- Some individuals could contribute money into an IRA account on a pre-tax basis, i.e. the money contributed into the IRA would not be taxable income at the time earned.
- Money in an IRA could be invested in a variety of investments commensurate with the individual’s risk preference. Income taxes would be deferred on those investment earnings until moneys were withdrawn from the account.
- Money withdrawn from the account would be subject to income tax at ordinary income tax rates.
- People who withdraw money from an IRA prior to age 59 ½ must pay ordinary income tax on the amount withdrawn plus a 10% premature distribution penalty.
- Required mandatory distributions from an IRA occur when the individual reaches age 70½. Tables from the Internal Revenue Service govern the amount of distribution.
- Contributions were generally limited to amounts from earned income and were traditionally in the low 4 digit range for maximum contributions; therefor IRA accounts would have limited total values.
Thursday, March 6, 2014
Thursday, February 27, 2014
Ah, no alarm clock to set; no meetings with peers/clients—nothing to do but what you wish. However, what will you do in retirement? The 40-55 hour work week will free a lot of time in your schedule. Have you thought about what you will do in retirement? The first few weeks of “honey-do" or deferred travels will pass. Then how will you spend your time. It really is a factor that should be considered. Some individuals may be content to do little; others may decide to expand their horizons through new activities or new vocations (possibly starting a new business). What time—and money—will be required in this new world? At the very least, the pre-retiree should develop a preliminary plan of what to do in retirement. Preliminary planning and, if possible, some actual time spent in anticipated retirement activities would help the future retiree decide if those activities are truly what he/she wants to do. One option to consider might be a “phased-in” retirement where work hours are reduced over time. Such an arrangement may help the retiree determine how he/she chooses to utilize his/her time as well as provide some relief in expenses through continued employment income.
A Family Affair
Retirement is a significant change in family dynamics. The spouse of one recently retired husband complained of “twice as much husband and half as much income.” After 30-40 years of working outside the home, ‘togetherness” may require some significant inter-personal adjustments. Spouses may wish to have discussions about how their time will be spent after retirement.
In addition, following the recent recession and loss of jobs/wealth, many families are now in the situation of helping either younger, adult children/grandchildren or parents/grandparents. Such assistance may jeopardize the long term retirement prospects of a potential retiree. While parents have a natural tendency to help children financially, the children have a longer time frame in which to recover financially; retirees usually have neither the time nor the economic opportunity to recover.
Expense in retirement is a significant consideration. Ascertaining those expenses can be problematic. Some current expenses will go away (work related commuting expenses, noon time meals, business clothing, etc.) Other expenses may increase! With no work requirement, how will you fill your time? Will the method you choose cost more than you are currently spending on such activities? Current retirees face a long period in retirement—in many cases over 30 years. Consider the different stages in retirement. The first stage is usually one of good health, interest in varied activities, and developing new interests. That stage (around the first 10 years of retirement) may actually increase expense because the new activities cost more than the work related expense savings. The second stage (the next 10 years) generally involves less activity than early retirement years and thus may require less expense than initial retirement years. The latter years of retirement usually involve a diminished activity level but may require additional expense related to health care.
The expense estimate cannot be overstated. Determining how much to budget involves estimating costs from a new activity level at a time when income levels are also changing. Consider preparing two post-retirement budgets. The first budget should contain the normal, ongoing expenses in retirement. That budget would include things such as food, shelter, utilities, taxes, insurance, and those known items that will be required to maintain the basic standard of living you wish to enjoy. The second budget should include those items that you wish to do: travel, hobbies, starting a new business, etc. If possible, live according to those budgets in advance of retirement—see if they are reasonable; if not, then make adjustments as required. Don’t overlook the expenses that will “go away” in retirement. When will the house be paid off (if not already)? There will no longer be contributions to the 401(k) plan. Will college expenses for the children be paid off?
We at Paragon Financial Advisors can assist you in the preparation of your retirement plan. Please call us and we can discuss the particular circumstances associated with your retirement or retirement plan. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.
