Longevity of Retirement Income

In early May, we attended an “Inside Retirement” conference sponsored by Financial Advisors magazine; the topics were centered on “income and longevity.” Various nationally known speakers discussed pertinent items related to those themes. We found some presentations worthy of discussion here. Some presentations were individual speakers; some presentations, panel discussions. Various concepts were presented for discussion; we don’t necessarily agree with all ideas presented but did find most of them thought provoking.

 

The World Today

 

Interest rates today are at historic lows. The 10-year US Treasury note yields approximately 1.8%, and some overseas developed countries have negative interest rates for their sovereign bonds. Low interest rates mean lower earnings available from an investor’s bond portfolio to supplement retirement income. Also, since bond prices relate inversely to currently low interest rates (as interest rates increase, bond prices decrease), bond prices are currently high.  The Federal Reserve Governors have continuing discussion about when (not if) to raise interest rates.

 

The stock market also poses some interesting challenges. Volatility in the market is significant, and some market analysts feel that stocks may be overvalued. Low interest rates have made some investors move into dividend yielding stocks in search of return—taking increased risk in the stock market in exchange for a higher current yield. Note that this higher current yield could be offset by loss in value if the stock prices decrease.

 

Other sources of retirement income have come into question. Social Security, a major source of retirement income for many Americans, faces funding shortages in the not too distant future. Changes are needed; however, the nature of those changes is still to be decided.

 

Finally, retirement life spans appear to be increasing. As life expectancies increase (and people are not working significantly longer), the length of time spent in retirement increases. Couple that increased longevity with potentially higher health care costs, and we face increasing pressure for financial longevity.

 

What to Do?

 

Much has been written and discussed about retirement planning (or the lack thereof) of Americans. We believe that retirement should also have a defined plan. Such planning should include planning for contingencies, structuring an investment portfolio, and a distribution strategy from any qualified plans. Since our major discussion above was related to investments, that’s what we will discuss here.

 

Market volatility is a fact of life. Stock market downturns will occur: the questions are when and how much. A retiree needs a stock component in a retirement portfolio. Stocks provide the long term growth necessary to preserve buying power over the long term—especially given the longevity previously discussed. Consequently, an investment portfolio should be structured to provide several characteristics.

 

1. Liquidity--enough liquidity to cover necessary expenses over years when the stock market is down. This structure implies cash equivalents and bonds to cover 4-5 years of needed income without having to sell stock in a down market. Liquidity also means the ability to readily convert a portfolio holding into cash. In the 2008 downturn, some securities (auction rates) could not be readily sold at a fair market price.
2. Total Return—low interest rates practically guarantee that an investor cannot meet all income needs from interest income only. Therefore, consider an investment plan that encompasses interest/dividend income with harvesting some of the investment gain in the portfolio. That’s “total return” investing where the income needs from the portfolio are met from a combination of dividends, interest, and gain from appreciated securities.
3. Diversification—much has been made of the need to diversify assets. That diversification should include asset classes that may not have been utilized in the past. Use of alternative investing strategies (hedging techniques, conservative option strategies, etc.) and asset classes (commodities, etc.) may be warranted in selected portfolios. Note that alternative investing may be used to reduce risk, not just as a yield enhancement.

 

Investing for long term income in the current environment poses special challenges. Not all items mentioned here are necessarily advisable for all investors. We at Paragon Financial Advisors assist our clients in building portfolios that match that particular client’s goals and objectives. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

 

 

Paragon Perspectives

The first thing every investor should know and accept is that there is no such thing as a sure thing when it comes to investments.  Risk is a part of the investing process; we need some risk in order to generate profits.  There is always the possibility that your investment won’t be profitable.  Or worse, you can lose some or even all of what you have invested. In this quarter’s newsletter we will examine how you can manage total portfolio risk by reducing systemic risk though asset allocation and by reducing non-systematic risk with portfolio diversification.


