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

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Joint (Photo credit: Chris KWM)

One result of the strike-down of DOMA is that legally-married same-sex couples will now be required to file federal tax returns as marrieds – either married-filing-jointly or married-filing-separately. This ruling takes effect on September 16, 2013. This means that, regardless of how the members of the couple filed their returns in the past, they only have the MFJ or MFS filing statuses to choose from for returns filed on or after September 16, 2013.

For couples who have not filed a return for 2012, now is the time to review whether filing as Single status provides a superior result (lower overall taxes) versus the MFS or MFJ option. If filing Single or Head of Household works out better for the couple, the (presumably) extended 2012 tax return must be filed before September 16, 2013 in order to utilize a Single or Head of Household filing status. After that date, the Single and Head of Household filing statuses will no longer be available.

State tax return filing status will still rely on the state’s law: if same-sex marriages are not recognized as “legal”, then the couple will still not be allowed to use a “married” status, regardless of whether the marriage was performed in another state where same-sex marriages are recognized.

In addition, couples in civil unions or domestic partnerships are still not allowed to use the “married” options – they must use either the Single or Head of Household filing status, whichever pertains to the situation.

A couple of technical notes:

Even though, since DOMA was invalidated, meaning that legally-married same-sex couples are retroactively considered to be legally married at the federal level, it is not expected that these couples will be required to re-file tax returns using one of the married statuses.
On the other hand, legally-married same-sex couples may benefit by filing using one of the married statuses, and it is my understanding that amended returns may be filed in those cases, within the statute of limitations for such filings. If a refund is included, this means that most 2010 and later returns could be amended after the September 16, 2013 date. The latest date for filing a 2010 amendment with a refund is October 15, 2013.

Posted on Sep 3rd, 2013

by author: jblankenship.

Posted in: 2013 calendar year, 2013 tax year, DOMA, head of household, income tax.
Tagged: DOMA · filing status · income tax

What is Risk Tolerance?

Aug 30th, 2013

by sraskie.

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Happy Tums

What is risk tolerance and why is it important to investors? As an investor you’ve probably been asked this question by yourself, or your financial advisor. It’s not an easy question to answer and not a question that can be answered with one word or a quick sentence.

Risk tolerance is simply a particular investor’s appetite for risk. Some investors have little appetite for risk and their stomach churns when they think about losing money in the market. Generally these investors are considered risk averse or risk intolerant.

Other investors aren’t really concerned about the ups and downs of the market and are willing to accept these market gyrations in or to receive the benefit of potentially higher returns. This is called the risk/return trade-off. In order for investors to receive higher returns they generally have to be willing to accept more risk for those returns. In other words, these investors are risk tolerant.

So why is this concept important for investors? It’s important for a number of reasons. The first is that it helps the investor and their advisor properly line up the correct investment portfolio for that particular investor. A risk averse investor will generally be more at ease in a low-risk portfolio with few, if any equities, more exposure to high-quality bonds and cash. A risk tolerant investor would be more tolerant of risk – such as more exposure to equities, and riskier assets.

But determining what an investor’s appetite for risk isn’t that easy. There are a number of risk tolerance questionnaires used by various companies and professionals to help investors narrow down their true tolerance. This is hard to do depending on the day – literally!

The reason why is because on any given day the market could be way up, way down, or flat. Someone who is really risk averse may feel risk tolerant in a bull market (isn’t everybody?), but that same person will run for the antacids the second the market drops; which leads to this point:

Investors’ real appetite for risk appears in bear markets.

So what can investors do? Find a professional that asks a lot of questions and takes the time to get to know you. Yes, a risk tolerance questionnaire can be used and is a good thing, but the questionnaire should be only a piece of the conversation. Investors can ask themselves questions too.

Imagine you have $100,000 invested and in two weeks it grows to $150,000. How do you feel? In another two weeks it plummets to $75,000. Now how do you feel?

You answer will determine nodding in expectation or running to the medicine cabinet.

Posted on Aug 30th, 2013

by author: sraskie.

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

Can Both Spouses File and Suspend?

Aug 28th, 2013

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portrait of C. A. Rosetti (Photo credit: Wikipedia)

Note: with the passage of the Bipartisan Budget Act of 2015 into law, File & Suspend and Restricted Application have been effectively eliminated for anyone born in 1954 or later. If born before 1954 there are some options still available, but these are limited as well. Please see the article The Death of File & Suspend and Restricted Application for more details.

This question continues to come up in my interactions with readers, so I thought I’d run through some more examples to illustrate the options and issues. The question is:

Can both spouses file and suspend upon reaching Full Retirement Age, and collect the Spousal Benefit on the other spouse’s record, allowing our own benefit(s) to increase to age 70?

Regarding file & suspend and taking spousal benefits, although technically both of you could file and suspend at the same time, only one of you *might* receive spousal benefits at that point. The reason is that once you file (regardless of whether you suspend) the spousal benefit is then limited to the amount over and above your own Primary Insurance Amount (PIA), up to 50% of your spouse’s PIA. (Remember, PIA is the amount of benefit that you would receive at exactly Full Retirement Age.)

For example, if you and your wife have PIAs of $2000 and $800 respectively and you both file and suspend, your wife could file for spousal benefits of $200 (half of your PIA minus her PIA equals $200). However, you would not be eligible for a spousal benefit since half of your wife’s PIA minus your PIA is a negative number.

Now, if we change the numbers so that you have a PIA of $2,000 and your wife’s PIA is $1,200 and both of you file and suspend, neither of you would be eligible for a spousal benefit. Half of either of your PIA’s is less than the PIA of the other, so no spousal benefit is available if both file and suspend at the same time.

Typically this works out best if only one spouse files and suspends, usually the one with the greater PIA, and the other spouse files a restricted application for spousal benefits only. Using my first example numbers, if you filed and suspended and your wife filed a restricted application for spousal benefits only, she would be eligible for a $1,000 spousal benefit, and both of your own benefits would accrue Delayed Retirement Credits (DRCs) up to age 70. At that point, again, using the first example numbers, you would be eligible for a benefit of $2,640, and she would be eligible for a benefit of $1,056.

