Financial Ducks In A Row • Independent financial advice: IRA, Social Security, income tax, and all things financial

Posted in: income in respect of decedent, IRA, IRD, tax.
Tagged: IRA · tax

How to Check the Status of Your Tax Refund

Mar 25th, 2019

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tax refund So – you’ve gone through the effort of filing your tax return, or maybe you went to a tax preparer and your return has been filed. You see that you’re going to be getting a sizeable refund this year – in spite of your careful planning – and you’re anxious to get your hands on it! How can you check on it to see what’s going on with it??

Go Online (where else?)

First of all, you can go to the IRS’ website at www.IRS.gov and access the interactive tool called Where’s My Refund (also available in Spanish as ¿Dónde Está Mi Reembolso?), which will give you quick, accurate information about your refund. From the IRS.gov front page click on “Refund Status” to get to the tool.

After you’ve eFiled (or had the return eFiled for you) you can get information about the refund 72 hours after the IRS acknowledges receipt of your return. If you file a paper return, the refund information will not be available online for three to four weeks after you’ve mailed the return.

In order to check on the status of your refund, you’ll need to have a few items with you (so don’t try this on the train):

Your Social Security number or ITIN
Your filing status (Single, Married Filing Jointly, Married Filing Separately, Head of Household, or Qualifying Widow(er))
The EXACT whole dollar refund amount shown on your return

Once you’ve plugged all that into the system, you might get several responses. For example, the system may simply tell you that your return has been received and is being processed. Or, you could receive the mailing date or direct deposit date of your refund. Or, if you’re really unlucky (or maybe you have enemies in the Post Office), you may find that the IRS could not deliver your refund due to an incorrect address. In that case, you may be able to correct or change your address online.

If there happens to be an issue with your particular situation, the online system may give you some options to work with to resolve those situations. An example would be if you have not received your refund within 28 days from the original mailing date (per IRS records), you can initiate a refund trace using the system.

If you don’t happen to have internet access, you can always call the IRS refund hotline at 800-829-1954. You’ll have to have the same information listed above (Social Security number, filing status, and exact whole dollar refund amount) to use the phone system as well.

A little insiders’ tip: refund checks are normally mailed on Fridays. If you check the status of your refund and don’t find a mailing date, it won’t do any good to check again until after the following Friday.

Posted on Mar 25th, 2019

by author: jblankenship.

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Posted in: income tax, income tax refund, tax.
Tagged: tax

Missing a W2? Here’s What to Do…

Mar 20th, 2019

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missing a w2 So – you’re all set to do your taxes. And then… you realize you’re missing something. One of your W2’s hasn’t shown up in the mail. Maybe it was a short-term or a part-time gig, or maybe the business changed hands – or maybe it just got lost in the mail.

Whatever the reason, you’re missing one of the documents that you need in order to prepare your tax return. So what do you do?

What Do You Do?

Your employer is required to send your W2 earnings statement to you by February 1 for the prior year’s earnings. But sometimes things go awry, and you don’t receive the form. There are four steps to follow to retrieve the required information…

Contact your employer – inquire if and when the W2 forms were mailed out. It’s possible that the postal service returned it to your employer due to an incorrect or incomplete address. Even if it hasn’t been returned, your employer should be able to produce a new copy of the form and send it out to you.
Contact the IRS – the IRS receives a copy of all W2 forms filed. Wait until after February 16, and then you can call the taxpayer assistance line at 800-829-1040. Make sure you have as much information about the earnings as possible – including your employer’s name and address, your dates of employment, and an estimate of your earnings (you can get this from your end-of-year pay stub). The IRS should be able to produce the appropriate information for you or direct you to the steps you need to take.
File your return – on time if you can, or with a timely filed extension request, even if you have not received the W2. If you have taken the first two steps and still have not received the form by April 15, use Form 4852, “Substitute for Form W2, Wage and Tax Statement”. Attach Form 4852 to your return, using your last pay stub to estimate your earnings and withholding taxes. Keep in mind that using Form 4852 may delay any refund due to additional processing required.
File an amended return – if you happen to receive your W2 after you’ve filed using Form 4852 and the W2 includes different information than you used to prepare your return. Use Form 1040X to file this amended return, within 3 years of the original return deadline.

You can find the forms mentioned above on the IRS website.

Posted on Mar 20th, 2019

by author: jblankenship.

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Posted in: income tax, tax.
Tagged: tax

Why track expenses?

Mar 18th, 2019

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One of the primary things that we suggest to clients is to track expenses. In some cases, this means noting down each expense as you make it, daily, so that even the incidental cash outlays are tracked.

Another way to do this is to use an automated method, one of the many apps available, to monitor your expenses through your credit card and bank accounts.

Either way, when you track expenses there are a couple of outcomes that can have a positive influence on your financial life.

The first is that you become more aware of each outlay of money, whether in cash or from a credit card. Since you track expenses they don’t just pass by, they have a record that you can see and refer to. That coffee you bought on a whim has a life now, and you can see the impact that the purchase had on your life.

The second positive outcome is that once you track expenses and summarize them, you begin to see a picture of your priorities. Whatever you’re spending money on is a priority, and the more you spend, the higher the priority.

These are also reasons why the concept of bullet-journaling is so popular and effective. If you track your every activity on a day-to-day basis, you have a record of all the things you spend your time on. And, as when you track expenses, you can review the history of your time spent – showing your priorities in terms of time. Whatever you spend your time on is a priority, and the more time you spend, the higher the priority.

Knowing where your priorities are historically gives you a chance to address these priorities for the future.

And since you’re taking note of your spending (in time or money) regularly, you can make decisions about how that spending is done. In some cases the decision can be made in the moment – deciding not to spend your precious time or money on that particular item – or making long-term decisions about spending time or money.

