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Archive for June 2012

Three Retirement Rollover Mistakes to Avoid

Jim Lorenzen, CFP®, AIF®

IFG BlogPlanning to retire?  Contemplating a rollover?  Here are three ways NOT to do it.

1. Get a check from the company

Of course, this is just foolish. The company must withhold 20% from the payment, so that a person with a $100,000 account will have $20,000 withheld, and will receive a check for $80,000. In order to complete a tax-free rollover, the taxpayer must deposit that $80,000 in an IRA plus $20,000 from their pocket to complete a tax-free $100,000 rollover.

The taxpayer may eventually get the $20,000 withheld as a tax refund the following year, but that will not help their cash flow, as they need to complete their IRA rollover within 60 days of receiving the check from their qualified plan.

The bottom line is that people should never touch their qualified funds. The only sensible way to move funds is a direct transfer from the qualified plan to the IRA custodian and avoid withholding.

2. Rollover company stock

Shares of employer stock get special tax treatment, and in many cases, it may be fine to ignore this special status and roll the shares to an IRA. This would be true when the amount of employer stock is small, or the basis of the shares is high relative to the current market value.

However, in the case of large amounts of shares or low basis, it would be a very costly mistake not to use the Net Unrealized Appreciation (NUA) Rules.[1]

If your company retirement account includes highly appreciated company stock, an option is to withdraw the stock, pay tax on it now, and roll the balance of the plan assets to an IRA. This way you will pay no current tax on the Net Unrealized Appreciation (NUA), or on the amount rolled over to the IRA. The only tax you pay now would be on the cost of the stock (the basis) when acquired by the plan.

If you withdraw the stock and are under 55 years old, you have to pay a 10% penalty (the penalty is only applied to the amount that is taxable).

IRA owners can then defer the tax on the NUA until they sell the stock. When you do sell, you will only pay tax at the current capital gains rate. To qualify for the tax deferral on NUA, the distribution must be a lump-sum distribution, meaning that all of the employer’s stock in your plan account must be distributed.

3. Rollover after-tax dollars

Sometimes, qualified plan accounts contain after-tax dollars. At the time of rollover, it is preferable to remove these after-tax dollars, and not roll them to an IRA. That way, if the account owner chooses to use the after-tax dollars, he will have total liquidity to do so.

You can take out all of the after-tax contributions, tax-free, before rolling the qualified plan dollars to an IRA. You also have the option to rollover pre-tax and after-tax funds from a qualified plan to an IRA and allow all the money to continue to grow tax-deferred.

The big question is, “will you need the money soon?” If so, it probably will not pay to rollover the after-tax money to an IRA, because once you roll over after-tax money to an IRA, you cannot withdraw it tax-free. The after-tax funds become part of the IRA, and any withdrawals from the IRA are subject to the “Pro Rata Rule.”

The Pro Rata Rule requires that each distribution from an IRA contain a proportionate amount of both the taxable and non-taxable amounts in the account. The non-taxable amounts are called “basis.” In an IRA, the basis is the amount of non-deductible contributions made to the IRA.

————–Jim Lorenzen, CFP®, AIF®

This Guide is an excerpt from Six Best and Worst Rollover Decisions by Jim Lorenzen. 

Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors, and retirement and wealth management services for individual investors. IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues.  Content contained herein represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a written plan.  The Independent Financial You can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com, the IFG Investment Blog and by subscribing to IFG Insights letters for corporate plan sponsors and individual investors.  Keep up to date with IFG on Twitter: @JimLorenzen


[1]IRS Publication 575

Written by Jim Lorenzen, CFP®, AIF®

June 28, 2012 at 8:00 am

Does Market Avoidance Really Work?

IFG BlogWe’ve been in choppy times since 2008.  Many people feel the markets are ‘uncertain’ and have been avoiding the markets until they “see what the market will do”.  It’s an old mantra I remember hearing when I began in this business more than twenty years ago.  The markets were uncertain then, too.  Problem is, markets are always uncertain. 

