5/29: National 529 College Savings Plan Awareness Day

School Yourself Before You Invest


May 29^th is National College Savings Plan Awareness Day. This annual day celebrates the importance of preparing for future college expenses and the advantages of 529 College Savings Plans. Did you know that an alarming 70% of students who graduated from college in 2013 left college with an average of $28,400 in debt per borrower¹? It’s shocking how quickly tuition rates have risen and how expensive the price tag of a college degree has become.  Planning for future expenses has become a crucial necessity. See: Shocking Trends in College Expenses and College Debt Necessitate Earlier Planning for Families


College Savings 529 accounts have been getting a lot of exposure nationally and are starting to get the positive recognition they deserve. 529 plans offer a simple, affordable way to save for rising higher education expenses. These investment accounts allow tax-deferred growth, high contribution limits, and unique ownership features. See: School “Daze”


Characteristics of 529 College Savings Accounts:

• Anyone, regardless of income, can open a 529 account to save for their dependents or even their own educational expenses.
• Individuals can contribute annually up to the federal gift-tax exclusion ($14,000 for 2015 or $28,000 if married) per beneficiary. Keep in mind these contributions are made with after tax dollars.
• Under a special election you can combine up to five years’ worth of contributions into one contribution of up to $70,000 ($140,000 for married couples).
• Anyone (i.e. family) can also contribute until the account value reaches $350,000.
• Money from a 529 plan can be used for tuition, fees, books, supplies, and equipment required to study at any accredited college, university, or vocational school here in the United States.
• The money can also be used for room and board, as long as the beneficiary is enrolled as at least a half-time student.
• A distribution from a 529 account that is not used for the above qualified educational expenses is subject to ordinary income tax and maybe an additional 10% distribution penalty on the gains unless other conditions are met.
• Accounts are transferable: unused amounts are able to transfer to other qualified members of the beneficiary’s family without incurring any tax penalty.

Do you know how much do you need to save to send your child to college? Will your children need to take out student loans? See: Student Loan repayment and Forgiveness Programs

 

* Numbers are rounded for illustrative purposes and are not intended to portray an actual investment. Values are in today’s dollars and are not adjusted for inflation

 

May 29^th is recognized as ‘National 529 College Savings Day’ and we invite you to celebrate with us the importance of setting aside money for higher education. A little preparation to put money aside today could mean a lower financial burden for your children down the road and greater freedom for those of the next generation to pursue their own financial goals.

 

Do you have a child attending college this fall? Do you have questions about saving for future college expenses and how that fits into your overall financial picture? Contact us today and schedule a consultation. We, at Paragon Financial Advisors, are happy to have a more in-depth conversation with you about your personal circumstances.

 

Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

 

 

How do annuities alleviate the risk of outliving your money?

An annuity is a stream of income paid to the client over a specified time period.  Generally, annuities can be either:

1. Fixed or variable-where the amount paid is based on the nature of the underlying investments,
2. Single premium or flexible premium-how the annuity fee is paid,
3. Immediate payout or deferred payout- which determines when the annuity payments begin.

Aside from these basic categories, annuities have a broad range of additional options available to customize the type of policy for the appropriate needs of the client.  Annuities have four main parties:

1. The insurance company providing the annuity contract,
2. The owner who purchases the annuity contract,
3. The annuitant over whose life benefits are paid, and,
4. The beneficiary who may receive payments after the death of the annuitant. 

Payouts are determined based on the life expectancy of the annuitant.  Payments are initially made to the annuitant then finally to the beneficiary based on the payout and survivor benefits selected.  Payouts can be for a certain period of time (term certain) or for the life of the annuitant with some portion to the remainder beneficiary.

Growth of annuity assets is tax deferred while the investments are in the annuity account. Tax treatment when benefits are distributed depends on the method of payment of the annuity contract. Non-qualified annuities are purchased with money on which income taxes have been paid. According to Section 72, withdrawals and annuity payments from a non-qualified annuity are taxed using an exclusion ration so that a portion of each payment is return of principal and a portion is taxable.  Return of principal (basis) is tax free while the rest is taxed at ordinary income. 

Qualified annuities are generally sponsored by employers, meaning that most of the purchase cost of the annuity contributions will be pre-tax (i.e. not taxed) when added to the account.  As such, they are subject to required minimum distributions at age 70.5 with taxes due on the entire distribution amount as ordinary income.  Distributions before age 59.5 are assessed a penalty and taxes for both non-qualified and qualified annuities.

Once the appropriate retirement spending need has been identified, it is possible to discern which expenses make up the base level of spending versus the discretionary level of spending.  One useful strategy is to purchase an annuity to provide the base level of expenses while keeping assets aside for the discretionary expenses and potential medical expense shocks that may occur. 

Specifically, an immediate life annuity could serve as the fixed income portion of the overall portfolio along with an equity portfolio.  An annuity is considered as an alternative to other fixed income because as explained by Pittman (2013, November) "Annuities are designed to perfectly hedge one's retirement spending liability, and they tend to have a higher yield to the retiree than a bond due to mortality credits" (p. 56).  Purchasing the immediate annuity could take place at multiple times depending on specific needs with consideration given to liquidity, bequest motives, longevity, and maximization of income.  Pittman (2013, November) confirms that this combination will allow the annuitant to:

1. maintain liquidity for as long as possible, have the option to fulfill bequest motives for longer should death occur prior to the annuity purchase,
2. secure income for core expenses through the remainder of their life thus partially transferring the longevity risk to the annuity company, and
3. receive a higher income than a combination of bonds with equities by adding in the mortality credits from the annuity contract (p. 60).

