Paragon Perspectives

Welcome to the spring installment of our quarterly newsletter.  For us, spring is a time for new growth as we emerge from the winter, spring cleaning, and TAXES…  We hope that you can use our newsletter to “spring clean” some of your financial planning topics with the included articles.

Each year around tax filing time we receive questions about the 1099.  Have you ever wondered why a corrected 1099 was sent or why it is taking so long to get your 1099 statement?  For help in understanding the how’s and why’s, our first article explores reporting requirements for custodians and different income inclusions that may be seen on the 1099 statement along with their tax treatment. 

The second article addresses strategies to maximize your IRA through timing of cash flow, maximizing potential assets to beneficiaries, tax efficiency in placement of assets and Roth conversions among others.  Which of these strategies would be advantageous for you?

With ever changing estate planning laws in the very recent history, we finish off with items from the estate plan that should be reviewed sooner rather than later.  Are there items from this list that you have been meaning to update?  There is no time better than the present!

If there are topics that you would like to see covered in more detail in our newsletter or blog please give us a call and thank you to our readers!  We are so thankful you have allowed us the opportunity to work with you.

Sincerely,

Sarah D. Buenger, CFP®


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Alternative Investments

There is considerable talk these days about “alternative investments.” The portfolios of large universities and pension plans frequently contain a significant percentage of their assets in such investments. What are alternative investments? Are they truly different investments from the traditional stocks, bonds, and cash; or, or they different tactical methods of managing those traditional asset classes? The answer: both!  Some portfolio managers specialize in types of securities that the “average” investor has not utilized (think “derivatives,” “futures,” “commodities,” etc.). Other portfolio managers specialize in using different tactics involving the traditional asset classes (think “long-short,” “quantitative,” “mergers and acquisitions,” etc.). Our purpose here is not to discuss the alternative universe in detail; it is instead to discuss whether such things might now be beneficial in the “average” investor’s portfolio.

Alternative investments/strategies have historically been used by large, sophisticated investors or institutions (pension plans, endowments, etc.) Why haven’t smaller investors been involved? The characteristics of this type of investing usually did not fit the goals/needs of the average investor. Alternative investments historically have been:

1. Less liquid-thus not allowing easy access to the investor’s money in case the need arose,
2. Less transparent in value-since many of the investments traded outside traditional markets making the determination of portfolio values more subjective,
3. More risky-since many of these assets could lose a significant (all) portion of the investment, and,
4. Long time frame-some investments (private equity) are designed to have life spans of 7-10 years.

Given these factors, why are we discussing such investing? Because some things have changed. Prior to the financial crisis, there were only a few dozen mutual funds that used such investments. Now there are over 400 such funds-funds which basically use hedge fund strategies but are done in a mutual fund wrapper. Such mutual funds are desirable for the smaller investor because they provide the ability to buy/sell small investment amounts on a daily basis. In addition, we face some “interesting times” in the investment markets. Interest rates are at historic lows and investors realize that increasing interest rates are going to result in the loss of bond investment principle. The stock market is at an all-time high—are we due for a significant correction with a resulting loss in stock investments?

Do alternative investments/strategies have a place in individual portfolios? Possibly-it depends on the goals/objectives of the individual. The biggest advantage is to diversify the portfolio. Alternative investments usually don’t provide the same level of return on the upside of the markets, but they also don’t lose as much in down markets. Therefore, using alternative investments can dampen the risk of the portfolio. We at Paragon Financial Advisors have investigated some alternative investment mutual funds and back-tested their use in integrated portfolios. Please call us and let’s discuss whether or not alternative investing has a place in your portfolio. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

Long Term Care

Declining ability to take care of one’s self is a rising concern, especially as life expectancy increases. The prospect of spending time in a care facility is not something anyone desires; however, it will be a fact of life for some. As such, prudence demands that long term care provisions be addressed in any financial planning—especially for aging individuals. Let’s review some facts:

1. Currently, 70% individuals over the age of 65 will spend time in a long term care facility.
2. The average length of stay in a long term care facility is 2.44 years.
3. The national average cost of a semi-private room in an assisted living facility is about $250 a day, or $91,000 a year
4. Long term care costs have been rising at about 4% per year.

Given these statistics, the financial impact of long term care must be considered in retirement planning. In addition, family conditions must be considered. Will there be a support system (family close-by) that will allow individuals to live at home as the ability to take care of themselves declines? How do we plan for those contingencies? We discuss some of the options below.

 

Self-Insure

 

Individuals with significant assets have the ability to cover costs of long term care from their own income/assets. Level of benefits and quality of care simply becomes a cost/benefit decision. However, the majority of individuals are not in the position of doing this.

