December Quarterly Newsletter

Paragon Perspectives

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!

 

Sincerely,

 

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 Another important consideration is the tax payments required if assets are withdrawn from qualified plans.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?

 

1. 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)
2. 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.
3. 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.
4. 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 info@paragon-adv.com.  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.

Your IRA Investment

Clients frequently ask about “non-traditional” investments in their IRA-especially in this investment climate.  Let me quickly say that some of these investments are possible; however do not make any investments without consulting your tax advisors.  Improper investments can result in disqualifying your IRA and subjecting yourself to IRS penalties and interest.  Here we are briefly discussing some of the questions we have been asked. 

 

While there is great latitude in permissible assets in an IRA, there are some restrictions.  There are some assets which are prohibited (such as art, antique cars, etc.)  There are also prohibitions against self-dealing (using IRA funds to purchase your home or borrowing money from your IRA).  There are some investments which generate unrelated business taxable income, or UBTI (income which is taxed to the IRA and again when the money is withdrawn from the IRA).  In addition, one must realize that some “nonstandard” investments are illiquid; therefore, how do you satisfy the required minimum distribution (RMD) amounts at age 70 and a half?  While it is not our intent to say “never”, it is our intent to caution IRA holders that improper investing in an IRA can have severe and significant tax consequences.

 

Can I own real estate in my IRA?  Perhaps.  If you can find a custodian willing to hold the real estate, you are not engaged in self-dealing, and you have other IRA assets from which to take required minimum distributions, then yes.  But be careful of any potential UBTI consequences.

 

Can I use my IRA assets to start a business?  Again, perhaps.  This area is really complex.  Realize that loses (as many startups do not succeed) are not deductible in an IRA.  Also, a partial funding of the business with a loan for the balance is not permissible.

 

We at Paragon Financial Advisors will be happy to visit with you about any non-standard investing; however any such investments should be discussed with your tax counsel prior to investing.  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.

Stock Market Bubble

The word “bubble” is surfacing around the stock market as it marches to all time highs.  But is there rationale for that movement-or is quantitative easing (QEI, QE2, Operation Twist, QE Infinity) and a zero interest rate policy (ZIRP) drawing investors to riskier assets (stocks) since bond yields are so low?  The Federal Reserve personnel have been indicating a “tapering” of QE in late 2013 or early 2014; they are also saying that ZIRP will be around significantly longer.  A recent Federal Reserve research study indicated such a policy might continue until 2017.  So what do you do?

First, examine the asset allocation in your investment portfolio.  Is the proportion you hold in stocks, bonds, and money market reserve appropriate for your goals and objectives?  If there is a correction in the stock market, how will your portfolio be affected?  If interest rates rise, what will be the impact on your bond holdings (interest rates and bond prices are inversely related, so as interest rates rise, bond prices decrease).  Can you tolerate, financially and emotionally, the decrease in your portfolio that such changes might bring?

Second, examine your individual investments.  If there is another credit (lending) crisis, will your stock holdings be able to survive?  Companies with low debt and large cash positions on the balance sheet aren’t as dependent on the credit markets as highly leveraged companies.

Third, stocks are not equally susceptible to price changes in the general market.  Some stocks have a lower “beta” or movement relative to the general market than others.  Such stocks will decrease less in value in a general market correction.  A frequent advantage of such stock is they usually pay higher dividends to stock holders.

Fourth, examine your bond holdings.  As we noted, bond prices will decrease as interest rates increase.  That decrease generally will be less dramatic on shorter maturity bonds or bonds with higher coupons.  With interest rates at current (low) levels, it would appear that the next major move in interest rates would be an increase.

We at Paragon Financial Advisors will be happy to assist you in reviewing your portfolio to assure that it is consistent with your goals and objectives.  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 investmentmanagement services for clients.

Sunshine and Roses

It’s Friday November 8, 2013 as I write this and the stock market is basking in all-time highs-which were driven by based on an employment report of 204,000 jobs added vs. the 120,000 median forecast of 91 economists surveyed by Bloomberg.  In addition, the third quarter gross domestic product (GDP) grew at an annualized rate of 2.8% vs. 2.5% for the prior quarter.  Happy days are here again, right?  Well, as broadcaster Paul Harvey used to say, there’s always “the rest of the story.”