Friday, February 21, 2014
Basically, a trust is a separate, legal entity established in a written document that has three components: 1)The Grantor- who puts assets (the trust corpus) into the trust, 2)The Trustee-who manages the assets placed in the trust, and 3)The Beneficiary- who receives benefits from the trust according to the terms specified in the governing trust document. Trusts still offer advantages in particular circumstances. Please note that items listed below are general in nature; specific questions and appropriateness for your particular situation should be discussed with competent legal counsel. Trusts can provide the benefits in situations such as the following:
Spendthrift protection- Some individuals, regardless of age, may be incapable of managing significant levels of assets. In such situations, the trustee may manage the assets and provide funds to the beneficiary to satisfy beneficiary needs. A common provision for such beneficiary income is for “…health, education, maintenance, and support…”
Blended families—Trusts can be used in blended family situations to ensure that assets are passed to specific individuals. For example, a trust can be used to provide income to a second spouse for that spouse’s lifetime; the trust corpus can be left to other individuals (children from the first marriage).
Creditor protection- Assets held in trust may be unavailable for attachment in creditor situations. Those assets could be protected depending on trust provisions and who established the trust. It is important to note that an individual cannot establish creditor protection trusts for themselves and still maintain control of the assets. Consult your attorney for specifics in your case before relying on trust arrangements for creditor protection.
Divorce protection- Unfortunately, divorce is becoming a common factor in marriages today. A well drafted and well maintained trust can remove assets to be shared by a departing (ex) spouse. Again, an individual cannot establish such a trust for themselves; establishment must be done by another party (i.e. parents leaving assets to their child in trust are not subject to divorce proceedings).
Estate planning—Even though the exclusion amount discussed above eliminated the need for some trusts, there are other tax advantages to be gained through trust planning. Income shifting or estate growth planning can be done with specialized trust. Charitable trusts, personal residence trusts, and numerous other techniques may be used for specific circumstances. These cases are best discussed with your attorney.
We, at Paragon Financial Advisors, do not draft legal documents; that is to be done by the attorney of your choosing. However, our principals have extensive experience working with trusts and can assist you in determining the questions to ask as you use trusts to further your financial goals. If you have any questions please call us. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management services for our clients.
Thursday, February 13, 2014
The prudent investor should determine why corporations are pressuring buy-backs. Corporate management may have these concerns:
- Slow growth in the economy does not justify spending corporate cash in expanding operational capability.
- A declining demand for corporate products has occurred.
- No better available alternatives may exist for investment (in the opinion of corporate management).
The return of cash to investors may occur because the corporate management worries about the general economic growth in the coming years, a particularly troubling possibility in light of the stock market increase in 2013.
Of course, management may have felt that investment in their shares was appropriate and that their stock was undervalued at current market levels. Many things must be considered in making an investment decision. We at Paragon Financial Advisors help our clients analyze the investments that may be appropriate for their investment goals.
If you have unanswered questions about corporate stock buy-backs or need additional guidance please call us. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management services for our clients.
Friday, February 7, 2014
Fee only compensation means the advisor is compensated by a flat fee or percentage of assets under management (annually); compensation may also be based on an hourly rate or fee for service for specific tasks performed. In either case, there is no additional compensation (sales commissions, etc.) for services performed or investments provided. Registered investment advisors (RIAs), such as Paragon Financial Advisors, operate under this arrangement.
A fiduciary requirement exists: the firm must put the best interest of the client first in all cases. This fiduciary requirement includes advising the client of all aspects of advisor compensation and the disclosure of any conflicts of interest the advisor may have with the client’s portfolio.
Regulatory oversight for fee only advisors is provided by either the Securities and Exchange Commission (for firms with more than $100 million in assets under management) or the state securities agency (for firms with less than $100 million in assets). Such advisors are subject to random audits by the oversight agency and to penalties if appropriate rules are not being followed.
Fee Based (Fee and Commission)
In contrast, broker-dealers and businesses that buy/sell securities and also give advice are compensated by fees plus commissions. Those commissions may be based on a “per transaction” basis thereby giving the advisor an incentive to sell a specific product or products from a specific vendor (because of higher commissions paid).
No fiduciary standard exists (except in a few states) for fee based advisors. They are subject to a “suitability” requirement (i.e. “Is the investment recommended/sold suitable for the investor?”). Therefore, if two investments can be deemed “suitable” for a client and one provides a higher commission to the advisor, the advisor is free to choose either as appropriate for the client. Fee based advisors are generally not required to disclose to the client all compensation arrangements or conflicts of interest.
