Alliance Investment Planning Group

Washington, D.C. - 02/18/2010 - There was a $1 trillion gap at the end of fiscal year 2008 between the $2.35 trillion states had set aside to pay for employees' retirement benefits and the $3.35 trillion price tag of those promises, according to a new report released by the Pew Center on the States.  The shortfall, which will have to be paid over the next 30 years by state and local governments, amounts to more than $8,800 for every household in the United States.

The figures detailed in Pew's report, "The Trillion Dollar Gap," include pension, health care and other non-pension benefits promised to both current and future retirees in states' and participating localities' public sector retirement systems. 

Pew's numbers likely underestimate the bill coming due because the most recent available data do not account for the second half of 2008, when states' pension fund investments were particularly affected by the financial crisis.  Additionally, most states' accounting methods spread the investment declines over a period of time-meaning states will be dealing with their losses for several years.

"While the economic crisis and drop in investments helped create it, the trillion dollar gap is primarily the result of states' inability to save for the future and manage the costs of their public sector retirement benefits," said Susan Urahn, managing director, Pew Center on the States.  "The growing bill coming due to states could have significant consequences for taxpayers-higher taxes, less money for public services and lower state bond ratings.  States need to start exploring reforms."

To help policy makers and the public understand these challenges, Pew assessed all 50 states on how well they are managing their public sector retirement benefit obligations.

In fiscal year 2008, states' pension plans had $2.8 trillion in long-term liabilities, with more than $2.3 trillion reserved to cover those costs.  Overall, states' pension systems were 84 percent funded-above the 80 percent funding level recommended by experts.  Still, the unfunded portion-$452 billion-is substantial, and states' performance is down slightly from an 85 percent combined funding level in fiscal year 2006.  Pension liabilities have grown by $323 billion since 2006, outpacing asset growth by almost $87 billion.

Retiree health care and other non-pension benefits, such as life insurance, create another huge bill coming due: a $587 billion total liability to pay for current and future benefits, with only $32 billion-or just over 5 percent of the cost-funded as of fiscal year 2008.  Half of the states account for 95 percent of the liability.  Because of a 2004 Governmental Accounting Standards Board rule, the full range of non-pension liabilities was officially reported in fiscal year 2008 for the first time across all 50 states.

In spite of the large and growing shortfall and the variation among states, momentum for policy reform is building nationwide.  Fifteen states passed legislation to reform their state-run retirement systems in 2009 compared to 12 in 2008 and 11 in 2007.  Reforms largely fell into five categories: (1) keeping up with funding requirements; (2) reducing benefits or increasing the retirement age; (3) sharing the risk with employees; (4) increasing employee contributions; and (5) improving governance and investment oversight.

With legal restrictions in most states on reducing pensions for current employees, the majority of changes in the past two years affect new employees.  Ten states increased the contributions that current and future employees make to their own benefit systems, while ten states lowered benefits for new employees or set in place higher retirement ages or longer service requirements. 

"A growing number of policy makers recognize that their states' fiscal health depends on how well they manage the bill coming due for public sector retirement benefits," said Urahn.  "We are seeing more and more states explore policy reforms aimed at putting their systems on stronger fiscal footing."

"The Trillion Dollar Gap" identified significant variations in how states are managing their employee retiree benefits:

Pension benefits

• Sixteen states were deemed solid performers, 15 were in need of improvement and 19 states were flagged for serious concerns.
      
• States like Florida, Idaho, New York, North Carolina and Wisconsin all entered the current recession with fully funded pensions, and were rated top performers by Pew.
      
• In 2000, just over half the states had fully funded pension systems. By 2006, that number had shrunk to six states.  By 2008, only four-Florida, New York, Washington and Wisconsin- could make that claim. 
      
• In eight states-Connecticut, Illinois, Kansas, Kentucky, Massachusetts, Oklahoma, Rhode Island and West Virginia-more than one-third of the total pension liability was unfunded.  Two states-Illinois and Kansas-had less than 60 percent of the necessary assets on hand.
  
  
  Health care and other non-pension benefits
  
• Nine states were deemed solid performers, having enough assets to cover at least 7.1 percent-the 50-state average-of their non-pension liabilities.  Only two states-Alaska and Arizona- had 50 percent or more of the assets needed.
      
• Forty states were classified as needing improvement, having set aside less than 7.1 percent of the funds required.  Twenty of these have no assets on hand to cover their obligations. (Nebraska does not provide estimates of its retiree health care or other benefit obligations and did not receive a grade.) 
      