Employment- the unemployment rate increased slightly (from 7.2% to 7.3%); however, there are some calculation “quirks” that influence that number.  Any person who drops out of the labor force (i.e. not actively looking for a job) is not counted as “unemployed.”  An elimination of such persons thus reduces the unemployment rate.  The number of people not in the labor force increased in October by 923,000 bringing the total number to 91.5 million Americans.  This increase was the third highest monthly increase in Americans leaving the labor force in U.S. history.  Perhaps a better employment indicator is the labor force participation rate which measures the proportion of Americans actually working.  In October, the labor force participation rate declined to 62.8% from 63.2 % in September; making this is the lowest participation rate since March 1978.

GDP- the GDP (sum of all goods and services produced in the U.S.) annualized growth of 2.8% appears to have been heavily influence by a one-time buildup of business inventory.  That growth rate will subside if demand for that inventory doesn’t materialize.  Excluding inventory gains, the growth rate for the third quarter was 2%; dropping below the 2.1% second quarter rate.  Meanwhile, consumer spending (which makes up about two thirds of spending) rose at the slowest rate since 2011 while corporate investment fell.

All of this brings to mind the old Chinese proverb or in this case a curse: “may you live in interesting times.”   Times are interesting, aren’t they?

While the resources presented here can be a great start, we recommend that you speak to a professional.  If you have unanswered questions or need additional guidance please give us a call.  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.

Student Loan Repayment and Forgiveness Programs

Earlier in the summer we wrote about the troubling increase in student loan debt.  As mentioned HERE, since 1999 and adjusted for inflation, tuition has increased more than 50%. As costs continue to rise, if sources of college funds fall short of what is needed, student loans are taking up more of the slack. 

According to Heather Jarvis, an expert specializing in student loan law, student loan debt has almost tripled between 2004 and 2012.  There was a 70% increase in the average balance per person.

There are programs available that may possibly help alleviate some student loan debt.  To create a customized strategy it is necessary to:

• Review your particular records (the loan application and all associated documents)
• Determine each specific loan type
• Check the status of each loan

After completing these steps, it will be easier to determine if you qualify for one of the available repayment and forgiveness programs.  They are:

• Pay As You Earn—a repayment plan for eligible Direct Loans that is designed to limit your required monthly payment to an amount that is affordable based on your income and family size.
• Income-Based Repayment Plan—a repayment plan for the major types of federal student loans that caps your required monthly payment at an amount intended to be affordable based on your income and family size.
• Loan Forgiveness for Public Service Employee—a repayment plan created by congress in 2007 to encourage individuals to enter and continue to work full time in public service jobs. 

The programs are explained here (insert link to summary document from R: drive) in more detail. 

While the resources presented here can be a great start, we recommend that you speak to a professional before making any decisions regarding your student loans.  If you have unanswered questions or need additional guidance please give us a call.  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.

Maximizing Your Social Security Benefits

As more baby boomers near retirement the topic of Social Security planning is becoming more prevalent in financial publications like the Wall Street Journal and magazines.  Simply put, Social Security planning is evaluating your specific situation to determine the best course of action to take with benefits to meet your goals during retirement.  If your goal is to maximize the family income received from the Social Security system, there are a growing number of resources available to help.

An article from Monday, September 9^th in the Wall Street Journal found HERE mentions five online programs that offer the ability to generate customized scenarios.  These various programs offer suggestions on when you and a spouse should file for Social Security benefits in order to maximize your family income given certain assumptions.  Some are offered for free and some require a paid subscription or fee.

So which resource is best?  The best resource is one that 1) looks at your overall financial situation and any opportunities to combine Social Security strategies with tax planning and retirement planning 2) offers different options based on communicated goals and 3) helps you decide which of those options best meets the needs of your family. 

While online resources can be a great start, if you have unanswered questions or need additional guidance, please give us a call.  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.

 

Citation: Tergesen, Ann. "How to Maximize Your Social Security Benefits." The Wall Street Journal  9 Sep. 2013: R3. Print

Paragon Perspectives

In this quarter’s newsletter I will be discussing Estate Planning, Exchange Traded Funds (EFTs), and Retirement.  Although each of the following articles cover a different topic, they are all components of the financial planning process.

