Monday, October 8, 2018

Things to Think About: Tempus Fugit! Time Flies!


Time does fly—and with it, some potentially significant tax benefits. There are actions which, if taken in October 2018, can have consequences on taxes—even 2017 retirement plans. We will discuss some of the general rules here; you should discuss the specifics of your situation with your tax professional.

Roth IRAs

  • Conversions- Individuals who converted a traditional IRA to a Roth IRA in 2017 may “recharacterize” that conversion back to a traditional IRA if the recharacterization is done by October 15, 2018. Income taxes are due on the amount originally converted from a traditional IRA to a Roth IRA. If the account value has decreased, a lesser tax amount would be due if the Roth was converted back to a traditional IRA, then re-converted to a Roth in 2018. Tax rates have also changed in 2018 due to the Tax Cuts and Jobs Act passed this year. Many individuals may find themselves in a lower tax bracket for 2018; hence, recharacterizing and reconverting in 2018 might mean lower taxes even if the account value remains unchanged. Note that such recharacterizations are allowable only for transactions made in 2017; no such recharacterizations are available for 2018 or later years.
  • Recharacterizations- Contributions to a traditional IRA can be recharacterized to a Roth IRA or vice versa. Suppose an individual contributed to a traditional IRA in 2017 but found their income was too high to take a tax deduction. Recharacterizing to a Roth IRA would have no tax increase but would move the future earnings on the account from tax deferred to tax free. While the Tax Cuts and Jobs Act eliminated recharacterization of conversions beginning in 2018, recharacterization of contributions remains in effect.
  • Excess Contributions- Excess contributions made into an IRA are subject to a 6% excess contribution penalty. Any excess contribution made in 2017 (plus accumulated earnings thereon) removed from the account by October 15, 2018 will not be subject to that penalty. No relief from this penalty is allowable if the October deadline is missed.
  • SEP IRAs for 2017- October 15, 2018 is the deadline for establishing and funding a SEP IRA for businesses if the business filed for an extension. This differs from the “normal” deadline for contributing to a traditional or Roth IRA (the tax filing deadline excluding extensions).
  • Simple IRAs for 2017- Employer contributions to Simple IRAs must be made by the tax filing deadline (including extensions) of the business. Again, if the business filed for an extension if 2017, the deadline is October 15, 2018.


Trusts

Inherited IRAs may be “stretched” over the life expectancy of beneficiary—a significant extension in the time over which IRA proceeds must be distributed (and taxed). If the beneficiary is a trust, the trustee has until October 31, 2018 to provide proper documentation that may allow this stretch provision for IRAs inherited in 2017. Miss the deadline and the IRA must be distributed fully over a much shorter period.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.


Friday, July 20, 2018

Taxes and Investments


The single greatest expenditure that most individuals face is taxes. Google “tax freedom day” and you’ll find the number of days you work during the year just to pay taxes. In 2017 that day was April 23; or 114 days (about 1/3 of the year) before you begin to keep what you earn. The Tax Foundation estimated that you work January to pay off federal taxes. In February, you pay Social Security, Medicare, other payroll taxes, and state income tax. In March, you pay state and local sales taxes, property taxes, and excise taxes. The first 23 days in April paid corporate income taxes (through higher prices on goods/services), motor vehicle taxes, and severance and estate taxes.

Tax Priorities

Given the impact of taxes on an individual’s financial well- being, tax discussions warrant a discussion in financial planning. Conventional wisdom on taxes is:
  1. If legally possible, avoid taxes.
  2. If avoidance is not possible, defer the tax to sometime in the future.
  3. If deferral is not possible, pay the tax at the least tax rate possible.

The income tax and investing consequences above can best be exemplified by contributions to a 401(k) defined contribution plan. Such contributions fulfill the planning priorities because:
  1. Contributions into a 401(k) plan are not counted as taxable income in the year earned. Those contributions are excluded from taxable gross income for the year (avoid taxes).
  2. Contributions grow tax deferred in the 401(k); no income taxes are paid until money is withdrawn from the plan (tax deferral).
  3. Retirement plan distributions are generally mandated by age 70 ½ (well past the normal retirement age for most individuals). Assuming the individual is retired, income should be lower than in working years, and, income tax rates should be less (pay at the least tax rate).