For example, you might make the conscious choice to no longer spend time with repetitive tasks by automating or outsourcing. And when you track expenses, you might make decisions about trimming back or eliminating frivolous incidentals, like lottery tickets.

The point is, whether you track expenses or track your time, summarizing this historical record gives you the opportunity to make decisions about how you spend those precious resources in the future. You can control your priorities only if you pay attention to what they actually are.

Posted on Mar 18th, 2019

by author: jblankenship.

Posted in: budgeting, financial planning, priorities.

Taxation of Income, Capital Gains, and Interest

Mar 15th, 2019

by sraskie.

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When you receive income, it’s likely going to be subject to taxation. However, the type of income will determine the specific tax treatment, and ultimately determine how much you get to keep.

We can break income down into three basic types: ordinary income, capital gains income, and interest income. Here’s a breakdown of each.

Ordinary Income – Ordinary income (OI) is income received that is subject to ordinary income tax rates. These tax rates are the rates individuals pay on incremental amounts of income. Rates can be as low as 10% and as high as 37%. Income typically subject to OI rates is income from your wages (W2, self-employment), taxable bond interest, taxable retirement income, and annuity income.
Capital Gains Income – Capital gains income occurs from the sale of assets such as stocks, bonds, mutual funds, ETFs, real estate*, and other assets. Depending on how long the assets were held determines if capital gains are taxed at OI rates or more favorable long-term rates. Assets held for one year or less and then sold, have any gain subject to OI rates. Asset held longer than one year and then sold have gains taxed at long term capital gains (LTCG) rates – which are either 0%, 15%, or 20% – depending on your total income. The higher your total income, the higher the LTCG rate you’ll pay. Qualified dividends from stocks are generally taxed at the favorable LTCG rates.
Interest Income – Interest income is income from assets that generate interest such as bonds, savings accounts, CDs, treasuries (savings bonds, T-bills, etc.), and money market accounts. In most cases this income is taxed at OI rates. One exception is interest from municipal bonds issued by city or state governments. Interest on these bonds is not taxable at the federal level and may avoid state and local taxation as well.

Knowing how specific income is taxed can help with the process of where to hold specific assets and in which accounts – called asset location (discussed later). This can improve your tax efficiency. Additionally, capital losses (selling an asset for less than you paid for it) may be used to offset other income, also improving tax efficiency.

These are the basics of income. Naturally, there are going to be exceptions and complexities that may apply to you. To avoid costly mistakes, you may benefit from the advice of a tax professional -usually a CPA who specializes in tax, an Enrolled Agent (EA – enrolled to represent taxpayers before the IRS), or a tax attorney. *Gains on the sale of your primary residence may not be taxed up to $250,000 for single and up to $500,000 for married tax filers. Specific rules app

Posted on Mar 15th, 2019

by author: sraskie.

Posted in: capital gains tax rates, income tax.

IRA Inheritance – Not Taking Timely Distributions

Mar 13th, 2019

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Photo credit: diedoe

A comment on the post about splitting inherited IRAs sparked this particular post – the question was “What are the consequences for not re-titling an inherited IRA as F/B/O?” You can see my response to that specific question at the original article…

But the question sparked the idea of discussing what happens when a beneficiary doesn’t act in a timely fashion with regard to taking Required Minimum Distributions from the inherited IRA?

The Inheritance

So, let’s say you inherited an IRA from your mother – this was her own IRA that she had contributed to or rolled over funds from a qualified plan at some point. Your mother designated you as the sole primary beneficiary. Things get really hectic and confusing after the death of a parent, and sometimes we don’t cover all of the bases properly… In this example, you didn’t realize that you needed to begin taking Required Minimum Distributions (RMDs) from your inherited IRA as of December 31 of the year following the year of your mother’s death. As of now, for example’s sake, let’s say we’re in the fourth year after your mother’s passing. (see Notes below)

At this point you have two choices:

take the entire balance of the IRA as a distribution before the end of the fifth year; or
“unwind” the mistake by taking your RMDs for the first four years, paying the 50% excess accumulations penalty on each distribution, and then continuing on with your lifetime RMDs.

In each case, of course, you would be required to pay ordinary income tax on the distributions.

Five Year Distribution

This is the “default” distribution option – and the rules are that you must take the complete distribution (either a series of payments or a lump sum) within five years following the year of the original IRA owner’s death. In the example we’ve started, this means that you have roughly a year to complete the distribution.

Since ordinary income tax is owed on distributions from your inherited IRA, if the balance is significant this could represent a sizeable tax bill for you. It might even put you into a higher (or much higher) tax bracket, causing lots of unnecessary additional tax – versus taking the other route, unwinding the mistake.

Unwinding the Mistake

In order to avoid the excess taxes described above in the Five Year Distribution, you would need to go back and take distributions for the three prior years that you missed, based upon your Table I factor. For example, let’s say your inherited IRA was worth $100,000 at the end of the year in which your mother passed away, and your age in the following year was 28. According to Table I, your life expectancy is 55.3 years. Dividing the IRA balance by 55.3 gives us a RMD of $1,808.32. That’s your first year’s distribution.

Continuing the example, you subtract 1 from the Table I value, along with the balance of the IRA at the end of the first year (minus $1,808.32) to come up with the RMD for the second year. For the sake of the example we’ll assume that the IRA is growing at a fixed rate of 5% per year, and so the balance at the end of the second year is $105,000. Subtract $1,808.32 from that figure to come up with an end of year balance of $103,191.68. Your Table I factor is 54.3, yielding an RMD of $1,900.40.

For the third year, your IRA has now grown to $110,250. Subtracting your two years’ worth of RMD leaves you with $106,541.28, and your Table I factor is 53.3, giving you an RMD for the year of $1,998.90.

