Moment on Money

Letter to Clients – 4th Quarter 2009

Dear Clients and Friends,

The move to our new office went well and we settle in more every day. By the time you receive this we should have pictures on the walls and the signs should be up. Hopefully that means no more lost clients trying to find the office! In case you are not familiar with the area, we are in the office building on the northeast corner of 70^th and University Ave in Windsor Heights. It is the first building east of the HyVee and across the street from the Apple Valley Shopping Center. Our office is on the first floor and there is plenty of parking in the back.

The markets never stopped, despite my move. We have reached the end of the third quarter in what continues to be a most eventful year for both the markets and the economy. It's also one year since the foundations of Wall Street and the global financial system were shook--when Lehman Brothers collapsed, Merrill Lynch vanished as an independent entity, and AIG was taken over by the government.

In light of that, I thought it might be worthwhile to briefly summarize where we've been this year, where we are today, and the prospects for the period ahead--and also to highlight some lessons from last year's financial collapse.

Where we've been

Seven months ago, in early March, it truly did feel like the world might be coming to an end. Talk of a return to a Great Depression-like economy dominated radio, television, and print. Understandably, fear was rampant, and stocks responded to these nightmarish scenarios by hitting their lowest levels in years, with financials especially hard hit.

Although no one knew it at the time, that turned out to be the bottom. Since then, we've seen the economy move back from the precipice; there is a growing consensus that we'll return to economic growth in the second half of this year. The Economist recently ran a cover story discussing the extent to which the economic recovery was led by Asia.

As a result, we've had a strong recovery in markets. From their bottom in the beginning of March, stock markets are up 50%, retracing a good portion of the losses since last fall.

In the meantime, here are six lessons from the past 12 months:

1. We were reminded of just how volatile stocks can be...

2. ...and of the importance of true diversification.

3. Many investors discovered that they're less comfortable with risk and volatility in their portfolio than they had believed.

4. Investors were also reminded of the need to focus on what they can control, understanding cash needs, and thinking through how much risk they can live with to fund thosse needs.

5. In some cases, investors began rethinking retirement plans as a result

6. Finally, we were reminded that in today's world, we need to expect the unexpected.

Where we are today

A year ago, the market was characterized by rampant optimism. The market had hit a new high the previous fall, and any concerns were set aside as minor annoyances.

By contrast, six months ago the market was overwhelmed by absolute pessimism--there was no sign of hope anywhere.

Today, the market is somewhere between those two extremes, and many investors can be characterized as extremely nervous.

As a general rule, I think a certain level of healthy anxiety is positive--what gets investors in trouble is an excess of either optimism or pessimism. While today's mood may be erring on the side of being a bit too pessimistic, I think being cautious in the current market makes sense, provided that prudent caution doesn't cross the line into panicked inertia.

I spend a lot of time listening to the best market minds and to managers who have lived through multiple cycles. I am reassured that most say that they are still finding very good value--not to the extent that they did earlier this year, but still well ahead of what they would have seen a year ago.

The good news is that there are still excellent opportunities for investors who are prepared for short-term volatility. What has changed is the old model of asset allocation. The new model of today includes considering alternative investment classes such as commodities, energy partnerships, leasing programs, and real estate. Several clients have taken advantage of FDIC insured CD's whose interest payments are linked to market performance. Some clients have even instituted short term trading strategies which have a high income potential in a sideways markets.

The outlook going forward

In August, Business Week ran a cover story called "The Case for Optimism." The premise was simple: beyond the issues facing the global economy, there are many underlying positives that give cause for optimism if we look out two or three years and beyond.

Looking that far ahead, there are things happening under the surface that will drive economic growth. Economic growth will drive growth in stock prices. Examples include the positive impact of technology, the recovering housing market, the revitalization of the American economy currently taking place, and the incredible energy from the developing world's educated youth and emerging middle class.

But the road to recovery is not expected to be smooth. Let me close by talking about market volatility.

In 1907, financier J. Pierpoint Morgan singlehandedly averted a banking panic. Later in life, someone asked him his best guess on the direction of markets. His answer: "They will go up and they will go down."

