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October, 2009:

The Bright Side of H1N1

Oct 29th, 2009
by jblankenship.
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No, you can't get it from this. All around us are some pretty ominous signs:  this has been a wetter than normal year (at least here in the Midwest), flu seems to have started earlier than normal (seasonal influenza, that is), and last Spring we saw a lot of signs pointing to the influx of H1N1 influenza – globally.  If this is as bad as some folks are predicting, it could get to be as widespread as the 1918 Spanish flu pandemic – when over 600,000 folks in the US alone died.

Of course, many advances have occurred since 1918, and as such it is expected that the death rate will be dramatically less than the 2.5% of the infected rate that occurred then. First of all, these days we have vaccines available, albeit fewer doses than we’d hoped for by now.  Secondly, we have quite a few advance plans ready to go – school closings, business readiness and travel bans, to name a few – to help with management and containing the pandemic.  And thirdly, our treatments are far more advanced than what little was available back then.  But these reasons aren’t what I was referring to in the title of this post…

The Bright Side of H1N1

There are no absolutes in life, especially when it comes to global relations and economics… but I believe that in the evolution of the H1N1 pandemic to date we’ve seen some baby steps toward reconciliation – a more “normal” economic environment. While there are bound to be some short term negatives, global focus on resolving this pandemic quite likely will help to lead our worldwide economy out of the doldrums that we’ve been experiencing.  Don’t get me wrong, I don’t think it’s reasonable to think that we will see world markets rallying in short order.  In fact, the pandemic could lead to a dampening effect – but in the end result this could be good as well, by forestalling too-rapid growth in the economy, thereby negating inflationary concerns.

It’s not a sure thing by any stretch, but it’s my guess that we will come out of this crisis in much better condition than we’re going into it… what do you think?

Photo by Dan4th
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Have Confidence – In Good Times and Bad

Oct 27th, 2009
by jblankenship.
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Note: this is a re-working of a note I received in email today… it’s not necessarily about investing, but rather success in all things. It is particularly applicable to financial matters, I think, as it is critical to maintain confidence in your plans, both in prosperity and adversity.

dream within a dream by lepiaf.geo Confidence is one of your most important success ingredients. With it, you can achieve most anything. Without it, there is no psychological pill that can make you succeed.

Faith is the ability to believe even when you have no reason to. Faith is necessary sometimes to move forward and do something you don’t know if you can do, or when the world around you is telling you that you cannot. This is also when a trusted guide can be useful to help you figure out what is valid and what is not.

Experience gives you the proof you want and need to build future confidence on, and is something you get after you use faith and confidence first to achieve what you want. Experience is developed incrementally – in baby steps at first, with more momentum as you gain more confidence.

It is easy to make grand gains when the greater forces like “the economy” are going in your favor. Those who are truly successful make gains by having faith and confidence in themselves no matter what direction the so-called greater forces around them appear to be going. Short-term “noise” doesn’t bother these folks one bit.

In all things you can benefit by strengthening your confidence and faith in yourself. Seek guidance from others who have the experience that you lack.  Look to and recall your past successes as a foundation to build your confidence in yourself and your plans.

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Estate Tax in 2010: Redux and Predictions

Oct 25th, 2009
by jblankenship.
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As an update to the earlier post – “Estate Tax Changes for 2010 and 2011” – I’ve recently seen some compelling arguments and interesting predictions about what may or may not happen with the Estate Tax for 2010.

Prognosticators

rs_tax_cuts_sepia Things may be a little different from what I described in the earlier post.  Some very smart guys (John Buckley, Chief Counsel for the House Ways and Means Committee, author and Estate Tax expert Jonathan Blattmachr, and Frank Berall, co-Chair of the Notre Dame Estate and Tax Planning Institute, among others) who make it their business to know everything about the Estate Tax from 1939 forward (when the current system was put in place), have been looking at the possibilities with regard to the projected 2010 repeal of the Estate Tax, and they have several predictions that could come into play.