Taxes and Investing

Tax circumstances should be considered in the financial planning process in the context of investing. Why? Different investments are more suitable in specific investment accounts than others. There are two main types of investment accounts: 1) taxable (where taxes are due depending on actions in the current tax year), and 2) tax deferred accounts (IRAs, 401(k)s, etc.) where taxes are payable at some time in the future.

There are specific taxes consequences associated with these two types of accounts that can potentially impact investments in each.
  • Tax deferred accounts—While taxes on the growth of investments in these accounts are not due until money is withdrawn from the account:
    • When money is withdrawn from the account, the money (tax deferred contributions plus all earnings on those contributions) is taxed at ordinary income rates.
    • Losses on investments in the account are not deductible against ordinary income or other investment gains.
  • Taxable investment accounts—Current taxes are due depending on activities in the account during the year.
    • Investments in the account which are sold within one year at a profit are taxable as ordinary income.
    • Investments in the account which are sold after one year at a profit are taxable at a lower, long-term capital gains tax rate.
    • Investments sold during the year at a loss can use that loss to offset gains on investment sales or to offset other income (currently limited to $3000 per year).
    • Some dividends and interest are deemed “qualified” and are taxable at lower tax rates.

The characteristics above can provide some general guidelines for investments in specific types of accounts. Those investments less subject to loss of principle and more stable income (bonds) would be more suitable in tax deferred accounts. Investments subject to possible significant fluctuations in value (positive or negative) such as stock would be more appropriate in taxable accounts. Again these are general rules; specific circumstances may make deviations from the rule entirely appropriate.

Other Tax Consequences

Financial planning should also include possible tax consequences of estate transfer. While the Tax Cuts and Jobs Act of 2017 significantly increased the estate tax exemption amount to approximately $11 million per person, that increase may expire in 2027 or with other political changes.

We at Paragon Financial Advisors help our clients minimize the tax consequences on financial planning. Of course, we recommend that specific actions associated with particular client circumstances be discussed with the client’s tax professional. Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.




Monday, April 23, 2018

Goals Set-Goals Met!


The base of your financial planning should be your goals and objectives. Goals are basically a result or achievement toward which you are willing to expend time and effort. Goals vary with the individual’s wishes; hence, you set your own. Defining effective goals requires developing some particular characteristics for those goals. For example, “I want to retire comfortably” is not a well-defined goal. Additional information is required.

Goal Characteristics

A well-defined goal requires the following characteristics:
  1. Specific- An effective goal is specific in nature. It clearly defines the desired result or achievement in an unambiguous manner.
  2. Measurable- Goals must be measurable, i.e. you must have a way to determine the attainment of the goal and monitor the process toward goal attainment. Financial goals would be measured in dollars.
  3. Achievable- Effective goals must be achievable. For example, a goal of playing quarterback for an NFL football team would not be achievable for me given my age, size, and athletic ability. Achievable does not necessarily mean easy. “Stretch” goals requiring significant effort are permissible as long as it is possible to achieve the final goal.
  4. Relevant- Goals must be relevant; a relevant goal provides incentive for expending the effort required for goal attainment.
  5. Priority- Most individuals will have multiple goals as they go through the goal setting process. Some goals will be more important to the individual than others. Therefore, goals should be ranked by priority. Which goals are most important and which goals have lesser importance? Identify and rank according to priority.
  6. Time frames- An effective goal has associated time frames for completion and “mile posts” to monitor progress toward goal achievement.
  7. Action Items- Action items outline the actions necessary to attain the goal. What needs to be done in order to successfully reach the goal?

Goal Definition


Let’s restate our retirement goal according to these parameters.

“My first priority is to retire in 30 years at an income level equal to 85% of my current income adjusted for inflation at 3% per year. In order to accomplish this goal, I need to save X dollars per year and my investment portfolio needs to grow at Y % per year.”

