Financial Planning Corner:
What You NEED to Know!
Eric Walter, Financial Planner
Congress just passed two very important pieces of legislation- the SECURE Act & the CARES Act. Both have many important provisions. Some of the financial planning highlights are below*:
SECURE ACT (Setting Every Community Up for Retirement Enhancement) 12/20/2019:
RMDs delayed to 72 from 70.5;
IRA contributions may continue past age 70.5 (Earned income requirements still apply.);
Most non-spouse IRA beneficiaries must distribute all funds by end of 10th year after IRA owner’s death;
401(k) plans may offer annuities;
529s may be used for apprenticeships, student loan payments, and other elementary & secondary education costs;
Children’s unearned income taxed at parent’s marginal tax rate;
Several changes to employer retirement plans making them more accessible and cost effective.
CARES ACT (Coronavirus Aid, Relief, and Economic Security) 3/27/2020:
2020 RMDs for IRAs & 401(k)s suspended;
Based on the 2019 tax return (2018 if not filed), many individuals will receive up to $1,200 (phased out beginning at $75,000 of AGI for single filers & $150,000 for joint), plus $500 per child 16 or under.
Caveat- payment is an advance on a 2020 refundable tax credit;
The April 15th tax filing deadline moved to July 15th (SWM ALL CLIENT EMAIL 3/27/2020);
First quarter 2020 estimated tax payments are postponed to July 15th;
For tax filers who itemize, 2020 charitable deduction limit increased; for those using the standard deduction, up to $300 may now be deducted for AGI;
Unemployment benefits expanded to the self-employed, independent contractors, and others; increased by $600/week up to 4 months;
401(k) loan limit increased to $100,000 from $50,000;
10% early withdrawal (up to $100K) penalty from retirement plans waived for coronavirus-related purposes, retroactive to January 1st; may claim this income over 3-years;
Coronavirus-related retirement fund distributions may be repaid within 3 years;
Federal student loan payments & interest accrual suspended until September 30th;
Paycheck Protection Program helps small businesses make payroll and cover other expenses (www.sba.gov).
*Please consult your tax preparer or CPA for guidance on your specific situation or for information on additional provisions.
Eric Walter, Financial Planner
Many people call themselves “financial planners” but lack the credentials and standards of CFP® Professionals. One key differentiator between the two is the certified designation. A CERTIFIED FINANCIAL PLANNER™ professional or CFP® professional is held to high educational, ethical, and fiduciary standards that require them to act in a client’s best interests at all times. The CFP Board spent two years developing a new Code of Ethics and Standards of Conduct that took effect October 1, 2019.
I. The Code of Ethics states that a CFP® professional must:
Act with honesty, integrity, competence, and diligence.
Act in the client’s best interests.
Exercise due care.
Avoid or disclose and manage conflicts of interest.
Maintain the confidentiality and protect the privacy of client information.
Act in a manner that reflects positively on the financial planning profession and CFP® certification.
II. The Standards of Conduct state that a CFP® professional must:
Act as a fiduciary at all times when providing advice.
Comply with all objectives, policies, restrictions, and lawful directions of the client.
Provide competent professional services by maintaining the relevant knowledge and skill to apply that knowledge.
Treat clients, prospective clients, fellow professionals, and others with dignity, courtesy, and respect.
Comply with the law.
Comply with practice standards for the financial planning process.
Anyone seeking to become a CFP® practitioner must submit to a background check and meet the CFP Board standards. Once attaining certification, any violation of ethical and/or practice standards may lead to disciplinary action or even revocation of certification. Education, experience, and exam requirements ensure that everyone using the CFP® mark has the expertise necessary to deliver on the standards set forth by the CFP Board.
I am currently taking the 6th course, Estate Planning, through Boston University’s Financial Planning Program. I have already completed Introduction to Financial Planning, Risk Management & Insurance Planning, Investments, Tax Planning, and Retirement Planning & Employee Benefits. After Estate Planning, I will take the Financial Planning Capstone course which integrates the knowledge from the previous 6 courses into a comprehensive financial plan. This will complete my accredited education requirement. In May, I will also complete the 6,000 hours experience requirement to take the CFP® Certification Exam. I look forward to joining Susan & John as a 3rd CFP® professional on your SWM team.