Back to the Future

Instead of the supposed $1.3 million cutoff for basis step up, these guys figure that it’s every bit as likely that, IF the repeal goes through for 2010, that we’ll revert to the rules that were in effect with the 1976 Tax Reform Act.  This means that the old “carryover basis” rule would go into effect – meaning that, when you inherit a piece of capital property, be it a stock or 80 acres of farmland, instead of receiving the step-up value as of the date of death of the decedent, you’d have to retain the original basis, or purchase price.  So if granddad bought AT&T at $2 and now it’s worth a split-adjusted $300, you’d still have to use the carried-over basis of $2 when you sell the stock, and owe capital gains tax on the difference.

The reason this rule is expected (again, IF the repeal goes through for 2010) is because there is a significant amount of tax revenue that would be foregone, otherwise.  It’s always about the Benjamins, right?

The good news is that those same guys don’t think the repeal will go through at all…

Back to the Present

Instead of the repeal, it is expected that the real outcome will be an extension of 2009’s limits:  45% maximum rate and $3.5 million exemption, with the same step-up basis rules in effect.  The primary reason that this is the most likely outcome is because even with the carryover basis rule in effect, there would be an adverse impact on revenues, and with the “pay as you go” rule in place, any benefits must be paid for with cuts or increased revenues – however Estate Tax and Gift Tax provisions are exempt from paygo.

The extension is expected to be announced sometime in December, possibly just before Christmas, although it is possible that Congress could delay and pass the law sometime in 2010 retroactive to the first of the year – which has been deemed a constitutionally-allowed action.

However it works out, it’s going to be interesting to see what does happen with Estate Tax in 2010 and beyond.  Stay tuned!

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Sam, You Made The Pants Too Short!

Oct 23rd, 2009
by jblankenship.
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high water pants by TimWilson With apologies to the writer and performers of the original “Sam, You Made The Pants Too Long!”… This article is about what happens when your IRA declines substantially in value and you’ve put a 72t Series Of Substantially Equal Periodic Payments plan (SOSEPP) into play – and the decline in value has brought your IRA to a point where the balance will no longer support your Equal Payments.

What Happens When Your IRA Will No Longer Support Your SOSEPP?

Here’s an example:  You’ve set up a SOSEPP in your IRA, beginning at age 50.  As we all know (see this post for details) you have to keep the payments going until you reach age 59½.  During that time, many things can happen, both positive and negative.  In this case, the IRA began with a balance of $100,000, and your annual payments are $3,000.  Things go fine for the first few years, although your account doesn’t seem to be growing.  So, you decide to take a leap and invest it all in a wild-eyed fund – some Madoff fellow’s running it.  Then, lo and behold, one morning you wake up and find that your IRA balance has become – $12 total.  You’re age 56, so you have three and a half more years that you are supposed to be taking this regular payment of $3,000 from your account!  What do you do?  You’ve read about the crazy penalties for busting a 72t payout plan – yikes!

Options

Calm down.  Take a breath, it’s really not so bad.  There are several options:  You could rollover funds from another account into the IRA, either from another IRA account or a 401(k).  You could also choose to make your one-time change to your SOSEPP plan.  Or, you could choose to let it die, and go on with your life.  The best option is the last one – it allows you to be as flexible as you can be.

If you chose the first option, it certainly would work – and your SOSEPP would just continue on as originally planned.  But what if you have decided at this stage that you really don’t need that series of payments anyway?  And it’s just a pain in the rear keeping up with the paperwork and remembering to take the payment each year…?

The same holds true for the one-time change to the RMD method.  If you did that, now you’d have to re-calculate your payment each year on a very small balance.  Once again, a pain in the rear – so why not just take the third option?

Let it die

If you go ahead and take the last payment out of your account (the remaining $12) and close the account – your SOSEPP is no longer in effect.  You now have the option of starting a new SOSEPP from another IRA account, or just discontinuing the idea of the 72t payout.  If you chose to start a new plan, you’d have to start over with a new five-year or (since in the example, you’re age 56) for three and a half more years until you reach age 59½.