One hundred years later, that's still the best answer to someone looking for a short-term market forecast. No one can predict market movements in the immediate period ahead--all we can do is understand clearly how much short-term volatility we can live with, adjust our portfolios accordingly, and stay focused on the horizon as we deal with the rough waters. No one likes volatility, but for most of us, it's the necessary price for arriving at our ultimate destination.

In the meantime, I am constantly looking for opportunities to realign portfolios to give clients the best trade-off between risk and return. If you would like to discuss your investments in more detail, I am always delighted to have that conversation.

Thank you for the continued opportunity to work together.

Self Employed Retirement Plan Options for 2009

One of the disadvantages of being self employed is the lack of an employer sponsored retirement plan. Fortunately, there are several options available depending on how much you want to contribute each year.

$6,000 or less

The simplest retirement plans are the Traditional IRA and Roth IRA which are available to everyone, self employed or not. Eligible taxpayers can contribute $5,000 per year to a Traditional IRA and/or a Roth IRA. Taxpayers who are 50 or older can contribute an additional $6,000. Most self employed people are not an active participant in an employer sponsored retirement plan. Therefore, they are eligible to make a tax deductable contribution to a traditional IRA. Self-employed people who are active participants in an employer sponsored plan such as a 410(k) may still be eligible subject to phase out rules based on adjusted gross income(AGI). Roth IRA eligibility is based solely on AGI. The phase out ranges are $166,000 - $176,000 (married filing jointly), $105,000 - $120,000 (single and head of household), and $0 - $10,000 of modified AGI for married filing separate.

$5,000 - $14,000

For the self employed who want to contribute more than a Traditional IRA would allow, the next option would be a SIMPLE plan. SIMPLE is an acronym for Savings Incentive Match Plan for Employees, and not a description of how easy the plan is. As the name implies, if you have employees you must make an employer contribution or match for them. But if you are your only employee the SIMPLE allows you to contribute up to $11,500 regardless of your age or income. If you are 50 or older you can contribute up to $14,000.

Up to $49,000

By employing a SEP (Simplified Employee Pension) plan, you can contribute up to 25% of your income to a maximum of $49,000. Like the SIMPLE, you must also make contributions for your employees which can be a significant factor to consider. But if you are the only employee, the SEP works very well. Another alternative that allows you to exceed the 25% limitation, is the solo 401(k) (often referred to as the solo k) which is a 401(k) plan for one person businesses. With the solo k you can make a salary deferral election of $16,500 ($22,000 if you are 50 or over) and also make an employer contribution of 25% of your income as long as it does not exceed $49,000 limit.

While the retirement landscape seems complex, a qualified financial planner can point out the advantages and disadvantages of the options and assist in designing the retirement plan which fits your goals and budget.

The Retirement by ted.sali

In the News: Solving Retirement Problems

I was recently interviewed for my views on retirement in the "modern" environment. Here is a link to the article.

The author provides a concise summary of the only three solutions (which can be combined) to solve a retirement funding problem. When faced with a shortfall in retirement money, there are three choices:

1. Retire on less
2. Postpone retirement
3. Save or earn more before retirement

Enjoy the article. I did.

Neon signs, Mansfield, Ohio – City News and Coney Island Diner by brianbutko

The Key to Tomorrow

I recently had the opportunity to listen to a presentation by Dr. Paul Stoltz, author of the book The Adversity Advantage, about a concept he calls the Adversity Quotient or AQ. In a nut shell, AQ is a measurement of how well someone deals with adversity and he believes that resilience is the single most important indicator of success. Given the adversity which faces us each and every day in today's economy, everyone gave Dr. Stoltz their full attention.

The message is as significant as it is simple. Everything is a matter of cause (situation) and effect (response). We cannot control the situation, but our resilience can help shape our response. As it specifically relates to the financial crisis Dr. Stoltz said "We cannot turn the dial on the world economy, but there are a number of things we can do." It was a defining moment. He is right. The economy is a fact. The market has suffered losses. History is beyond our control. Now, What are you going to do next?

If you are hoping to find a one-size-fits-all solution or a quick fix, let me know when you find it. I do not have an easy answer. But I can recommend that this is an excellent to time to reassess and look at your financial position from a distance. Are you still in line to meet your financial goals? If not, what needs to change? Maybe the goal is no longer realistic or maybe it is.