 

Although estate planning is a subject that some people would prefer not to discuss, it is a vital part of a financial plan. The first article, "To Trust or Not to Trust," explains why high net worth couples should include a trust in their estate planning process.  Keep in mind that trusts are not just for high net worth individuals.  There are other reasons to include a trust in your estate plan.  Trusts provide asset protection for your heir(s), manage assets for your minor or impaired children, and have age specific asset distribution benchmarks for your heir(s) (i.e. age 25, 30, etc.). 

 

The second article, “Three Reasons to Add ETFs to Your Portfolio," considers why ETFs could be a good addition to your portfolio.  ETFs are a relatively new investment product than became available in the U.S. in 1993 and have gained in popularity over the past several years.  ETFs started as index funds, but in 2008 the Securities and Exchange Commission began allowing the creation of actively managed ETFs.

 

Lastly, the third article “So, You’re Ready for Retirement…Or Are You?” discusses how over the past several years retirement planning has come to include a period of transition.  This transition period is not for everyone, but the option should be explored before retiring.        

 

   As always, we at Paragon Financial Advisors welcome your questions about your account.  If you are interested in Financial Planning or any of the topics discussed please call us. 

 

If you did not receive a copy of this quarter’s newsletter please email info@paragon-adv.com to request one.

 

Sincerely,

 

David W. Hailey CTFA^®, CFP^®

Principal and President

What’s Your Number?

A recent TV commercial featured ads asking individuals the question above. The number referred to the amount of money the individual would need to fund their retirement. While that number was hypothetical, numbers can have significance. Witness the “talking heads” on the financial news channels as they await and report the periodic economic data news (Gross Domestic Product (GDP), unemployment, Consumer Prices (CPI), etc.). They will discuss the numbers, the trends, and the potential impact that data has on the financial markets. Ah, but now-as radio commentator Paul Harvey used to say- for “the rest of the story.”

Columnist Samuel Rines wrote an interesting article entitled “Monthly Economic Data Aren’t Reliable” in the June 28, 2013 Wall Street Journal. His basic premise is that all economic data is incorrect when initially issued; it is then corrected in subsequent time periods as more data are received. For example, the annualized change in GDP for the fourth quarter of 2008 was reported as -3.8%. Following subsequent revisions, the final GDP number for that quarter was -8.9%; an error of 134%. Revisions apply in much of the economic data reported. Those revisions matter. The Federal Reserve uses such economic data to analyze the economic growth and then make economic policy.

Employment data is another example. Initial employment data in February, 2013 was reported as a net new job growth of 236,000. It was revised in March to 268,000, and again in April to 332,000. The unemployment rate (currently 7.2%) is a frequently reported number. Its calculation counts anyone who works at least one hour as “employed,” and does not count anyone who stops looking for work as “unemployed” even though that person does not have a job. A much better number might be the actual employment percent of the eligible workforce—that number stands at all-time lows.

So what’s an investor supposed to do? Consider economic data figures as a “best guess” and view the data in terms of a broad indicator of the economy and its direction of growth. Monitor future adjustments and factor those into your assessment of actual economic growth. Certainly a macro view of the economy is important in your investment plan; but keep in mind your long term financial goals. Make investment decisions with those goals as a guide. We, at Paragon Advisors, will be happy to discuss your financial plans with you and assist you as you work to achieve your financial objectives.

Annuities—Times are a-changing!!

Americans have invested approximately $661 billion in an estimated 6 million variable annuity contracts with benefit guarantees (according to insurance industry researcher Limra in the April 20-21, 2013 Weekend Investor section of the Wall Street Journal). Such products were sold with the promise of a guaranteed retirement benefit that could be “reset” higher if the underlying investments perform well. These products also carried higher fees than the normal “immediate” annuities that started annual payments in exchange for a lump sum contribution.

The decline in long term interest rates has impacted some of the insurance companies who provide such annuities in a negative manner—so much so that the companies are changing provisions of the contracts sold in previous years. Some of these changes include limiting the investment options within the annuity, prohibiting additional contributions to the contract, raising contract fees, and even buying back (or offering alternatives for switching) the contracts themselves. We are experiencing client questions about such changes. Question: would an insurance company want to change a contract that was performing (i.e. making them money) at expected or better rates? The answer is usually “NO.” Therefore, when an annuity contract owner is offered an “opportunity” to switch or modify an annuity contract, it should be viewed quite carefully.