Adding these three years’ worth of RMDs together equals $5,707.62, which you’d take out in a distribution for the prior (missed) years. This amount is subject to ordinary income tax (just like your other income), but is also subject to a special tax on “excess accumulation”. This tax is for failure to take RMDs in a timely fashion, and amounts to 50% of the distribution that was required, or $2,853.81. While you could take this amount out as an additional distribution, keep in mind that you’d also have to pay ordinary income tax on that amount – but at least you wouldn’t have to pay the 50% penalty on it. You’d probably be better off just paying half of what you take out in the RMDs, since you hadn’t had that money in your hands anyhow.

For the current (fourth) year, you would also need to take a RMD – and continuing our example your IRA balance at the end of last year was $115,762.50 – from which you would subtract the RMDs of $5,707.62, leaving $110,054.88. Your Table I factor is 52.3, which provides you with an RMD of $2,213.43, which you need to take as a distribution by the end of the year. (You’ll need to continue this RMD calculation process for each year hereafter until your death or the IRA is fully distributed. You can always take a larger distribution, but you have to at least take the minimum.)

Don’t Try This At Home, Kids

I know I’ve cautioned you about this before, and perhaps you see it as self-serving (tax guy recommends a tax guy, duh!) but you can really cause yourself some extra grief if you foul this one up. It would be worth it to have a tax professional review your calculations at the very least. To tell the truth, you’re probably just as well to have the tax guy do the calculations for you because the cost is likely about the same for him to review your work as to do it himself. The tax pro can help you with the required filing of Form 5329 (to account for the excess accumulation tax) as well. In addition to the tax, interest may be owed as well on the accumulation tax due in prior years.

Notes:

It should be noted that the fact that the decedent in the example is your parent is not critical to the facts of this explanation – only that you are inheriting the IRA from someone other than your spouse. A spousal inheritance is a different animal altogether.

A factor of this example that IS important is that the IRA belonged specifically to the decedent (your mother) and is not an IRA that she inherited from someone else. If you’ve inherited an IRA that was already an inheritance, if it was specifically directed to you as the designated contingent beneficiary then the rules are the same. But if you received the IRA via the estate (because you were not named as a beneficiary on the IRA documents), you’ll have to follow the five-year distribution rule exclusively.

Lastly, it is also important to note that the example only identifies a single primary beneficiary – if there is more than one beneficiary, the process described would be complicated by the fact that the oldest of all the beneficiaries (with the smallest Table I factor) would be the one whose distribution period is used for all beneficiaries, since the IRA was not split by the end of the year following the year of the death of the original owner.

Posted on Mar 13th, 2019

by author: jblankenship.

1 comment already - add to the conversation!

Posted in: Early Distribution, financial planning, IRA, minimum distributions, retirement plan, rmd, rmds, tax.
Tagged: financial planning · IRA · retirement plan · tax

What’s Up With Medicare Premiums? How Increases Are Determined

Mar 11th, 2019

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If you are covered by Medicare, you may be wondering how the premium increases are determined. Sometimes there is no increase, and sometimes there’s an increase for some enrollees but not others. And some folks have to pay way more than everybody else.

To understand this quandry, we need to look at the system for determining increases to Social Security benefits first.

Social Security – No COLA Increase for 2015

Let’s look at how it worked the last time there was no COLA. This is how future zero-COLA years will work as well.

For the year 2015 there was no Cost-Of-Living Adjustment (COLA) in Social Security benefits. This occurred because the Consumer Price Index (CPI) had not increased for the prior year (2014). While the COLA figures don’t parallel the CPI exactly, the CPI is a rough guide to follow when determining increases.

This was the third time in seven years that there was no COLA – before that, there was an automatic increase in benefits every year since 1975.

Impact to Medicare Premium

So what does this mean for Medicare premiums? Well, for most folks (about 75%) receiving Social Security, since you are already receiving Medicare Part A for no premium, there is no change. Since your Part B premium is linked to the COLA for Social Security, it remained unchanged for 2015. What isn’t linked to COLA is Part D drug coverage, so this increased for most all beneficiaries.

In the future, if there is another zero-COLA year, Part B premiums will likely enjoy similar treatment (unless the rules are changed).

The Other 25%

How can you know if you’re in the 75% that will have unchanged Medicare Part B premiums or the “other” 25%? One of the following three circumstances puts you into the “other” 25%:

You don’t have Medicare Part B premiums deducted from your Social Security checks;
Your first year of Medicare benefits is the year when there is no COLA for Social Security; or
You make too much money, and are subject to IRMAA rules.

The first one seems pretty simple, but it’s more complicated than it seems. For nearly all Social Security recipients, deduction of Medicare Part B premiums is compulsory.

But there’s another, larger group that is enrolled in Medicare Part B that are not currently receiving Social Security benefits. Therefore, individuals who are not receiving Social Security benefits cannot have Medicare Part B premiums deducted from their checks. So this group is in danger of increased Medicare Part B premiums when most other enrollees are enjoying a premium increase holiday.

When these folks eventually apply for Social Security benefits, Medicare Part B premiums will be deducted from their checks – and they’ll be in the special 75% group that may (depending upon COLAs) enjoy a year or so with no increase to premiums. But this won’t apply to the first year of Social Security benefits – only after you’ve received benefits in one calendar year and received a COLA increase does this rule apply.

The second circumstance is cut-and-dried: since this is your first year of receiving Medicare, there was no previous benefit to apply an increase to. So you just have to accept the current standard premium, with no limitation for you. That is, unless you make too much money, because then the third provision applies to you.

