Rocky Road Ahead?

October 2018 marked the 10^th year of the longest bull market in history. In 2017, the stock market (S&P 500) moved placidly upward; in fact, the market set record highs over 100 times since the Presidential election in November 2016. This year, 2018, has given investors pause to think, however. In late January, the S&P 500 peaked around 2873, fell just over 10% in February, and recovered to January levels by mid-August. Another record level in late September (around 2930), then the market fell about 7% in mid-October. The roller coaster ride, especially following last year’s “tranquility,” has been a concern to investors. This might be a good time to step back and look at the bigger picture. 

Historical Market Corrections

History can give some guidance on the severity of previous market corrections, as well as how long their recovery took. Since 1926, there have been 16 instances of market downturns more than 10%.

The longest and largest downturn was the Great Depression (Sept 1929-June 1945) during which the stock market lost 83%. That downturn lasted 34 months and the recovery took 151 months. The rampant speculation associated with stocks in the years preceding the downturn resulted in the Securities Exchange Act of 1933 (which regulated the offer and sale of securities—previously governed by state laws, commonly referred to as “blue sky” laws). That law was followed by the Securities Exchange Act of 1934 which created the Securities Exchange Commission and governed the secondary trading of securities.

The second longest downturn was the early 2000 bear market in which the market lost 44.7% and lasted 25 months. The recovery period was 49 months.

The second largest market downturn was the Nov 2007-March 2009 liquidity crisis. The market lost 50.9%, lasted 16 months, and recovered in 37 months.

Let’s look at the record categorically (excluding the Great Depression which, hopefully, won’t happen to such an extreme again because of more stringent securities regulation). The total period is 1926 through October 2018—approximately 92 years.

• Greater than 50% downturn- One occurrence lasting 16 months and recovering in 37 months.
• Greater than 40% but less than 50% downturn- Two occurrences lasting an average of 23 months and recovering in an average of 35 months.
• Greater than 30% but less than 40%- There have been no such occurrences.
• Greater than 20% but less than 30% downturn- Four occurrences lasting an average of 8.5 months and recovering in an average of 18 months. (There have been no instances of a 30-40% downturn.)
• Greater than 10% but less than 20% downturn- Eight occurrences lasting an average of 8 months and recovering in an average of 5 months.

The Take-Away

Make no mistake—watching your investment portfolio lose money is not fun. It brings anxiety, especially for individuals near or in retirement and depending on their portfolio for a portion of living expenses. History is not guaranteed to repeat, but the data above does indicate that “this too shall pass,” and that a portfolio positioned to withstand downturns can prosper. An investor should have cash and short-term fixed income investments needed to cover 36-60 months of normal living expenses in a combination of personal savings and an asset allocation in the portfolio. Stocks remaining in the portfolio will then be given time to recover with no necessity to sell at a loss to cover distribution needs.

For individuals who are not near retirement—congratulations! Stocks just went on sale. You have an opportunity to buy desirable companies at a discount. You should maintain your 3 to 12 months cash “ready reserve,” and consider your risk tolerance and future time horizon, but a downturn may be an opportunity to really boost your future portfolio performance.

Let’s also consider the other alternative—selling stocks when the market is down. We’ll use the 2008 liquidity crisis (market downturn of 50.9%) in our calculations. Our hypothetical stock portfolio will be invested in an S&P 500 index fund with a $500,000 value at the beginning of the market downturn. At the bottom of the downturn, the portfolio retained 49.1% of its original value or $245,500. Definitely an uncomfortable feeling! Now assume the investor takes one of three actions listed below and fast forward to October 17, 2018.

• Sell the equities and go to CDs—Assuming a generous 2% CD rate, the portfolio would now be worth approximately $296,400.
• Sell the equities, wait one year until the market stabilizes, then reinvest in the S&P 500—The investor would have missed a year of gain in the S&P but realized a cumulative increase of 224%: a total portfolio value of approximately $549,900.
• Do nothing, hold the equities and wait—The S&P increased a cumulative of 378%; the portfolio value would be approximately $928,000.