Another way this could be done would be for your wife (again, working with the first numbers) to file for her own benefit at Full Retirement Age, receiving $800 per month. Then you could file a restricted application for spousal benefits only, and receive half of her PIA, or $400 per month. You’d continue to receive this for four years until you reach age 70, at which point you would file for your own benefit, enhanced by the DRCs to $2,640. At this point your wife could file for spousal benefits, increasing her own benefit to half of your PIA, or $1,000. This second option actually gives you more money over the four-year span from FRA to age 70, but your wife’s benefit would be limited to a maximum of $1,000 (rather than $1,056) for her lifetime or yours, whichever is shorter.

At any rate, hopefully this resolves the question once and for all – while technically both spouses can file and suspend at the same time, there’s not a lot of reason to do so as the spousal benefits would only be available to one of them, at most.

If you have other situations that you’d like to review, leave a comment below and I’ll do my best to answer promptly.

Posted on Aug 28th, 2013

by author: jblankenship.

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Posted in: #noTOP, file and suspend, restricted application, Social Security, Social Security spousal benefit, Spousal Benefit.
Tagged: file and suspend · restricted application · Social Security · spousal benefit

Book Review: The M Word

Aug 26th, 2013

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Subtitle: The MONEY TALK Every Family Needs to Have About Wealth and Their Financial Future

This book, by Lori R. Sackler, presents to us a very insightful overview of the types of conversations that families need to have with one another – beginning with spouse to spouse, following with intergenerational conversations – about money topics. These conversations are critical to the success of most all financial plans that require some interaction between two or more people.

Mrs. Sackler has a great deal of experience with the topic, having for several years hosted a radio program dealing specifically with this subject. It is this wealth of experiences, coupled with her own clients’ experiences, that really delivers a wonderful array of knowledge about the process.

Throughout the book are excellent examples, which provide the reader with a portrait of each concept, in the flesh as it were. The book walks you through the various types of transitions that require a Money Talk – including a change in financial circumstances (positive or negative), such as when a job change occurs or a windfall is received, when a marriage or re-marriage occurs, when planning for retirement, end of life, or caring for an aging parent. These transitions can bring out the worst in family members, or they can be opportunities to successfully pass the milepost with little stress. Too often when passing these transitions it’s the stressful reaction of others that causes the planning to go awry – and according to research, it is conversation (or lack of) that causes the stress.

The author then goes on to explain how preparation and planning are important to the success of the communication – and then explains a five-step process for successful communication in all types of transitions.

I found this book to be an excellent guide for the communication process, and the shining star is Mrs. Sackler’s examples. The real-life situations help to provide the reader with illustration of the process that can easily be put into place in similar circumstances. I highly recommend this book for any advisor who finds himself or herself in the position of helping clients with this sort of transition.

The above book review is part of a series of reviews that I am doing in an arrangement with McGraw-Hill Professional Publishing, where MH sends me books with the only requirement being that I read the book and write a review – like it or not. If you find the information in this review useful, let me (and McGraw-Hill) know!

Posted on Aug 26th, 2013

by author: jblankenship.

Posted in: Book review, fiduciary, financial planning.
Tagged: book review · fiduciary · financial planning

A Stable Pyramid

Aug 23rd, 2013

by sraskie.

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Pyramids (Photo credit: Mathew Knott)

One of the basic fundamentals regarding financial planning and saving money revolves around what is known as the financial planning pyramid. You may hear other names such as the wealth management pyramid, the financial house, etc. You may also see different stages or “building blocks” added here or there, but I’ve broken it down for the purpose of this book to three basic levels for easier understanding.

The first level is where we see risk management. This is the foundation of your plan. It’s important to have a strong base to build off of, otherwise the slightest of breezes or tremors can send it toppling. Risk management can be simply seen as your insurance – and this can range from your auto, home, renters, life, health, disability, and umbrella insurance, to your will, emergency fund, and debt management.

The reason why insurance is the base is due to the fact that we have risks that most of us cannot afford to take on ourselves. Most of us don’t have $300,000 stored away to rebuild our home if it’s destroyed and most of us don’t have a million dollars to pay in case were liable for damages in an auto accident. By using proper risk management and having the correct insurance in place, we can leverage that risk and only pay a small amount of premium for a large amount of coverage.

The proper insurance coverage will make sure in the event of the worst happening, you have a bad day, not a bad life. Proper coverage can protect our wealth and our savings. Likewise with an emergency fund and a will. An emergency fund is just that – 3 to 6 months of living expenses in case you lose your job, become ill or suffer a loss and have high insurance deductibles. A will protects you making sure if and when you die, your possessions go to the people you want them to, and assign guardians for your children.

The next level is the wealth accumulation level. This is where we start saving via IRAs, 401(k)s, and other savings vehicles. It may also be the area where you may invest in not only the stock market, but also real estate, and other investments you know. Notice that it builds off of the risk management foundation – just in case you’re sued or suffer a catastrophic loss, your wealth is secure, since you have a solid base.

Finally, you have the estate planning level making the pyramid complete. This is where distributions strategies are employed regarding the wealth you’ve built, where proper trusts and other legal entities are employed to protect wealth from taxation. It’s also the level where people think about charitable giving and leaving a legacy.

It goes without saying; please see a competent professional when working and employing strategies in any of the levels of the pyramid.

Posted on Aug 23rd, 2013

by author: sraskie.

Posted in: estate planning, estate tax, fee-only, fiduciary, financial planning, goals, home insurance, Insurance, investing, investment, life insurance.

Are You Protected?

Aug 21st, 2013

by sraskie.

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Home destroyed by Hurricane Elena (Photo credit: State Library and Archives of Florida)

I recently received a call from a friend of mine asking questions about his newly acquired rental property. He had just moved from a duplex where he owned the entire duplex and lived on one side. Having purchased a home and finding a new tenant to replace where he was living, he was surprised and upset when his insurance on the duplex nearly doubled.

After some debate he decided to reduce the replacement cost of the building that the insurance company had placed on the building from $500,000 to $250,000. This, of course, sent red flags flying in every direction in my brain.

His first question to me was why his insurance nearly doubled. The reason was that since he was no longer a tenant in his own duplex the insurance company assesses that as more risky and adjusts the premium accordingly. He further commented that the replacement cost was just too high and that he hadn’t paid nearly $500,000 for it and even $250,000 seemed high.