So, what’s too much money? Medicare Part B premiums start to increase when your income is more than $85,000 for single filers, or $170,000 for joint tax filers. At this level, your Part B premium will increase by $54.10 per month, an increase of roughly 40% over the standard 2019 premium of $135.50.

As your income increases, the Part B premium increases as well, up to a maximum premium increase of $325 per month if your income is above $500,000 for single or $750,000 for joint filers.

Summary

For the majority of Social Security recipients, the overall impact is minimal, if not a positive.

This is not to downplay the significance, especially to low-income seniors who rely almost exclusively on Social Security benefits, as many other costs (energy costs, food, housing, etc.) have increased, plus the value of home real estate has decreased dramatically. These factors taken together can have a devastating impact on folks who have no other “safety net” available to them. If you’re not presently in the position to have these concerns, you should take this information as a warning: it is critical to develop additional resources to be ready and available in the case that subsidized sources of income are not available or are limited when in retirement.

Posted on Mar 11th, 2019

by author: jblankenship.

Posted in: cola increase, cost of living adjustment, Medicare, medicare, medicare costs, medicare part b, medicare part b premiums, Social Security, social security benefits, social security checks.
Tagged: Social Security

Defined Benefit Pensions

Mar 9th, 2019

by sraskie.

3 comments

A defined benefit pension is a type of retirement plan that your employer may offer as the only plan offered, or in conjunction with a 401(k) plan. If you have access to a defined benefit pension or are currently participating in one, you are in rare company as these types of plans are becoming few and far between.

Defined benefit pensions are different from 401(k)-type plans (called defined contribution plans) in several ways. One of the biggest differences is the fact that the employer is responsible for the funding of the plan in addition to accepting all the investment risk of the plan’s assets. With a 401(k)-type plan, the employee is responsible for funding and the risk in the investment portfolio. Many defined benefit pensions are also backed by the Pension Benefit Guarantee Corporation (PBGC), which protects your pension up to a certain amount in event of plan termination.

Another difference is that at retirement, the defined benefit pension pays the retiree a guaranteed income stream for life (an annuity), and that guaranteed income may or may not have an inflation increase. If you’re married, by law the pension must be paid as a joint and survivor annuity – meaning that if the spouse who has the pension dies, a benefit is still paid to the surviving spouse.

With a 401(k)-type plan, the account balance at retirement is based on the employee’s contributions (and any employer match) and how it was invested. At retirement, the retiree is responsible for taking income from the account. They may choose to take periodic withdrawals, fund an annuity, or leave it invested should they not need the money just yet.

The key point is the employee is responsible for these decisions. With a defined benefit plan, the decisions are already made, and if not, are very simplified.

The amount of the retirement benefit from a defined benefit pension is generally based on length of service, age, and final average salary. Thus, the longer you work and are participating in the pension, the higher the monthly benefit. Usually, companies will cap the years of service credit at some number such as 30 years – which means there’s no increase in the pension based on working longer. Most companies allow employees to become “vested” (the pension is fully the employee’s) after 5 years, sometimes less.

If you work for a company offering a defined benefit pension and are considering changing jobs, see if the new company has a defined benefit pension (among other benefits). Also check to see if you’re vested in the current pension. If not, consider staying until you are. Even a small pension can make a difference in retirement. Naturally, this won’t be your only criteria for staying or leaving but it’s important. Imagine receiving a guaranteed retirement income where no matter what happens, you’ll get the same payment every month. Regardless of how the economy is doing, and regardless of your 401(k) or IRA performance, you’ll get the same monthly amount. This is the beauty of a defined

Posted on Mar 9th, 2019

by author: sraskie.

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Posted in: pension, retirement, retirement plan.

Splitting Inherited IRAs

Mar 6th, 2019

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Photo credit: diedoe

In the case of an inherited IRA, splitting it often is desirable in order to better accommodate a distribution plan after the primary owner dies. This can be done prior to the death of the IRA owner, or it could be done after the death of the IRA owner, as long as it’s accomplished before the end of the year following the year of death.

Why is this important?

When an IRA is inherited by a non-spouse individual, that individual is required to begin taking distribution of that IRA. The required distribution is based either upon the heir’s age or the age of the decedent. In most cases when the beneficiary is younger than the decedent, it is more advantageous to stretch those payments out over the longer period of time by using the heir’s age for the required distribution.

If there is more than one beneficiary, unless the IRA is split, the Required Minimum Distributions (RMDs) will be based upon the attained age of the “designated beneficiary”. This is the oldest living beneficiary as of September 30 of the year following the year of death of the primary IRA’s owner.

You can split the IRA into separate IRAs for each beneficiary, each titled as “John Jones, deceased, FBO Jane Brown” (probably not exactly like that because the names will be different in almost all cases). Then the individual IRAs can be distributed according to the age of each individual beneficiary. Splitting the IRA must be completed by December 31 of the year following the year of death.

Note: you don’t have to split the IRA into separate IRAs by September 30 of the year following the year of death. This is just the administrative date for determination of the designated beneficiary. If you split the IRA into separate inherited IRAs by December 31 of the year following the year of death, then administratively the designated beneficiary of each separate IRA as of September 30 would be the individual heir owner of the account.

Splitting the IRA into separate IRAs for each intended heir before the original owner dies simplifies matters for the heirs. By splitting the IRA before death, the inheritants can simply take RMDs based on their own attained age, and nothing else is required (no account splitting, no deadlines to meet). But if this isn’t (or can’t be) done, splitting the IRA after death is usually best for all involved.

Posted on Mar 6th, 2019

by author: jblankenship.

Posted in: Early Distribution, IRA.
Tagged: IRA

You’re Not (necessarily) In Control

Mar 4th, 2019

by Jim.

