time spent. Clicking on the image of the book will take you to Amazon where you can order your own copy.)
The Lessons
Here are the lessons we’ve learned throughout the review of this book:
Part of all you earn is yours to keep. Another way to put this is: pay yourself first. Begin a savings plan with a portion of all you earn.- Take advice only from those experienced in the matter of your questions. Don’t ask your barber for advice on surgery, and don’t ask a surgeon for advice on building a house.
- Take advantage of compounding of returns. Don’t spend the earnings that your savings accounts generate; reinvest your dividends.
- Control your expenses – learn to “get by” on only a percentage of what you earn.
- Invest with wisdom. Understand the investments that you make, and make certain that the reward is worthy of the risk in all you invest in.
- Own your own home. This has both a financial and a spiritual benefit.
- Invest with an eye to the long-term. Make certain that your investing activities will provide you with an income in your old age.
- Always improve your ability to earn, either by improving your skillset in your job, or by increasing your knowledge of investment activities.
- Learn to recognize situations when you can take advantage of “good luck”. Take action with good insight, don’t procrastinate.
- Know when to be cautious, especially with regard to loaning money to family and friends.
- Plan in advance for events that might cause you harm – ensure that you’re insured against disaster in all its forms.
- Have a good advisor or advisors to help you understand all of the negative “clamor” around you. This can help you to maintain your discipline in good times and bad.
- Having the right attitude (“the soul of a free man”) can make all the difference in your outlook on life – and therefore on the results you achieve.
- If you find yourself in a debt situation, put a systematic plan in place to eliminate the debt, but not at the expense of your saving plans. Use organization, communication, and discipline to work yourself out of the debt hole and regain your status among your acquaintances and colleagues.
That’s the list that I’ve developed of the primary lessons from this book. I hope that if you weren’t already familiar with the book that this series has sparked an interest for you. I’d love to hear stories from anyone who has benefited from the book – as well as if you found other gems within its pages that you’d like to highlight. Just leave your stories in the comments section below.
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And if you've come here to learn about queuing waterfowl, I apologize for the confusion. You may want to discuss your question with Lester, my loyal watchduck and self-proclaimed "advisor's advisor".