Regulatory oversight for fee based advisors is provided by the Financial Industry Regulatory Authority (FINRA). FINRA does have circumstances in which additional information concerning disclosure of conflicts of interest must be disclosed to the client; it also provides for dispute resolution between advisors and clients according to binding arbitration.
In other situations a fee only advisor can have arrangements/ownership in firms that are actually fee based. For example, a fee only advisor might have securities licenses that entitle him/her to receive commissions from a broker dealer. In such a case, the advisor must be registered with the SEC and subject to FINRA oversight as a broker. Thus the advisor is subject to a fiduciary standard when giving advice and a suitability standard when providing commission services. Sound confusing? It is.
Much discussion is occurring in the financial services industry about fee only vs. fee based. In addition, industry groups weigh in on the subject. The National Association of Personal Financial advisors require its members be compensated solely by the client and that neither the advisor nor a related party receives any compensation based on the purchase/sale of any product. The CFP Board of Standards requires that Certified Financial Advisors™ may not use the term “fee only” if they are associated with a broker dealer or any firm that receives transaction based compensation.
We at Paragon Financial Advisors keep it simple—we are a fee-only™ designation. We offer registered investment advisory firm. We are also a firm member of the National Association of Personal Financial Advisors and the three firm principles at Paragon hold the Certified Financial Advisorsfinancial planning and investment management services for our clients.
Thursday, January 23, 2014
Health care costs have risen over 400% since the early ‘80’s (Dept. of Labor Statistics, Consumer Price Index as of Nov, 2012). In addition, they represent one of the top three (number 2) household budget items (Infogroup/ORC , Princeton, NJ telephone survey in March of 2010). Most people assume costs will be covered by private insurance or Medicare. The private insurance situation is certainly “up in the air” given uncertainty surrounding the implementation of Obama care. But how about the health care costs associated with Medicare? According to a Fidelity Benefits Consulting estimate in 2013, the average out-of-pocket health care cost for a 65 year old couple is $220,000 (assumed no employer provided retiree health care coverage, traditional Medicare benefits, and life expectancies of 17 and 20 years respectively for husband and wife). Obviously, individual costs will vary depending your specific health level and age at retirement. To evaluate how much you need to plan on health care spending, let’s look at some of the Medicare options.
Medicare has several options; these are as follows:
- Part A- Hospital insurance
- Part B- Medical insurance
- Part D- Prescription drug coverage
- Medigap- Medicare supplemental insurance
- Part C- Medicare Advantage Plans
Now let’s examine some of the cost the retiree must pay under Medicare.
- Deductibles (paid by the retiree) for Part A (Hospital insurance)
- Days 1-60---$1184
- Days 61-90--$296 per day copay (29 x $296= $8584)
- Days 91-150—“lifetime reserve days at $592 per day (59 x $592 =$34,928)
- Days 151+--All costs paid by retiree
- Monthly premium--$104.90 (increases as adjusted gross income increases
- $147 deductible
- 20% coinsurance paid by retiree on doctors’ services and outpatient care
- Benefits here are complicated depending on drugs (generic or branded) and the “donut” hole (i.e. that area in prescription cost in which the Medicare recipient pays the full cost of prescriptions). Suffice to say that the retiree can pay up $4,750 out of $6,735 in total drug cost.
Supplemental Medicare insurance (Medigap) provides insurance coverage for some of the items Medicare does not cover. The basic items in this insurance are as follows:
- There are 10 standardized plans offering different levels of coverage.
- The premiums for the same coverage or plan vary with the state where the Medicare recipient resides and the insurance company providing coverage in that state.
- Recipients may see any doctor who accepts Medicare.
- There is no coverage for prescription drugs, dental, hearing, or vision costs.
Medicare Advantage plans include HMOs, PPOs, private fee-for- service plans, and Medicare specialty plans. They usually address Part A and Part B expenses and may cover prescription drugs. Expenses are less if one uses the “in-network” medical providers; however, one may choose “out-of-network” doctors (usually by paying an increased cost). Other services (dental, hearing, and vision) may also be covered.