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So you’ve set up your 401k with your employer’s administrator, made your allocation choices, and everything is set to go. You’ve got this retirement saving thing by the tail, right?

Photo credit: jb

Not so, Mona Me. (or maybe that’s mon ami?) Or at least not completely so. You see, way back in 2006, Congress passed the Pension Protection Act, which had a provision in it that allows employers to automatically enroll employees in retirement plans, and make default investment choices for them.

Doesn’t apply to me, right? Since I enrolled on my own and made my own choices for allocation of my investments… right? Once again, Mona, you’re not completely correct.

The Most Common Change

The plan sponsor (your employer) can make changes to the funds available for investment choices at any time. So, instead of that no-load broad market fund that you originally chose, now you have a loaded (yes I know they’re usually waived loads in 401k’s) high expense ratio fund that doesn’t really accurately represent the total domestic equity market very well.

Your employer can make this change any time they want – maybe it’s to get their cousin an additional commission since he sold the plan to your employer. But then again, maybe it’s just because the bossman read an article that said A shares were superior to all other investments, or something equally idiotic.

The Other Kind

Another possible way that your employer could change your allocation in your 401k account is if it was determined that your account wasn’t diversified enough. Seems pretty big-brotherish, but it’s still a possibility, just not very common.

Default investments can be changed on a whim as well – from a basic money market account to, perhaps, a costly stable-value insurance product. When these choices are changed, your money is automatically moved. You can always change to something else (among the available options), but you have to make the change on your own.

The Bottom Line

So – the watchword you should take away from this is that you need to pay close attention to communications that you company sends you regarding your retirement plan. None of these changes can be made without communicating the change to you in advance – but if you are like most folks when you get that pack of paper and the book written on recycled cigarette paper, the last thing you want to do is sit down and study it thoroughly, right Mona?

Particularly pay close attention when your company sends you a letter explaining changes to the plan. These are supposed to be concise and easy-to read, so watch for them. When funds are going to be automatically moved you’ll get a notice in advance so that you can choose something different from the default. This may be helpful, or it may not – but you’ll be in a position to have better control over your funds.

Posted on Mar 4th, 2019

by author: Jim.

Posted in: 401k, investing, qrp, qualified retirement plan, retirement plan.
Tagged: retirement plan

TWO 5-year Rules for Roth IRAs

Feb 27th, 2019

by Jim.

5 comments

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

5-Year Rule #1: The Account’s Age

Photo credit: diedoe

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 the 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 purchase

See the IRS’ flowchart in Figure 2-1 (page 30) at this link in order to determine if your distribution is qualified.

5-Year Rule #2: Age of a Conversion

The second 5-year rule applies to a 5-year period beginning 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 401k. If any amount that was subject to taxation during the conversion is distributed before the 5-year period is complete will be subject to an additional 10% penalty applied to the distribution. This would also include post-conversion earnings on all amounts converted within the prior 5 years.

There are several exceptions to this rule, listed here:

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 (SOSEPP)
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

The two 5-year rules come into play when considering the order in which distributions are attributed. The IRS has specific rules determining which money is coming out of your account based on the source. The distribution ordering rules determine how each distribution is to be treated, depending on if it’s qualified or not. The order of distribution is as follows:

Regular contributions (this is your annual contribution amount to the account, not rollovers or conversions)
Conversion and rollover contributions, on a first-in, first-out basis. This means that the total of conversions and rollovers from the earliest year are distributed first. These conversions and rollovers are further sorted as follows:
1. Taxable portion (that portion that was taxed during the conversion or rollover) is distributed first, followed by the
2. Non-taxable portion (any amounts that were not taxed during the conversion)
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 2018 and the conversion or rollover contribution is made in 2019, treat the conversion or rollover contribution as contributed before any other conversion or rollover contributions made in 2019.

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

Posted on Feb 27th, 2019

by author: Jim.

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Posted in: Early Distribution, IRA, tax.
Tagged: IRA · tax

Hidden Costs to 401k Plans and Who Pays These Fees

Feb 25th, 2019

by Jim.

2 comments

Photo credit: jb

It should not come as a shock that there are certain fees involved in maintaining a 401k 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 cigarette paper, 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 worst 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.

These fees are disclosed to you, by law, ever since the fee-disclosure rule went into effect in 2012. Under that rule, plan administrators are required to mail you a quarterly statement showing your investments’ rates of returns, investment-related fees, and expenses, including any amounts the plan deducted from your account to cover administrative expenses.

Like many documents surrounding your 401k plan, these are long-winded and confusing. Most participants in 401k plans don’t even know that this information is disclosed to them, and among the ones that are aware, a paltry few actually take action based on the disclosed information.

Three types of fees

There are three different categories of fees in the typical 401k plan:

Administrative fees
Investment fees
Individual service fees

Of these fees, the Administrative fee is typically a per-account fee, such as $30 per year. This covers all of the back-end paperwork that each account, no matter the size, has to shoulder.

Investment fees are specific to the investments you’ve chosen, and can range quite wide. Depending upon the share class of the investments you have in your portfolio (in your 401k), you might be paying 1-2% annually in marketing and fund management fees. This one is the hardest to find (because it’s buried in a prospectus), but it is also likely the fee that causes the most drag on your account’s returns over time.

Individual service fees are based on actions you’ve taken with your account, such as taking out a loan against your 401k plan balance.

All of these fees cause a drag against your returns, but as mentioned previously, the investment fees are (potentially) the most harmful. Looking into these fees and adjusting your holdings to avoid the highest investment fees can make a huge difference in the long-term results.

For example, if you put $200 every payday ($5,200 a year) into your 401k, with an average return of 8%, you’d anticipate a balance of approximately $324,000 after 30 years. With an expense ratio of 1.2% on your mutual fund, however, the resulting balance would only be approximately $255,000. Changing from a mutual fund with a 1.20% expense ratio (another term for the investment fees) to one with a 0.30% expense ratio could bolster that result up to approximately $305,000 – an increase of $50,000!