Has avoidance worked?  Not likely.  Investors who wait until they feel good about the markets are, by definition, waiting until the market has gone up – they buy ‘high’, which means they usually are overpaying, rather than underpaying, for their investments.

Investors who have self-discipline, or lucky enough to be in auto-enrollment, automatic increase company retirement plans, have probably done a little better.

Let’s use a little hypothetical mathematical exercise to illustrate the point.  Let’s compare two investors: 

One has $20,000 in a retirement plan but stops investing just as the market starts to go down…. And won’t invest again until the market ‘comes back’. 

The other investor who has NO money in a retirement plan, but actually starts investing when everyone else is freezing up! 

Now let’s assume a market that starts going down and takes six years to realize a 30% loss, then ten years just to get back to even. 

Both investors end-up with the same amount invested in the same market, represented with a starting price of 50.

Who won?

Hmmm.  Maybe buying ‘on the cheap’ is good, ya’ think?

 ————–

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors, and retirement and wealth management services for individual investors.

Additional IFG Links:

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  securities  or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization. 

 

Written by Jim Lorenzen, CFP®, AIF®

June 21, 2012 at 8:00 am

Underperform the Market and STILL Beat It?

The Independent Financial GroupJim Lorenzen, CFP®, AIF®

What?  Never beat the market and STILL end-up outperforming it? 

Could that be possible?

If you watch enough tv or read enough articles, blogs, newsletters and e-letters, you’ll soon easily conclude that the two most important investment concepts seem to revolve around one of two basic concepts: Outperforming the market and/or limiting expenses.

What if they’re both wrong?

While I’ve never promoted the idea of trying to outperform the market, I have often talked about controlling expenses.  After all, it’s logical, isn’t it?   Any money you save on expenses goes into your pocket!   Not rocket science.

But, what if I’ve been wrong, too?

What if we’ve all been looking at the wrong things?

What if all the financial advisors – the ones who’ve been talking about managing risk and limiting the downside – actually have been telling everyone the little-known secret:  It’s maybe about limiting `downside capture’!

Let’s take an example and, just too keep our comparison of performance outcomes `apples to apples’, we’ll make all expenses equal at zero.

The following hypothetical example reflects a fictional market return showing 20% swings each year over a ten year period and what would have happened to Portfolio A, which invested $100,000 in ‘the market’.  As you can see, even though 6 of the 10 years were ‘up’ years, including both the first and last year, and even though 3 of the last 4 years were ‘up’ years, the market portfolio achieved an annualized return of only 2.12% and a gain of only $22,306. 

What’s interesting is what happened in portfolio B!    Portfolio B’s management emphasis was not on beating the market.  In fact, during the ‘up years’ it underperformed the market by 20% each time!   But, while the managers captured only 80% of the upside, they were successful in capturing only 70% of the downside.    How important was limiting the downside?   Take a look!

Interesting!   Now this is a hypothetical mathematical excercise, to be sure; but, it does illustrate the importance of managing risk and how unimportant ‘beating the index’ actually is!   It also demonstrates another important principle:  While it’s important to limit expenses, you don’t want to get caught in a ‘race to the bottom’.  Managers who know how to ‘optimize’ portfolio performance just might be worth what they’re paid.

 ——————-

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional. 

Additional IFG Links:

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  securities  or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.

Are You “On-Track” to a Successful Retirement?

IFG BlogJim Lorenzen, CFP®, AIF®

If so, you may be alone.

I attended a 401(k) Recon conference north of Los Angeles last week and was amazed, though not totally surprised, to hear a few very interesting points.

One speaker relayed a story about one company’s 401(k) enrollment meeting where 100% – yes, everyone – said they wanted to enroll in the company’s 401(k) plan.  They all were going through the materials and even choosing allocations they felt were appropriate – and all them were excited about starting to save for their retirement!