If you hold an annuity contract, there are several things which you should definitely do:

• Read the correspondence—Insurance companies usually give advance warnings of changes they are making to annuity contracts. That warning may come in a letter that looks like “standard document language” i.e. many pages with lots of small print; do not ignore what that letter is telling you. Some of the proposed changes may have a negative impact on your contract.
• “Reset” Opportunities- Some annuity contracts offer “guaranteed minimum income benefits” (GMIB) which can be reset over the life of the contract. That benefit level may change based on the investment performance of the underlying investments. That reset change may also allow for a change (increase) in the fee charged for the GMIB option. Weigh the cost/benefit carefully.
• “Trade-In the Contract”-Some insurers are offering to buy back the “old” contract in favor of a “new” offering. The new contract may not (usually does not) contain terms as favorable to the annuity holder as the old contract in terms of fees and/or benefits. Keep in mind that an advisor may be working on commission and such a trade-in could result in new commissions for the advisor.

Annuities are complex products. They usually carry fees that are higher than investing in the underlying investments directly and the sales commissions can restrict access to the funds invested subject to conditions outlined in the prospectus. One should never invest in an annuity without completely reading the prospectus and understanding the nature of the investment. We, at Paragon Advisors, do not use products that are commission based; hence we have very little need for such products. We will be glad to assist you in evaluating any contract (or proposed changes thereto) you may have.

Tax Time Again!!

Yes, we know it’s only August; however, now is a good time to review your 2013 tax status and (if necessary) do some preliminary planning. As you know, we at Paragon Financial Advisors do not prepare taxes and we advise you to consult your tax professional to ensure any suggestions made here are applicable to your particular circumstances. That being said, there are some items that may be worthy of your consideration.  This list is, of course, not inclusive of all items that might be beneficial to you.

Tax Free Income-SEC football at Texas A&M is about to start. As you know, hotel/lodging arrangements for football weekends are at a premium. Did you know you can rent your home for less than 15 days a year and the rental income is tax free? Often known as the “Masters’ Provision” because homeowners used it to rent their homes for the Masters Golf Tournament in Augusta, Ga., this tax benefit might prove useful to families willing to rent their home for home game weekends. However, be sure and visit with your property owner’s association and/or insurance company for possible conflicts or prohibitions before doing such a rental.

Required Minimum Distributions from and IRA- Congress has extended the provision allowing a maximum of $100,000 of a required minimum distribution (for account holders older than 70 ½) to be made directly from an IRA to the charitable organization with no tax consequences. The donor does not receive a charitable donation for the amount donated; however, the amount donated is not counted in taxable income. With the health care tax increases becoming effective in 2013, reducing taxable income can be very advantageous. Be sure to make arrangements well enough in advance to allow the charity to receive payment prior to the end of year; we recommend that you initiate such transfers no later than mid-November.

Capital Gains/Loss Harvesting- The stock market is at all time high levels. However, many people have losses carried forward from 2008. Review your portfolio gain and loss positions (selling gains to offset losses) so you can realize some of your current market gains with no tax consequences.

Charitable Donations-As you consider your end of the year donations, consider gifting appreciated assets (stocks) to the charity in lieu of cash. You can gift the stock and get credit for donations at current market value regardless of your cost basis. You do not have to pay capital gains on the stock as you would if you sold the stock and gave cash to the charity.

“Step-up”  in Basis at Death- While considering tax harvesting provisions, keep in mind that appreciated assets receive a “step-up” in basis at the first death of a spouse in community property states (or at death of the owner in separate property states). If a couple bought stock at $25 per share originally and the stock is now valued at $125 per share, sale of the stock would incur taxes on a gain of $100 per share (at ordinary income or capital gains rates depending on how long the stock had been owned). Transferring the stock to children would mean the original cost ($25 per share) would be passed to the children subjecting any subsequent gain on sale above that basis to income taxes. However, at the death of the first spouse, the stock value is “stepped up” to the market value as of the date of death and taxes on gains to that point are not calculated. Obviously this is not a preferred method of tax planning, but in those cases where medical/age conditions apply, one should be aware of it.

Estate Tax Exemption Portability- One provision of the 2013 tax changes was the exemption of $5 million per person exemption from estate or gift taxes. Therefore, a couple could shelter $10 million from estate taxes. That amount was indexed for inflation; the 2013 exemption amount is $5.25 million per individual. In addition, that exclusion amount is “portable” i.e. a deceased spouse’s estate can transfer to the surviving spouse any unused portion of that estate/gift exemption. However, an estate tax return must be filed to take advantage of this portability benefit.