You can look up the expense ratios for your 401k holdings pretty readily, most often by going to the plan administrator’s website. There, you should be able to find each offering’s expense ratio with a bit of searching. Swapping out the expensive fund for a less expensive alternative (but keeping the same asset class!) should be a relatively simple activity. It takes some time, but look at it this way: if you spend an hour doing this and the results are similar to the example above, you could be making $50,000 an hour for your work!

Posted on Feb 25th, 2019

by author: Jim.

Posted in: fiduciary, financial planning, investing.
Tagged: fiduciary · financial planning

The Granddaddy of ’em All: Keogh Plans

Feb 20th, 2019

by Jim.

2 comments

Ah, the poor, misunderstood and neglected Keogh (KEE-og) Plan. You don’t get the press that your fancy relatives 401(k), IRA and Roth, or even SIMPLE achieve… it seems as if the investment discussion world is completely abandoning you.

First brought into existence in 1962 (yes, it’s a late-boomer like me!) the Keogh or HR10 plan is essentially a vehicle that allows the self-employed to establish pension plans just like the big companies can. A Keogh plan can be either a defined benefit (traditional pension) or a defined contribution (such as a 401(k)) plan.

The Keogh plan has the same attributes as many other qualified plans, including the age 59½ limit for qualified withdrawals, as well as the age 70½ required minimum distribution rules. Depending upon the type of plan established, you can invest in most common investment vehicles within a Keogh plan.

The real benefit of a Keogh plan over a SIMPLE or other types of plans available to small employers is in the higher limit for contributions. In the Keogh plan, up to $56,000 (for 2019) can be contributed and deducted, limited to 25% of the overall compensation of the employee.

Alternative retirement plan vehicles such as the solo 401(k) plan have lessened the need for the Keogh plans in the defined contribution arena. However, for establishment of a defined benefit pension plan or a money purchase pension plan, the Keogh remains a very important piece of the puzzle for sole proprietorships and other unincorporated businesses.

One particular downside to the Keogh plan: If you have no employees, your Keogh plan is not necessarily protected from creditors. If there are employees in the plan (other than owner/partners) then ERISA law protects the accounts from creditors, but without employees, ERISA has no jurisdiction over these accounts, and your assets may be subject to creditor claims, depending upon applicable state laws. Just something to keep in mind with the Keogh.

You’re eligible to participate in a Keogh retirement plan if you are:

self-employed, a small business owner, or an active partner in an unincorporated business who performs personal services for the company
a sole proprietor who files Schedule C
in a partnership whose members file Schedule E (in this case, the partnership, not you, must establish the Keogh plan)
working for another company, but working for your own business as well (for example, if you’re a writer with a day job and you’re earning royalties on your first book, the royalties count as self-employment income)

You are not eligible to participate if you are:

a salaried worker for an incorporated business, with no other source of income
retired and not receiving compensation from a business
a volunteer at the business that offers the plan

Posted on Feb 20th, 2019

by author: Jim.

Posted in: financial planning, investing, retirement plan.
Tagged: financial planning · retirement plan

Why We Include Real Estate in Investment Portfolios

Feb 18th, 2019

2 comments

We construct portfolios out of various asset types in order to diversify, or spread out our risk. To spread risk we choose multiple asset types of differing profiles. Most often these asset types include domestic equities (US-based stocks) and domestic fixed income (US-based bonds), which provide for basic diversification. Then, we include additional asset types in order to achieve further diversification. Examples of additional asset types include commodities, foreign equities, foreign-denominated bonds, and real estate.

It is important to keep in mind as we review various asset classes for inclusion in our portfolio, that we must achieve appropriate return for the inherent risk associated with the specific asset class in question.

Why Include Real Estate?

Photo credit: diedoe

It is for that very reason that we choose to include real estate as a component of the well-rounded portfolio: due to real estate’s ability as an asset class to deliver a greater reward-to-risk ratio than most any other asset class. This goes, in general, for both personally-owned real estate and real estate owned via Real Estate Investment Trusts (REITs). REITs are like a mutual fund of real estate holdings, primarily commercial real estate holdings.

During periods of high inflation (as we may experience again soon), residential real estate has always provided a good hedge against rising inflation – even in times when some residential real estate loses value. The fact remains that, although at times many folks have been hit and hit hard devaluation of real estate, present value of real estate is generally expected to appreciate at a greater pace than inflation in the long run. On the downside, commercial real estate doesn’t always share residential real estate’s inflation-hedge benefits.

Global commercial real estate tends to provide the opportunity to benefit from currency gains when domestic inflation is higher than that of the countries that you (or your REIT) hold property in. This is a similar benefit to owning foreign-currency bonds.

In a period of deflation, another similar benefit is found, although it is more related to the appreciation of foreign currencies due to appreciating yields. The greater benefit during deflationary periods is found because commercial property rental rates tend to lag the market, which in turn produces real gains to the owner of commercial property.

As we know, during a normal (not overly inflationary or deflationary) economic period, residential property (directly owned, as in “your own home”) provides both an economic benefit and many emotional ones. Commercial property provides not only a generally more stable return with generally less risk than equities, with generally a higher return than can be found with bonds. In other words, the reward-to-risk ratio that you achieve with real estate is greater than with bonds or real estate, although the risk is different.

Correlation

We use a term – correlation – when describing how various asset types are affected by similar circumstances. If, for example, when one asset increased in value by 10% and a second asset class always increased by the same amount, 10%, then we would indicate that the two asset classes are perfectly correlated. If another asset class only followed the first asset class about half the time, sometimes increasing more, sometimes less, or even decreasing when the first increases (or vice versa), then we might indicate that this third asset class is 50% correlated to the first asset class. (The math is much more complex than this, but I wanted to give you an easy-to-follow example.)