• Only four states contributed their entire actuarially required contribution for non-pension benefits in 2008: Alaska, Arizona, Maine and North Dakota.

About the Methodology

Pew's analysis is based on data from states' own Comprehensive Annual Financial Reports, pension plan system annual reports and actuarial valuations.  Pew researchers analyzed the funding performance of 231 state-administered pension plans and 159 state-administered retiree health care and other non-pension benefit plans, which include some localities' and teacher plans.  States have flexibility in how they compute their obligations and present their data, so three main challenges arise in comparing their numbers: whether and how they smooth investment gains or losses; when they conduct actuarial valuations; and what assumptions they use for investment returns, retirement ages and other factors. 

The Pew Center on the States is a division of The Pew Charitable Trusts that identifies and advances effective solutions to critical issues facing states.  Pew is a nonprofit organization that applies a rigorous, analytical approach to improve public policy, inform the public and stimulate civic life. 

 

  Explaining some of the intricacies of withdrawals.

Sometimes people want to access Roth IRA funds for early retirement or other purposes. Maybe you're one of them. If you have ever thought about taking money out of a Roth IRA, be sure to consult your financial advisor first before you make a move ... and keep the factors mentioned below in mind. 

You can withdraw regular contributions tax-free, but not your earnings. This is a critical distinction, and many Roth IRA owners don't seem to know about it.

When you withdraw assets from a Roth, there is a set order in which contributions and earnings must be distributed - the IRS ordering rules for distributions.¹

• The IRS regards the first layer of withdrawals from a Roth as regular contributions instead of earnings. So this layer is treated as coming from your annual after-tax contributions. Therefore, if you just withdraw this layer of money, there are no taxes or penalties involved. (You can do this at any time, whether you have held your Roth for 5 years or not.) Basically, the IRS is permitting you to remove a percentage of your account before the alarm sounds on the five-year clock (see below).^2,3

• The next assets to be removed from the account, according to IRS rules, are the conversion and rollover contributions to your Roth. These are removed on a so-called "first in, first out" basis. For example, the amount of a contribution to your Roth resulting from a conversion made in 2002 would come out before the amount of a contribution to your Roth resulting from a conversion made in 2008. The taxable portion of the conversion/rollover contribution comes out first (the amount claimed as income), and then the non-taxable portion.(By the way, the IRS disregards Roth-to-Roth rollover contributions in these rules.¹)

• Finally, earnings accrued by the Roth IRA are distributed.

So in other words, merely withdrawing your regular contribution will not trigger tax. But if your Roth has realized earnings from contributions, the earnings will be subject to income tax if they are withdrawn.

Is your withdrawal a qualified distribution? Here's another important consideration. If you have owned your Roth IRA for less than 5 years and/or are younger than age 59½, you risk taking a nonqualified distribution if you withdraw money from it. You know what that means - a 10% penalty for early withdrawal in addition to taxes. (There are some exceptions to this outlined in IRS Publication 590, which is certainly worth reading.)¹

If you have owned your Roth IRA for more than 5 years ...

• You can make a qualified withdrawal of earnings.
• You can make a qualified withdrawal of taxable conversions (conversions made in separate tax years will have to meet separate 5-year tests).

You can withdraw nontaxable conversions to your Roth IRA at any time.³

Watch the 5-year clock. Yes, how is the 5-year period preceding a qualified distribution measured? The clock starts on January 1st of the tax year of your initial contribution, conversion or rollover to a Roth IRA. For example, let's say you opened up a Roth IRA account on January 1, 2007. On January 1, 2012, your Roth IRA will meet the five-year test.¹

What if you have multiple Roths? Well, when it comes to distributions, the IRS has some aggregation rules for you. You will have to figure out the taxable amounts withdrawn, distributions and contributions using a little addition. You must ...

• Add up all distributions made from all your Roth IRAs during the tax year.
• Add up all regular Roth IRA contributions made during the relevant tax year (including ones made after the close of the tax year, but before April 15 of the following year). Now add that total amount to the total undistributed regular contributions made in previous years.
• Add all conversion and rollover contributions made during the year together. To quote Publication 590: "For purposes of the ordering rules, in the case of any conversion or rollover in which the conversion or rollover distribution is made in 2008 and the conversion or rollover contribution is made in 2009, treat the conversion or rollover contribution as contributed before any other conversion or rollover contributions made in 2009."¹

There are additional rules for recharacterized contributions that end up in a Roth IRA.

If all this makes you want to talk to a financial advisor or accountant, before you take money out of your Roth IRA ... well, that is a wise step to take. Confer with the financial or tax advisor you know and trust.

Citations.