What’s key to understand in this is that, for SOSEPP’s, the IRS considers each IRA account separately – yeah, I know, for everything else, all IRAs are considered as one.  What can I say?  They don’t want you to get too comfortable and start predicting how they’ll move – just when you think they’re gonna zig?  they zag.  So with that in mind, if one account (the one with the SOSEPP attached) runs dry, there’s no penalty if you just drop it and move on with your life.

That’s literally all there is to it.  No penalty, no muss, no fuss.

Photo by TimWilson
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3 Ways to Do a Roth Conversion – Tax Free

Oct 22nd, 2009
by jblankenship.
1 comment

tax by PhillipSo you’re hearing all about this Roth IRA conversion – for 2010 there are no income limitations as there have been in the past – and you’re wondering if there is a way to do this tax free… There are actually several, three of which I’ll list here.

After-Tax IRA Contributions

If your IRA is composed only of after-tax (non-deducted) contributions, you can convert those funds over to a Roth IRA without tax consequence.  This is because the funds were taxed before you contributed them to the IRA, and so no tax is due when you convert the funds to a Roth IRA.

The “gotcha” in this is that the IRA must be ONLY non-deducted, after-tax contributions.  Plus this must be the only IRA that you have – see the this post for the “Turns Out You CAN Be A Little Bit Pregnant” rule.  There’s also a way around the “Pregnant” Rule in that post.

After-Tax Qualified Retirement Plan Contributions

If you happen to have after-tax contributions to a Qualified Retirement Plan (QRP), these can be rolled over tax free if you’ve terminated employment – without having to worry about the “Pregnant” rule I mentioned above.  This is because QRP funds are treated differently, and as such you are allowed to move specific contribution money separate from other contribution money (e.g., pre-tax contributions separate from after-tax contributions).

Zero Tax Bracket

If you have no or very low taxable income, that is, if you’re below the 10% tax bracket, any funds that you distribute from your IRA up to the limit – which would be your AGI minus your exemptions and itemized or standard deductions and any tax credits – would be tax free.  Granted, this is likely to be a somewhat small amount for most people in this situation, but for others, such as business owners or farmers with carried-over Net Operating Losses, it could be sizeable.  See this post for more information on NOL carryovers and Roth IRA conversions.

Photo by Phillip
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Turns Out You CAN Be A Little Bit Pregnant

Oct 19th, 2009
by jblankenship.
4 comments

surprise by PinkMoose Remember back in junior high (or whenever it was) during health class (or sex ed, or whatever they called it for you) – how it was explained that pregnancy is a black or white thing; “nobody gets just a little bit pregnant” was the story my health teacher gave us to remember. As it turns out, there are many other absolutes in life that are similar.  However, in a totally characteristic move, the IRS gives us a way that takes something that you would think would be absolute, and twists it so that you can, in fact, be a little bit pregnant (or rather, a little bit taxable, a little bit tax free, in this case).

Confused yet?  Sorry, that wasn’t my intent… some people refer to this as the “cream in the coffee” rule – meaning that you can’t take out just some of the coffee, you have to take out both cream and coffee.  Oh bother, with the analogies! Let’s get into this.

IRA Funds – Part Taxable, Part Tax-Free

If you have made after-tax contributions to your IRA, you are likely expecting that at some point you can take those contributions out again, tax free.  And you’re right to expect that, because that’s exactly what you can do.  However (and there’s always a however in life, right?), if the after-tax money you have in your IRA isn’t the only money in ALL of your IRAs, any money that you take out will be partly taxable and partly tax-free. (this was where the “little bit pregnant” thing comes in)

Here’s how it works:  for example, let’s say you have two IRAs, each worth $5,000.  One is a traditional deducted (pre-tax) IRA, and the other is a traditional non-deducted (after-tax) IRA.  If you wanted to take $100 out of either account, the IRS considers all of your IRAs as one – and money taken out of the account(s) comes out ratably.  So in the $100 that you take out, $50 will be tax-free, and $50 will be taxed.