Most of my time these days has been devoted to helping clients assess their retirement plans and discussing the alternatives. Sometimes they decide to change their plans by postponing retirement. Other times they are willing to allocate more resources towards meeting the original goal. And others have decided to redefine their retirement. Everyone has reconsidered their exposure to risk. No decision is right and no decision is wrong. The biggest potential mistake is choosing to ignore the situation and do nothing.

I am incredibly excited about the future. I always remember the words of Peter Lynch (paraphrased) "I have no idea which direction the next 1000, 2000 or 4000 points in the market will be, but I am confident that the next 10,000, 20,000 and 40,000 points will be up." I do not think market recovery is the question. The question is when.

I leave you today with The Portable Pep Talk by James J. Metcalfe:

I get discouraged now and then when there are clouds of gray,

Until I think about the things that happened yesterday.

I do not mean the day before, or those from months ago.

But all the yesterdays in which I had a chance to grow.

I think of opportunities that I allowed to fall aside

And those I took advantage of before they passed me by.

And I remember that the past presented quite a plight.

But somehow I endured it and the future seemed all right.

And I remind myself that I am capable and free,

And my success and happiness are really up to me.

 

You control your response. What are you going to do next?

 

The Key of my mind… by ul_Marga

Qualified Retirement Savings - Taxing Tidbits

I learned something at a recent meeting with my tax accountant. The Heartland Disaster Tax Relief Act of 2008 offers Iowans in 78 counties, including Central Iowans several broad tax reliefs even if they were not directly influenced by the 2008 floods. Some aspects of the tax relief were mentioned in a recent Des Moines Register article but a significant relief was overlooked.

Specifically, according to my CPA, premature distributions from a tax qualified account like an IRA taken in 2008 or 2009 are exempt from the usual 10% tax penalty. Of course the distribution would still be subject to income tax but the 10% relief is pretty significant. The details are supposed to be covered in IRS publication 4492-B but it is still not yet published but I did find some mention of it at the bottom of page 3 of IRS FS-2008-27, Tax Law Changes Related to Midwestern Disaster Areas.

Even though it was not the intent of the legislation, given the current economic situation, this relief may be quite handy to someone who has qualified assets but has lost their job and is having trouble making ends meet. Otherwise, there is no good reason to raid your retirement accounts. I must recommend to anyone considering making a withdrawal from an IRA that they first check with their tax professional.

I also recently learned of a tax credit for qualified retirement savings which I had never known about before. IRS Form 8880 provides instructions and a worksheet to calculate a tax credit to encourage retirement savings. It only applies to low income taxpayers (adjusted gross income of less than $53,000 for married filing joint or $26,500 for single) who are at least 18 years of age and not a dependent of another taxpayer or a student. See the form for the specifics but this credit essentially pays 10% - 50% of the amount saved for retirement. That is quite an incentive for those who qualify.

Art Dinkin does not provide legal or tax advice. If such advice is needed see a tax professional or an attorney.

 

A Reader Asks #16: A Countrywide IRA

It has been a while since I have answered reader questions. I recently received this email:

I have an IRA with Countrywide. Bank of America has purchased Countrywide.

If I do not want to be a Bank of America customer does the "law" allow me to withdraw my IRA from Bank of America without Bank of America penalizing me for an early withdrawal?

Ah yes, remember Countrywide? That was the "crisis" several months ago before Lehman Brothers, AIG, Freddie, and Fannie. You remember. When life was simple? You are correct. Countrywide was taken over by Bank of America and, for whatever reason, you do not want to be their customer but you do face two potential obstacles.

First, since this is an IRA the federal tax code (I assume this is the "law" you referenced) imposes some fairly severe penalties for accessing your money if you are younger than age 59 ½. Fortunately, this is a pretty easy obstacle to work around. If you transfer your IRA directly to another IRA, the distribution from the old IRA is neither taxable nor does a penalty apply. Your new IRA provider should be quite familiar with a direct transfer and will take care of all the details. You simply sign a direct transfer form, sit back, and let them take care of the details. Of course if you are older than 59 ½, the penalty is no longer an issue but a direct transfer is still your best method of avoiding current income tax.