At first glance, dividends and income-producing securities may seem like an attractive way to generate income in retirement.  But investing exclusively with income distributions may end up being riskier than you thought.  Income producing securities can leave retirees susceptible to the current interest-rate environment and the possibility of a decrease in revenue.  We will also discuss how a diversified portfolio may be a more stable way to generate revue in retirement.


In order to avoid unnecessary risk and account for living expenses in retirement you should adjust your portfolio accordingly. Even if you are comfortable with a decent amount of risk, the closer you get to retirement, the more conservative your investment portfolio may need to become. 



At Paragon Financial Advisors, we try to assist our clients in doing a thorough risk analysis to determine their risk tolerance.  We also design portfolios with diversification and asset allocations that suit the client’s current investing and income needs.   Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

If you are not on our email list for our quarterly newsletter and would like to be added please email info@paragon-adv.com to request a copy of Paragon Perspectives.

Paragon Perspectives

Retirement is a popular topic of discussion and, in some cases, an item of concern. There have been television commercials of “What is your number?” and “Do you have enough money for retirement?” This Quarter's newsletter discusses some of the factors that lead to a successful (financial) retirement. These factors can be complex and our discussion here is purely a cursory one.


We, at Paragon Financial Advisors, will be happy to have a more in-depth conversation with you about your personal circumstances. One particular success factor listed in Part 2 (portfolio expense) is one we monitor. Any mutual funds chosen for our client portfolios have no sales charges (for sales or purchases) and we try to select appropriate mutual funds with minimal expense ratios. For appropriate accounts, we select individual securities; this selection eliminates expense ratios completely.


 In addition, we at Paragon have negotiated lower security transaction fees for client transactions—again reducing the expense of investment management. The final item discussed is a graphical chart of funds flowing into and out of stock and bond mutual funds. The bottom line is most investors do the wrong thing—selling when they should be buying and vice versa.


If you did not receive a copy of this Quarter's Newsletter and would like to request one please email info@paragon-adv.com

The Value of a Job

I had a discussion with a friend today about the value of a job. Not the value of a job as a younger person, but the value of a job as a “phased in” retirement. Many baby boomers are facing the question “When should I retire?” Our discussion focused on some options available.

 

My friend is a professional and has the ability to continue working on a part time basis if he so chooses (earning approximately $75,000 per year). He is 65 years old and his marginal tax bracket is approximately 40%. His estimated social security benefit at full retirement age (age 66) is approximately $2400 per month.

 

Our discussion prompted some thoughts which I share here. Note that these thoughts are purely from a financial planning standpoint; they do not address the personal satisfaction questions of continued working vs. time use in retirement.

 

Social Security Benefits

 

Age 62

 

My friend has several choices concerning his social security benefit. He could have chosen to receive his social security benefit at age 62. He did not choose that option for several reasons:

1. At age 62, his monthly benefit would have been reduced by 25% (approximately 6% per year for each year of age before his age 66 full retirement age giving him only a monthly benefit of $1,800). That reduction in benefit is generally permanent and would continue for his life span.
2. If he continued to work, his social security monthly benefit would be reduced $1 for each $2 he earned in excess of $15,480 (this amount is applicable for 2014 –it changes annually)
3. He was not ready to quit working at that age.

Age 66

At age 66, my friend can choose to receive his full retirement age benefit of $2400 per month. He can continue to work with no reduction in social security benefit regardless of the amount he earns. He has another option at age 66. He can “file and suspend” his benefits which would allow his spouse to collect spousal benefits without affecting his or her future benefits. With a file and suspend election, he would file for his age 66 benefit but choose not to begin receiving his benefit payment. His spouse could begin drawing ½ of his benefit ($1200 per month) without affecting her social security benefits. The suspension of his benefit would allow his monthly benefit amount to increase as outlined in “Age 70” below.

Age 70

My friend can delay receiving his social security benefit until age 70; if he does, his monthly benefit will increase by 8% per year (or a total of 32%) for each year from age 66 to age 70. His monthly benefit at age 70 would then be $3,168. Note that his spouse could have been drawing spousal benefits for that four years or until she began drawing her own benefit.