This is what I explained to him. When an insurance company assesses the cost to rebuild your home, a number of factors go into that assessment. They will look at the price and kind of materials to rebuild, labor, style of the home, basement or not, landscaping, number of bedrooms, bathrooms, and more. When the home was first built, almost always the materials and labor were cheaper and chances are the home was built (if in the city) in conjunction with several homes in the subdivision. Big trucks, cranes, etc. could be used to build the home. Now it may take several workers with wheelbarrows to do the same thing so as not to infringe on the neighbor’s rose bushes.

In addition, insurance doesn’t care what you paid for the home, just what it costs to rebuild it. If the duplex was purchased for $125,000 in 1973, that $125,000 had much more purchasing power than it does today in 2013.

This leads to the heart of this story – the coinsurance clause.

Many insurance policies contain a clause that states that your home needs to be insured to at least 80%of its reconstruction cost. This means that in the duplex above, the home needs to be insured for at least $400,000. As long as a building is insured for at least 80% of the reconstruction cost then the insurance company will pay the full replacement cost of the home.

If not, a formula is used and you can guess it’s not to the insured’s advantage. For the duplex above, let’s say we had a $100,000 loss from a fire. In this case the policy would use the formula which is what the duplex is insured for ($250,000) divided by what it at least has to be insured for ($400,000) multiplied by the amount of the loss ($100,000).

So: ($250,000 / $400,000) x $100,000 = $62,500.

In this case, the insured would only get $62,500 for a $100,000 loss! This example also ignores any deductible which would bring that amount even lower.

Before we got off the phone my friend was now very concerned he was under-insured. He promised to look at his policy and get back to me to see if the coinsurance clause applied to him.

I highly suggest our readers consider doing the same.

Posted on Aug 21st, 2013

by author: sraskie.

Posted in: home insurance, mortgage, principal residence, renters insurance.

5 Essential Financial Planning Steps for Your 30s and 40s

Aug 19th, 2013

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(jb note: the article below is from my friend Roger Wohlner, who blogs at The Chicago Financial Planner.)

Many of the calls that I receive are from folks in their 50s or 60s who are either within sight of retirement or already retired. Many of these callers are pretty well-prepared for retirement and are seeking my help to fine-tune their situation and/or to help them through this next phase of life. This type of financial readiness doesn’t just happen it takes planning and preparation. Here are 5 essential financial planning steps for those of you in your 30s and 40s to help you reach your retirement goals and more importantly to help you achieve financial independence.

Get started

If for whatever reason you haven’t done much of anything to ensure your financial future it’s time to get going. Today is the best day to get started, tomorrow is the second best day, and so on. If you are in your 30s or 40s and haven’t begun to save for your retirement, if you have a family and don’t have a basic will or any life insurance, if you have debt or spending issues it’s time to get started on a path to secure your financial future.

Protect your family

I can’t tell you how many phone calls I’ve received from a 30 or 40 something professional (always a male) with young kids and a stay at home spouse. Typically the caller is all excited about investing or perhaps about buying income property. Both are great ideas. However when I ask whether he has any life insurance in place or even a basic will naming a guardian for his young children the answer is something like “… we’ve talked about that…” My response is to implore him to stop talking about it and get it done. I generally follow-up the phone call with a list of estate planning attorneys for them to consider.

My point is this, if you are in your 30s or 40s and have a family you need to ensure their financial security. Term life insurance is very cheap in this age range assuming that you are in good health. Until you’ve accumulated sufficient assets to provide for your family in the event of your death, life insurance is a great way to build an estate quickly.

It is vital that parents of minor children at least have a will in place that names a legal guardian for their children in the event of their death.

While we are on this subject make sure that all beneficiary designations on retirement accounts, annuities, and insurance policies are up to date and specify the correct beneficiary. There is no better way to say “I love you” to a spouse than to have you life insurance go to an ex-spouse or somebody else because you forgot to update the policy’s beneficiary designation.

Even if you are single at the very least you will want to give some thought as to where your money and assets would go if you were to die and take the appropriate actions to ensure this would happen.

Save for retirement

There is still time to accumulate assets for retirement. Time in fact is one of your greatest assets here. Contribute to your 401(k) or similar retirement plan. Contribute to an IRA.

In many cases you may be starting a family or looking to fund college during these years. While there may be conflicting demands for your money, save as much as you can for retirement. As you get to your 50s, 60s, and beyond you’ll be glad you did.

If you are single this is all the more reason to ramp up your retirement savings, assuming you never marry it’s all on you to save for a comfortable retirement.

Financial planning is vital

Many folks get serious about financial planning in their 50s and 60s as they approach retirement. There’s nothing wrong with this. However having a plan in place in your 30s or 40s gives you a head start. Are you on track to beat the odds in the “retirement gamble?” Better yet what will it take to help you achieve financial independence?

Make sure the basics are covered. Get your spending in check and pay down your debts. If you haven’t done so already, adopt the basic fiscal habits needed to live within your means.

If you work with a financial advisor become knowledgeable. Take an interest in your situation. This doesn’t mean that you need to be a financial expert, but a bit of knowledge combined with your own good common sense will help shield you from fraud or just plain bad advice. If your financial advisor recommends what seems to be costly, proprietary (to his/her employer) financial products trust your gut and look for advice elsewhere. My very biased view is that you should seek the help of a fee-only financial advisor. Check out NAPFA’s guide to help you in finding the right advisor for your needs.

Combine and consolidate

By this time you’ve likely worked for several employers. If you are like many people you haven’t paid as much attention to your old 401(k) accounts as you should have.

This is a good stage of your life to do something with these old retirement accounts. Combine them into a consolidated IRA account. Roll them into your current employer’s plan. Do something with these accounts, don’t ignore this valuable retirement asset.

Invest like a grown-up

There’s nothing wrong with allocating a portion of your investment assets to taking some”flyers” on a stock you like, or an ETF that invests in a hot sector of the market, play money in other words.

The vast majority of you investments should be allocated in a fashion that dovetails with your financial plan. Have an allocation plan, stick with it, rebalance your holdings periodically, and adjust your allocation as you age or if your situation warrants.

This investing plan should take into account all of your investments including IRAs, company retirement plans, taxable investments, and so on. If you are married this should include both of your accounts.

For most people mutual funds and ETFs generally make the most sense. There is nothing wrong with individual stocks, but they require a level of expertise and research that most investors don’t have.

The planning, saving, and investing that you do in your 30s and 40s will pay major dividends down the road, as you seek a comfortable retirement and financial independence. Don’t waste time, get started today. Don’t become part of the retirement savings crisis in the U.S.