¹ irs.gov/publications/p590/ch02.html#en_US_publink10006523 [12/4/09]

² investopedia.com/ask/answers/179.asp?viewed=1 [12/4/09]

³ smartmoney.com/personal-finance/retirement/nine-frequently-asked-questions-about-iras-7950/ [1/21/09]

  Socially Responsible Investing for the Long Term

The past few years have hammered home the importance of corporate integrity, as investors watched former Wall Street darlings collapse in the aftermath of corporate scandal. In fact, a majority of investors now believe that companies that operate with higher levels of social responsibility carry less risk (55%) and deliver better returns (52%).¹ And 71% of investors contend that knowing that companies are rated higher in terms of their social performance would make them more likely to invest in such companies.²

But how do you go about investing in companies with higher levels of integrity? An investment strategy called socially responsible investing (SRI) provides an option. SRI is based on the principle of investing in well-managed companies that act responsibly towards shareholders, communities, employees, consumers, and the environment.

Socially Responsible Investing

So, what exactly is SRI? SRI is an investment strategy that integrates social or environmental criteria into financial analysis. Although the term has a contemporary ring to it, socially responsible investing is hardly new. SRI was first formally practiced by religious investors who, nearly 100 years ago, avoided companies involved in tobacco, alcohol, and gambling. During the 1980s, there was a resurgence of interest in SRI as investors shunned companies operating in apartheid South Africa. Now many investors are concerned about a broader range of issues, including environmental protection, workers' rights, product safety, and business ethics. In fact, SRI represents nearly one out of every 10 dollars under professional management (or $2.29 trillion), up 258% from 1995 ($639 billion).³

How SRI Works

Of course, most investment managers look for companies with strong balance sheets, sound management, and viable products. But socially responsible investments add another layer of analysis on top of traditional financial analysis that seeks to identify companies that meet specific social and environmental criteria. Many social investors believe that this social research process can identify companies with lower risk and better quality management, thus helping to contribute to better long-term financial performance.

In addition, many socially responsible investors also actively use their position as owners to push companies to improve. For example, Calvert, one of the nation's largest families of SRI funds, often works with companies to encourage them to address issues of social and environmental concern. In 2007, Calvert filed or co-filed 36 shareholder resolutions on a variety of issues. Shareholder resolutions are formal requests that can come to a vote in front of all shareholders asking companies to take specific actions, such as working to diversify their boards, enhancing their corporate governance practices, and improving their environmental policies. Everyday shareholders can have an impact by simply voting in support of such social resolutions, much like you might cast a political vote.

Lastly, many social investors direct some of their assets to promote community investment projects in the U.S. and around the world. In addition to earning competitive returns, these assets contribute to ending poverty by increasing affordable housing, community development, access to capital, and more.

Millions of Americans are looking to integrate their financial goals with their concerns about the environment, safe products, fair labor practices, and other quality-of-life issues. SRI offers investors the opportunity to build sound portfolios for their financial futures, while helping to build a better future for the world.

1. "Attitudes Toward Socially Responsible Investing," Yankelovich Study conducted for Calvert, January 2006.

2. Ibid.

3. 2005 Report on Socially Responsible Investing Trends in the U.S. The Social Investment Forum, 2005, p. iv.

  A retirement transition might call for a shift in your investment approach.

Time passes ... and priorities change. When you approach retirement, your investment mindset may have to be modified. If you are in your thirties or forties, the goal is accumulation - investing and saving to amass as much as possible for your retirement years. When you are older, the goal changes to wealth preservation - the objective of making assets last through a combination of conservative investing, sensible cash flow, risk management and tax reduction.

A subtle shift. Committed investors who work with a financial consultant often receive guidance to help them adjust their investment approach to new phases of life.

If you're younger than 40, you will almost always be encouraged to invest for growth for two reasons. One, you probably have a very long time horizon until retirement (maybe as long as 40 years). Two, numerous studies have shown that the stock market has historically outperformed (in the long term) fixed-rate investments and savings accounts. Also, as your earnings increase, you can potentially defer greater and greater amounts of salary for retirement savings.

When people are in their forties, they usually begin to approach their maximum earnings potential. This is when many portfolios start to shift toward a mix of growth-oriented and preservation-oriented investments. For many people, this shift toward asset preservation gets more pronounced the older they get - though some growth investments usually remain in their portfolios, because their retirement capital may have to last for another 30 or 40 years.

In retirement, a financial consultant has to find an asset allocation that will encourage a regular income stream for you without discouraging your potential for growth. It must also be an allocation that you are comfortable with.