Would you like to guess how many actually followed through and actually participated?   3%.  That’s right; only three in one hundred actually did it.   Education didn’t seem to help, at least in that particular case, despite all the glowing post-meeting comments.

Benjamin Graham, the ‘dean’ of value investing who taught Warren Buffett at Columbia University, once said that behavior, more than investment choices, represent the largest impediment to financial success for most Americans; and the data seems to bear that out.

Poor savings habits, poor investor performance due to behavior, and paralysis often due to too many choices create roadblocks many have trouble overcoming.

Maybe the best gauge of investor success (or failure) might be whether they are ‘on track’ to a successful retirement, which some define as replacing 75% of preretirement income at age 67.   According to a study – I think it was conducted by Mass Mutual – revealed that only 15% of American workers are ‘on track’.   Even without my HP12-C, it’s obvious that means 85% are not.

It’s not rocket science.  It’s about three simple components:  time, savings rates, and return.   Time is the only component that constantly declines; and, as it does, it creates pressure on the other two.  When procrastination behavior impedes one of those, all the pressure falls on investment return.  This may be why some people reach a point where they begin making the risky choices they live to regret.

I’ve spoken about financial literacy before and how our schools need to do a better job – I even once met a CPA who didn’t know the difference between gain and yield.  When an accountant doesn’t know, it explains the deficiencies the rest America’s workers are experiencing.

————-

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional. 

Additional IFG Links:

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  securities  or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.

How Much Is That $1 Coupon Really Worth?

IFG BlogJim Lorenzen, CFP®, AIF®

Did you receive some coupons in the mail?

We get them at our house!  Sometimes they come in envelopes, sometimes in books; we even receive them by email!  My guess is most people simply throw them away; but should they?   Maybe they should rethink what they’re doing!

If I gave you a “$1-Off” coupon, how much would it be worth?  $1?   Think again.

Believe it or not, what you’d be holding in your hand represents real cash flow!  For you non-financial types, cash flow is what’s left over after all taxes and expenses.  Now we’re getting closer to what that $1 coupon is really worth.

If you had to produce that $1 in cash flow on your own, you’d have to earn $1.39, assuming you’re in a 28% federal tax bracket and pay no state income tax.  If you live in California, New York, or some other high tax state, you’d likely have to earn far more in order to have $1 left over!

Now look at that “$1-Off” coupon again. 

Now you know what you’re really looking at:  FREE CASH FLOW!   It replaces $1.39 (maybe) or more, maybe much more,  in earned income!  That’s significant, don’t you think?

$1 may not sound like much; but, as mom used to say, “Pennies turn into nickels, nickels into dimes, and…”  you know the rest.  And, you can find coupons for nearly everything.   Our daughter-in-law saved $50 on tires!

Couponing has been a smart hobby for many Americans over the years; now you know why some have even made a little ‘home business’ out of it.   I was behind a lady in the grocery store one day who purchased a fully-loaded shopping cart of food for exactly 39-cents.   I don’t know how much money she saved; but, if she’s shopping for a large family with any frequency, she could be earning more in cash flow than if she went to a job and paid commuting costs and taxes!

Important caveat:  Use coupons only for the things you would normally purchase anyway.  Never buy something just because the coupon looks like a good deal.    When used ‘instead of money’ for the things you normally buy, you might be surprised just how much free cash flow you can replace during the course of a year.

Use the savings to invest in your `future self’.  You’ll likely be glad you did.

 —————

Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional. 

 

Additional IFG Links:

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  securities  or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.

Written by Jim Lorenzen, CFP®, AIF®

June 12, 2012 at 8:00 am

How Does Inflation Affect the Markets?

IFG BlogDo all markets react to economic forces the same way all the time?  As any good consultant worth his salt will tell you, “It depends.”