Note: This social security discussion is a generalized one; you should discuss your particular circumstances with the Social Security Administration before making any decisions.

Investment Implication

There are consequences on my friend’s investment portfolio that should also be considered. His continued earnings of $75,000 per year for 4 years (age 66-70) are money that would not be withdrawn from his IRA. Since required minimum distributions (RMD) don’t start until age 70 ½, that amount could continue to grow tax deferred until he needed it or was required to withdraw for RMD purposes. At a conservative rate of return (the current 30 year US Treasury rate of 3.5%), the future value of not withdrawing for those 4 years is approximately $316,000. That is, his retirement portfolio will be about $316,000 more at age 70 if he continued working until that time.

What to Do?

Retirement is an individual decision that is dependent on many things (health circumstances, life style choices, economic factors, etc.).

We, at Paragon Financial Advisors, assist our clients in evaluating options available to them.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

Trusts and Taxes

Taxation on trusts warrants consideration. Trust income is subject to income taxation at one of two levels: 1) at the trust level if the income is retained in the trust, or 2) at the individual level if the income is distributed from the trust to the individual trust beneficiary. Since trust income is taxed at the maximum federal tax rate at relatively low levels of Income (39.6% at $11,950 in 2013), income is usually distributed to individual beneficiaries. 

 

Texas does not have a state income tax at this time; therefore, federal income tax rules are the primary consideration for Texas trusts. That is not the case everywhere. It is no secret that some individual states are facing significant challenges in financing their state operations. Those states are frequently turning to trusts for tax revenues.

 

The first consideration is state income taxes on trust income. Forty three states have a state income tax and thus tax income the trust earns. Seven (Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming) do not have state income taxes. The old rule was taxation by the state in which a trust has its “principal place of administration.” States are now attempting to tax trusts when there are other, minimal jurisdictional contacts.

 

In almost all cases, income earned by the trust in the state is taxed according to the state income tax rates. Income earned outside the state is not taxed at the state level. However, there are more attempts to tax the entire trust income at the state rate if some jurisdictional conditions apply. Some of these conditions include the following:

1. The deceased creator of the trust lived in the state at the time of death.
2. The grantor of a lifetime trust lived in the state at the time the trust was created.
3. The trust was administered according to the state’s trust laws.
4. One of the trustees lives or does business in the state.
5. One of the beneficiaries of the trust lives in the state.

Thus, consider a trust that became irrevocable under the following conditions:

1. The grantor lived in one state when the trust became irrevocable.
2. Two individual trustees reside in separate states from the grantor’s state.
3. Two trust beneficiaries reside in two separate, different states.

The trust could then be subject to state income taxes in five different states; the amount subject to state taxation could vary depending on allocation methods used by the state’s taxing authority.

Trusts created in Texas, administered in Texas, with Texas trustees and beneficiaries face federal taxation problems. However, with an increasingly mobile population, a review of wills creating trusts and existing trusts warrant a review of conditions.

We, at Paragon Financial Advisors, assist our clients in reviewing their estate/trust planning.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

IRAs and Creditors

As a general rule, IRAs are assets protected from creditors—i.e. IRAs cannot be attached by creditors to satisfy debts or judgments incurred by the IRA owner. However, the Wall Street Journal (Friday, June 13, 2014, page  A6, electronic copy found HERE) reported on a unanimous ruling by the US Supreme Court that changed that protection for some IRAs.


According to the new ruling, inherited IRAs (IRA accounts transferred from the original IRA account holder to a non-spouse beneficiary) are not protected from creditors. IRAs (original and transferred to spouses) are subject to restrictions that do not apply to IRAs transferred to non-spousal beneficiaries. Therefore, since the non-spouse beneficiary has complete access to the full account penalty free (but still subject to income taxes), the Supreme Court ruled that the IRA assets can be attached by creditors.