As tax rates increase and deductions decrease, tax planning becomes even more critical. We, at Paragon Financial Advisors, will work with you and your chosen tax professional to integrate tax benefits into your financial planning. Please do not hesitate to call us for review of your account.

Variable Annuities

Those of you with whom we have discussed variable annuities know that we at Paragon Financial Advisors are not fans of variable annuities. Our basic reasoning has been that variable annuities usually have high fees (for the insurance costs in addition to fund management expenses), required holding periods to avoid significant redemption penalties, and thus lower investment returns to you (the annuity holder). They also turn gains on investments that could potentially taxed as capital gains into gains taxed as ordinary income.

 The Wednesday, March 13, 2013 Houston Chronicle carried an excellent article by nationally syndicated personal finance writer Scott Burns. We would highly recommend you read the entire article at his website that can be found HERE . To pique your interest, we will quote some of his comments here to give you a general flavor of his opinion of variable annuities and with which we completely agree.

“According to the Morningstar variable annuity database, a typical VA contract carries insurance costs of 1 percent to 1.25 percent.”

 “…the fee burden becomes punitive in a low rate period. Over the last five years…the Vanguard Total Market Index (a proxy for all U.S. stocks) returned 2.18 percent a year. So … with an insurance expense of 1.1 percent a year, the cost of the insurance wrapper was 50 percent of your return.”

“…it would have been a bit worse if you had invested in the Vanguard 500 Index (a proxy for domestic large cap stocks) because … its return over the last five years was 1.57 percent, indicating a 1 percent insurance wrapper cost would have taken 64 percent of the return.”

 “The return from a variable annuity is taxed, upon withdrawal, at ordinary income rates.”

“Much of the return from a broad index fund … will be taxed at the capital gains rate. …now 20 percent, up from 15 percent last year.”

Mr. Burns is a proponent of indexing and he also discusses the performance issues associated with variable annuities vs. indexing. Anyone considering the purchase of a variable annuity will find this discussion a worth while read.

 

Taxes-Planning Strategies

We at Paragon Financial Advisors are not accountants and urge you to verify any items we discuss with your tax professional to determine its implications in your particular situation. We also do not believe you should “let the tax tail wag the investment dog.” That is, your investing should not be dependent solely on tax considerations. However, tax consequences certainly should be considered when all other things are equal. Taxes can have a significant impact on your total economic well-being. It is in that spirit that we discuss the Congressional resolution (enacted at the last minute) to the fiscal cliff.

In our past blogs, we have discussed quite a few items pertaining to the resolution of the debt situation currently facing the US. We would encourage you to read those blogs as they lead to the suggestions we make here on ways to prepare for your future. Some of these suggestions are to avoid known items of tax increase and some are designed to position you for changes that may be forthcoming in an environment where Congress is seeking additional revenues. Consider the following:

• Utilize strategies to reduce taxable income, thereby avoiding higher tax brackets on ordinary income/capital gains/interest/ and the 3.8% health care tax.
• Maximize contributions to retirement plans, IRA’s, FSA’s, HSA’s, etc.
• Seek deferred compensation agreements with your employer if available.Maximize the use of tax deduction strategies (charitable contributions, mortgage interest, etc.)
• Consider Roth strategies (contributions, conversions, Roth 401(k)) as a way to hedge against future tax increases.
• Consider a Roth IRA conversion if below the income thresholds.
• Investigate Roth conversion options in 401(k) plans which have now been expanded to include all participants.
• Invest in municipal bonds to generate tax free income (in taxable investment accounts).
• Extremely favorable for those in higher tax brackets especially since municipal interest is currently free from income tax as well as the 3.8% health care surtax.
• For those over age 70 ½ who face required minimum distributions from IRA’s, make donations to qualifying charities from the RMD amount (up to $100,000 maximum in 2013) as a way to avoid the RMD from increasing your taxable income.
• Consider the sale of appreciated assets (or gifting assets to other family members in lower tax brackets) to take advantage lower capital gains rates (0% or 15%).
• Considering the low interest rate environment, do some of the estate planning techniques (such as a Grantor Retained Annuity Trust) make sense for you?
• Consider, if appropriate, some of the advanced wealth transfer strategies (grantor trusts, dynasty trusts, family limited partnerships, etc.) while these strategies are still available.