  • This restatement clearly provides better definition with the characteristics discussed above.
  • Specific/Measurable- “…retire… at an income level equal to 85% of my current income adjusted for inflation at 3% per year.”
  • Achievable- certainly.
  • Relevant/Priority- “…first…”
  • Time frame- “… in 30 years…” with measurable mile posts—the value of the portfolio each year based on an assumed savings rate and portfolio appreciation rate can be identified and monitored.
  • Action Items- “… save X dollars per year.”

We at Paragon Financial Advisors help our clients appropriately define, and attain, their financial goals. Please give us a call and we’ll help you.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.




Tuesday, December 12, 2017

Social Security, If Not Now-When?

Social Security benefits are a component in the retirement planning of most Americans. However, those benefits pose questions for both younger and older employees. Younger employees are faced with the long term viability of the system (see our previous posting of “Social Security, Medicare, and You”. Older employees are faced with the question of how, and when, to start taking their benefit.
 
Social Security benefits are a function of age, length of working career, and earnings level. Therefore, we urge you to contact the Social Security Administration to determine your specific benefits. Our discussion here will be more general in nature and cover only the Old Age & Survivor Insurance (OASI) benefit.
 
Full Retirement Age (FRA)
 
Full retirement age is the age at which one is eligible to draw 100% of Social Security benefit earned. Retiring earlier than FRA reduces the amount received; retiring later increases the amount of benefit. Once benefits are begun, the amount is constant, subject only to cost of living adjustments (COLAs); that adjustment amount is tied to inflation. Full retirement age for benefits is shown in the following table:
 
Full Retirement Age

Year of Birth
Age Required for Full Benefits
1954 or Earlier
66 years
1955
66 years + 2 months
1956
66 years + 4 months
1957
66 years + 6 months
1958
66 years + 8 months
1959
66 years + 10 months
1960 and Later
67 years

The earliest age at which one can begin drawing benefits is 62. However, for those born in or before 1955, starting Social Security before FRA reduces the in full benefit by 6.25% per year. For those individuals born in 1960 or later, the reduction is 6.0% per year. Waiting until after FRA to begin drawing benefits increases the benefit by 8% per year until age 70. There are no further benefit increases after age 70.
 
Cost of living adjustments for Social Security are tied to inflation. In 2017, benefits increased by 0.3%. There have been years in which benefits did not increase; however, the average cost of living adjustment for 1985-2017 has been 2.6%.
 
Age 62 or Later?
 
When should one begin drawing Social Security benefits? Should one draw a lesser amount for a longer period of time (longer life expectancy) or a greater amount for a shorter period of time (shorter life expectancy)? That’s a complex question with many variables. What is one’s current financial situation (i.e. does one need the money)? What’s the long term prognosis for life expectancy (current health, heredity, etc.)? How can a couple plan benefits to maximize lifetime income received? There is a “breakeven” point which can be calculated. Consider the following example:
 
John Smith is entitled to $1500 monthly benefit at his FRA of age  66. If he chooses to begin benefits at age 62, his FRA amount will be reduced by 25% (i.e. 6.25% for 4 years) resulting in a benefit payment of $1125 per month. If he waits until FRA and begins  drawing $1500 per month, he will forgo the $1125 per month that he could have been receiving or $54,000 ($1125 x 48 months =   $54,000). If he begins benefits at age 66, that forgone amount will be recovered at $375 per month ($1500 benefit at 66 vs. $1125 at 62) which will require 144 months ($54,000 ÷ $375 = 144 or 12 years). Therefore, John’s breakeven age is 78. If he dies before   age 78, he made the correct decision to take benefits at age 62; if he lives past age 78, delaying until FRA would have been more  advantageous.
 
Obviously, life expectancy is a key component here. In previous postings we have referenced mortality tables. For the above example, the probability of a male at age 62 living to at least age 76 is 73%. There is a 60% probability he will live to age 80, and a 21% probability of living to age 90.
 
To compound the problem, beginning Social Security benefits prior to FRA and continuing to earn income has consequences. There is an annual earnings amount allowed ($16,920 in 2017); for each $2 earned above that amount, Social Security benefits are reduced by $1. That restriction no longer applies if one draws benefits at FRA. There are special rules that may apply here, so individual circumstances must be considered.
 