Please contact me at 847-506-9827 for a free 30-minute consultation to discuss all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.

Please check out our Resources page for some additional links that might be beneficial to you.

Photo credit: Flickr

Posted on Aug 19th, 2013

by author: jblankenship.

Posted in: education, fiduciary, IRA, qrp, qualified retirement plan, retirement.
Tagged: financial planning · guest

Why Diversify?

Aug 16th, 2013

by sraskie.

2 comments

Diversity (Photo credit: Wikipedia)

Remember Enron? I think we all do. Enron was once a powerhouse company that saw its empire crumble and took the wealth of many of its employees with it. Why was that the case? Many of Enron’s employees had their 401(k) retirement savings in Enron stock. This was the classic example of having all of your eggs in one basket and zero diversification.

Let’s say that the employees had half of their retirement in Enron stock and half in a mutual fund. Enron tanks but their mutual fund stays afloat. This means that they lost, but only lost half of their retirement, all else being equal.

Imagine if they had only a quarter of their retirement in Enron and the remaining 75% in three separate mutual funds. Enron’s demise is only responsible for a fourth of their retirement evaporating. This could go on and on.

The point is that when you choose to diversify you’re spreading your risk among a number of different companies. That way if one goes belly-up you’re not left with nothing.

Mutual funds are an excellent way to diversify among an asset class. For example, if you purchased a total stock market index fund you’d have nearly the entire US Stock Market in your portfolio which amounts to approximately 4,100 different stocks.

That’s great diversification but we can do better. The US equity market is only one area. We can diversify into domestic bonds, international stocks, international bonds, real estate, and so on. This is called diversifying among asset class. The point is that you want to spread your risk and diversify as much as possible so one market or asset class doesn’t ruin your entire portfolio.

A term we use often in the industry is correlation. This simply means how one particular security moves in relation to another. If I own two large cap growth funds they’re pretty closely correlated; meaning that if large cap companies fall both of these funds are going to fall very similarly.

If I own a large cap fund and a bond fund, then if large cap stocks fall, the bonds may rise or may stay the same or even fall slightly. This is because they are a different asset class and move differently than equities. Keep adding different assets to the mix and you have a potential portfolio that can withstand the dip and turns of the market.

Even the Oracle of Omaha, Warren Buffett diversifies. Granted he may have all of his eggs in one basket, Berkshire Hathaway, but own Berkshire Hathaway stock and you’ll get exposure to insurance, bricks, candy, cutlery and underwear to name a few. Admittedly, not many people have $175,000 to buy just one share of BRK stock, but the point is that even Mr. Buffett diversifies.

Diversify. It works.

Posted on Aug 16th, 2013

by author: sraskie.

Posted in: 401 k, 401 k 403 b, 457, asset allocation, asset class, diversify, financial planning, investing, investment, investment diversification, Roth IRA, roth ira.
Tagged: 401 k · 401k · investment · IRA · retirement savings · roth ira

Education Expense Tax Tips

Aug 14th, 2013

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Title page to Locke’s Some Thoughts Concerning Education (Photo credit: Wikipedia)

One way to help ease the bite of the cost of a college education is to use all available tax rules to your advantage. There are several items you can use, including 529 plans, Coverdell ESAs, and various credits for tuition and fee payments.

The IRS recently released their Summertime Tax Tip 2013-19: Back-to-School Tax Tips for Students and Parents, providing a valuable overview of a couple of important credits and deductions. The actual text of the Tip follows:

Back-to-School Tax Tips for Students and Parents

Going to college can be a stressful time for students and parents. The IRS offers these tips about education tax benefits that can help offset some college costs and maybe relieve some of that stress.

American Opportunity Tax Credit. This credit can be up to $2,500 per eligible student. The AOTC is available for the first four years of post secondary education. Forty percent of the credit is refundable. That means that you may be able to receive up to $1,000 of the credit as a refund, even if you don’t owe any taxes. Qualified expenses include tuition and fees, course related books, supplies and equipment. A recent law extended the AOTC through the end of Dec. 2017.
Lifetime Learning Credit. With the LLC, you may be able to claim up to $2,000 for qualified education expenses on your federal tax return. There is no limit on the number of years you can claim this credit for an eligible student.You can claim only one type of education credit per student on your federal tax return each year. If you pay college expenses for more than one student in the same year, you can claim credits on a per-student, per-year basis. For example, you can claim the AOTC for one student and the LLC for the other student.You can use the IRS’s Interactive Tax Assistant tool to help determine if you’re eligible for these credits. The tool is available at IRS.gov.
Student loan interest deduction. Other than home mortgage interest, you generally can’t deduct the interest you pay. However, you may be able to deduct interest you pay on a qualified student loan. The deduction can reduce your taxable income by up to $2,500. You don’t need to itemize deductions to claim it.

These education benefits are subject to income limitations and may be reduced or eliminated depending on your income.

For more information, visit the Tax Benefits for Education Information Center at IRS.gov. Also, check Publication 970, Tax Benefits for Education. The booklet’s also available at IRS.gov or by calling 800-TAX-FORM (800-829-3676).
Additional IRS Resources:

Tax Benefits for Education Information Center
Am I Eligible to Claim an Education Credit? – Interactive Tax Assistant tool
Publication 970, Tax Benefits for Education

Posted on Aug 14th, 2013

by author: jblankenship.

Posted in: american opportunity tax credit, coverdell accounts, education expenses, income tax credit, lifetime learning credit.
Tagged: american opportunity credit · college expenses · coverdell · education credit · education expenses · income tax · lifetime learning credit

Book Review: Asset Allocation-Balancing Financial Risk

Aug 12th, 2013

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This was a re-read for me, with the recent publishing of the fifth edition of this very important book. Roger Gibson has updated his excellent work with the results of his strategies during the Great Recession, up to date as of late 2012.

Advisors have much to learn from Mr. Gibson’s tome regarding the optimal methods for allocating your investment assets. Throughout the first portion of the book, the concepts of market-timing and superior asset selection are summarily debunked, and the benefits of market index investment and diversification are shown to be optimal. The author uses real-world data to underpin his findings. The result is the explanation that, with known investment time horizons, an optimal mix of investments can be determined that will produce superior long-term risk-adjusted results.

