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Posts Tagged ‘Financial Literacy

Market Guesswork Can Come Back to Haunt.

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

People have been wondering what the stock market will do since they first began trading under the buttonwood tree in lower Manhattan.

I read an article – one of a zillion such articles that always get multiple opinions from people who invariably prove they never had a clue to begin with – yesterday by Gil Weinreich, writing for AdvisorOne,  You can find a link to it on the IFG Facebook page; and this from the article caught my eye:

“The most recent Chicago Booth/Kellogg School Financial Trust Index indicates that 47% of the public expects the stock market to plunge in the next 12 weeks, according to Wharton professor Olivia Mitchell. Mitchell’s own portfolio has outperformed the stock market since 1999, when she put all her investments in Treasury inflation-protected securities. Her difficulty today, however, is figuring out what to do now that TIPS are paying negative returns.”

The professor put ALL her investments in TIPS.   Translation:  She was ‘timing the market’.  Not the stock market, but the bond market.  And, she’s got lucky.    But, there was a price.    Those who ride high on one side are often in danger of getting ‘whipsawed’ on the other.   

The market giveth and the market taketh away. 

The professor isn’t alone.  Many intelligent people – the same people who would never build a home without a blueprint, or launch a business without a well thought-out business plan – often make investment decisions and asset allocations based on an outlook, which means it’s virtually always without a long-term written investment plan.  It’s important to note there is NO professionally-written plan on earth, for a home, business, or investments, that would use only one material, or concentrate all risk into one sector.

Risk concentration isn’t a strategy.  It’s a guess.  It’s a hope.  Yet, too many Americans do it all the time.  It’s called ‘chasing returns’.

It doesn’t work.

It’s never worked.

Some point to past successes, similar to the example above; but, those always end-up being short-term.  When you calculate the returns over time – and one might argue the professor’s track record since ’99 isn’t exactly short-term – it’s also true that returns are now negative and her investment life isn’t over yet – and won’t be for many years to come.

Anyone who’s attended a large gathering of financial types knows the room is always filled with better-than-average investors; yet, few – although the number may be closer to ‘none’ – can even beat the indexes consistently.

It’s not about being brilliant; it’s about being smart.  Being smart really all about knowing what you don’t know… it’s about managing risk, not money… you just do it with money…. And market risk is only one of them.

Jim

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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.  

The Independent Financial GroupAdditional IFG Links:

 

IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description. Opinions expressed are those of the author.  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.

Six Tips for Surviving Challenging Markets

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Here are six tips to help cope with challenging market environments:

1. Stay Engaged

When you sell an investment simply because it has declined in value,  it becomes impossible to benefit when it rebounds.  The same is true of the broad market in general.  Many of these major upside moves can happen quickly, often in just a few days.  To avoid missing these key days, you may want to consider staying invested and avoid panic selling. Consider this hypothetical example furnished to us by the folks at Principal Financial Group:

An individual who was invested in the S&P 500 from January 2, 1991, until December 31, 2010 would have turned a $10,000 investment into $58,137.02 for an average annual return of 9.20%, while an investor who panicked and sold their positions during this same period and missed the 10 best trading days in this period would have seen their return fall from 9.20% to 5.47%. [Source: Ned Davis Research]

The lesson is clear: No one can predict when the market will experience its best days.

2. Keep a Long-Term Focus

Studies show that time is your ally.   Of the three types of investments studied (stock funds, bond funds, and asset allocation investment options), the average investors in asset allocation funds held their investment options the longest (an average of 4.30 years) over the five time periods studied (1-, 3-, 5-, 10-, and 20-years).  It’s little surprise that these investors successfully weathered one of the most severe market declines in history (2000-2002). [Source: Dalbar 2010 QAIB study]

3. Have a Diversification Plan

According to the Dalbar study, investors guess incorrectly about the market’s direction 50% of the time.  So, diversification helps guard against those errors; but, many people mistake duplication for diversification by buying multiple mutual funds not knowing many of the underlying holdings are identical.

Choosing different management styles and market capitalizations of equities and bonds isn’t as simple as you’re lead to believe on television.  When was the last time you heard a financial entertainer the impact of highly correlated assets?   It’s boring stuff and makes for poor television, which is why it isn’t discussed, but it’s what you need to know.  Quality diversification enhances the benefits of asset allocation so investment balances are less affected by short-term market swings than they would be if you invested in a single asset class.