By investing in the first and third asset classes in equal amounts, it stands to reason that we’d benefit by having different sorts and degrees of risk that affect our investments, and not all of our funds would be negatively impacted at any one time. Real estate is just such an asset class, when related to equity or stock investments. Historically speaking, real estate in general is only about 40% correlated with equities, making it a very good diversifier.

Bottom Line

I realize that you may not necessarily agree with all of this in light of what we’ve seen happen not so long ago in the real estate world, but there is reason to believe that the same sorts of returns will continue in the future for commercial real estate. Plus, it is very important to keep in mind that real estate should be only a small part of your overall allocation – in no case have I recommended more than a 5% to 10% allocation to this investment class.

Posted on Feb 18th, 2019

by author: jblankenship.

Posted in: investing, real estate investment.
Tagged: investing · real estate

Roth or Pre-Tax 401(k)?

Feb 15th, 2019

by sraskie.

2 comments

As an employee of a company you may have access to a 401(k). A 401(k) is an employer-sponsored (offered) retirement plan that allows you to save money for retirement. Sometimes your employer may provide a match based on a percentage of your contributions.

Your employer may give you the option of saving to a pre-tax account or a Roth account. A pre-tax contribution means that your contributions are made to your account before federal and state taxes are applied to your paycheck. A Roth contribution means that taxes are taken first, then the contribution goes to your account. This is also known as an after-tax contribution.

If you make pre-tax contributions, you avoid tax now, but then are taxed when withdrawals are made in retirement. If you make Roth contributions now, you’re taxed today, but withdrawals in retirement are tax-free.

It can make a lot of sense to contribute to your Roth 401(k) for a few reasons.

If you’re in a lower tax bracket now, you’ll pay less tax on your contributions today, and avoid taxes in retirement when taxes rate may be higher, or your income is higher and taxed at a higher rate. This is especially true for young college grads in their first job.
The bulk of your money in your account will eventually be growth of your investments and reinvested dividends. With a Roth account, this will be tax-free when withdrawn at retirement.
Having tax-free income in retirement means that your Social Security benefits may not be subject to taxation; since qualified Roth distributions are not taxable income.
Mentally, not having to pay any (or very little) tax in retirement can be reassuring when it comes to planning for expenses, distributions, and bequeathing.
It may mean that since your Roth distributions are not being taxed, any long-term capital gains may be subject to zero tax.
You may not be able to make Roth IRA contributions (your income may be too high). A Roth 401(k) doesn’t have income restrictions.

Personally, I favor Roth contributions. I like the tax-free benefit of qualified distributions in retirement. It should be noted however, that any employer match to a Roth 401(k) will be made to a pre-tax account (as the employer is allowed a tax deduction for the matching contribution). Your employer match will not be Roth dollars.

This should not be a discouragement from saving to your Roth 401(k).

Posted on Feb 15th, 2019

by author: sraskie.

Posted in: 401 k, 401k, after-tax, after-tax contributions, retirement, retirement accounts, roth 401 k, Roth 401(k), Roth 401k.

Doing All The Right Things

Feb 13th, 2019

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I am diabetic.

Photo credit: jb

This is one of those situations we’re dealt 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 away from sweets, 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? Not completely – 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 have been in a similar position with their investing and savings activities. We thought we were doing the right things. Turns out it was only some of the right things. We are putting 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, saving and investing while 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. Lots of folks who work for the federal government experienced this problem recently. Lots of formerly “in check” debt is coming dangerously close to getting 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 the same economic factors correlated in their reaction to changes. To be properly diversified, a portfolio should include components that are not in any way related to one another. With this diversification, when an economic downturn affects the US domestic large-cap equity market, only that portion of our portfolio that is invested in large-caps 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 other sized companies, will have reacted differently to the negative impact in the domestic large-cap 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 late in 2018. Your overall result would have been much better than most folks (with concentrated positions) 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, and 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!

Posted on Feb 13th, 2019

by author: jblankenship.

Posted in: financial planning.
Tagged: financial planning

Medigap Plan C and Plan F are going away

Feb 11th, 2019

by Jim.

No comments yet

The following is an expansion of an excerpt from the book A Medicare Owner’s Manual. This book was published in January, 2019 and is available on Amazon.

With the passage of the Medicare Access and CHIP Reauthorization Act of 2015 (MACRA), Medigap Plan C and Plan F will no longer be available beginning in the year 2020. This is due to the fact that these plans pay for the Medicare Part B deductible, and the MACRA law eliminates Medigap plans that provide this coverage.

If you have enrolled in a Medigap Plan C or Plan F prior to 2020 you may be able to keep the plan, but you will not be able to change to a new policy of Plan C or Plan F with a starting date of January 1, 2020 or later.

Plus, if you were eligible for Medicare, either by virtue of your age (65 before 2020) or by disability or end-stage renal disease (ESRD) before 2020, you can still purchase a Medigap Plan C or Plan F, even if you had another plan previous to 2020.

MACRA

The Medicare Access and CHIP Reauthorization Act had many facets. The primary provisions are:

changes to the way providers are reimbursed by Medicare
changes to funding provisions
an extension of the Children’s Health Insurance Program (CHIP)

So the provision we’re interested in was actually just an add-on, put in place to eliminate a class of benefit that Congress deemed was inappropriate to the way the Medicare system should work. Specifically, under Medigap Plan C and Plan F, even the first dollar of cost (of Medicare Part B) to the enrollee is covered. Plan C and Plan F both have complete coverage of the deductible for Medicare Part B. For 2019, the Medicare Part B deductible is $185.