Let’s do another example, a little more real world:  You have two IRAs, one worth $5,000, which is made up exclusively of a $3,000 deducted contribution and $2,000 worth of growth and interest; and the second is made up of a $4,000 deducted contribution, a $5,000 non-deducted contribution, and $1,000 worth of growth and interest, for a total of $10,000.  You would like to take a distribution of $1,500 from one of the accounts.  In the IRS’ eyes, you are taking out $500 which is non-taxed, and $1,000 which will be taxed.  This is because, out of the total of $15,000 in the two accounts, only $5,000 was “after tax” funds.  Everything else, the growth and interest and the deductible contributions, is considered taxable.

How To Get Around It (or How You Can NOT Be A Little Bit Pregnant)

Don’t lose faith, though, there is one way around this dilemma.  The IRS allows you to roll over funds from your IRA into a Qualified Retirement Plan (QRP) such as a 401(k) plan – but ONLY the taxable portion, if there are commingled funds in your account(s).  So, in this case, the IRS goes along with the absolute (go figger – they treat the same money two different ways!) and requires that no after-tax contributions be rolled over into the QRP.

So, if you have a 401(k) plan at work, or an existing 401(k) that you haven’t rolled over into an IRA, you can use this account to split out your taxable IRA money from the non-taxable IRA money.  And then you could do a tax-free conversion of the non-taxed IRA money into a Roth IRA if you wished, for example, as long as you fit all the other criteria.

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Economic Slowdown Impacts Prepaid Tuition Plans

Oct 17th, 2009
by jblankenship.
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whitman college by Joe ShlabotnikSeveral months ago I pointed out an article where the Illinois prepaid tuition plan, CollegeIllinois!, seemed to be elated over the impacts of the economic downturn on other types of 529 savings plans.  Essentially these prepaid plans offer a guarantee of value – the cost of a semester of college at an in-state public institution per unit purchased – regardless of market returns.

However (and there’s always a however in life, right?) – as suspected, the economic slowdown has begun to impact these prepaid plans across the country, as reported in the Sound Mind Investing blog recently, with the article Prepaid college tuition: it seemed like a good idea at the time.  Essentially, the plans have made promises that supposed a certain level of return on investments; a level that has been subverted with the downturn of the economy.  As a result, in some cases the plans are being propped up by state funds (that are continually running in short supply), or imposing additional “fees” to participants in order to make up the difference.  In some cases, the plans are putting forth the concept that they may come up short of funds altogether…

I have not heard of any actions by the state of Illinois on these problems, but the article in the New York Times (referenced by Sound Mind Investing) indicates that 16 of the 18 prepaid tuition plans across the country are facing difficulties… which leads you to believe that the remaining two can’t be far behind.

Photo by Joe Shlabotnik
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Facing the Possibility of Incapacity

Oct 15th, 2009
by jblankenship.
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Incapacity means that you are either mentally or physically unable to take care of yourself or your day-to-day affairs. Incapacity can result from serious physical injury, mental or physical illness, mental retardation, advancing age, and alcohol or drug abuse.

Incapacity can strike anyone at anytime

Even with today’s medical miracles, it’s a real possibility that you or your spouse could become incapable of handling your own medical or financial affairs. A serious illness or accident can happen suddenly at any age. Advancing age can bring senility, Alzheimer’s disease, or other ailments that affect your ability to make sound decisions about your health, or to pay your bills, write checks, make deposits, sell assets, or otherwise conduct your affairs.

Planning ahead can ensure that your wishes are carried out

Designating one or more individuals to act on your behalf can help ensure that your wishes are carried out if you become incapacitated. Otherwise, a relative or friend must ask the court to appoint a guardian for you, a public procedure that can be emotionally draining, time consuming, and expensive. An attorney can help you prepare legal documents that will give individuals you trust the authority to manage your affairs.

Likelihood of Suffering a Disability by Age 50

Source: 1985 Comimissioner’s Individual Disability Table A (most recent data available)

Managing medical decisions with a living will, durable power of attorney for health care, or Do Not Resuscitate order

If you do not authorize someone to make medical decisions for you, medical care providers must prolong your life using artificial means, if necessary. With today’s modern technology, physicians can sustain you for days and weeks (if not months or even years). If you wish to avoid this, you must have an advanced medical directive. You may find that one, two, or all three types of advanced medical directives are necessary to carry out all of your wishes for medical treatment (make sure all documents are consistent).