Still accumulating? Perhaps you started saving for retirement relatively late, or maybe you had a financial setback or two. This is not unusual: many people in their fifties or sixties are still in the accumulation phase out of necessity.

There are people in their forties or fifties who have no retirement savings. Many are predisposed to "make up for lost time" and adopt an aggressive investment strategy. This can be dangerous. People may be tempted to invest the bulk of their assets in a "hot" sector of the market, crossing their fingers and hoping for double-digit returns. But as we have seen with the real estate market, what seems "hot" may turn cold. Diversification is just as important for late savers.

The psychology of preservation. "Wealth preservation" is a broad term that can signify a number of financial steps. A good wealth preservation strategy addresses the things that have to be addressed for any mature couple or individual or maturing family.

It should outline how retirement plan savings will be reinvested and managed (asset allocation, investment objectives). It should establish a schedule of sensible income withdrawals. It should provide measures for tax efficiency (in investing) and tax reduction, to potentially increase the after-tax return. It should incorporate an estate plan, to permit the tax-efficient transfer of assets to heirs and/or favorite causes.

It should NOT expose an individual, couple, or family to dangerous levels of risk with the mission of obsessively pursuing the best possible stock market returns.                             

Is preserving wealth on your mind? If not, it may need to be - particularly if you are in your forties, fifties or older. Now might be the right time to confer with a qualified financial advisor and discuss a shift in emphasis from wealth accumulation to wealth preservation.

This was prepared by Peter Montoya Inc., not the named Representative nor Broker/Dealer, and should not be construed as investment advice. Neither the named Representative nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information.

  Make sure you pay attention to the rules.

What do you do when you inherit an IRA? Good question. Most people don't know the rules and regulations pertaining to inherited IRA assets. You should. You, not the IRS, should benefit the most in this circumstance.

Will my income taxes soar this year as a result? Not necessarily. If you roll the assets into an inherited IRA, you have up to five years to either a) withdraw the money entirely or b) withdraw the money over your lifetime according to an IRS life expectancy formula.¹ Many heirs would prefer b) because the tax scenario is better - but some IRA custodians require you to go by the five-year rule.²

What if you don't roll the money into an inherited IRA? What if you just take the balance as a lump sum and spend it? Look out. All that money will be taxed at your regular income tax rate.³ After income and estate taxes eat away at the IRA balance, you may be left with a fraction of the original assets.

Let's look at some options for those who inherit IRA assets. Keep in mind: this brief article discusses only some basic, common scenarios. Tax laws pertaining to inherited IRA assets are complex, with constant "new wrinkles" - so be sure to talk to a financial advisor or tax advisor who is up to speed on IRS rule changes. 

What if you inherit your spouse's IRA? The IRS says a surviving spouse can elect to be treated as the owner of such IRA assets rather than the beneficiary.¹ A surviving spouse can therefore roll this money into his or her own IRA. That makes a lot of sense, especially for younger spouses: distributions can be extended over your lifetime and the lifetime of your beneficiaries.

If you roll over your late spouse's IRA assets into your IRA, they may be able to compound for a long time, as you don't have to take a Required Minimum Distribution from your IRA until you reach age 70½. (If you have a Roth IRA, you don't have to take them at all.) On the other hand, you must take a distribution from an inherited IRA a year after your spouse's death.⁴

You also have other options. If you are younger than 59½ and need the IRA assets for living expenses, you could keep all or part of the money in your late spouse's IRA, whereby you could take penalty-free distributions. Or you could disclaim some or all of the IRA assets if you don't need them (this has to happen within nine months of the original IRA owner's death). Disclaiming them will allow the IRA assets to go to the contingent beneficiaries named by the original IRA owner. This might result in a better estate tax picture for your kids.⁴

You inherit an IRA from someone other than a spouse. Okay, this is complicated. Was the original IRA owner younger than age 70½ at death? Did he or she turn 70½ last year and die before April 1 this year? If the answer is yes to either question, you have two choices. 1) You can liquidate the inherited IRA by no later than December 31 of the fifth year after the year the original IRA owner dies. This is mandatory for some IRAs. 2) You can take minimum withdrawals over your life expectancy, calculated per IRS tables.²

Did the original IRA owner pass away on or after April 1 of the year after he or she turned 70½? Then forget the five-year rule. You must start taking minimum withdrawals over your life expectancy. Your first such withdrawal has to happen by Dec. 31 of the year after the year the original IRA owner dies.²

The IRD deduction. The federal government offers certain IRA beneficiaries a break - the "income in respect of a decedent" (IRD) deduction. This deduction appears when an IRA beneficiary faces a "double tax".