Eric Walter, Financial Planner
In the 2019 Gallup poll on Social Security, 67% of Americans listed Social Security as one of their top worries with only 33% of non-retired adults expecting it to be a major source of retirement income. When working on Financial Plans, client discussions most often include benefit amount and claiming strategy; however, sometimes we address the more fundamental concern of sustainability. Even if you are already claiming, you may have concerns.
This concern is further illustrated by the disclaimer on the current Social Security statement. “Your estimated benefits are based on current law. Congress has made changes to the law in the past and can do so at any time. The law governing benefit amounts may change because, by 2034, the payroll taxes collected will be enough to pay only about 79 percent of scheduled benefits.” While this creates a distressing headline, Social Security has never missed a payment and had reserves of $2.9 trillion at the end of 2018. Nevertheless, changes will have to be made at the congressional level.
Earlier this year, a bill (H.R. 860) was introduced in the house to address this long-term shortfall by gradually increasing payroll and self-employment taxes. Income above $400,000 would also be included in calculations. Currently, income above $132,900, indexed each year, is not subject to the Social Security portion of taxes. This would create revenue and additional planning opportunities. The bill also updates the method for the cost-of-living adjustment (COLA) and the calculation for benefits, increasing benefits across the board. This bill may not become law but with 210 co-sponsors it demonstrates that a fix is likely on the horizon.
If you haven’t already, we recommend setting up a mySocialSecurity account at www.ssa.gov/myaccount. If you receive benefits or have Medicare, you can check your benefit and payment information, update direct deposit, and get replacement tax documents. If you are not yet receiving benefits, the homepage gives you a snapshot of your estimated benefit at full retirement age (FRA) and your last reported earnings, as well as, the ability to print your full statement, view your earnings record, and estimate benefits. As situations change, Susan and John are here to discuss any questions or concerns you have.
Second Set of Eyes
Eric Walter, Financial Planner
For our analysis work, we have at least one other team member review the methodology, results, and conclusions to minimize errors and take full advantage of planning opportunities for clients. When we receive your financial planning documents (i.e. estate plans, insurance policies, and tax returns), we thoroughly review them before giving advice. The impact of these additional checks is often hard to quantify but usually there are “big dollars” involved. Let me give you some recent examples.
Tax Returns have many moving parts and just one mistake can be costly. One of the common errors is with Qualified Charitable Distributions (QCDs), which are tax-free IRA distributions paid directly to a qualified charity. The issue stems from the provided tax form, the 1099-R, not distinguishing/differentiating the QCD amount. You must let your tax preparer know AND provide copies of the checks written to the nonprofits. If filed improperly, this can lead to a substantial tax overpayment. Just this year we have identified errors leading to nearly $3,000 in additional tax refunds for our clients.
Many of us have purchased an Insurance Policy, set up automatic payments, and never looked at it again. After discussions of specific coverage needs with several clients, some discovered they were actually over-insured. We reviewed the pros & cons of reducing the benefit or canceling the policies. Several clients chose to keep their long-term care policies but reduce potential premium increases by changing the mix of benefits. Another cancelled the life insurance policy they no longer needed. These risk planning sessions will save thousands in premium payments over their lifetimes.
Estate Planning is meant to ensure your wishes are followed during incapacity and after death. The biggest gaps we usually find are no named successor trustees, guardians, or contingent beneficiaries (2nd and 3rd person(s) in line). It can be a tough decision, which often leads to no decision. Then, a difficult estate settlement can loom during already stressful times. We have assisted several clients this year with their options and helped them reach a final decision so the attorneys and custodians could complete the estate plans. By setting specific directives and designating beneficiaries for ALL assets, the onus is taken off loved ones and unnecessary costly expenses are avoided.
By providing us with your Financial Planning documents, we are able to discuss issues and provide perspectives you may not have considered. Our second set of eyes may even find some extra money for you, too!