As you choose your options under health care services, there are several questions you should consider.
- Do you have insurance coverage for dental, hearing, and vision (services not covered by Medicare)? If not, is that coverage important to you?
- Do you want to continue seeing your current health care providers?
- Have you considered the total out of pocket costs for prescription drugs—especially as you age.
- Do you want the ability to choose your own health care provider (particularly specialists) rather than be forced to choose from a pre-selected group of providers?
- Do you have protection in the case of catastrophic illness?
Wednesday, January 15, 2014
Gross Domestic Product (GDP)
The gross domestic product of the United States is a measure of its economic activity. For the mathematically inclined: GDP=C+I+G+NX (or Consumption + business Investment + Government + Net eXports). Consumer spending accounts for approximately two-thirds of GDP. Some of the categories here include durable goods (autos, furniture, etc.); non-durable goods (food, clothing, etc.); and services (approximately 45% of GDP). Investments (excluding real estate) in business equipment and furniture account for approximately 18% of GDP. Third quarter 2013 GDP showed an annualized rate of about 4%; however, estimates for 2013 in total are in the 2% range. Estimates for 2014 are in the 2-2.5% range. The bottom line at this point in time is spending is up but at a lower rate than recoveries from previous recessions; non-durable goods spending is weak but improving.
Employment is down approximately 8 million people in the recession and about 3.5 million jobs below pre-recession levels. The most commonly quoted “unemployment rate” is the U3 rate—the current number of unemployed divided by the civilian labor force (currently 7%). There has been much discussion about this number. The “unemployed” in the numerator is affected by people dropping out of the job search and “part time” employees. Therefore, other employment data warrants consideration. The U6 rate captures these discouraged and part time workers—it is approximately 14%. Another consideration is the extended unemployment figure (unemployed persons for greater than 27 weeks). There are approximately 4 million such persons (about 3 million greater than prior recessions). One of the most significant numbers (in our opinion) is the civilian participation rate. That ratio is the number of people in the labor force divided by the working age civilian population (currently 63% and at levels not seen since the mid-1970s). From a societal standpoint, there are significant differences in unemployment rates; the unemployment rate for high school graduates over the age of 25 (with no college) is approximately 15%.
Quantitative Easing (I, II, Operation Twist, and III) has increased the nation’s balance sheet by approximately $4 trillion with the first sign of tapering just appearing in December. The large scale asset purchase plan is still buying $75 billion in Treasury and mortgage backed securities per month. In addition, the second part of the interest rate plan (the zero interest rate policy) of 0 to 0.25% on feds funds appears to be in place until the 2016 or 2017 time frame. The fed funds rate in the ’81-’82 recession was 18%; in the ’74-’75 recession it was 12.5%. In spite of the excess liquidity coming into the system, inflation (see below) has been below Federal Reserve target levels. The money multiplier has dropped significantly as the reserve required for banks has been increased by banking regulators.
The rate of exchange of the US dollar vs. other major currencies is much lower than previous recessions; this rate has a direct impact on the net exports included in GDP.
Inflation, as measured by the personal consumption expenditures (PCE) price index, is currently below 2% (the Federal Reserve desired level). The current rate (excluding food and energy) is approximately 1.5%. The PCE rises less than the Consumer Price Index (CPI); however, the CPI does not take into account “substitution” (where consumers have substituted goods whose prices are stable for those goods whose prices are rising). Lower inflation raises the prospect of deflation—a much harder problem to manage. Just ask the Japanese over the last two decades.
So what does all of this mean for the investor? Weak GDP growth, high unemployment rates, low interest rates, low foreign exchange rates, and low inflation lead to modest expectations for 2014 (as the Fed keeps QE and ZIRP in play). Pension benefit obligations of $7.5 trillion on federal government retirees and approximately $21.6 trillion in unfunded Social Security benefits are not included in our current $17 trillion national debt. These unfunded obligations, and the declining number of workers per retiree (from 9:1 to 3:1), imply that there will be significant changes in the future. What are those changes? Ah, remember the old curse—“May you live in interesting times.”
If you have unanswered questions or need additional guidance please call us. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management services for clients.