Much is written in the book, which is directed primarily to investment advisors, about the mind-set of the investor himself or herself. The point is that, even though as an advisor you develop and implement the best possible investment allocation, if the investor is reluctant to stick with the allocation plan through thick and thin, the benefits of the allocation are lost.

It is important to ensure that the advisor understands where the investor stands on the concepts of market timing and superior investment selection. Mr. Gibson displays this as a matrix as follows:

		Is Successful Market Timing Possible?
		YES	NO
Is Superior Security Selection Possible?	YES	Quadrant 1	Quadrant 2
	NO	Quadrant 3	Quadrant 4
Source: Roger C. Gibson, 1995

Folks who fall into Quadrant 1 believe that it is possible to choose the best time to enter and exit the market (e.g., buy low, sell high), and that it is possible to choose specific securities that will result in superior returns. This means that one day the investor wakes up and looks at his charts, graphs, and company reports and magically, he’s able to tell the future. He is capable (in his mind) of choosing just the right investment at just the right time, and furthermore he is capable of knowing when to sell that investment to avoid a downturn. Without going into the backing data, hopefully you can see that these folks, while they do exist, their results aren’t as anticipated – if the results were clearly superior, obviously all investable funds would eventually be placed with such a manager. No one has that kind of result.

Quadrant 2 devotees only believe that it is possible to choose superior securities, but that choosing the entry and exit times is not predictable. This investor buys his chosen superior investments and holds them for long periods of time, a true “buy and hold” investor.

Those with a Quadrant 3 worldview are of the belief that superior investment selection is not possible, therefore these investors choose to invest in index mutual funds or other methods of owning a broad basket of securities across various asset classes. However, Q3 folks believe it is possible to determine when is the best time to enter a holding in a particular asset class and when to exit the holding. This investor is constantly choosing between the asset class that he believes is in favor versus the asset class he believes is out of favor. Long-term results have shown that this sort of market timing is similarly unsuccessful as the Q1 worldview. Again, had this ever been the case, the results would speak for themselves.

This leaves us with Quadrant 4 – giving in to the fact that superior asset selection is not predictable, and timing is not possible. This means that we choose index-type broad market investments, and we hold to the investment allocation over long periods of time. This is the only long-term successful method of investment allocation, proven time and again with real world results.

This of course doesn’t mean to just simply determine the asset classes across which your investments should be allocated and split your investments evenly across all chosen asset classes. Time horizon for the investment activity must be known, as the shorter the time horizon, the less risk the portfolio can endure.

In addition, the investor’s appetite for (and tolerance of) risk must be determined. This determination is made by considering the amount of loss that the investor can emotionally withstand – and using knowledge of the risk profile of various mixes of investments to match up with the risk appetite. Naturally this risk appetite is countered by the requirement for returns from the investment – in order to achieve increased returns, generally risk must be increased.

In addition, once the asset class allocations are chosen based on the time horizon, return requirement, and risk appetite of the investor, as investment results occur over time the investment allocation must be re-balanced regularly. This is necessary to maintain the same risk/return profile that was originally selected. As well, over time the time horizon becomes necessarily shorter, so the original asset allocation must be re-aligned to fit the new horizon.

The above is only a brief overview of what I found to be the most important take-aways from this critical book. I highly recommend this book for any advisor who is looking to develop long-lasting superior risk-adjusted returns for his clients. Individual investors can benefit from the book as well, although the much of the book is devoted to working with clients to develop allocation plans.

Posted on Aug 12th, 2013

by author: jblankenship.

Posted in: Book review, investing.
Tagged: book review · investment

Book Review: The 7Twelve Portfolio

Aug 9th, 2013

by sraskie.

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Diversification – Investing (Photo credit: 401(K) 2013)

The 7Twelve Portfolio is an excellent concept for financial planners and novice investors alike. The book is very well written and easy to comprehend as Dr. Israelsen keeps the concepts simple and analogies easy to follow. The crux of the book is regarding diversification and Dr. Israelsen uses the analogy for making salsa as a reference. For example, you don’t have salsa of you just have diced tomatoes and it really doesn’t improve if you simply add some onions and salt. It improves a little bit, but still isn’t salsa.

The same is true for diversification. You’re not diversified if you own one stock or bond in your portfolio and have all of your holdings in that one asset. The benefits of diversification begin when you start adding additional ingredients to the mix. This starts to lower risk and help maximize return. This is a concept us nerdy planners call correlation. The less assets are correlated the better. That means when one asset class falls a different asset class may rise or even stay the same.

With enough ingredients in our salsa of investments we get a portfolio that’s well diversified and less susceptible to extreme gyrations in the market. It also provides a portfolio that generates better returns than one would think simply because we got the ingredient mix correct.

Think of it this way: you absolutely love dessert. But too much of a good thing isn’t always the best idea, right? If you just ate dessert all the time, your blood sugar would spike and then you’d crash later in the day. What you want is a balanced meal that keeps your energy relatively even throughout the day. With investing, if you only have one or two investments, you’ll reach extreme highs and then you may crash later as well. Having the right mix of assets keeps your portfolio balanced and better prepared to handle “market indigestion”.

Overall if you’re looking for a good book that reinforces the diversification discussion (and you like salsa) the 7Twelve Portfolio is a good, short read that will give some valued insight on proper diversification and asset allocation.

Posted on Aug 9th, 2013

by author: sraskie.

Posted in: Book review, investing, investment, retirement, retirement plan, retirement plans, retirement savings, retirement savings plans.
Tagged: investment · qualified retirement plan · retirement accounts · retirement savings

Social Security Spousal Benefit at or After FRA

Aug 7th, 2013

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Actress Alice Terry (Photo credit: Wikipedia)

Some time ago I wrote an article on the Social Security Spousal Benefit Before FRA, and an astute reader (thanks, SD!) pointed out the obvious to me: I hadn’t written the complementary piece on calculating the spousal benefit at or after FRA. So let’s get right to it!

When you wait until Full Retirement Age to file for spousal benefits, there is no reduction of that portion of your benefits. In other words, the spousal benefit will be based on 50% of your spouse’s PIA minus your own PIA, and then this amount will be added to whatever retirement benefit that you’re receiving on your own record. This additional benefit can’t increase your total benefit to a point greater than 50% of your spouse’s PIA.