 

Long Term Care (LTC) Insurance

 

Long term care insurance is an option for many individuals; however, the LTC insurance industry is in a state of flux. There are several factors to consider here:

1. Insurance Company- As with any insurance product, the quality of the insuring company affects the likelihood of future ability to pay. It is interesting to note that two of the largest insurance companies (Genworth Financial and John Hancock) have filed for premium increases on their long term care product. Apparently the actual costs experienced have exceeded the actuarial assumptions used in pricing older long term care policies. NOTE: An obvious implication for policyholders of older policies is to carefully weigh any “opportunity” to switch from an older policy to a newer policy. It is quite likely that newer policies will not provide the same level of benefits at a comparable cost.
2. Insurance Policy- The actual insurance policy options vary significantly. Some of the questions to ask about policy coverage are:
• Gate keepers- Gate keepers are those conditions that must be met before the policy begins paying benefits. Usually these are expressed in the ability to perform specific functions (i.e. feeding, toileting, transfer of locations, etc.)
• Care location- Does the policy provide for benefits when the individual is at home with a caregiver, or do benefits become payable only when the individual is in a long term care facility?
• Benefit coverage- How long will care benefits be paid? Is there an escalation benefit to allow for increases in long term care coverage costs over time?
• Exclusion provisions- How long must the individual wait before benefits under the policy begin paying? Is a prior hospital stay required?

Long term care policy purchase decisions warrant significant consideration. Policy differences can be substantial and costs vary dramatically. A frequent question arises concerning when to purchase a policy. The older the individual, the more costly the policy; consequently, purchasing a policy at a younger age (in the 50s age group) might make more sense.

 

Medicaid

 

In some cases, long term care benefits are available for individuals who lack personal resources or long term care insurance. Such Medicaid payments are made to the long term care provider on behalf of the individual. Obviously there are conditions which must be met. There are two primary conditions:

1. Means test- The amount of monthly income for the individual cannot exceed a certian amount per month.
2. Asset test- The assets available to the individual in terms of savings, investments, etc. cannot exceed specified levels.

There are planning techniques available to address these two conditions; they are complex and warrant discussion on an individual case basis.

 

We at Paragon Financial Advisors do not sell insurance (or any other) products; however, we can help our clients evaluate long term care options available to them. There are alternative products (usually in the life insurance market) which are available but the cost/benefit in them warrants specific analysis. Please call us if you need assistance in planning for your long term care needs.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

 

 

United States. Department of Health & Human Services. Long –term Care Insurance Costs. N.p.: Administration on Aging, June. 2012. Web. 14 March 2014.

IRA Distribution Strategies

Individual Retirement Accounts (IRA) became popular with the Economic Recovery Tax Act of 1981. Some basic premises drove IRAs creation. (Other rules may apply):

1. 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.
2. 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.
3. Money withdrawn from the account would be subject to income tax at ordinary income tax rates.
4. 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.
5. Required mandatory distributions from an IRA occur when the individual reaches age 70½. Tables from the Internal Revenue Service govern the amount of distribution.
6. 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.

The basic idea underlying the rule allowed individuals to shelter a nominal amount per year from current (ordinary) income tax, have that investment grow in a tax deferred account, and have future distributions made when the individual retired at (presumably) a lower tax rate.

 

In that situation, the most appropriate course of action for individuals allowed them to make IRA contributions and leave them to earn tax deferred until the IRS mandated distribution. However, things have changed. IRAs now include “Rollover” and “Conduit” IRAs that could receive qualified benefits from company benefit plans. Individuals could move payments from such company plans to an IRA with no tax consequences. Thus, amounts going into IRAs no longer faced limits of smaller contributions. IRA accounts could easily grow into accounts worth significant amounts of money—much more than amounts expected based on $3000-$5000 annual contributions. Also, tax rates and surtaxes increased substantially in 2013 due to the Affordable Care Act (Obama care). As a result, some individuals experience significant required minimum distributions from an IRA (because of large account values) and face tax rates at least as great as those paid before retirement!

 

These changes have necessitated a review of IRA withdrawal strategies. It might be beneficial for an IRA account holder to begin drawing from their account prior to the 70½ required minimum distribution date (but after age 59 ½ to avoid the premature distribution penalty). Income tax would be due on such IRA distributions but the entire amount could be rolled into a Roth IRA if taxes on the distribution were paid from current earnings. (Note: Roth IRAs were implemented with the Taxpayer Relief Act of 1997. There accounts do not allow tax deferred contributions but do allow tax free growth and no required minimum distributions.) Notice that such a strategy allows investment of the total amount taken from a traditional IRA (not just the after tax paid amount) into an account that grows tax free and doesn’t have any future required distributions.

 

Should you or shouldn’t you? That’s the question. Can you envision your future income tax rate? How much will you have to withdraw from your IRA? Don’t forget the minimum requirements on defined contribution plans (401(k) and 403(b)) plans that will also impact taxable income in retirement. While we at Paragon Financial Advisors do not prepare tax returns, we can help you analyze the potential advantages/disadvantages and when and how to take distributions from your IRA. Please call us and we can discuss the particular circumstances associated with your IRA. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.