Given the amount of money in IRAs and the ageing baby boom generation, such non-spousal transfer will become more common. Prudent debt management will prevent some problems; however, judgment awards may still apply.  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

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

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.

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.

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.

A "How To" Estate Plan for Your Digital Assets

The last two posts introduced what digital assets are, the importance of planning for them, as well as some obstacles that exist.  Please take a moment to read them HERE.  In this final post we will explore a few solutions that have been developed to help with planning for digital assets.

“After you pass away, the everyday things in your life will become significant to your friends and family.  No matter how simple, your digital content is no exception; in many respects, it may become even more valuable.”  Evan Carroll, Your Digital Afterlife.  We know that planning for digital assets is important.  Now how do we do it?  While there is no single answer, a combination of options may help.

The very first step is compiling a list of all websites where accounts are held.  For each website, read the terms of use or find out how each website handles the account and the data within it upon death.  Do they let you choose who can access the account?  What documentation is required to grant access to an heir?

Second, research the laws in your state.  Are there any existing laws governing digital assets?  If there are, do they cover access to any digital account AND access to any digital assets held within the account.  If no laws exist, speak to legislators in your state to voice concern. 

Estate planning attorneys can also be an asset.  Visit with your estate planning attorney about including language in your last will and testament to express your desires about management of your digital assets.  Do you want the executor to also handle access to your digital accounts and digital assets?  Do you want to leave a memorandum with instructions for digital assets and their access, handling, distribution and disposition?

Services and technology solutions have been introduced to try to address this growing area of need.  There are programs for the purpose of storing usernames, passwords, and other documents in an encrypted format.  Some of them are strictly for the purpose of making a record of all accounts and access to each that cannot be used during life.  Upon receipt of a death certificate they will release all information to the authorized individual. 

“In its simplest form, a digital legacy is a summation of the digital assets you leave behind for others.  As the shift to digital continues, the digital assets left behind will become a greater part of your overall legacy.”  Evan Carroll, Your Digital Afterlife.  A complete plan uses several of these options in conjunction.  Visit with loved ones, your financial advisor and your estate planning attorney to begin developing a plan to ensure that your digital legacy continues—your way. 

How important are your digital assets to you?

In the last post we explored what digital assets are and how important they are in day to day life.  If you would like a refresher you can view that blog post here.

Now that we know what digital assets are, how is management of digital assets different than the management of the account?  An account is just a shell to house content.  It is not necessarily the account that is valuable—it is the content within the account that may be worth having and planning for. 

In the example where email is the hub of all online account activity, the actual account is a compilation of information needed in order to operate different aspects of our finances, volunteer activities, work, friends, relatives, clubs and organizations, travel, online purchasing, banking etc.  It is the actual emails are digital assets that hold value to us. 

The following are issues in planning for digital assets as identified by Evan Carroll with website The Digital Beyond.

1. Awareness—Do heirs know about the digital account and how to find it?
2.  Access—Do heirs have the appropriate credentials or means to access the account?
3.  Ownership—Who owns the data inside accounts?
4.  Rights—Do heirs have the right to take control of or access the account?

Different rules surround how accounts and the digital assets within them are treated upon death.  Consideration should be given to the laws in your state, the terms of service that govern each account (and what state they are governed by), what is desired as far as an estate plan and the solutions available to ensure these assets pass in the best most efficient way possible.

Difficulties that come up:

1.   Legally the basic rights of privacy expire at death.
2.  Laws on estate planning for digital assets vary from state to state.  There is no uniform treatment of these assets upon death.
3. As a relatively new planning topic, many states including Texas have NO laws on the treatment of digital assets upon death.  As of April, less than half of the states have laws (or proposed laws) in place for the management of digital assets. –Evan Carroll, The Digital Beyond
4. The laws in your state may differ from the laws that govern the terms of service for accounts.  Which laws prevail?

Once again I’ve presented several ideas to get the wheels spinning.  Stay tuned for the next blog which will explore options to help address some of the issues introduced today.