If you inherit an IRA as part of an estate whose assets exceed the current federal estate tax exemption ($3.5 million in 2009), you face the "double tax": the possibility of paying estate taxes on the IRA assets (45%) plus income taxes on those assets (35%). Rather than lose 80% of the IRA to taxes, the IRA heir can claim the IRD and take an income tax deduction for federal estate taxes that were paid on the inherited IRA assets.⁵

How big is the deduction? It is equal to the marginal federal estate tax rate that applies to the estate being distributed. In other words, if the inherited IRA assets are subject to 45% estate taxes, the designated beneficiary can deduct $450 from every $1,000 distribution from the IRA. The deduction can be claimed with each plan distribution, until either the deduction is used up or the assets in the inherited IRA are depleted.⁵

The no-RMDs-in-2009 wrinkle. No one has to take a Required Minimum Distribution from an IRA in 2009. What does that mean for inherited IRAs? If the IRA owner died in 2008, you don't have to take a distribution in 2009 and you get six years rather than five to withdraw inherited IRA assets if you would ordinarily go by the five-year rule.

But watch out: if you inherited an IRA from a non-spouse and the original IRA owner named multiple beneficiaries, you still have to split up the IRA into separate inherited IRAs by the end of 2009 to permit minimum withdrawals over heirs' life expectancies. If you don't, each beneficiary will have to take withdrawals based on the age of the oldest beneficiary, which could be a tremendous blow to tax deferral.⁶

You can't contribute to inherited IRAs. This applies to traditional and Roth IRAs.^7,8 However, as mentioned above, surviving spouses can elect to treat an inherited IRA as their own - in IRS eyes, they do so by making any contribution to it.¹ 

A Roth IRA wrinkle. It is possible to pay taxes on an inherited Roth IRA. Roth IRA earnings can be withdrawn tax-free starting on the first day of the fifth taxable year after the year the Roth IRA was established. So if an inherited Roth IRA was established less than five years ago, an heir may have to pay tax on earnings withdrawals if the original owner's death and the withdrawal both occur within five years of the creation of the account. However, a beneficiary can circumvent this penalty by leaving the earnings in the Roth IRA for the required time period, even if he or she withdraws everything besides the earnings.⁸

Citations.

¹ irs.gov/publications/p590/ch01.html#en_US_publink10006321              [2009]

² smartmoney.com/personal-finance/taxes/Inheriting-Uncle-Henrys-IRA-11874/     [1/21/09]

³ investorsinsight.com/blogs/retirement_watch/archive/2008/09/19/avoiding-ira-inheritance-disasters.aspx/         [9/19/08]

⁴ kiplinger.com/features/archives/2009/02/krr_leave_an_ira_that_is_heir_tight2.html?kipad_id=42        [3/3/09]

⁵ advisor.morningstar.com/articles/article.asp?docId=16516     [5/22/09]

⁶ forbes.com/forbes/2009/0302/045_heir_alert.html              [3/2/09]

⁷ schwab.com/public/schwab/investment_products/retirement/inherited_iras/faq?cmsid=P-2008538&lvl1=investment_products&lvl2=retirement               [5/22/09]

⁸ fairmark.com/rothira/inherit.htm          [1/24/08]

 

This was prepared by Peter Montoya Inc., not the named Representative nor Broker/Dealer, and should not be construed as investment advice. Neither the named Representative nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information.

 

Do they go hand in hand?

Does money actually buy a degree of happiness? In this recessionary holiday season, it is worth thinking about the effect money has on our lives. What role does money play in our happiness? Is that role overrated?

Most psychologists and sociologists will tell you that our happiness comes largely from social interaction. But studies indicate that there is a direct correlation between wealth and a kind of mental health.

As Pearl Bailey immortally quipped, "Honey, I been poor, and I been rich. And let me tell you, rich is better." Having a well-paying job, being successful at what you do - these are definite cornerstones of self-esteem and contribute to happiness.

So is Warren Buffett happier than we are? The math is not quite that simple. American wealth grew remarkably in the late 20^th century, but surveys found that Americans on average weren't any happier than they'd been decades before.

Does spending money make people happy? It depends on the purpose. Perhaps you've heard of the "hedonic treadmill" theory, an economic theory which holds that the middle-class and the affluent exhaust themselves and diminish their happiness through endless pursuit of the latest material goods. Americans are proudly competitive, and can't help but measure their wealth in relation to their friends and neighbors. We have to have more than the next guy.