Here are some examples:

Started own benefits early

Alice and Terry are both age 66. Alice started her own benefit early, at age 62. Her PIA is $800, and Terry’s PIA is $2,000. Since she filed early, Alice’s monthly benefit is reduced to $600, 75%, of her PIA. Now at age 66 (FRA for both of them) Terry files and suspends, allowing Alice to file for spousal benefits. The calculation is as follows:

50% of Terry’s PIA ($1,000) minus Alice’s PIA ($800) equals $200

Therefore, when Alice files for spousal benefits, she will receive an additional $200 on her monthly check, for a total of $800.

Started own benefits at FRA

If Alice had delayed filing for her own benefit until she was at FRA, her own benefit would be $800. If Terry has filed for his own benefit or filed and suspended, Alice can now file for the spousal benefit. The calculation is as follows:

50% of Terry’s PIA ($1,000) minus Alice’s PIA ($800) equals $200

This $200 is then added to Alice’s own retirement benefit, so her total benefit amount is now $1,000. This is equal to 50% of Terry’s benefit, so there is no further reduction.

Started own benefits after FRA

If Alice was two years older than Terry, for example, Alice could have delayed starting her own benefit to an age later than FRA, and therefore her benefit would be increased by Delayed Retirement Credits of 8% per year. If she filed for her own benefit at age 68, her own benefit would now be $928, an increase of 16%. When Terry reaches FRA and files for his own benefit (or files and suspends), she is now eligible for the spousal benefit. The calculation is as follows:

50% of Terry’s PIA ($1,000) minus Alice’s PIA ($800) equals $200

Since adding the spousal offset to Alice’s own benefit would result in a total monthly benefit greater than 50% of Terry’s PIA, the overall increase for the spousal benefit would be reduced to $72, so that Alice’s total monthly benefit would not be greater than half of Terry’s PIA, the maximum benefit due to spousal increase.

Posted on Aug 7th, 2013

by author: jblankenship.

Posted in: delayed retirement credit, file and suspend, Social Security, Social Security spousal benefit, Spousal Benefit.
Tagged: delayed retirement credit · Social Security · spousal benefit

A Good Reason to File and Suspend: Back Benefits

Aug 5th, 2013

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Man wearaing suspenders (Photo credit: Wikipedia)

We’ve discussed the file and suspend option in the past as it relates to enabling your spouse or dependents to begin receiving benefits based on your record while you delay filing to accrue the delay credits. But there’s another reason that you might want to file and suspend at Full Retirement Age (FRA) – and this one has little to do with a spouse, even single folks can take advantage of this.

When you file and suspend, what you have done is to establish a filing date notation on your record. By establishing a filing date notation, as mentioned before, your spouse and dependents can file for benefits based upon your record. In addition, since there is a filing date on your record, you are eligible to change your mind about delaying your filing to a later date and receive your benefits retroactively from that point to the point when you “unsuspend” your filing. Then from that point forward you will receive your benefits monthly as if you had filed (and not suspended) on the original date.

An important point is that you cannot file and suspend until you have reached Full Retirement Age. This option is not allowed prior to FRA.

Why would you want to do this?

There may be more reasons, but the one that immediately comes to mind is if you have a reason to believe that your lifespan will be much shorter than the crossover age, typically around age 80. After the crossover point, your lifetime benefits from delaying your retirement become more than if you had filed earlier.

Commonly when the decision is made to delay benefits past FRA, you are assuming that it will be beneficial for you in the long run – in other words, you anticipate that you’ll live beyond the crossover age.

For example, you could file and suspend at age 66 (FRA) and then later, at age 68 you are diagnosed with a significant health problem that will likely shorten your life. Instead of waiting until age 70 to file for your benefits, or unsuspending your benefits at your current age, you could ask to unsuspend your benefits as of the date that you originally filed at FRA (age 66). You would then be eligible to receive back-benefits from the point of the original filing in a lump sum, and then you’d receive benefits each month going forward at the rate you would have received at age 66 (plus COLAs).

If you’re single and delaying your benefits past Full Retirement Age, I can’t think of any reason why you wouldn’t want to do this. There’s always the possibility that you will have a change in your outlook (heaven forbid). If that were the case, the back-benefits could come in really handy, not to mention that you could receive ongoing benefits from that point on.

On the other hand, if you’re married you need to consider if there’s a possibility that it might be beneficial to receive spousal benefits based on your spouse’s record. If so, then you wouldn’t want to file and suspend, because this would substantially reduce or eliminate any spousal benefit that you would be eligible for. Keep in mind as well that if you unsuspend your benefit, your surviving spouse and dependents’ benefits will be based on the lower benefit level (when you originally filed).

For example, Tom and Joy are age 66 and 62 respectively. Tom’s expected age 66 benefit is $1,800 per month, and Joy’s is $800. Joy intends to begin receiving her own benefits right away at age 62, and as such her benefit will be reduced to $600, or 75%. Tom has a choice now: he could file and suspend, or he could file a restricted application for spousal benefits only.

If Tom files and suspends, Joy will be eligible for reduced spousal benefits of an additional $70 on top of her reduced retirement benefit, for a total of $670 per month. However, if Tom were to file a restricted application for spousal benefits only, he would be eligible for $400 per month. So this way, Tom and Joy are receiving a total of $1,000 per month. In this case Tom would not want to file and suspend his benefits at FRA – unless he’s concerned about the possibility of a shortened lifespan.

Posted on Aug 5th, 2013

by author: jblankenship.

Posted in: #noTOP, delayed retirement credit, Social Security, Social Security spousal benefit, Spousal Benefit.
Tagged: delayed retirement credit · Social Security · social security spousal benefits

The Airplane Analogy

Aug 2nd, 2013

by sraskie.

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Safety Instructions… (Photo credit: Ranieri Ribeiro)

Many parents face the decision during their working years to try to fund both retirement and college education. Some can adequately do both while others are forced to do the best they can with what money they can save.

Sometimes parents can get caught up in wanting to save as much as they can for their children’s college education and forgo the need to save for or save more for retirement.

When this situation presents itself, I have given my clients my airplane analogy. It goes something like this:

Have you ever flown on an airplane before? If you have you know that once you’re scrunched in and belted and the plane makes its way from the gate the flight attendants break radio silence and start with their routine flight instructions. After you’re taught where the exit rows are and how to use your seat as a floatation device they inevitably change the conversation to cabin pressure.

Should the aircraft experience a decrease in cabin pressure oxygen masks will fall from the overhead compartments. Grab the mask and fully extend the cord to allow the release of oxygen.