A living will allows you to approve or decline certain types of medical care, even if you will die as a result of the choice. However, in most states, living wills take effect only under certain circumstances, such as terminal injury or illness. Generally, one can be used only to decline medical treatment that “serves only to postpone the moment of death.” Even in states that do not allow living wills, you might want to have one anyway to serve as evidence of your wishes.

A durable power of attorney for health care (known as a health-care proxy in some states) allows you to appoint a representative to make medical decisions for you. You decide how much power your representative will have. A Do Not Resuscitate order (DNR) is a doctor’s order that tells all other medical personnel not to perform CPR if you go into cardiac arrest. There are two types of DNRs. One is effective only while you are hospitalized. The other is used while you are outside the hospital.

Managing your property with a living trust, durable power of attorney, or joint ownership

If no one is ready to look after your financial affairs when you can’t, your property may be wasted, abused, or lost. You’ll need to put in place at least one of the following options to help protect your property in the event you become incapacitated.

You can transfer ownership of your property to a revocable living trust. You name yourself as trustee and retain complete control over your affairs as long as you retain capacity. If you become incapacitated, your successor trustee (the person you named to run the trust if you can’t) automatically steps in and takes over
the management of your property. A living trust can survive your death. There are, of course, costs associated with creating and maintaining a trust.

A durable power of attorney (DPOA) allows you to authorize someone else to act on your behalf. There are two types of DPOAs: a standby DPOA, which is effective immediately, and a springing DPOA, which is not effective until you have become incapacitated. A DPOA should be fairly simple and inexpensive to implement. It also ends at your death. A springing DPOA is not permitted in some states, so you’ll want to check with an attorney.

Another option is to hold your property in concert with others. This arrangement may allow someone else to have immediate access to the property and to use it to meet your needs. Joint ownership is simple and inexpensive to implement. However, there are some disadvantages to the joint ownership arrangement. Some examples include:

  1. your co-owner has immediate access to your property,
  2. you lack the ability to direct the co-owner to use the property for your benefit,
  3. naming someone who is not your spouse as co-owner may trigger gift tax consequences, and
  4. if you die before the other joint owner(s), your property interests will pass to the other owner(s) without regard to your own intentions, which may be different.
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401(kids)? A Rehash of the Coverdell

Oct 14th, 2009
by jblankenship.
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farmhouse hash by adactioWith much fanfare, Illinois congressman and US Senate candidate Mark Kirk (R-Illinois) has pushed his plan, adorably referred to as 401(kids) (see news story here).  But what is this plan he’s referring to?  Unless I’m missing something, this is the Coverdell ESA (Education Savings Account) that has been in existence for quite some time now.

Kirk’s primary beef is with the Illinois-based BrightStart 529 plan – which is mostly a swipe at one of his main opponents in the Senate race, Illinois’ Treasurer Alexi Giannoulias, since BrightStart falls under Giannoulias’ responsibility.  Last year, one of the funds in the BrightStart plan, managed by Oppenheimer, was severely impacted by the fallout in the bond market due to overexposure in the derivatives market.  Negotiations between Oppenheimer and Giannoulias’ office are continuing, and investors are expected to receive some sort of remuneration soon.

So anyhow, as is often the case, in the heat of the moment during the economic fallout of last year, this 401(kids) plan was recommended.  It’s my contention that this plan is nothing new – the Coverdell ESA is pretty much exactly the same thing.  Let’s do a quick comparison between the proposed plan and the existing Coverdell ESA:

401(kids)

Coverdell ESA
Annual Limit

$2,000 per year

$2,000 per year
Tax Treatment

No tax deduction, earnings are not taxed if used for qualified education costs

No tax deduction, earnings are not taxed if used for qualified education costs
Other Limits

Can be used for education expenses at any accredited institution

Can be used for education expenses at any accredited institution
Additional

If not used for education, could be distributed for other purposes such as first home purchase; earnings would be subject to 10% penalty for non-qualified distribution

No other provisions for usage; earnings would be subject to 10% penalty for non-qualified distribution

So, other than the provision that these funds might also be used for a first-time home purchase, there’s no difference.  And consumers have already voted with their actions:  the Coverdell ESA is too little, too late.  With the miniscule annual funding amount (in comparison to the costs of college), paired together with the fact that there is no up-front tax benefit (as is available with the BrightStart plan for example), it seems that this proposed legislation is another example of unnecessary posturing-based law, with no or extremely low perceived benefit.