As usual, we at Paragon Financial Advisors are here to assist you and your family in the long range planning of your financial well-being. Please do not hesitate to give us a call.

Pensions To Lump-sums

Retirees from large companies who have been drawing retirement checks may face a new option. Their former employer may offer to swap them a lump sum payment now in exchange for all future retirement checks. An interesting offer but one that requires very close scrutiny.

First of all—why is the past employer making such and offer? Pension payments are generally made from defined benefit plans, i.e. plans that guarantee the retiree a prescribed benefit based on retirement age, length of employment service, and salaries earned while working. Note here that the employer is bearing all investment risk—the employer must contribute enough money into the plan such that the contributions plus investment earnings will provide the retirement benefits to the retiree over his/her expected lifetime. National media stories are abounding about corporate retirement plans and their underfunded status(i.e. the plans do not have adequate assets to meet the projected pension obligations). That problem has been compounded because the estimated plan earnings assumption has been very difficult to achieve for many plans because of investment performance over the past decade.

Another change working in favor of the employer is a change in allowable interest rates for lump sum calculations. The basic assumption in a lump sum distribution is that the employer will provide the retiree a lump sum of money that can be invested by the retiree to replicate the pension payment stream over the retiree’s life expectancy. The lower the interest rate assumption, the greater the amount of lump sum dollars that were required. Historically, US Treasury security interest rates were the assumed interest rates for lump sum calculations. Plan administrators can now use corporate bond interest rates in their lump sum calculations; those corporate bond interest rates are higher than the Treasury securities. The net impact—the higher the assumed interest rate, the lower the amount of lump sum dollars needed.

The bottom line—some pension plan administrators are attempting to remove retirees from their plans and the offer may not be in the best interest of the retiree. Should you or someone you know face such a choice, we at Paragon Financial Advisors will be happy to assist you in analyzing this decision.

Happy Days Are Here Agian??

The stock market is bumping up against all-time highs. The question is why. Are these legitimate levels based on fundamentals or is the excessive liquidity being pumped into the money supply simply going into stock because it’s the better (?) place now. David A. Rosenberg (Chief Economist & Strategist) at research@gluskinsheff.com had some interesting comments in his Economic Commentary of March 25, 2013. He commented on the lack of economic recovery (“… the worst recovery in recorded history.”) and gave the following statistics:

• Industrial production: -1.2% (1.2% lower than the previous cycle peak)

• Manufacturing output: -4.3%

• Real manufacturing and trade sales: -1.7%

• Total payrolls: -2.2%

• Full time employment: -5%

• Real personal income ex transfers: -4.5%

• Real disposable personal income per capita: -6.2%

And this performance is in the wake of:

• Four years of $1 trillion deficits
• Four years of 0 interest rate policies
• A tripling of the Fed balance sheet (QE1, QE2, Twist, QE3, etc.
• Bailout stimulus

Hummm-let me think about that!!!

Shocking Trends in College Expenses and College Debt Necessitate Earlier Planning for Families

The July 2013 issue of Bloomberg Businessweek found HERE includes troubling trends in college expenses as originally presented by the Federal Reserve Bank of New York, National Center for Education Statistics.  Since 1999 and adjusted for inflation, tuition has increased more than 50%.  As costs continue to rise, if sources of college funds fall short of what is needed, student loans are taking up more of the slack.

The problem is magnified by the fact that congress missed the deadline for making a change on July 1^st meaning the subsidized Stafford loan rate has doubled from 3.4% to 6.8%.

What can you do?  Saving for future college costs can seem ominous but there are things you can do now to get a jump start.  Always discuss any options presented with your financial advisor prior to acting.

529 College Savings Plan – Numerous states sponsor 529 College Savings Plans through various institutions.  A 529 plan is a great way to begin savings for college.  Contributions for 2013 can be as much as $14,000 per donor for a child ($28,000 for a married couple).  There is a 5-year rule allowing donors to make contributions of $70,000 per donor for a child ($140,000 for a married couple).  Using this rule the one-time gift is treated as having been contributed over a 5 year period.  There are several planning strategies that can be utilized with this type of account.