The next words are crucial to your survival.

Place the mask over your face and tighten the straps on the side. Once your mask is secured then attend to your child or help the person next to you.

Why would they say that? Because if you pass out at 35,000 feet you’re of no use to anyone.

A similar comparison can be made for those parents saving for both retirement and college. If the focus is solely or mostly on college savings, there may be little if any money accumulated for retirement. In addition, there are plenty of financial aid opportunities available for college. The options for financial aid in retirement are slim.

I’m not saying don’t save for your child’s education. It is very important and a priority for many parents. What I am saying is make sure your retirement savings are being added to as well. Otherwise the reward for all of that money saved for college may be a degree – and two future roommates for the graduate!

Posted on Aug 2nd, 2013

by author: sraskie.

1 comment already - add to the conversation!

Posted in: 529, coverdell esa, retirement, retirement plan, retirement plans, retirement savings, retirement savings plans.
Tagged: 401 k · investment · qualified retirement plan · retirement accounts · retirement plan · retirement savings

3 Reasons to use the new safe harbor home office deduction and two reasons not to

Jul 31st, 2013

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home office (Photo credit: Sean MacEntee)

Home office workers! In case you hadn’t heard about it, the IRS made some changes to the way the home office deduction works for 2013. Essentially, you are now allowed to deduct a flat $5 per square foot of dedicated office space, with a maximum of 300 square feet. But this new “safe harbor” option isn’t for everyone. Listed below are three reasons this may be good for you, and a couple of reasons that you might want to use the old method.

3 Reasons It’s a Good Thing

Depreciation recapture not needed any longer – if you are just starting out taking the home office deduction, you can forget about this concept of “depreciation recapture”. This is a required add-back (actually basis reduction) when you sell your home. If you took the old-style home office deduction, including depreciation of your home office space, you’ll still need to keep records of the depreciation that you claimed in earlier years and recapture that depreciation when you sell your home. (Note: you’ll also need to maintain these records even if you start taking the safe harbor amount, since you might switch back to the old method, as well. More on that later.)

Less record keeping – In the past when calculating the home office deduction, you needed to gather together your utility bills, mortgage interest, real estate taxes, repair bills, etc., in order to determine the amount that is attributable to the home office. Under the safe harbor rule, this isn’t necessary.

No loss of mortgage exp deduction – In addition to the above, under the old method, any amount for real estate taxes and mortgage interest that are claimed under the home office deduction had to be subtracted from those expenses for use on your Schedule A – this is no longer required if using the safe harbor $5 rule.

2 Reasons You May Want to Stick With the Old Rule

Office or dedicated space is larger than 300 square feet – You’re limited to 300 square feet under this new provision. For many home office deducters, this will be plenty, but there are likely many exceptions. If your office includes a dedicated waiting area, for example, this could easily go beyond the 300 square foot maximum.

Carry overs from prior years are lost/no carryover allowed – if your home office expenses are greater than your gross income less business expenses and you’re using the new safe harbor method, there is no carryover of the excess to future years. Using the old method, the excess could be carried over. In addition, if you switch to the safe harbor method, any prior year carryover is lost.

(Here’s a bonus, but it’s not for the faint of heart!) If you later switch to the old method you have to account for the prior depreciation (only as basis for depreciation). This over-complicates the depreciation calculation, as you must skip the years when depreciation isn’t charged to determine basis for the current year, but account for those years when determining which year’s depreciation to deduct.

General

Choice can be changed each year – Using the safe harbor rule in one year doesn’t lock you into that choice for the future. You can switch back & forth every year if you wish… but keep in mind that this is going to complicate your depreciation calculations quite a bit. Also, once you’ve filed a return with one choice or the other, you cannot go back and amend the return to change the method of home office deduction – it’s an irrevocable choice.

If you have more than one home and you intend to take the home office deduction for offices in each home, you are limited to using the safe harbor for only one of the offices in any particular year. You can still use the old method on your other home offices in that year. You’re not required to use the safe harbor rule for any of the offices.

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Posted on Jul 31st, 2013

by author: jblankenship.

1 comment already - add to the conversation!

Posted in: 2013 tax year, income tax, irs, itemized deduction.
Tagged: home office deduction · income tax · income tax deduction · irs

Book Review: A Random Walk Down Wall Street

Jul 26th, 2013

by sraskie.

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A Random Walk Down Wall Street (Photo credit: Wikipedia)

Right from the start this book will be an excellent read for both financial advisors as well as their clients. Dr. Malkiel provides academic insight on the reasons why passive management works and some great commentary on the use of index funds as part of someone’s overall portfolio.

This was the second time I read this book and certainly not the last. It’s great reinforcement on why we invest our clients’ money the way we do and provides solid academic evidence that doing anything to the contrary is counterproductive, more expensive and simply playing a loser’s game.

Some of the bigger takeaways from the book are Dr. Malkiel’s thoughts and research on the different part of the Efficient Market Hypothesis or EMH. The EMH consists of three parts – the strong form, the semi-strong form and the weak form. The EMH essential admits that markets are efficient – meaning that current prices of stocks reflect all available information and prices adjust instantly to any changes in that information.

The weak form of the EMH rejects technical analysis as a way for beating the market and getting superior returns. Technical analysis can best be described as using past information to exploit future stock picks. Examples of exploiting such information are through charting, which is analyzing a stock based on its pattern of movement on a chart. Other examples given are those of anomalies that investors try to exploit such as the January Effect and the Dogs of the Dow.

The semi-strong form of the EMH says that analyzing a company’s financials, managers, and quarterly and annual reports will not help an investor or manager find stocks that will beat the market overall, thus bot technical and fundamental analysis of companies is futile.

The strong form of the EMH goes even further by stating that even inside information (think Martha Stewart and ImClone) won’t lead investors to superior returns over the market. So technical and fundamental analysis along with insider information are useless.

Admittedly, we know that anomalies exist and there are going to be differences here and there. Even Dr. Malkiel admits this – which is why it’s called a hypothesis and not a law. But the point to remember here is that even though markets have anomalies they are generally efficient and to the extent markets are inefficient, we won’t be the ones to beat them.

Think of it this way: if hundreds of Wall Street professionals and analysts can’t get it right, what makes us think we can?

So don’t try to beat the market; buy the market.