The Bottom Line
 
Social Security benefits are a key component in retirement planning. How and when those benefits are begun can have a significant impact on long term financial well-being. We at Paragon Financial Advisors can assist our clients in planning for their future. Please call us to discuss your specific circumstances.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

 

 

Tuesday, November 21, 2017

Social Security, Medicare, and You

Each year the Trustees of the Social Security and Medicare trust funds provide a report on the financial status of these programs—current and projected. The information below is from a summary of the 2016 Annual Reports www.ssa.gov, Office of the Chief Actuary, 2016 Trustees Report-Jacob J. Lew, Sec. of the Treasury and Managing Trustee, and Thomas E. Perez, Sec. of Labor, and Trustee).
 
In general, both programs (as currently scheduled) are facing funding shortfalls. Social Security and Medicare accounted for about 41% of Federal program spending in 2015. Both programs will have cost growth in excess of Gross Domestic Product (GDP) growth through the mid-2030s. This shortfall is due to: 1) growth in the aging population (baby boomers beginning retirement—about 10,000 per day) eligible for benefits, and 2) fewer employees entering the labor market (because of lower birth rates) to fund the programs. Medicare expenditures per beneficiary are also projected to increase above the growth in per capita GDP over the same time period.
 
Social Security
 
Social Security has two separate trust funds to provide benefits for two programs: 1) Old Age and Survivors Insurance (OASI), and 2) Disability Insurance (DI). Although the trust funds are technically separate, the Trustees typically combine the funds to provide the actuarial financial status for the total plan. Funding for plan benefits comes from combined payroll taxes from both employees and employers. Current benefit payments to plan recipients are paid from these payroll taxes and any excess payment is scheduled to be added to a “trust fund” to provide for future benefit payments. In the 2016 report, the Trustees project that combined fund asset reserves will exceed projected benefit costs through 2028; benefit payments will then begin to dip into trust fund reserves. Trustees currently project that those trust funds will be depleted in 2034. When the funds are depleted, projected tax income is sufficient to pay about three-quarters of projected benefits through 2090.
 
Medicare
 
The Medicare program also has two trust funds: 1) Hospital Insurance Trust Fund (Part A), and 2) Supplementary Medical Insurance Trust Fund (Parts B and D). Part A of Medicare helps pay for the cost of hospitalization, home health care following hospital stays, skilled nursing care, and hospice care for the elderly and disabled. Part B of Medicare helps pay for the costs of physicians, outpatient hospitalization, and home health services. Part D subsidizes the cost of drug coverage.
 
The Trustees project that the Part A trust fund will be depleted in 2028 (two years sooner than projections in the 2015 report). Part A expenditures have been exceeding income received since 2008; at fund depletion in 2028, revenues are projected to pay 87% of Part A costs. Parts B and D are adequately funded because current law allows funding from both general revenues and beneficiary premiums. However, because of an aging population and increasing health care costs, the cost of Parts B and D are expected to grow from 2.1% of GDP in 2015 to about 3.5% of GDP in 2037.  Trustee projections in the 2016 report are that total Medicare expenditures will grow from about 3.6% of GDP in 2015 to 5.6% of GDP in 2040. The costs are projected to increase to about 6.0% of GDP in 2090.
 
The Bottom Line
 
Social Security and Medicare benefits are a key component in long range planning for most individuals. The 2016 Trustee Report indicates that changes in these plans will be forthcoming. Please contact us at Paragon Financial Advisors to see how your future plans may be affected.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.