The New Retirement
Eric Walter, Financial Planner
Saving and systematic investing have always been such a significant focus of Retirement Planning that it can be an overwhelming emotional shift to start withdrawing from a portfolio. One of the hardest decisions choosing an ideal withdrawal rate to feel fulfilled now but not impair future solvency.
The withdrawal rate best for you and your portfolio depends on many factors, including downward pressure on stock prices. As discussed in many recent editions of our Macroeconomic View and Outlook, volatility in the aging global stock market recovery is increasing and can prevent portfolios from maintaining their values for a period of time. This risk increases with portfolio withdrawals during corrections, especially if made at the same pace as when markets are up.The risk is even greater for new retirees.
Retirement researcher Wade Pfau simulated this risk in a 2018 study, Two Bad Years, Two Different Outcomes. He assumed “…a 30-year retirement and an average annual return of 3%, and a new retiree with $1 million who decides to withdraw 5% a year. If the portfolio declines 15% in the first and second years of retirement, the retiree is out of money by year 21. If the retiree saw the same decline of 15% in years 29 and 30, they would still have $364,000.” Depending on the size of your portfolio, your spending vs. fixed income (pension, social security, part-time income) and your longevity, making NO withdrawals when the market is down could be a significant portfolio risk reduction strategy. This leads to the question every retiree faces: How much can I/we withdraw now to have what is needed and wanted but not run out of money in later years?
Other recent research supports varying your withdrawal rate. The old “4% Rule” is just that, old…and outdated. There are too many variables for a one-size-fits-all approach. One thing is for sure. We have to plan on living longer. “In the 1950s, people retiring at age 65 lived until 78. Today’s retirees can expect an average lifespan of 83 or 84 years – which means that half of (us) will live much longer than that.” (Kathleen Coxwell, 2017, What Are the New Rules of Retirement? 10 Guidelines for Financial Security) Indeed, we have clients in their 90s in good health, enjoying their lifestyles. As long as you are in good health, solid financial planning should include portfolios lasting into your 90s.
The Center for Retirement Research (CRR), using Required Minimum Distribution formulas, recommends the following withdrawal rates based on life expectancy: ages:60s: 3-3.5%; 70s: 3.5%-5%; 80s: 5%-8%; 90s: 9%-15%.
Determining your ideal withdrawal rate should be part of your annual financial planning review. It’s important to find a balance between being so conservative you struggle financially and the risk of running out of money. Please contact Eric at email@example.com to request the forms for us to start work on your financial plan.
Eric Walter, Financial Planner
If you wish to contribute to your school age child’s/grandchild’s education, those expenses should be part of your financial plan. Considerations include the child’s age, years to attend, cost, plan tax efficiency for you and them, control of assets, etc. Contributions to plans are not federally tax deductible but some plans have state specific income tax deductions. Contributions also count toward annual gifting limits- $15k per person. All information provided as of tax year 2018.
529 Savings (529 Plans) & Prepaid Tuition Plans (Prepaid Plans)
Coverdell Education Savings Accounts (ESAs)
Uniform Gifts (UGMAs) & Transfers (UTMAs) to Minors Acts
Series EE (EE Bonds) & I (I Bonds) Savings Bonds
Beneficiary May be Changed:
YES: 529 & Prepaid Plans, Coverdell ESAs, EE & I Bonds
NO: UGMAs & UTMAs
YES (Timing of deposits may affect.): 529 & Prepaid Plans, Coverdell ESAs, UGMAs & UTMAs
NO: EE & I Bonds
Financial Aid Calculation Impact:
GRANDPARENT OWNS: No- in year distributed; Yes- in year after distributed
PARENT OWNS: Yes
CHILD OWNS: Yes
Note: For more information contact the Federal Student Aid Information Center at 1-800-433-3243 or visit studentaid.ed.gov.
Ownership (control of distributions):
ADULT UNTIL BECOMES CHILD: UGMAs 18-21 & UTMAs 18-25
ADULT OR CHILD: 529 & Prepaid Plans, Coverdell ESAs, EE & I Bonds
YES (lifetime): 529 & Prepaid Plans (Ranges by state plan from $250k and up.)