But wait, you say. Suppose the market doesn’t recover as quickly. Let’s look at the periods of consecutive negative stock returns since 1926. There have been four such periods. The market was down four consecutive years during the Great Depression: 1929-1932. In 1933, the market rose 54%. The early 2000s saw three consecutive down years: 2000-2002, followed by a 29% gain in 2003. There were three down years in 1939-1941 followed by a 20% gain in 1942. The market was down two consecutive years in 1973-1974; the market gained 37% in 1975.

There are no guarantees in the stock market. What has happened historically may not happen in the future. However, the next time the market drops, have a cup of coffee and re-consider your long-term investing goals. Maybe the world isn’t ending after all. Paragon Financial Advisors is a fee only registered investment advisory company located in College Station, TX.  We offer financial planning and investment management services to our clients.

Interesting Times

There is an old curse: “May you live in interesting times.” The stock market has definitely had those “interesting times” in the last few months. Triple digit moves in the index (both positive and negative) have had investors hanging onto their hats for a wild ride. Pundits on the financial news channels have mentioned that the third quarter of 2015 was the worst quarter in the last four years. For 2015 (January 1 through September 30), major financial indices have been as follows:

 

• Dow Jones Industrial Average: -8.8%
• S&P 500: -6.7%
• Russell 2000 (Small Caps): -8.8%
• Barclays Aggregate Bond Index: -0.6%
• High Yield Corporate Bond Index: -7.8%

In this quarter's newsletter I discussed  a “white paper” from the Vanguard Group that I found quite interesting. As you probably know, the Vanguard Group manages significant amounts of money in their mutual funds and exchange traded funds (ETFs). A major area of emphasis for them has been indexing markets and market segments. The article, “The added value of financial advisors,” provides some interesting research insights from a company that was founded for individual investors. One of advisor benefits cited is “…helping you get through tough markets.” There are strategies which can potentially reduce the market downturns. We hope you find the information worthwhile, and urge you to call us to discuss those downturn strategies.

For a complete copy of this Quarter's Newsletter with the "white paper" article discussed please email info@paragon-adv.com and request to be added to the mailing list.

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.

               

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

IRA Transfers

Happy New Year; 2014 is a year of memories and 2015 is a year of promises. Some of those promises might not be pleasant for individuals transferring an Individual Retirement Account (IRA) unless they follow very specific rules.

The Transfer

IRAs can be transferred to a new advisor or trustee in one of two ways:

 

1. Direct transfer- where the IRA funds move from one trustee to another trustee without the account owner ever receiving the money, and
2. Indirect transfer- where the account owner receives funds from the IRA in the form of a check made payable to the account owner. The account owner can then deposit the IRA check into another IRA within 60 days and have no tax obligation for the “rollover.”  This 60 day withdrawal has also been used by some IRA owners to temporarily access IRA funds for short term purposes. An account owner has been allowed to access each IRA account he/she owned once in a 12 month period with no tax consequences as long as the 60 day rule was met. This once per year rule was allowed for each IRA account an individual had.

 

The Change

There has been a major change in these IRA rollover rules beginning January 12, 2015. Now, only one IRA (defined as traditional IRAs, Roth IRAs, SEP IRAs, and Simple IRAs) can be transferred or accessed in the preceding twelve months regardless of the number of IRAs the individual has. A tax court case in early 2014 changed the interpretation of once per year per account to once per year per individual.

The Consequences

The result of this change is that any subsequent transfer or access to another IRA within the same 12 month period will be considered a taxable distribution—subject to income tax and 10% pre-mature distribution tax if applicable (i.e. the individual is under age 59 ½). There are no provisions for remediation of an erroneous second transfer in the same 12 months—the second transfer is taxable.

Consider the following example. An account owner accesses his/her account for a small distribution in March. In January of the following year, the account owner decides to transfer the same (or a different) IRA to another trustee. If the account owner receives the funds for the transfer, the second distribution is a taxable distribution. A significant tax burden may be incurred inadvertently.

Clarifications

Given the complexities involved, some clarifications are warranted. This rule does not apply to rollovers from an employer sponsored plan (401(k), 403(b), etc.) into a self-directed IRA. Rollovers from an IRA back into an employer plan are also exempt. Roth conversions (rolling funds from a traditional IRA to a Roth IRA) are excluded from the rule.