Friday, October 20, 2017

Old Age and Retirement

The World Economic Forum produced a white paper entitled “We’ll Live to 100-How Can We Afford It?” (Lead Author, Rachel Wheeler, Project Lead, May 2017) The basic premise of this white paper was the status of world-wide retirement plans and potential problems and reforms necessary to address those problems. The disclaimer in the white paper is that “…views in this White Paper … do not necessarily represent the views of the World Economic Forum or its Members…” In addition, these papers “… describe research in progress by the author(s) and are published to elicit comments and further debate.” The report is “… part of the Forum’s Retirement Investment Systems Reform project that has brought together pension experts to assess opportunities for reforms that can be adopted to improve the likelihood of our retirement systems adequately and sustainably supporting future generations.” The paper, in its entirety, can be accessed at  http://www3.weforum.org/docs/WEF_White_Paper_We_Will_Live_to_100.pdf  Our discussion in this posting is done without comment or endorsement of the contents of the white paper. However, in light of the positions taken by some candidates in the 2016 US Presidential election, it behooves us to look at some propositions being espoused in the academic community and conditions that exist in the international community.

Old Age

Life expectancy is increasing. For individuals born in 1947, the median life expectancy is 85 years; for those born in 2007, it is age 103. The increased life expectancy leads to a longer working career. If retirement age remains unchanged and current birth rates continue, the global dependency ratio (the ratio of the workforce to retirees) will decrease from 8:1 today to 4:1 by 2050. The position taken in the Forum’s white paper “…focuses on the sustainability and affordability of our current retirement systems.” Retirement “…system needs to be affordable for today’s workers and sustainable for future generations…"

Challenges to Retirement Systems
 
The primary causes of retirement systems problems, according to white paper authors, are increasing life expectancy and a declining birth rate. The authors identify five additional factors affecting global retirement systems:
  1. Lack of access to pensions- Many workers (especially the self-employed) don’t have access to pension plans or savings products. Over 50% of global workers work in the informal or unorganized sectors of the economy. Forty-eight percent (48%) of retirement age people don’t receive a pension.
  2. Low investment returns- Long term investment returns over the last 10 years have been significantly lower than historical averages. Equities have returned 3-5% below averages; bonds, 1-3% below. These lower returns have exacerbated pension plan shortfalls and reduced individual retirement savings balances.
  3. Personal responsibility for pension plan management- Defined benefit plans have been decreasing in number while the number of defined contribution plans has been increasing. Defined contribution plans now account for over 50% of global retirement assets. The investment risk has thus been shifted from the employer to the employee.
  4. Low levels of financial literacy- While investment risk has been shifted to the individual, the ability of those individuals to make sound investment decisions appears to be lacking. Most people are not able to correctly answer questions on basic financial concepts.
  5. Inadequate savings- Individual savings in all countries are well below the 10-15% level necessary to fund a reasonable retirement income.
The Retirement Savings Gap
 
Historically, retirement income has come from three sources: 1) governmental sources (Social Security, etc.), 2) employer pension plans, and 3) individual savings. According to the authors of the white paper, the world-wide retirement savings gap in 2015 is estimated to be approximately $70 trillion with the largest shortfall being in the US. Of that gap, 75% is in the government and public pension obligation, 1% in unfunded corporate pension plans, and 24% in lack of personal savings. This gap is predicated on a 70% income replacement in retirement.
 
The Findings
 
The authors of the white paper espoused three key areas to address overall financial security:
  • Provide a “safety net” pension for all persons
  • Improve access to effective, efficient retirement plans
  • Increase personal savings initiatives
The authors of the paper state:
 
“Poverty protection for the elderly should be the minimum requirement for any government pension system. It should be the responsibility of the government to provide a pension income for all citizens that acts at a “safety net” and prevents those who miss out on other forms of pension provision from dropping below the poverty line.”
 
“In countries where there are challenges to establish employer-based or individual pension schemes, introducing universal pension benefits may be the only way to significantly reduce poverty among the elderly.”
 
“Technology can make saving automatic by deducting contributions directly from employees’ pay before it reaches their personal accounts.” “Governments can make it compulsory for all employers to automatically enroll new employees into a retirement savings account and to contribute on their behalf.” (italics added)
 
Principles for Change
 
Authors of the white paper identified four principles that they felt should be addressed in retirement plan provisions.
 
