As 2013 draws to an end, we want to use our final newsletter to say “Merry Christmas,” “Happy New Year,” and “Thank You” to our readers. We are privileged to work with you and we truly appreciate the opportunity to do so.
We have included in this issue some items that are intended to begin 2014 on the right “note”. Our first article discusses a common question we are asked: “Can I meet my income needs in retirement.” This article will discuss how to plan and measure effectiveness to ensure that you have adequate retirement income.
The second article discusses a lapsing required minimum distribution option, qualified charitable distributions made directly to a church/charity. Although that option is technically expiring in 2013, we are hopeful it will be extended (as it has been in the past).
Our final article is a discussion based on a Nobel Laureate economist, Robert J. Schiller. Mr. Schiller feels strongly that financial advice would benefit many more Americans than just those who are currently using it.
We at Paragon Financial Advisors hope you and your families enjoy a truly joyous holiday season!
Wm. Jene Tebeaux CFP® CFA® CAIA®
Meeting Income Needs in Retirement
One of the most frequent questions we are asked by clients is, “Do I have enough assets to meet my income needs in retirement?” The most obvious question we first ask is “How much will you need for living expenses?” Most clients have a general idea of that amount. Frequently they will know an amount in today’s dollars; we will adjust for inflation. One factor frequently overlooked, however, is healthcare costs. That cost is especially critical in light of the Affordable Care Act. That act is causing significant changes in health insurance coverage, as well as the premiums for coverage, and the deductible amounts to be paid by the individual. Another important consideration is the tax payments required if assets are withdrawn from qualified plans. We will discuss this more in a later article on charitable donations from an IRA.
So how do you plan (and measure effectiveness to ensure adequate retirement income)? There are several methods. We will discuss them below.
Capital Preservation- This is a relatively simple approach where one tries to preserve principal and spend only dividends and interest. A successful year is one in which your account balance at the end of the year is equal to or greater than the balance at the beginning of the year. There are potential problems with this method. Dividends and interest may not meet your income needs, especially when you adjust for inflation. You may also need to spend principal if your actual life exceeds the projected mortality table.
Rate of Return- With this method, one considers whether the expected return on the portfolio meets or exceeds the required rate of return to meet living expenses. A potential problem in this method is “chasing return” by increasing risk in the portfolio. That risk means a higher chance of success and failure. Remember, portfolio losses can be more devastating than potential gains not realized.
The Balance Sheet- This approach is more complicated but it mirrors the method used by large pension plans. You match the actual present value of your investments with your projected income needs. This method is the least frequently used method by financial planners; however, in our opinion, it is the most effective. This approach basically matches the present value of your estimated income needs with the present value of investment growth and income streams (such as Social Security and pension benefits.) A key assumption in this approach is the interest rate assumption (the least risky one) used in discounting to present value.
Combined Methods- some investors prefer to combine methods to provide a “cross check” on reaching income needs. The key is to determine whether your portfolio lasts beyond your household’s expected life span.
One item is critical in this entire process; answering this income sufficiency question is an ongoing process. It should be re-evaluated annually. Life circumstances change. Investment markets are volatile. Social Security/pension benefits change at first death. Politicians are still active at the federal and local level. We, at Paragon Financial Advisors, help our clients in this ongoing monitoring process. Please call if you have any questions.
Charitable Donations from an IRA
December 31, 2013 is fast approaching. With year end comes another end, the end of the qualified charitable distribution (QCD) provision that allows up to $100,000 per year in required minimum distributions (for those age 70 ½ or older) to be donated directly to charity with no income tax consequences to the donor. This provision has expired before ( in 2012) and was reinstated (in 2013). Will it be reinstated again? We don’t know but sincerely hope so. The provision allowed IRA holders who faced a required minimum distribution (RMD) from their IRA to make a donation paid directly from the IRA to the charity and have that donation count as part of their RMD. The IRA owner would not get a tax deduction for the contribution; however, the distribution would not count as taxable income. Sounds benign, does it not? Why go through the process? Tax law changes beginning in 2014 have provisions that could definitely affect such distributions to IRA owners in the higher tax brackets. Consider the following example:
Ted and Alice are age 71 (thus subject to RMD) have IRAs with total RMD amounts of $200,000. Assume they have an adjusted gross income (AGI) of $250,000 for 2013 (excluding the RMD amounts). Let’s look at their alternatives. They could donate the entire $200,000 RMD amount from their IRAs directly to church/charities of their choice. They could not deduct the donations from their taxable income; however, the IRA distributions would not be included in their taxable income for 2013. In this case, the RMD would not change their tax situation at all.
Now assume Ted and Alice decide not to utilize the QCD option. They take the distributions from the IRAs and make the same $200,000 in donations. What happens?
- Their AGI would rise from $250,000 to $450,000. That increase would move them into a higher income tax bracket and subject the additional $200,000 to the 3.8% health care tax. (see 4 below)
- The couple would not be able to claim their two full personal exemptions. The $3900 per exemption begins to phase out at $300,000 in AGI. Their exemption would disappear as the phase out is complete at $422,500.
- Their deduction for $200,000 donated would be reduced. In 2013, there is a 3% limitation on overall itemized deductions; that limitation begins at $300,000 for a couple filing a joint return.
- Ted and Alice would also find themselves subject to the 3.8% Obama care tax on the lesser of their net investment income or their marginal adjusted gross income above their threshold amount of $250,000 (married couple filing jointly).
With no difference in what the church/charities receive, Ted and Alice have subjected themselves to a tax increase of approximately $10,000.
We, at Paragon Financial Advisors, do not prepare tax returns or legal documents; we work with the professional of your choice for those services. However, we can assist you in developing strategies for your consideration to maximize your financial goals. Please call us with any questions.
Financial Advice for Everyone
The December 9, 2013 issue of "Investment News" (Universal Financial Advice a Costly Endeavor, p. 8) discussed some interesting points presented by Nobel Laureate economist Robert J. Shiller. Mr. Shiller feels financial advice is important for all, so important that he has advocated that the government subsidize personal financial planning advice for those who can’t afford it! This is especially true for the middle and lower income economic classes. His comment: “People make better decisions with financial advisors.” He indicated that the past economic crisis was exacerbated by the lack of good financial advice. (Americans took out enormous amounts of debt on houses which they were incapable of repaying.)
Mr. Shiller is suggesting that the government subsidize four hours per year (at $75 per hour) for financial advice. He has noted that most Americans have relied on salesmen (in one form or fashion) to assist them in financial decision making. Non fiduciary financial advisors, real estate agents, direct sales people, etc. have provided assistance/influence in financial decision making for many Americans. In many (most) cases, the advisor has a vested interest in the outcome of the transaction, an interest that might not always be in the best interest of individual receiving the advice.
Likely? Probably not, as the expense would be significant. However, it is interesting to note that a Nobel Laureate is recommending financial advice for the majority of Americans. One need only to look at the curriculum of high schools, junior colleges, and senior colleges to fully understand how much (or how little) emphasis is being placed personal financial planning topics. After all, some of these items come under the heading of “basic financial literacy” required in our world today.
If you would like to receive a copy of our quarterly newsletter please email firstname.lastname@example.org. 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.