In Summary

In summary, individuals transferring IRA accounts to another trustee should always use a direct transfer (where funds are transferred directly from the old trustee to the new trustee or the check is made payable to the new trustee if it comes to the IRA owner). Short term, 60 day access to IRA funds should be done with great care—only once in any 12 month (not calendar year) period regardless of the number of IRA accounts owned.

We at Paragon Financial Advisors will assist our clients as they prepare for accessing their IRA accounts. Which accounts should be accessed first and asset allocation within accounts for investment purposes can have significant long term implications on your retirement planning. Consult your tax professional if you are contemplating indirectly transferring your IRA in this new year of “promise.”  Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.

Monthly Pension or Lump Sum Benefit?

More and more retiring employees are facing the question of whether to take their retirement benefits as a lump sum payment or a life-time monthly payment. The “correct” decision obviously lies with the individual’s particular circumstances (health of retiree and spouse, other financial assets, fund needs, etc.). There are compelling reasons for both scenarios in today’s interest rate environment. Monthly pensions usually come from employer sponsored defined benefit plans. Such pensions are “guaranteed” by the employer as long as the employee (and/or possibly another beneficiary) is alive. Following death, all benefits cease. The lump sum option represents a current payment of all future retirement benefits offered by the employer; the employer’s obligation ceases with the lump sum payment.

Monthly pension amounts are usually based on formulas established by the benefit plan. Common conditions include length of employee service with the company and the highest annual earnings of the employee for a specified number of years. This type of plan is just what the name implies: a defined benefit. The employer is guaranteeing the retiree an income for the rest of the retiree’s life. Therefore, the employer is responsible for providing contributions into the retirement plan that will sustain anticipated benefits for all employees and retirees of the company over their lifetimes. The employer also bears the investment risk for plan assets. If the plan assists earn more than projected, less money can be contributed to the plan. If the plan assets earn less than projected, the employer must increase contributions to the plan.

Each choice offers advantages and disadvantages which we will discuss below.

Monthly Pension

When a retiree elects the monthly pension option, there are several payment offerings available. The amounts differ depending on the actuarial assumptions involved. The retiring employee may select a single life payment (for the life time of the retiree only), a joint and survivor payment (where monthly payments continue as long as the retiree or a designated beneficiary is alive), or an option for payment over a certain time period (which guarantees payment for life time but also for a minimum specified period). The obvious benefit is a steady source of monthly income. However, inflation may erode the value of monthly payments depending on the cost of living adjustments (if any) to the monthly benefit. In addition, the retiree is depending on the strength of the plan to maintain payments over a retirement lifetime.

Lump Sum Payment

With a lump sum payment, all retiree benefits are given to the retiring employee at retirement. The retiree is now responsible for investing the benefit payment in such a way that the monthly income checks are duplicated. The length of time such payments continue is purely dependent on how successfully the investments perform. The investment risk has been shifted from the employer pension plan to the retiree. In exchange for that risk, the retiree gains a significant opportunity. While payments stop at death for monthly pensions, retirees with a lump sum option may have assets remaining which they can pass to heirs of their choice.

Lump sum payments are based on an assumed earning rate over the retiree’s lifetime. The higher the assumed earning rate, the lower the amount that needs to be distributed as a lump sum payment. Conversely, the lower the assumed earning rate, the greater the amount that needs to be distributed as a lump sum. Today’s low interest rates favor larger lump sum payments.

Why are employers offering the lump sum option?

The primary reason for a lump sum option is the shifting of responsibility for future benefits from the employer to the retiree. Many retirement plans today are underfunded; i.e. the plan does not have enough assets to meet the expected liabilities of current and future retirees. The lump sum payment removes any further obligation from the employer.

Employers also pay an annual premium to the Pension Benefit Guaranty Corporation for each employee covered by the plan. This premium is made to guarantee that the retiree will receive some (not necessarily all) retirement benefits if the employer’s plan fails. The current premium (for 2014) is $49 per employee; it is rising to $64 per employee in 2016. That increase will likely continue as the premium payments are tied to inflation in the future. Reducing the employees covered by a plan also helps reduce overall plan expenses.

What to Do?

As mentioned earlier, this retirement election is critical to a successful retirement. We at Paragon Financial Advisors will assist in analyzing the benefits available under retirement plan options to ensure that the choice matches the best interest of the retiree. 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

How long can a good thing last?  This summer has been quite mild in comparison to the past several Texas summers, but as many of us know, one strong high pressure system can change all of that.  The stock market and Texas weather may have a few things in common. Over the last 18 months the stock market has been performing well, but how long will it last and is there a bubble brewing?   