Principle 1: The work force is changing. Occupations that are most sought after today didn’t exist 10 years ago. In addition, about 65% of today’s primary school children will work in jobs that don’t yet exist. The number of workers over age 65 is increasing; it has more than doubled since 1995. The number of employers for whom a person works over his/her career is increasing. That requires “re-tooling” work skills and portability of job benefits.
 
Principle 2: There is a gender imbalance. Retirement balances for women are 30-40% below those for men. Longer periods out of the workforce and lower salaries in general contribute to the lower retirement account balances. In addition, the longer life expectancy of women means those reduced assets need to cover a longer period of time. Unisex life expectancy tables and valuing work performed outside the workplace for retirement benefits could help alleviate this disparity.
 
Principle 3: Shared risks could reduce individual burdens. Collective defined contribution systems (as employed in some countries, such as Canada) could help with the burden on individuals for their retirement savings, account management, life expectancy, etc. Pooled money and risks could be based on “target” benefits. An example of such a plan, as presented by the authors, is shown below.


Defined Benefit Plan

Collective Defined Contribution Plan

Defined Contribution Plan
Pooled assets across all accounts
Pooled assets or notional accounts
Individual accounts
Predominantly employer contributions
Combination employer and individual contributions
Combination employer and individual contributions
Trustees determine investment policy and investments
Trustees determine investment policy and investments
Individual makes investment decisions
Trustees takes investment risk
Investment risk pooled
Individual takes investment risk
Trustees takes longevity risk
Longevity risk pooled
No longevity protection
Guaranteed pension
Target pension, not guaranteed
No target or guaranteed pension

Principle 4: All financial needs should be considered. People who save early for retirement will have much larger retirement savings than those who start later. However, retirement savings may not be a priority for younger employees. Therefore, the authors contend, the full financial picture (assets and debts) should be considered for financial need.

The Bottom Line

When one reads the World Economic Forum white paper and analyzes its recommendations, it is obvious that items presented are significantly different than what we have in the US today. However, as we examine our current public benefit systems (Social Security), it is also obvious that some changes must be made. Prudent financial planning means looking at alternatives and trying to plan for what “might happen.” Visit us at Paragon Financial Advisors to review your individual circumstances. Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

 

           

Monday, September 18, 2017

Equifax Data Breach – How Should I Respond?


You’ve probably heard by now that Equifax, one of the four major credit reporting agencies, experienced a security breach resulting in the exposure of the personal information of 143 million Americans between May and July of this year.
 
While Paragon does not have a relationship with Equifax, we feel that it is important to reach out and let you know how you can protect yourself.
 
What Happened?
 
Equifax reported that hackers accessed people’s names, Social Security numbers, birth dates, addresses, and in some cases, driver’s license numbers. They also stole the credit card numbers of around 209,000 people. Thus, your personal information may have been compromised.
 
What can I do to protect my information?
 
Rather than going to the Equifax website to assess whether your personal information may have been compromised as suggested by some, we recommend you presume it has been compromised and take the following proactive steps:
 
  1. Change the passwords to all your online accounts, particularly the accounts at your financial institutions.
  2. Check your credit reports from Equifax, Experian, Transunion by visiting annualcreditreport.com. Federal law allows you to get a free copy of your credit report every 12 months from each credit reporting company.
  3. Consider putting a freeze on your credit with each credit reporting agency, particularly if you identify suspicious activity on your credit report. Freezing your credit is the only way to prevent those with your personal information from opening new accounts in your name. A credit freeze limits who can see your credit report information.
How do I initiate a credit freeze?

Contact each of the credit reporting agencies separately to request a credit freeze.
Equifax 1-800-685-1111 | www.freeze.equifax.com
Experian | 1-888-397-3742www.experian.com/freeze/center.html
TransUnion | 1-888-909-8872www.transunion.com/securityfreeze
Innovis | 1-800-540-2505 | www.innovis.com/personal/securityFreeze

Please note that each agency charges a fee to initiate a credit freeze (approximately $10 per agency).
 
Can I still get a credit card or a loan after initiating a credit freeze?
 
Yes, but you will need to notify the credit agencies to lift the freeze before you ask the lender to approve you for credit.

If you have any additional concerns or questions, please feel free to contact us directly.  Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.