The bigger potential problem is this particular situation could be the current IRA product. Is it an annuity, mutual fund, certificate of deposit (CD), or a simple savings account? An IRA could be any of these and possibly something else. While a direct transfer avoids current income tax and tax penalties, it does not excuse any charges imposed by the product itself for a premature distribution. The only way to know if your account is subject to a charge is to ask. Just call Bank of America and tell them you are considering a direct transfer for your IRA. Ask them if there are any charges or penalties imposed by your current IRA product. If there are, find out what the charges are, how they are calculated, and how long they last. For example, CD's often require that you forfeit 3 or 6 months of interest. Annuities often have surrender charges which may be imposed from 0 to 10+ years and are a percentage of the balance. Mutual funds may, or may not, have back end sales charges. Savings accounts are usually readily accessible.

Even if you product imposes a cost this just may be the best time to pull the trigger on a change. If your account is exposed to the markets then your balance may be at a low. If your charge for closing your account is a percentage of the balance, the charge is down now too.

Without knowing the specifics of your account I cannot give a specific recommendation, but I hope I have given you enough of a background to help you make your best decision. Just weigh the cost of making a direct transfer (if any) against the reason you do not want to be a Bank of America customer.

Is there a financial topic you have a question about? Or is there something you have always wanted to know but were afraid to ask? This is your opportunity! Send me an email and ask your question. I will publish the answer here at the blog and promise to keep your identity confidential. No cost. No obligation. No strings attached.

mail by chona kasinger

Nice Try, But…

One of my clients called with an interesting question.

"I need to take the money out of my IRA" he explained. "I know I have to pay income tax, but I think I found a way to avoid paying the penalty" he continued. He certainly got my attention and I was all ears. "What I want to do is convert my IRA to a Roth IRA. I will pay the income tax on the conversion. Since after the conversion I can withdraw my Roth contributions at any time without penalty, I can liquidate the Roth right away and avoid the 10% penalty" he explained.

For a while I was stumped because, at first glance, it seemed logical. But something in the back of my mind told me there was a rule or regulation that prohibited that very circumstance. So I called a good friend and former co-worker of mine, Dave Breuer, CFP®. Dave and I worked together ten years ago when we were both Advanced Market Consultants at the same company. Our job was to provide advice and support for the company's advisors who's clients had complex estate planning, business planning, and retirement planning issues. We were partners when the Roth IRA went into effect and we had both spent considerable time studying the intricacies of program when the tax code was our only resource.

Dave was quick to find the answer (I knew he would be). Distributions from a Roth IRA conversion are still subject to the 10% penalty for 5 years after the conversion.

But Dave and I never give up at the first roadblock. We even considered the potential for avoiding the penalty by converting an IRA into a Roth IRA which was already over 5 years old but unfortunately someone else had thought of that before we did and closed that potential loophole too. If converted IRA contributions are co-mingled with ordinary Roth contributions, distributions from that Roth are treated as FIFO (first in, first out). You can withdraw the ordinary contributions without paying the penalty only up to the amount in the Roth prior to the conversion. If that amount is exceeded, then the 5 year limitation is applied.

I have to give a lot of credit to my client for his creative thinking, but thankfully he checked with me before he put his plan into action. I was able to save him from a nasty 10% surprise next April.

Nice Try by YoLoPey

Every Cloud Has A Silver Lining

Are you having trouble finding a silver lining in today's financial turmoil? I'll give you one:

This may be an excellent time to re-characterize IRA assets to a Roth IRA.

When you do the conversion, you have to pay taxes on the amount converted. Since the value of your IRA is probably lower than it was, the tax cost of the conversion will be lower too. When the markets recover your growth will remain tax deferred. If you have had a Roth for more than five years and you are over age 59 ½ when you withdraw the growth, you may never pay taxes on the growth!

Before you jump in with both feet, here are a few additional considerations:

1. To be eligible to make the IRA to Roth Conversion, you must have a Modified Adjusted Gross Income (MAGI) of $100,000 or less and not be filing taxes as married – separate.
2. The tax would be due on April 15^th of 2009, unless you wait until January 2009 to make the conversion. If you wait then the taxes would not be due until April 2010. But you also have to ask yourself if you think your account values will go up or down between now and January.
3. Changes coming to the Roth IRA conversion rules which take effect in 2010 will allow you to pay the tax over two years and will also eliminate the income limitation.