Coverdell Education Savings Account – While not as generous as the limits for a 529 plan, the Coverdell Education Savings Account (ESA) is another potential savings vehicle allowing the accumulation of assets on a tax free basis if used for college.  For 2013, individuals may contribute as much as $2,000 to a Coverdell ESA if they qualify under the income limitations.

Scholarships – Seek out scholarship opportunities diligently.  Begin compiling a list of possible avenues now and continue to add to the list as you find new opportunities.  Research what is required for each one and work with your child to ensure they are not just eligible but hopefully near the top of candidates applying.

Grants – If you qualify for grants, by all means accept them!  If you need help with the FAFSA process find a financial advisor in your area who is knowledgeable about college financial aid.

Part-time employment during high school and college – Although it may not be an answer for everyone, consider encouraging the student to contribute towards their future by partially paying their own way. 

Encourage an entrepreneurial spirit in kids – Children are creative beings, capable of so much.  Encourage them to realize their potential through setting a good example.  Find a mentor or teacher who can help them develop ideas into potentially viable businesses that could succeed beyond expectations.

Most importantly, begin saving and preparing now instead of waiting.  Every dollar contributed helps towards the end goal.  Structure a proactive plan of seeking out opportunities and saving early so there is less reliance on student loan debt which is becoming more unreasonable.

 

 

 

Applegate, Evan. "Correlations: Student Debt Explodes." Bloomberg Businesswek. 1 July 2013: Page 18. Print.

Applegate, Evan. "Correlations: Student Debt Explodes." Bloomberg Businesswek. 1 July 2013. www.businessweek.com Web. 2 July 2013

 

Taxes-Estate and Gift

We at Paragon Financial Advisors are not accountants and urge you to verify any items we discuss with your tax professional to determine its implications in your particular situation. We also do not believe you should “let the tax tail wag the investment dog.” That is, your investing should not be dependent solely on tax considerations. However, tax consequences certainly should be considered when all other things are equal. Taxes can have a significant impact on your total economic well- being. It is in that spirit that we discuss the Congressional resolution (enacted at the last minute) to the fiscal cliff.

One of the more favorable (relatively) aspects of the American Taxpayer Relief Act of 2012 was the impact on estate and gift taxes. Prior to this act, estate tax rates were scheduled to rise to a maximum tax rate of 55% and the exclusion amount from this tax was to fall from $5.1 million per person to $1 million per person. With the 2012 Act, the exclusion amount was made permanent at $5 million indexed for inflation (the current amount for 2013 is $5.25 million). The tax rate, however, was raised from 35% to 40%.

Another permanent aspect of the ’12 Act was the provision of “portability.” Portability simply allows the surviving spouse to utilize the deceased spouse’s unused portion of the exclusion amount without the necessity of utilizing trust arrangements. This concept appeared in 2011, but was made permanent in 2012. It is important to note that this portability applies only to the last deceased spouse so, for multiple marriages, some planning pitfalls appear.

While the exemption amount remained higher and the tax rate lower than many had expected, there are other estate planning techniques that are still “at risk.” Some trust planning techniques ( such as grantor retained annuity trusts—GRAT’s) and the discount valuations for family limited partnerships (FLP’s) may be in danger; hence, there is some urgency in implementing those types of plans if appropriate.

As usual, we here at Paragon Financial Advisors remain available to assist you in working with your legal professional as you complete your estate planning. Please do not hesitate to call on us.

Paragon Perspectives

In this month’s edition of Paragon Perspectives advisor, Jene Tebeaux, commentates on three articles concerning risk.  The first is risk in relation to natural disaster planning, followed by risk in the current market conditions, and lastly how to evaluate your portfolio’s risk from two points of view.

 

June is the beginning of hurricane season along the Gulf Coast. In light of last year’s events (Hurricane Sandy, et al, and tornadoes in Oklahoma), we thought a discussion on disaster planning as it relates to your financial affairs would be appropriate.   The underlying theme for our second quarter newsletter is how our investment portfolios can be affected by unforeseen events and what we might do to mitigate those risks. The time to plan for natural disaster events is before the execution of such a plan is necessary. 

 

When planning for the unexpected in turbulent markets, the risk of sudden change is something that investors need to be aware of. Our current economic climate certainly has the potential for major change: Is the stock market overpriced? Will the Fed reduce QE (quantitate easing)? All factors are in place for an “interesting” time in the financial markets.  This edition of Paragon Perspectives discusses some of the things to keep in mind during such times.