We at Paragon Financial Advisors manage client assets primarily for the long term, depending on the client’s goals, objectives, and risk tolerance.  When constructing an investment portfolio consideration is given to diversification, current investment environment, and which investment vehicle is the best fit for a portfolio (ETFs versus actively managed funds for example). This quarter's newsletter discusses three different investment topics.


The first article is a market commentary which outlines strengths and weaknesses in the economy.  The second article “ETFs Versus Actively Managed Funds” discusses what one should consider when choosing between ETFs and Actively Managed Funds.  The last article examines some broad points on types of diversification: the normal diversification between stocks and bonds and the diversification within a certain asset class. 


How long will this current bull market last and is there a bubble brewing in the stock market?  Only time will tell for sure! Therefore, we will continue to review economic data, asset allocations, and asset diversification to guide us as we move into the remainder of this year and into next year.


Sincerely,


David Hailey CTFA® CFP®


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

Fee Only or Fee Based Advisors

There is considerable discussion in the investment profession concerning the compensation of advisors for investment advice. What is the difference and does it matter? That’s the subject of this discussion.

Fee Only

Fee only compensation means the advisor is compensated by a flat fee or percentage of assets under management (annually); compensation may also be based on an hourly rate or fee for service for specific tasks performed. In either case, there is no additional compensation (sales commissions, etc.) for services performed or investments provided. Registered investment advisors (RIAs), such as Paragon Financial Advisors, operate under this arrangement.

A fiduciary requirement exists: the firm must put the best interest of the client first in all cases. This fiduciary requirement includes advising the client of all aspects of advisor compensation and the disclosure of any conflicts of interest the advisor may have with the client’s portfolio.

Regulatory oversight for fee only advisors is provided by either the Securities and Exchange Commission (for firms with more than $100 million in assets under management) or the state securities agency (for firms with less than $100 million in assets). Such advisors are subject to random audits by the oversight agency and to penalties if appropriate rules are not being followed.

Fee Based (Fee and Commission)

In contrast, broker-dealers and businesses that buy/sell securities and also give advice are compensated by fees plus commissions. Those commissions may be based on a “per transaction” basis thereby giving the advisor an incentive to sell a specific product or products from a specific vendor (because of higher commissions paid).

No fiduciary standard exists (except in a few states) for fee based advisors. They are subject to a “suitability” requirement (i.e. “Is the investment recommended/sold suitable for the investor?”). Therefore, if two investments can be deemed “suitable” for a client and one provides a higher commission to the advisor, the advisor is free to choose either as appropriate for the client. Fee based advisors are generally not required to disclose to the client all compensation arrangements or conflicts of interest.

Regulatory oversight for fee based advisors is provided by the Financial Industry Regulatory Authority (FINRA). FINRA does have circumstances in which additional information concerning disclosure of conflicts of interest must be disclosed to the client; it also provides for dispute resolution between advisors and clients according to binding arbitration.

Hybrid Arrangements

In other situations a fee only advisor can have arrangements/ownership in firms that are actually fee based. For example, a fee only advisor might have securities licenses that entitle him/her to receive commissions from a broker dealer. In such a case, the advisor must be registered with the SEC and subject to FINRA oversight as a broker. Thus the advisor is subject to a fiduciary standard when giving advice and a suitability standard when providing commission services. Sound confusing? It is.

Much discussion is occurring in the financial services industry about fee only vs. fee based. In addition, industry groups weigh in on the subject. The National Association of Personal Financial advisors require its members be compensated solely by the client and that neither the advisor nor a related party receives any compensation based on the purchase/sale of any product. The CFP Board of Standards requires that Certified Financial Advisors™ may not use the term “fee only” if they are associated with a broker dealer or any firm that receives transaction based compensation.

We at Paragon Financial Advisors keep it simple—we are a fee-only registered investment advisory firm. We are also a firm member of the National Association of Personal Financial Advisors and the three firm principles at Paragon hold the Certified Financial Advisors™  designation.  We offer financial planning and investment management services for our clients.

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

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.