Does spending money on others make people happy? Yes, according to the results of a study published in March 2008 in Science Magazine.¹ Researchers took a sample of 600 Americans. They instructed 46 to spend a $5 or $20 bill on a particular day. Some were told to spend the money on others, and the study found that they were happier at the end of the day than the ones who spent the money on themselves. The study also tracked 16 workers who got profit-sharing bonuses, and observed that employees who gave a majority of their bonus to others ended up happier than those who spent it on themselves. In fact, the main forecaster of happiness was not the size of the bonus, but how it was spent. The Science study also discovered that spending more money on gifts and charity correlated with increased happiness.²

Are we ultimately only as happy as we want to be? Perhaps. Researchers now increasingly feel that people have a genetic "baseline" or "set point" of happiness, and deviations from this norm are temporary. In other words, how the stock market does doesn't rattle our basic level of happiness. Even life-altering tragedies or seeming miracles don't ultimately budge us much from the norm. (Studies of the brain indicate that people with more activity in their left prefrontal cortexes seem to be happier than some others.)

Recently, University of Virginia psychology professor Jonathan Haidt wrote a classically-rooted book called The Happiness Hypothesis. Haidt observed that within a year of their life-changing experiences, "lottery winners and paraplegics, have both, on average, returned most of the way to their baseline levels of happiness." He feels that happiness can grow from "vital engagement" with other people and one's passions, and from a spiritual and moral "coherence" in yourself and your life.³

How about some Gross Domestic Happiness (GDH)? No joke: since 1972, the government of Bhutan has dedicated itself to boosting GDH, Gross Domestic Happiness, via a platform of equitable and sustainable economic growth, cultural preservation in the face of the West, good government, and environmentalism.⁴ Other nations have studied Bhutan's example; in fact, conferences have been held on the concept in Bhutan, Mongolia and the Netherlands.

Wishing you a great holiday season. May it be warm, wonderful, and bright; may 2010 be a year of great things for you. And may you know great happiness. Let's vow to retain our optimism through the financial challenges ahead.

 

Citations

¹ Science, vol. 319, March 2008, by E. Dunn, L. Aknin, and M. Norton    [3/08]

² tierneylab.blogs.nytimes.com/2008/03/20/yes-money-can-buy-happiness/    [3/20/08]

³ happinesshypothesis.com/chapters.html                         [10/1/05]

⁴ nytimes.com/2005/10/04/science/04happ.html?pagewanted=all  [10/4/04]

 

This was prepared by Peter Montoya Inc., not the named Representative nor Broker/Dealer, and should not be construed as investment advice. Neither the named Representative nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information.

 Giving kids a better understanding of money and finances.

How do you give your children or grandchildren the right attitude about money? And a good financial start? While you can gift your child up to $13,000 a year tax-free, consider these options, wrapped up with financial lessons. After all, what better time than during a financial crisis to convey your hard-earned financial wisdom to little Junior?

Roth IRAs. If your child has a job, why not encourage saving for retirement with one of these accounts? Your child can contribute to the Roth IRA, and so can you. An individual can put up to $5,000 in a Roth IRA during a single year, but you cannot contribute more than the child or grandchild will earn annually from his or her job.

529 plans. These are state-based college savings accounts, and federal laws now make all investment gains in these plans tax-free (provided you use the money for qualified higher educational expenses). Each year, a married couple can put in up to $26,000 per beneficiary without triggering gift taxes; grandparents can put in up to $130,000 by making a 5-year election*. Plans vary by state and you do not need to choose the plan from your state - Utah, Iowa, New York and Nevada offer some of the most highly regarded 529s. However, by investing outside of the state in which you pay taxes, you may lose tax benefits offered by the state's plan and tax treatment at the state level may vary. Illinois' BRIGHT DIRECTIONS 529 Plan, for example, does provide a state tax deduction to Illinois residents for 529 contributions up to $20,000 per year per couple. And BRIGHT DIRECTIONS withdrawals are exempt from Illinois state taxes as long as the money is used to pay for qualified higher education-related expenses.

Stock. Grandparents and parents might think about gifting stock shares from a well-known company to a child - preferably, a company the child knows about and has an interest in. Over time, a child can follow the progress of the stock and the company, and learn lessons about the economy and the markets.

Custodial Accounts. Minors under the age of 21 can't legally own stocks, bonds, mutual funds, annuities, or life insurance policies directly.  For this reason, the Uniform Gifts to Minor's Act (UGMA) established a simple way for minors to own securities though state-structured trusts known as custodial accounts. The Uniform Transfers to Minors Act (UTMA) is similar, albeit more recent, but more flexible, also allowing minors to own fine art, real estate, patents and royalties. Custodial accounts are typically established at banks and brokerages, with the custodian (i.e. trustee) - typically the child's parent, guardian, or grandparent - controlling the account and managing the money until the minor turns 21, although the child technically owns the account once the UGMA or UTMA account has been set up by a donor. Establishing a custodial account is simple and inexpensive.