YES (annual): Coverdell ESAs ($2k per child), EE Bonds (electronic only- $10k) & I Bonds
(electronic- $10k & paper- $5k)- may buy all 3 up to individual limits
NO: UGMAs & UTMAs
Income Limitations to Contribute:
YES: Coverdell ESAs (AGI phase out: single $95k-$110k & married filing jointly $190k-$220k)
NO: 529 & Prepaid Plans, UGMAs & UTMAs, EE & I Bonds
YES: 529 Plans, Coverdell ESAs, UGMAs & UTMAs
MAYBE (guaranteed & non-guaranteed vehicles): 529 Plans, Coverdell ESAs, UGMAs & UTMAs
NO: Prepaid Plans (simply tuition credits), EE Bonds (fixed rate*), I Bonds (fixed rate + inflation
*5/1/18 – 10/31/18 issue @0.10%, compounded semiannually
**5/1/18 – 10/31/18 issue @2.52% (fixed @0.30% + semiannual inflation @1.11%)
Taxation of Annual Interest, Dividends, &/or Capital Gains:
TAX-DEFERRED: EE &I Bonds (Must elect deferral.), 529 & Prepaid Plans, Coverdell ESAs
TAXABLE: UGMAs & UTMAs (at “Kiddie Tax*” rate)
*First $1,050 tax-free per child under age 19 or 24 if student (not per account), $1,051-$2,100 child’s rate, $2,101+ parent’s rate.
Taxation of Capital Distributions:
TAX-FREE (qualified expenses within limits): EE & I Bonds* (if owner is married, must file joint
return), 529 & Prepaid Plans, Coverdell ESAs
TAXABLE: UGMAs & UTMAs (at “Kiddie Tax” rate)
*Must purchase at age 24+ for tax exclusion.
Note: Always speak with your CPA for state specific tax information.
YES: Coverdell ESAs (by child’s age 30*), EE & I Bonds (Redeem same year as expense.), UGMAs
(18-21) & UTMAs (18-25)- state specific ages; may transfer to 529 Plan as cash
NO: 529 & Prepaid Plans; may roll to family member, i.e. siblings, cousins, in-laws, etc.
Qualified Expenses for Plan Disbursement:
PREPAID PLANs: tuition & fees, some cover room & board
529 PLANs: tuition & fees, room & board, books & supplies, required equipment (may be used for K-12 or private school expenses, state specific, up to $10k per year)
COVERDELL ESAs: tuition & fees, room & board, books & supplies, required
equipment (may be used for K-12 or private school expenses)
EE & I BONDs: tuition & fees, such as laboratory and other required course expenses- room &
board and books not included
UGMAs & UTMAs: No requirement to use for educational expenses.
Noise, Pullbacks, Corrections and Bears
Susan Spraker, Ph.D., CFP®
Although Investments is just one integral part of total financial planning and wealth management, it stands center stage more often than Estate Planning, Tax Planning, Risk Management and Asset Protection Planning. Unlike probate costs, income taxes, home depreciation, healthcare costs, and risk taking, portfolio values can be watched daily, even by the minute. The Age of Instant Information and nearly 9 years of uninterrupted stock market recovery against the backdrop of the 2008-2009 Great Global Recession keep investors on edge. Though we hate taxes and depreciation and rising healthcare costs, they feel both boring and out of control when, in fact, they are excellent areas for planning to minimize losses.
As we age, losses are harder to emotionally withstand even when they are only paper losses and even though we have years of life expectancy. We don’t have as many years to retrace the price curve up-even though the curve down could be short-lived and a great buying opportunity, regardless of age. When we retire, we don’t have the earned income to supplement portfolio income, and aren’t adding to the portfolio (usually). Add the current global political uncertainty discussed in Macroeconomic View and it’s a good time to discuss “losing” and “losses.”