Annuity contracts are complex investments and require considerable analysis to ensure the annuity contract purchased is the best vehicle for the client. We, at Paragon Financial Advisors, will assist in the analysis of those contracts. As fee only advisors, we do not sell annuities—we only attempt to verify they are in the best interests of our clients.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

References:

Pittman, S. (2013, November). Efficient retirement income strategies and the timing of annuity purchases. Journal of Financial Planning, 56-62.

 

Smart Beta

Beta, in the investing universe, is a measure of risk relative to a chosen benchmark. For example, if a stock has a beta of 1 vs. the S&P 500, it should move just as far up (or down) as the index itself does. The definition and calculation of investment indices have numerous components (see our previous discussion in Investment Strategies). The S&P 500 stock index is composed of the 500 largest companies (as defined by their market capitalization) in the US. The company’s market capitalization is determined by multiplying the number of corporate shares outstanding times the price of the stock. That calculation results in a relative concentration of large companies. In fact, the top 10 companies in the index (2% of the 500 companies) comprise approximately 17% of the index.

In April, 2005, a group of researchers (Rob Arnott, Jason Hsu, and Philip Moore) posited in the Financial Analysts Journal that there were better measures of a company than its market capitalization. They claimed to “show that the fundamentals weighted, non-capitalization based indexes consistently provide higher returns and lower risks than the traditional cap-weighted equity market indexes while retaining many of the benefits of traditional indexing.” They felt that measures such as revenues, book value, sales, dividends, cash flow, etc. should be better measures used in valuing a company. The basic intent was to decouple the price of a stock with its weight in an investment portfolio. That coupling, according to them, results in excessive holdings of large cap stocks in the funds that track a capitalization weighted index.

This fundamental weighting has led to a significant number of new “smart beta” or fundamental weighted mutual funds or exchange traded funds (ETFs). Some strategies are return oriented seeking to increase returns over a standard benchmark by using company revenue, earnings, momentum, size, etc. Other strategies seek to modify the risk level vs. the benchmark by employing other strategies.

There is significant disagreement among financial professionals about the usefulness of such strategies. In fact, are they truly “indexing” or another form of active management? Smart beta has generated a lot of interest in terms of new funds and ETFs; however are they sound investment principles or “marketing hype?” There are proponents on each side of the argument. The jury is still out on the final decision.

Smart beta investments usually charge a higher expense ratio than standard indexing investments; the investment methodology is usually more complex. That fee is in the 25-40 basis point range.

We, at Paragon Financial Advisors, believe you should invest in those things which you understand—and which lead to the attainment of your financial goals at your accepted risk level. We’ll be glad to discuss your investment options with you.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

               

Investment Strategies

There has been much discussion about investment strategy. Is an active management strategy (where the investor or an investment manager actively selects the investments in the portfolio) or a passive strategy (simply trying to replicate a broad market index with selected investments) the better choice? Or does the best answer lie somewhere in between (a semi-active portfolio). Our attempt here is simply to discuss both. The ultimate decision lies with the individual investor.

 

Passive Investing
Passive investing usually involves trying to replicate the performance of some broad market index. The S&P 500 is one of the most common stock indices. If one chooses the passive approach, one should know the characteristics of the underlying investment. For example:

1. How well does the index represent the desired asset population?
2. What is the criteria for inclusion in the index (i.e. the specific characteristics of the stocks desired in the index universe)?
3. How are the stocks weighted in the index?
4. What is the computational method used in the index (i.e. does the index represent only the price change in the included stocks or does it include dividends (total return))?

Let’s look at index weighting. Stock in the index can usually be weighted in the following manner:

1. Price Weighted- Each stock is weighted by its absolute price. A stock priced at $50 has twice as much weight in the index as a $25 stock. The index construction is relatively simple; however, there is obviously a price bias.
2. Value (Market Capitalization) Weighted- Each stock is weighted according to the company’s market capitalization (the company’s price per share times the number of shares). The bias here is toward large capitalization companies. This bias can result in a less diversified portfolio concentrated in a relatively few companies. The S&P 500 is composed of the 500 US stocks with the largest market capitalization; however, the top 10 (2%) companies comprise about 17% of the index.
3. Equal Weighted- Each stock is weighted equally in the index. In this case, small companies have the same weight as large companies.

The dominant passive approach is indexing. This approach assumes the financial markets are fairly priced with few opportunities for mispricing. The turnover in the portfolio is low (changing only when the index composition changes) and the internal expenses are generally low. The most popular investment vehicles are index mutual funds and exchange traded funds (ETFs).

Active Investing

 Active investing assumes there are strategies which can be used to yield a higher return the market index. Such strategies usually assume: 1) holding more of the higher return companies in the index, or 2) holding less of the lower return companies in the indices. This active strategy can include segmenting the market (growth stocks, value stocks, large cap stocks, small cap stocks, international stocks, etc.) and using complimentary investing strategies (selling stock short, using options, derivatives, etc.).

Which Is Best?

Much has been written and numerous academic studies have been conducted to answer that question. There have been periods when each method has been the better performer. Consider the “lost decade” in stocks. On January 3, 2000, the S&P 500 index was approximately 1468; on December 29, 2009 it was approximately 1114. However, in between it reached a low of 681 (March, 2009) and a high of 1565 (October, 2007). Therefore, indexing for that decade would have lost money. Active management could have yielded gains in the decade.

A more reasonable approach might be temper maximized investment returns with the client’s risk tolerance and the return necessary to reach the client’s goals. We, at Paragon Financial Advisors, will help our clients identify and realize this balance.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.