Books and games. Consider The Sims 2: Open for Business, a computer game in which a child can set up and run a mock chain restaurant, hair salon, fashion boutique, or almost any other kind of small business - even a lemonade stand. Most likely they'll have fun and not even realize they're learning valuable financial lessons. In print, you might try Growing Money: A Complete Investing Guide for Kids by Gail Karlitz (Penguin Putnam), Investing Tips Grampa Taught Us by Victor Eber (Authors Choice), and Ben Franklin's The Way to Wealth (Applewood), just 30 pages and full of timeless principles.

Most importantly, start talking candidly to kids about money as early as possible. With the media covering the global financial crisis 24 x 7, kids can't help but be exposed to all kinds of financial and economic reporting that must seem confusing if not frightening. Too often children have little or no information about finances until they're forced to deal with them. By sharing your knowledge now and providing a grown-up's perspective, you can take the fear out of financial matters and help your child plan for a more secure future.

* According to January 2007 data.

This was prepared by Peter Montoya, Inc., not the named Representative or Broker/Dealer, and should not be construed as investment advice. Neither the named Representative or Broker/Dealer give tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. Please consult your Financial Advisor for further information. Stock investing involves risk including loss of principal.

 

A useful year-end move to counteract capital gains.

Because financial markets have improved since March, you may realize short-term capital gains this year in your investment portfolio. What can you do about them? You could do what many savvy investors do - you could "cash in your losses" and practice tax loss harvesting.

Selling losers to offset winners. Tax loss harvesting means taking capital losses (you sell securities worth less than what you first paid for them) to offset the short-term capital gains you have amassed.  While this doesn't get rid of your losses, it can mean immediate tax savings. It can also help you diversify your portfolio. It may even help you to position yourself for improved long-term after-tax returns.

The tax-saving potential. Sure, you can use this technique to put your net gains at $0, but that's just a start. Up to $3,000 of capital losses in excess of capital gains can be deducted from ordinary income, and any remaining capital losses above that can be carried forward to offset capital gains in upcoming years.¹

So by taking a bunch of losses this year and carrying over the excess losses into next year, you can potentially shelter some (or maybe even all) of your long-term and short-term capital gains next year. This gives you a chance to shelter winners you've held (even for less than a year) from being taxed at up to 35%.¹

The strategy in action. It is really quite simple. Step A is to pick out the losers in your portfolio. Step B is deciding which losers to sell and telling your Financial Advisor what you want to do.  However, both investor and advisor have to watch out for the IRS "wash sale" rule. You can't claim a loss on a security if you buy the same or "substantially identical" security within 30 days before or after the sale.² In other words, you can't just sell a stock or mutual fund to rack up a capital loss and then quickly replace it.

But ... you might be able to avoid the wash sale rule by using an Exchange Traded Fund (ETF) to make a "tax swap": an ETF for a stock or mutual fund, or even an ETF for another ETF if the ETFs are linked to different indexes.³ Although these "tax swaps" are widely done, this is still sort of a gray area, so consult a qualified tax advisor first.  Here's a heads-up: a recent IRS ruling (Revenue Ruling 2008-5) says you can no longer use an IRA to acquire "substantially identical" securities within the 61-day wash sale window - and you can't boost your tax basis in said IRA by the amount of the disallowed loss.⁴

The (minor) drawbacks. You may not wish to alter a carefully chosen portfolio to the degree that you must for tax loss harvesting, especially if it has been built strategically for the long term. Also, you could end up missing a rally in which a stock, ETF or mutual fund you've sold could take off. Transaction costs do add up, so a fee-based "wrap" account, sometimes referred to as an advisory account, might make more sense when tax loss harvesting.

Will long-term capital gains be taxed more in the future? They could. President Barack Obama has talked about possibly raising the long-term capital gains tax rate for taxpayers earning over $250,000 per year from 15% to 20%.⁵ Is that you? If so, you might think of triggering excess capital losses in 2009 and using the losses to shelter future long-term capital gains that could be taxed at a higher rate.

Not just a year-end tactic ... also a year-round strategy. Some investors harvest losses throughout the year, not just in December. You may want to ask your Financial Advisor how you can harvest losses this holiday season and beyond.

Citations.