First and foremost, investment losses and gains don’t occur until they are taken or “realized.” A paper loss isn’t a “real” loss unless we cash out of the investment while its value is down from the amount invested, “realizing the loss.” A paper gain isn’t “real” until we cash out and take or “realize the gain.” Successful portfolio management involves buying on downturns (good companies share prices on sale) and selling to take good profits (not being greedy during upturns and having money to further diversify). Unfortunately, the average individual investor is unsuccessful because they do the opposite. They buy more when stocks are performing very well, buying more at higher prices, “piling in” with everyone else reading all the happy bandwagon headlines, not wanting to miss out on a good thing. These same investors sell when the market is going down, sometimes liquidating entire portfolios at the bottom of corrections or in the middle of a bear market. This behavior was rampant during the tech bubble and bust and more recently during the housing boom that was then followed by the global credit crisis that led to the Great Recession. Literally billions were being invested at the top when we were selling in 2007 and 2008; and billions were being sold while we were buying at the bottom of the market in March 2009. It took guts and understanding the macroeconomic environment…and it paid off.
Digging deeper to understand markets and “losses,” a NORMAL MARKET CYCLE INCLUDES PULLBACKS AND CORRECTIONS. Price movements in the 0%-5% range is common statistical noise. Right now we are getting a tremendous amount of statistical noise. Beyond 5%, there are three types of market downturns which when understood will lead to better investment decisions and portfolio management. A pullback is a 5%-10% market drop; a correction is a 10%-20% drop; a bear market is a 20%+ drop.
Noise and pullbacks need to be ignored unless you are a day trader. The reason is because they are short-lived and it’s almost impossible to buy back in at anything other than higher prices than the sells. Portfolio decisions during a correction are a function of risk tolerance, income needs, capital needs, and time horizon. Long-term investors with truly diversified portfolios, especially with portfolios that exceed the capital needed for life expectancy, as well as portfolios being added to, should use corrections as opportunities to buy more of oversold, well-run companies.
One of the disappointments during the past few years has been the whipsaw nature of pullbacks and lack of time to buy more. We have lamented in the Commentary how we look forward to a long overdue correction as an opportunity to buy more of good funds and ETFs.
Clients who cannot tolerate corrections are by definition risk averse and should be in our most conservative Growth & Income model, less than 50% stock exposure. So when stocks are down 10%-20%, those portfolios should be down maybe 6%-12% depending on what’s happening with bonds. Aggressive clients by definition should be unconcerned with both corrections and bear markets. It’s the Growth clients, whose portfolios have less than 65% stocks, who generally want to have most of the up and little of the down. Even though those portfolios are positioned to avoid at least a third of a correction, a Growth portfolio by definition means most of the money is invested for the long haul (more than 5-7 years), with more than a third for the short haul (2-4 years).
We asked Kyron to conduct a totally nonscientific analysis of the portfolios we manage, choosing a typical one from each of the 3 models for the period January 26 through March 29, from the stock market price peak to the end of the quarter. The only criteria was that the client could not have added nor taken out any money during this 1st Quarter 2018 on which we are reporting. The question was, given all the volatility AND the correction that John reported in Markets and Trading, how much did our respective portfolios decline? As we (your Investment Committee) expected, here’s the performance of our managed portfolios: Aggressive Growth: -5%; Growth: -4%; Growth & Income: -3.2%; S&P 500: -8.1%.
We look forward to discussing how YOUR portfolio performed during this and other periods. Of course, cash flows in and out will have an impact on performance. For instance, if you added money to your portfolio and wanted it to be invested immediately during market highs, that portion of your portfolio would be down compared to someone with the same portfolio who withdrew the same amount at those highs. Regardless, the main lesson is that whatever the Dow 30 Industrials performance is today, whatever the S&P 500 has racked up (or down) for the day/week/quarter, whatever the NASDAQ has plummeted or skyrocketed, your portfolio is performing differently because it is being professionally managed to garner as much of the upside and as little of the downside as possible, given its objective.
Is your portfolio positioned in the right model for your risk tolerance? What is your life expectancy? What percent of your portfolio do you need in the next 5 years? Let’s discuss these and more factors in your next portfolio and planning session. Let’s also review your tax return, your estate plan, your car depreciation, and your health care costs – all areas in which you may be experiencing unnecessary losses.