In fact, if the investor in a Coverdell or the new 401(kids) plan were to experience a similar issue as BrightStart investors did with Oppenheimer – how successful do you think the individual investors would be in negotiating remuneration on their own?  Don’t get me wrong, I’m in favor of less governmental involvement in most cases, but in this case I think the 529 plan wins out.

What do you think?

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IRA Trick – Eliminate Quarterly Estimated Tax Payments

Oct 13th, 2009
by jblankenship.
3 comments

the old cat trick by wstryder Retirees:  don’t you get tired of making those quarterly tax payments?  January, April, June and September, like clockwork, you have to hand over tax money, just because you’re receiving a pension, retirement funds, and/or Social Security benefits.  What if there was a way to send this money off one time, and then you wouldn’t have to remember it every few months?

There is.

IRA Trick – Eliminating Quarterly Estimated Tax Payments

A little-known fact about IRA distributions is that when you have taxes withheld from the distribution (which are then sent directly to the IRS), the withheld money is considered to have been received throughout the year – even if it is received late in December.  Using this fact to your advantage, you could figure out how much your total estimated tax payments should be for the year sometime in early December, and then take a distribution from your IRA in that amount.  Here’s the trick:  Instead of taking the distribution yourself, fill out a form W-4P to direct the funds to be withheld and sent to the IRS.  Voila!  You’ve now made even payments to the IRS for each of the four quarters, on time with no penalties!

The downside to this plan is that, in the event of the taxpayer’s untimely death before the annual distribution is made, the estimated payments will be considered as unpaid up to the date of death, and therefore the estate will be responsible for paying the underpayment penalty.  Other than that shortcoming, this trick could provide you with several months’ additional interest/return on your money, plus remove the hassle of the quarterly filings.

But, Jim, what if I’m retired and under age 59½?  Won’t there be a penalty?

There doesn’t have to be, although I’d place this particular move into the “higher degree of difficulty” category of tricks – not to be taken lightly.

Pre-59½ Retiree: How to Avoid Penalty?

Same situation as before, but now you must take another step:  once you’ve taken the distribution and properly filed the W-4P to have the distribution withheld as tax – execute a 60-day rollover, placing the same amount of money either into the same IRA or another IRA… effectively, you’ve pulled the old switcheroo with the IRS on this:  What has happened is you’ve paid tax with a distribution that didn’t happen!

How can this be?  Well, the IRS allows you to replace (or rollover) money from any source back into your IRA, so it doesn’t matter that your original distribution was used for withholding.  So you have made up for missing all those quarterly estimated payments (no underpayment penalty now) plus by rolling over the funds you’ve avoided the 10% early withdrawal penalty as well.

Caveat

I mentioned that this last trick fits into the “higher degree of difficulty” category of tricks.  The reason I say this is because using your account in this fashion (essentially a 60-day loan) can be hazardous – the primary reason is that 60 days is all you have, and 60 days can be a relatively short period of time.  Plus, the IRS HAS NO SENSE OF HUMOR ABOUT THIS.  If you miss the rollover period by one day, you’re outta luck.

In addition to the 60-day period, there is also the limitation of only one 60-day rollover per 12-month period.  Again, remember: no sense of humor at the Service.  This is especially true if it’s clear that you’ve been pulling a fast one on them with a scheme like suggested above.  It is for these reasons that this rollover trick should only be used in the most dire of circumstances – such as if you completely forgot to make quarterly payments and are facing a stiff underpayment penalty, for example.  Otherwise, I’d suggest leaving this one alone.  By all means, you should not try this trick year after year.

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