If you are an investor who is nearing retirement, consider consulting your advisor about this issue.  Remember, asset allocation/diversification does not guarantee a profit or protect against a loss, but it will likely make your journey much smoother.

4. Utilize an Auto-Rebalance Strategy

Historically, business cycle contractions last about one-sixth as long as expansions.  Now may be a good time to re-evaluate your risk tolerance. If you want a professionally managed investment option to handle this complicated task, you might want to consider a unified managed account (UMA).  It’s an option that simplifies your paperwork, virtually automates the rebalancing process, gives you consolidated reporting while providing the diversification of management, styles, and investments needed to do the job right.  UMAs can hold mutual funds, index funds, ETFs, institutional separately managed accounts, and more.  A UMA is not an investment; it’s a type of account you use to execute your investment plan.  Ask your advisor or – shameless plug – feel free to contact me for information about UMAs. 

There are also target-date and target-risk asset allocation funds available on the market; but, tread carefully.  Different funds with the same target date or target risk can still have very, very different holdings, styles, and risk profiles.  Not everyone retiring in the same year has the same financial picture or ideas about how they want to make the financial journey.  As you can tell, I’m not a big fan of ‘cookie-cutter’ solutions.

5. Keep Your Focus

Discipline is something everyone has until panic sets-in.  Quite often, that’s when an advisor can show the most value.   Successful investing is a marathon, not a sprint.  The tortoise did win the race, you know.

6. Get Regular Checkups

Too many individual investors are still stuck in the old paradigm under which their advisor, actually a broker, would call them with investment ideas or changes they should make.  Today, with the emergence of the fee-only – that’s different from fee-based – business model utilized by ‘pure’ Registered Investment Advisors (not dually registered to sell securities, too), the new paradigm operates more like other professional practices in law, medicine, or accounting.  In short, you need to make an appointment for your checkup, at least annually.   And, today, with online meeting technology, you can even do it without getting in your car… so there’s no excuse.   Get your checkup!  If you don’t, your financial health will likely suffer.

If you like information UMAs, you can request it here:

 
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The Independent Financial GroupSubscribe to IFG Insights letters for individual investors. 

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, Keep up to date with IFG on Twitter: @JimLorenzen

How Tax Increases and Redistribution Really Works

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

It seems every election cycle brings with it the issue of who should bear the cost of government spending and to what degree.  For many, the discussion begins with taking it from the rich and giving it to the poor.  It’s as old as Robin Hood – probably older.  And, since there are more poor people than rich, it plays usually plays well at the ballot box.    

While most voters may not understand economics, they do know when they’re out of work; and they don’t like seeing their jobs going overseas.[i] Unfortunately, the U.S. tax code has become a ‘book of favors’ – a virtual  ‘jobs protection act’ for elected officials primarily concerned with raising money for the next cycle and insuring votes for re-election.  

How do tax cuts really work?  IMHO the following little story[ii] – entirely made-up – provides a good example of how capital follows opportunity.

Here’s our scenario: Every day, ten men go out for dinner. The bill for all ten comes to $100  (I know, that couldn’t happen, but we’ll pretend).  If they paid their bill the way we pay our taxes, it might look something like this[iii]:

  • The first four men (the poorest) would pay nothing.
  • The fifth would pay $1.
  • The sixth would pay $3.
  • The seventh $7.
  • The eighth $12.
  • The ninth $18.
  • The tenth man (the richest) would pay $59.

So, the ten men ate dinner in the same restaurant every day and seemed quite happy with the arrangement, until one day the owner threw them a curve.

“Since you are all such good customers,” he said, “I’m going to reduce the cost of your daily meal by $20.”

Now the dinner for all ten cost only $80.  The group still wanted to pay their bill the way we pay our taxes.
So, the first four men were unaffected. They would still eat for free. But what about the other six, the paying customers?   How could they divvy up the $20 windfall so that everyone would get his ‘fair share’?

The six men realized that $20 divided by six is $3.33.  But if they subtracted that from everybody’s share, then the fifth man and the sixth man would each end up being ‘PAID’ to eat their meal! 

So, the restaurant owner suggested that it would be fair to reduce each man’s bill by roughly the same amount, and he proceeded to work out the amounts each should pay[iv].

Here’s how it turned out: 

  • The fifth man, like the first four, now paid nothing (100% savings).
  • The sixth now paid $2 instead of $3 (33% savings).
  • The seventh now paid $5 instead of $7 (28% savings).
  • The eighth now paid $9 instead of $12 (25% savings).
  • The ninth now paid $14 instead of $18 (22% savings).
  • The tenth now paid $49 instead of $59 (16% savings).