¹ smartmoney.com/personal-finance/taxes/a-down-stock-market-offers-tasty-tax-breaks/                                       [10/29/08]

² irs.gov/publications/p550/ch04.html#d0e12561            [TY 2007]

³ filife.com/stories/market-meltdown-opens-door-to-tax-swaps-rebalancing     [10/26/08]

⁴ smartmoney.com/personal-finance/taxes/A-Sneaky-New-Twist-on-the-Wash-Sale-Rules-23611/?page=all       [8/6/08]

⁵ blogs.abcnews.com/politicalradar/2008/08/obama-clarifies.html  [8/14/08]

 

This was prepared by Peter Montoya Inc., not the named Representative nor Broker/Dealer, and should not be construed as investment advice. Neither the named Representative nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information.

An investment in Exchange Traded Funds (ETFs), structured as a mutual fund or unit investment trust, involves the risk of losing money and should be considered as part of an overall program, not a complete investment program.  An investment in ETFs involves additional risks: not diversified, the risks of price volatility, competitive industry pressure, international political and economic developments, possible trading halts, Index tracking error.

Investing in Mutual Funds involve risk, including possible loss of principal. Investments in specialized industry sectors have additional risks, which are outlines in the prospectus.

Does this sound familiar?  "My name is Joyce and I've been divorced for a little over three years.  I have two grown children.  My daughter was married last spring and is expecting my first grandbaby.  My son is moving back home this fall and plans to attend an area technical institute.  My father died last year and my mother recently suffered a series of small medical setbacks...  I earn a modest but comfortable salary.  Over the years, I've steadily contributed to my 401(k) plan.  I closely watch my spending, faithfully pay my bills, and carry little debt."  This is the story of a woman who, in spite of her education, hard work, and attention to her family and finances, still worries about whether she's on the right track.¹

Joyce goes on to say, "When I was married, my husband handled all the household finances and investments.  I was responsible for paying the bills and keeping the checkbook.  I want to be able to help my mother.  I want to be there for my kids and grandkids, too.  But I worry about the possibility of someday ending up a homeless bag lady."  Remarkably, Joyce isn't alone.  A 2006 study found that almost half of women surveyed feared someday becoming a bag lady - even women earning over $100,000 annually!¹

For perspective, consider that women fought for and won the right to vote a mere 88 years ago.  Nearly 2/3 of women are in the workforce today, compared with only 1/3 in 1950.  Over 2 Million women earn over $100,000 annually, a 400% increase over the past decade!  Many women today out-earn their husbands - 60% of women with business degrees and 75% of executive women working for Fortune 500 companies.  In 2005, female college graduates outnumbered male graduates by 33%.  Half of all stock investors are women, and women will soon control 60% of the country's wealth.  Women business owners control half of America's companies, employing more than 19 Million workers and generating nearly $2.5 Trillion in sales.^1,2  Impressive progress for sure!

Despite their remarkable achievements, women must deal with unique and daunting financial challenges.  Women take off, on average, 12 years from work to care for children or parents, compared to less than 2 years for men.  Not only does this extended time away from work impact their salaries and limit their career growth, but women's access to pensions is also negatively affected along with the pension benefit level itself.  A 2003 study found that 45% of retirement age men received average annual pension benefits of $16,470, whereas only 28% of retirement age women received average annual pensions of $9,217.^3,4  That says nothing of the reduction in social security benefits.

Following a divorce, women's standard of living decreases by 27% while men's increases by 10%.  Money is also the primary cause of marriage problems today, with women reporting that money is 20 times more likely than sex to be the biggest source of conflict with their husbands.⁵    Women still live longer than men, by a little over 5 years.  Women comprise 70% of the age 85+ population, with only 13% still married.⁵  In summary, women earn less, are less likely to have a (smaller) pension, put their careers on hold longer to support family, and suffer financially following a divorce.  To top it off, women's lower salaries, pensions, and social security checks must stretch further because they outlive men and typically die widowed or divorced.

Can you now start to appreciate why Joyce and other women feel insecure about their financial situation, despite the enormous progress women have made over the last century?  U.S. Census data indicates that, across every age group, poverty rates among women far exceed those of men.  Fortunately, there are strategies women can employ to get on the right track and prepare, as much as possible, for what may lay ahead.  We'll explore some of these strategies in upcoming blogs.

¹ Allianz Women Money & Power Study, 2006

² "Key facts about women-owned businesses", Center for Women's Business Research, 2004

³ Bureau of Labor Statistics, 2006

⁴ Institute for Women's Policy Research, 2005

⁵ Center for Disease Control, 2005