If you request a Medigap Plan C or Plan F from your insurer and you first became eligible for Medicare in 2020 or later, you will instead get a Medigap Plan D or Plan G, respectively. Plan D is identical to Plan C, except for the Medicare Part B deductible coverage. The same applies for Plan G – it’s identical to Plan F except for the Medicare Part B deductible coverage.

In addition, since there is a high-deductible Medigap Plan F, there will be a new option, a high-deductible Medigap Plan G available in 2020 for new enrollees.

Posted on Feb 11th, 2019

by author: Jim.

Posted in: Medicare, medicare part b, Medigap.

IRS Private Letter Rulings, Revenue Rulings and Revenue Procedures

Feb 4th, 2019

by Jim.

No comments yet

Photo credit: jb

The IRS has a couple of different ways to provide guidance, 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.

Recently the costs for these items has increased – as of February 1, 2019. The information below reflects the new costs.

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 cannot be cited as precedent for other cases. They do give insight as to what the IRS’ position may be on a particular situation of similar circumstances. 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 which may be cited as a precedent.

PLR’s have significant costs associated with them: generally you must have a tax attorney prepare the request for you, which may cost anywhere from $5,000 to $15,000 depending upon the complexity of your case, and then the IRS charges a fee for delivering the PLR.

The basic user fee from the IRS is $30,000 (up from $28,300), but can be as little as $2,800 if the taxpayer’s income is less than $250,000. If the taxpayer’s income is between $250,000 and $1 million, the fee is $7,600. More details on these user fees can be found in IRS Internal Revenue Bulletin 2019-01, Appendix A.

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 state and local taxes. On the other hand, a Revenue Procedure explains how those deductions are treated, such as the $10,000 cap on state and local tax deductibility on your Schedule A.

Posted on Feb 4th, 2019

by author: Jim.

Posted in: financial planning, IRA, tax.
Tagged: financial planning · IRA · tax

Mutual Funds and ETFs – A Great Choice for Your Portfolio

Feb 1st, 2019

by sraskie.

No comments yet

Investing in individual stocks* is an option for your portfolio. However, investing in stocks involves a lot of diligence, research, and discipline. Many of us don’t have the time, money, or fortitude to carry through with an investment plan that includes individual stocks.

Additionally, stock picking can lead to additional stress if you find yourself constantly (daily) looking at your stocks and worrying if you should buy, sell, or hold. If you think you’re the type of person who could unemotionally buy and sell stocks for your portfolio and remain consistent in doing so, then you may be the rare investor where this could be a viable option.

Building a portfolio of stocks also means you must purchase enough stocks – and enough different types of stocks – to have adequate diversification to reduce your risk compared to owning just one or a few companies. This can be difficult to do if your money is limited or the prices of the companies you’ve researched are out of your budget (e.g. as of this writing, Berkshire Hathaway A shares are trading at just over $300,000 per share).

Here’s where investing in mutual funds and ETFs (exchange traded funds) can be beneficial. Some of the advantages of investing in mutual funds or ETFs include instant diversification, economies of scale, professional management, and (generally) lower expenses.

Instant Diversification – Unlike investing in several single stocks to achieve diversification, purchasing just one share of a mutual fund or ETF gives you expose to hundreds, if not thousands of different companies.

Depending on the goal of the fund (large, medium, or small company, US, international, bond, etc.) it will hold a sample of the companies that make up the investment allocation the fund is trying to achieve.

Let’s say you want to invest in the S&P 500 – an index of roughly 500 larger US companies. Purchasing a fund replicating the S&P 500 would get you access to over 500 companies with only one share! The same would be true for a bond fund, international fund; you get the point.

Economies of Scale – This means that by using mutual funds or ETFs allows you to have access to many companies for less than the cost of purchasing them separately. Looking at our S&P 500 example, an investor purchasing individual stocks would have to buy over 500 different stocks to replicate this index. Very expensive to do.

Buy purchasing a mutual fund or ETF replicating the S&P 500, the investor gets exposure to over 500 companies, with only 1 share of the fund, for substantially less money.

Professional Management – Investing in mutual funds or ETFs gives you access to professional money managers whose job it is to monitor the portfolio of stocks so you don’t have to. Often fund managers have extensive experience, education, and certifications that qualify them to manage the fund(s) they oversee. The alleviates you from the stress of constantly looking at your investments (which you shouldn’t do anyway).

Depending on the type of fund (actively versus passively managed), the fund may have more than one manager and may have more expenses due to the goal of the fund (e.g. funds that try to beat the market typically charge more).

Lower Expenses – In many cases investing in mutual funds or ETFs carries lower expenses. In additional to requiring less money to invest in more companies, choosing lower expense funds means that more of your money is working for you. You should consider looking for funds that have expense ratios of .5% (one-half of 1 percent) or less. This should be easy to do by choosing index mutual funds or ETFs.

*Or individual bonds

Posted on Feb 1st, 2019

by author: sraskie.

Posted in: diversification, diversify, etf, expense ratio, mutual fund expenses, mutual funds.
Tagged: etfs

Fiduciary Standard for All Advisors?

Jan 28th, 2019

by Jim.

No comments yet

dog-in-suit-by-matt512 There has been a debate going on in the financial advisory world for many years. You see, there are two primary governing bodies for folks in the financial services business: the Securities Exchange Commission (SEC), which promotes a fiduciary standard, and the Financial Industry Regulatory Authority (FINRA), promoting a suitability standard. These are the two primary governing bodies (but there are others).

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. Further, he must disclose any conflicts of interest, including potential conflicts of interest. 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.

Posted on Jan 28th, 2019

by author: Jim.