And that’s the meat and potatoes of this book.

Posted on Jul 26th, 2013

by author: sraskie.

Posted in: Book review, index funds, investing, investment, IRA, ira funds, ira money, iras, life insurance, mutual fund expenses, mutual funds, qualified retirement plan.
Tagged: 401 k · 401k · efficient market hypothesis · EMH · fiduciary · investment · IRA · mutual fund expenses · passive fund · qualified retirement plan

Be Careful When Using Your Social Security Statement for Planning

Jul 24th, 2013

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The Statement (Photo credit: Wikipedia)

Recently I received an interesting email from a reader (thanks, JRT!) that illustrates one of the problems with interpreting your statement from Social Security on a regular basis. Part of the email follows:

I am just reaching 66 and have been self employed for many years. I have worked continuously for 30+ years reaching $100,000 or so per year but have been slipping into retirement and last years income dropped to $70000. SS has already reduced my monthly payment estimate. It appears that if I postpone beginning taking my SS retirement I will lose in the long term because each year I have reduced income before retiring my SS distribution will be less. For instance if I defer to 70 and have 4 years with zero income won’t I be hurting myself???

In the situation described above, what the reader is describing is the amounts he is seeing on statements from Social Security. When he was (for example) 64 years old, he saw a projected benefit at age 70 approaching the maximum benefit. Then when he got his new projection a year later, after he had reduced his income for the most recently-reported year, the amount was less. It appears that he’s losing benefits by delaying – right?

Not really.

The problem is with the way that the SS calculates your projected benefit. They always assume two things that will tend to cause problems:

Your most recently-reported wages will continue at that same rate until you retire.
You will continue working until you file for SS benefits.

Jeff’s Statement at Age 64

So let’s work this out in an example. FYI, I’ve done all of this work using the Social Security “Any PIA” online calculator. The reader (let’s call him Jeff) was born in 1949, so in 2013 he is 64 years of age. He has earned the Social Security maximum earnings from 1978 to the present. When he receives his estimate for benefits at age 70, the projected amount of his benefit is $3,452. (Note: When I plugged in the numbers for 2013 and 2014-beyond, I used the current max amount of earnings, $113,700, to reflect what SS does for the statement.)

If I go back and change the retirement age to 66, the benefit calculates to $2,579. It’s safe to assume that if the situation was exactly as I described, Jeff would have received a statement showing him that information when he was 64 years of age.

Jeff’s Statement at Age 65

To estimate what would happen to Jeff’s estimated benefits the next year when he gets his statement, I changed his birthdate to 1948, and – since he indicated he is now earning less, I showed that instead of the maximum amount for 2012, 2013, and 2014-beyond, he actually projects to earn $70,000. Now, his projected benefit at age 70 is $3,394 – since the future projected income is less than was projected a year earlier. The projected age 66 benefit is now $2,571, also less than before, but by a smaller margin since fewer years are impacted.

Jeff hasn’t “lost” benefits – because the projected amount was only that, a projection. Since the reality is that he received less in earnings than was originally projected, his accurately-projected benefit is now less. In other words, the only way Jeff could have achieved the projected benefit is if he continued to work at the same income level ($113,700) as was projected for him.

Jeff’s Statement at Age 66

Taking Jeff’s last statement into account now – what happens if he stops working at age 66 and has four zero years? To display this, I again dropped his birthdate back by a year, so that it indicates he is age 66 this year. The past three years (including 2013) he has received earnings of $70,000 – but for future years, he will receive zero income. Now the calculator shows a projected age 70 benefit of $3,306, which is likely to be very accurate – the only difference would be the annual COLAs that are applied (if any) between now and when Jeff reaches age 70.

Conclusion

So – as you can see, it can be dangerous to assume that the projected benefits on your Social Security statement are completely accurate for your situation, unless you actually will earn the same income between now and the date you begin receiving benefits. In the case of Jeff, since his income is reducing and potentially going to zero for his last four years before age 70, the projected benefit from a couple of years prior was overstated. The overstatement in this case was roughly $150 per month.

Posted on Jul 24th, 2013

by author: jblankenship.

Posted in: Earnings Limits, Social Security, social security benefits, social security retirement.
Tagged: maximum benefit · Social Security · social security statement

Tips When Renting Out Your Vacation Home

Jul 22nd, 2013

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English: Rental cabins near the Great Smoky Mountains National Park in Sevier County, Tennessee. (Photo credit: Wikipedia)

If you have a vacation home that you only use during for brief vacations throughout the year, you might have entertained the thought of renting out the home to defray some of your expenses. Using a property for mixed purposes – that is, partly as personal and partly as a rental (business use) – can lead to some complications with regard to your income taxes.

This is due to the fact that the income earned from renting out the property is likely to be taxable income, which you will need to report on your income tax return. Of course, you’re allowed to deduct the expenses that are related to the production of income, and then you’re only taxed on the net income after the deductions.

The IRS recently published their Summertime Tax Tip 2013-08, which provides some of the guidelines to keep in mind if you’re going to rent out your vacation home. The complete text of the Tip follows:

Renting Your Vacation Home

A vacation home can be a house, apartment, condominium, mobile home, or boat. If you own a vacation home that you rent to others, you generally must report the rental income on your federal income tax return. But you may not have to report that income if the rental period is short.

In most cases, you can deduct expenses of renting your property. Your deduction may be limited if you also use the home as a residence.

Here are some tips from the IRS about this type of rental property.

You usually report rental income and deductible rental expenses on Schedule E, Supplemental Income and Loss.You may also be subject to paying Net Investment Income Tax on your rental income.
If you personally use your property and sometimes rent it to others, special rules apply. You must divide your expenses between the rental use and personal use. The number of days for each purpose determines how you divide your costs.Report deductible expenses for personal use on Schedule A, Itemized Deductions. These may include costs such as mortgage interest, property taxes, and casualty losses.
If the property is “used as a home”, your rental expense deduction is limited. This means your deduction for rental expenses can’t be more than the rent you received. For more about this rule, see Publication 527, Residential Rental Property (Including Rental of Vacation Homes).
If the property is “used as a home” and you rent it out fewer than 15 days per year, you do not have to report the rental income.

Get Publication 527 for more details on this topic. It is available at www.irs.gov or by calling 800-TAX-FORM (800-829-3676).

Posted on Jul 22nd, 2013

by author: jblankenship.