For many, there may be no better time than now to make the Roth IRA election. You may want to consider it too.

Every cloud has a silver lining (5.00 pm) by jensaar

Apparently I Burned Down Disney Land!

The best part of my work is the clients.

One client in particular has a great sense of humor. Not too long ago she came in to fund a retirement account. As she wrote the check, she complained a little that it was a lot of money. I reminded her that she was putting the money into her retirement account, not spending it. I also asked if we should re-consider the amount of her contribution. I reminded her that funding a retirement account should help her sleep better at night and that if it kept her awake, she was probably putting in too much.

"Oh no" she replied. "I am not losing any sleep over this. I will just tell my kids that you burned down Disney Land."

I could not help but laugh when I heard that, but later I realized the true and meaningful underlying message.

It is a matter of choice. Take your family on vacation now or sacrifice a little for your future.

The castle at Disney Land Paris by Chris Hogg

The History of Retirement

I came across an article in Research Magazine titled From Bismarck – How the idea of retirement evolved. I found it quite interesting and decided to share a synopsis intertwined with my own perspective since I doubt many of my blog readers keep up on the financial professional publications. If you are interested, the complete article is available at the magazine's website.

Retirement, as we know it, is a relatively modern concept. Until the late 19^th century, people typically worked for as long as they were able and then depended on relatives or charities to support them beyond that point. Life expectancies were shorter, and a lifetime of work was typical.

On November 17, 1881 German Kaiser Wilhelm I issued an imperial decree at the urging of Chancellor Otto von Bismarck declaring "those who are disabled from work by age and invalidity have a well-grounded claim to care from the state." Bismarck pushed for the creation of a government supported social program and the German pension system was enacted in 1889. The initial retirement age in the German system was 70 years old, but it was lowered to 65 in 1916. Age 65 was eventually adopted by the U.S. Social Security system as well.

Over the next several decades, other European countries adopted state run pension systems. In the United States, with the notable exception of a failed Theodore Roosevelt platform plank for a national pension system in his 1912 presidential campaign, the concept of a government support pension program had little support until the depression era of the 1930's.

Instead, U.S. businesses favored employer provided pensions. By 1916, more than half of railroad employees were covered by a pension plan and the concept was spreading. The concept of retirement as a time of leisure and financial security was growing deep roots in the culture. Workers were beginning to view a retirement as something that could be planned for and enjoyed with payments earned over decades of labor. But in 1923 the Morris Packing Company failed leaving behind a pension fund unable to meet its obligations. As the depression hit, many other corporate failures lead to pressure on politicians to create a retirement system supported by the government. President Franklin D. Roosevelt sent a message to Congress on June 8, 1934 calling for "social insurance … to provide security against several of the great disturbing factors in life – especially those which relate to unemployment and old age" which led to the passing of the Social Security Act into law on August 14, 1935 to enhance corporate pensions.

When the second half of the 20^th Century came around retirement was a more attractive than it had ever been before. Workers labored until their 65^th birthday when they got a gold watch and then had plenty of time for golf. But the system assumed that workers would stay with one company for most of their career, and that the companies would stay in business for long periods of time. In 1963, automaker Studebaker collapsed and became unable to fulfill the generous pension benefits their workers were expecting. That event spurred a push for new regulations to protect pension plan holders and the Employee Retirement Income Security Act of 1974 (ERISA) created the Pension Benefit Guaranty Corporation to provide insurance against plan termination. Soon, new types of retirement accounts were becoming part of the system including 401(k)'s which were made possible by a change in the tax code in 1978.

There are a few things we can take for granted. The concept of retirement a permanent fixture in our culture, but our system will have to change as it faces future challenges both known and unforeseen. The only true security for a retiree is their own savings and investments. Neither government nor corporate pensions can be relied upon as the foundation of a stable retirement.

From other blogs:

• The history of Social Security (as we know it today) at The Retirement Planning Blog
• Social Security Facts and History @ Spaces
• Academy of actuaries: Raise the retirement age @ Notes on Social Security Reform

NY – Hyde Park: Franklin D. Roosevelt Presidential Library – Social Security Act by wallyg