 

Lastly we discusses “risk” and suggest that an investor needs to evaluate portfolio risk from two points of view: 1) the investor’s capacity (ability) to assume risk (i.e. level of assets vs. desired goals), and 2) the investor’s tolerance (willingness) to assume risk. Sometimes these two points of view do not agree for a specific investor. In such cases, the investor needs to reconcile these differences.

 

If you would like to read the newest edition of Paragon Perspectives but did not receive a copy, please email info@paragon-adv.com to request the newest edition of our newsletter.

 

Taxes-Health Care

We at Paragon Financial Advisors are not accountants and urge you to verify any items we discuss with your tax professional to determine its implications in your particular situation. We also do not believe you should “let the tax tail wag the investment dog.” That is, your investing should not be dependent solely on tax considerations. However, tax consequences certainly should be considered when all other things are equal. Taxes can have a significant impact on your total economic well-being. It is in that spirit that we discuss the Congressional resolution that provided the Health Care Act (sometimes called “Obamacare.”).

One of the Congressional leaders advised that “…we should pass the bill so we can see what’s in it…” and she was absolutely right—it has some tax implications on investments that are worth noting. In our third quarter of 2012 newsletter, we mentioned some of the provisions of this law. We will summarize some of the more investment related impacts again here:

• There is a 3.8% Medicare surtax on “net investment income” beginning in 2013. This surtax affects taxpayers with a modified adjusted gross income of $200K for singles or $250K for couples.
• It affects interest, dividends, capital gains, annuity income, rental income, and royalties. Business income from “passive” activities is also affected.
• Interest income from municipal bonds is excluded.
• Retirement plan distributions are not subject to the surtax; however, such retirement plan distributions can increase a taxpayer’s income over the threshold levels.
• There is an additional payroll tax of 0.9% on workers earning more than $200K for singles or $250K for couples.

So what happened with all these changes? The top tax bracket went from 35% to over 43.4% (39.6% + 3.8% for health care + the phase out of deductions—see our previous blog). Capital gains tax rates went from 15% to 23.8% (20% for capital gains + 3.8% for health care –a whopping 59% increase in the tax rate). Oh, and by the way, not all of the health care costs are being included yet—some don’t become effective until 2014!!

As always, please feel free to contact us here at Paragon Financial Advisors if you have questions about providing for your long term financial security.

 

“We have to pass it to know what’s in it.”

That quote is well remembered in conjunction with the passage of the Affordable Health Care Act (“Obamacare”).  Well, we are finding out what is in it—and the associated (increasing) costs. Our purpose here is not to debate the passage of the bill; it’s the law of the land. What we do try to do is see how we can help our clients preserve their financial status in light of the political realities that face us. What do we know so far?

• The law is not fully implemented—it won’t be until 2014.
• Costs (even by the administration’s estimates) are increasing above original projections.
• The cost of the Act (taxes) won’t be fully implemented until 2014.
• Employers will be subject to “fines” if they don’t provide “appropriate” health care coverage.

Proponents and opponents have their own points of view concerning the impact the Act will have on businesses. We are not going to rehash those here. However, one thing we have noticed is that business does not act in a vacuum. Entities revise their plans in accordance with what will be in the best interest of business continuation. In that light, we cannot help but compare the health care plan with the retirement plans that business provide.

Decades ago, many employers provided defined benefit plans for their employees. The employer guaranteed a certain benefit for the employee at retirement. The employer bore the contribution and investment risk of the plan to ensure that the retiree’s benefit would be available at retirement. Because of the inherent risk on the investment performance side, defined benefit plans are being replaced by defined contribution plans (401(k)). Under such plans, the employer is providing contributions only and shifting the investment performance risk to the employee. Employers know their retirement plan costs—the contributions only. It’s up to the employee and their investment acumen to determine the benefit provided at retirement.

Will we see a similar shift in focus with employer health care plans? Increases in plan costs are rampant and now the employer is bearing both the costs of benefits for the employee as well as the probability of health care incidents. Will employers start providing employees a dollar amount for health insurance and tell the employee to provide their own insurance coverage? We may find out something else is in the health care act after it was passed.

Should you have any questions, please contact us at Paragon Financial Advisors. We will be happy to assist you as you plan for your financial future.