Asset Protection??

Normally, retirement plans are generally considered safe from creditors. A recent ruling by the Bankruptcy Panel for the 8^th U.S. Circuit Court of Appeals has called that safety into question. An individual was awarded ½ of his ex-wife’s 401(k) plan and her entire individual retirement account in their divorce settlement. He later filed for Chapter 7 bankruptcy and claimed those assets were exempt from creditors because they were in retirement plans. The Bankruptcy Panel disagreed on the basis that the retirement plans were not originally his; thus, they were subject to creditor claims.

Defined contribution 401(k) plans are sheltered from creditors in bankruptcy filings for individuals who own the plan. IRAs are also usually exempt from bankruptcy as well (subject to a cap under federal law that is approximately $1.2 million). However, once the assets are separated from the original owner, you should expect that the asset protection will go away. In the Supreme Court ruling of Clark v. Rameker, the Court held that inherited IRAs are not considered retirement funds for bankruptcy protection.

Although the 8^th Circuit ruling applies only in that district, other courts may follow suit. For protection, IRA assets received in a divorce settlement should not be intermingled with the individual’s own IRA. Co-mingling funds could possibly jeopardize the creditor protection of the entire IRA.

Please note that this discussion does not constitute legal or tax advice; it is informational only. Your individual circumstances should be discussed with your legal and/or tax counsel.  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.

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.

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.

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.

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.

 

           

Hurricane Harvey

Hurricane Harvey has come—but hasn’t gone. This storm is one the Gulf Coast will remember for a long time. A sudden strengthening category 4 hurricane trapped between high pressure areas dumping a year’s worth of rain in several days is not something one plans for. However, it happened and we’re left with the cleanup.

Priority One--Are You and Your Family OK?

Our primary concern is for our family and loved ones. Loss of “things” is not easy, but loss of life is irreplaceable. We encourage our clients to let us know if they have suffered loss and how we might help. The recovery process is arduous; let us help you if we can.

Next

Insurance agents are going to be overwhelmed with claims in the coming days. There are some things you can do to make their (and your) life a little easier:

• Make only the repairs necessary to prevent further damage. The adjuster will need to see the full extent of the damage. TAKE PICTURES.
• Save all receipts—replacement housing, food costs, transportation, expenses for daily living. You may be eligible to receive an advance from your insurance company.
• Make a list of all damages as soon as possible. Document to the best of your ability.
• File your claim as quickly as possible. Document all interactions with insurance companies, FEMA, or anyone else with whom you discuss the damage.

Homeowner’s insurance coverage usually does not cover damage from rising water; though your first contact should be with your insurance company. For rising water, the National Flood Insurance Program provides basic coverage for building property and contents. For claims not covered by insurance, check for disaster assistance as President Trump has declared much of the Gulf Coast as a disaster area. To research and apply for aid, go to https://www.disasterassistance.gov/

For small business owners, the U.S. Small Business Administration has low interest disaster loans for small businesses in declared disaster areas. (https://www.sba.gov/loans-grants/see-what-sba-offers/sba-loan-programs/disaster-loans)

A home equity line of credit may provide assistance if established before the damage was done. Check with your friendly banker.

Taxes

People living in a disaster area may be allowed to delay tax filings and payments without penalty. Be sure and keep records of all costs relating to the disaster as these may be claimed as a casualty loss on tax returns.

No question that there are trying days ahead for many Gulf Coast residents. Let us at Paragon Financial Advisors know if we can help.  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.

Are We There Yet?

It is no secret that returns in the capital markets (stocks and bonds) have been volatile (and below historical averages) for the past few years. Some market “experts” are predicting that those lower returns will be the “new normal” for some years to come. If that prediction is correct, individuals must save more to maintain their desired standard of living in retirement.

We are presenting below a “savings checkpoint” table for determining whether your current savings amount is “on schedule” to fund retirement at your current standard of living. The table is a function of current age and income level. This table is based on J.P. Morgan Asset Management’s proprietary model with their capital market assumptions and an 80% confidence level.¹  Several additional assumptions are involved:

• The assumed annual gross savings rate going forward is 10% (about twice the current US average savings rate).
• Pre-retirement investments earn 6.0% per year.
• Post-retirement investments earn 5.0% per year.
• Inflation is 2.25% per year.
• Retirement age is 65 for the primary wage earner; age 62 for the spouse.
• Retirement will last 30 years.

You can use the factors in the table below to determine if your accumulated savings is sufficient:

Age	$50,000	$75,000	$100,000	$150,000	$200,000	$250,000	$300,000
30	-	0.5	0.8	1.3	1.8	2.1	2.2
35	0.3	1.2	1.5	2.1	2.6	3.0	3.2
40	0.8	1.9	2.3	3.1	3.7	4.1	4.3
45	1.5	2.8	3.3	4.2	4.9	5.4	5.7
50	2.4	3.9	4.5	5.6	6.4	7.0	7.3
55	3.4	5.2	5.9	7.2	8.2	9.0	9.3
60	4.5	6.8	7.5	9.1	10.4	11.2	11.7

The income levels across the top are gross income (before taxes and savings). Go to the intersection of age and income level to determine the appropriate factor. For example, a 40 year old person earning $100,000 per year has a factor of 2.3. Multiply your current salary times that factor to determine the amount you should have saved today or $230,000 in this case (2.3 x $100,000). Savings are assumed to continue at 10% per year until retirement.

Are we there yet? Please visit us at Paragon Financial Advisors to determine whether your savings level is sufficient to provide the retirement lifestyle you desire. We can help you plan for your future financial goals. 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.

 

¹The J.P. Morgan model uses household income replacement rates from an inflation-adjusted analysis of Consumer Expenditure Survey (BLS) data (2011-2014). Social Security benefits are assumed using modified scaled earnings in 2017 for a single wage earner at age 65 and a spousal benefit at age 62 reduced by Medicare Part B premiums.