Asset classes, for some reason, seem to have this annoying habit of reacting differently to different environments – probably because investors react differently to varying environments, and all these indexes we keep talking about are only reflecting what investors are doing with their money.

For example, it should come as no surprise to most that bonds and commodities generally react differently in high inflation environments, whether inflation is rising or falling.

Here’s a chart from JP Morgan Asset Management that depicts how different asset classes have reacted to varying inflation environments since 1972.  It’s important to remember this represents a forty-year period and that during those forty years, these asset classes have rarely moved in tandem.

Which environment are we in now?  It depends on what inflation number you use.  While the core consumer price index (CPI) excluded food and energy, the broad CPI today isn’t too different from the median CPI reflected above.   Since we seem to be coming off a low inflation base and can realistically expect a rising inflation scenario – the government hasn’t stopped printing money – the lower left quadrant does get our attention.

Does this mean you should avoid bonds and cash?  Not likely.   Asset allocation is about diversifying risk – and that’s all about blending correlations in a way that brings portfolio volatility (standard deviation) in line with a given investor’s risk profile.

The central question to the puzzle:  How can we best diversify assets to achieve an investor’s long-term goals while staying within defined risk parameters? 

That’s the $64,000 question.  And, for many people, not knowing the answers or how to allocate assets, has been far more expensive than that.

Jim Lorenzen, CFP®, AIF®

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Jim Lorenzen, CFP®, AIF®Jim Lorenzen, CFP®, AIF® is founding principal of The Independent Financial Group,  a fee-only registered investment advisor serving retirement plan sponsors and selected private clients.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG also does not provide tax or legal advice.  The reader should seek competent counsel to address those issues.  Content contained herein represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a written plan.  The Independent Financial You can reach Jim at 805.265.5416 or through the IFG website, www.indfin.com  and by subscribing to IFG Insights letters  for corporate plan sponsors and individual investors.  Follow Jim on Twitter: @JimLorenzen

Written by Jim Lorenzen, CFP®, AIF®

June 7, 2012 at 8:00 am

Is Gold Really A “Store of Value”?

IFG BlogJim Lorenzen, CFP®, AIF®

It seems in every recession, the same two phenomena inevitably occurs:  Someone you know comes to you with a multi-level opportunity, and gold commercials begin filling the airwaves.

Those old enough to remember may recall that while the stock market struggled during the 1970s, a fellow named Howard Ruff hit the airwaves touting gold.  Not much has changed.  But, when you consider that money, even gold, is worth only whatever it will buy, how has gold really performed?

The line you see most often in commercials represents the nominal (dollar) value of gold – nominal value of money tells you how many pictures of Presidents you have in your wallet – but, what most investors really care about the ‘real’ return – real value tells you just how much all those pictures will actually buy – the return after inflation. 

Are the commercials right?  Is gold really a store of value?  To get some answers, I asked the folks at JP Morgan Asset Management to tell us what they’ve learned.  They sent me a chart.

Indeed, a picture is worth a thousand words.  It appears gold’s real return is far less than advertised by the gold retailers, who have to cover their acquisition, distribution, and television advertising costs.   In fact, gold’s real return is actually down since January, 1980; and like all indexes, these figures don’t account for the extra expenses incurred by investors associated with either the purchase or the custody of the asset.

Does this mean investors should avoid gold as part of their portfolio?  Probably not.  Gold is only one component of the commodities basket which most investors would be wise to consider.  Just how and to what extent is a good subject for individual discussion during your planning and portfolio reviews.

Hmmm.  Maybe commercials aren’t the best source of information, ya think?

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Jim Lorenzen, CFP®, AIF®Jim Lorenzen is a Certified Financial Planner® and An Accredited Investment Fiduciary® in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional. 

Additional IFG Links:

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  IFG does not provide legal or tax advice and nothing contained herein should be construed as  securities  or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.

Written by Jim Lorenzen, CFP®, AIF®

June 5, 2012 at 8:00 am