Seems fair enough.  Each of the six was better off than before.  And the first four continued to eat for free.   But once outside the restaurant, the men began to compare their savings.

“Hey!  I only got a dollar out of the $20,” declared the sixth man. He pointed to the tenth man “but he got $10!”

“Yeah, that’s right,” exclaimed the fifth man. “I only saved a dollar, too. It’s unfair that he got ten times more than me!”

“That’s true!!” shouted the seventh man. “Why should he get $10 back when I got only $2?”   He became upset at the injustice.  “The wealthy get all the breaks!”

“Wait a minute,” yelled the first four men in unison.  “We didn’t get anything at all. The system exploits the poor!” 

The nine men surrounded the tenth and beat him up.  Apparently, tax breaks for the wealthy aren’t popular. 
You can probably guess what happened after that.    The next night the tenth man didn’t show up!   So, the nine sat down and ate dinner without him.   

Alas, when it came time to pay the bill, they discovered something important:  They didn’t have enough money between all of them for even half of the bill!   Oops.

It’s a simple lesson many journalists and college Keynesian-schooled professors have problems grasping, yet this is how our tax system actually works!    Tax laws have historically been used to direct the flow of capital.   And, the ones who get the most money back from a reduction are – or should be – those who paid-in the most to begin with.   

Here’s the lesson of our dinner group story:  

Increasing taxes on those we feel have too much capital, simply because they have wealth, destroys their incentive.  As in our story, they just may not show up “at the table” anymore.   They will remind us all there are lots of good restaurants in China, India, South Korea, Europe and the Caribbean.    They know – and we should too – jobs are created where capital is directed.  If we provide incentives to direct capital someplace else, we will simply be draining capital from the economy and the rest of us will be stuck with a bigger bill.

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The Independent Financial GroupJim Lorenzen is a CERTIFIED FINANCIAL PLANNER® and an ACCREDITED INVESTMENT ADVISOR® 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 individual investors.  Keep up to date with IFG on Twitter: @JimLorenzen


[i] Recommended reading:  The World Is Flat, by Thomas Friedman, a volume on the economic impact of globalization – the leveling of the playing field –  and America’s new place in this paradigm.  Should be required reading for anyone interested in this issue. 

[ii] Not original and I don’t know the author.  It was relayed to me by a colleague about six years ago.

[iii] This is a hypothetical example of a progressive tax system and its impact on a population of taxpayers.

[iv] The restaurant owner figured, as an example, that if the eighth man was paying 12% of the tax before, he should be entitled to 12% of the savings.  12% of the $20 savings is $2.40.  Since he decided it should be ‘roughly’ the same and to make it easier on the diners to figure the bill, he rounded-up (in this case) and decided man #8 should get $3 of the savings.

Written by Jim Lorenzen, CFP®, AIF®

October 18, 2012 at 8:00 am

Abnormal Markets – Abnormal Times

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

When the Fed announced an open-ended QE3, the stock market rallied.  In fact, the market’s been trending up since 2009 after the meltdown when all the government spending began.  But, was that good?  Have those stock gains been real?

Since the meltdown, people have been chasing returns whereever they could find them, whether it was with high dividend-paying stocks or  buying gold – a demand largely fueled by all those tv commercials.

The financial industry, of course, has responded to both fear and greed by packaging yet another series of products, some of which come with either high or hidden costs… and sometimes both.

The question, of course, is whether all these “black box” solutions are really the answer… or whether the ‘basics’ are still relevant.

After all, companies that declare dividends are adjusting the price of the stock downward to compensate – you could arguably simply buy growth stocks that don’t pay dividends and simply sell what you need for income and still arrive at the same result! 

And, while gold has increased in value – in terms of the numbers of pictures of presidents you receive for each ounce – have you really received more value when adjusted for inflation?  Some say ‘yes’ but a J.P. Morgan study says something else.

We have more about this in our IFG Insights E-zine, which is appeared earlier this morning and is available in our archive.

It’s my guess much of the increase we’ve seen in virtually all equity categories, have been more nominal than real and are driven by the growth of debt.

We’ll see, won’t we?

Jim

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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.  

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 to Recognize Investment Service Models

IFG BlogThe average investor can often have a difficult time understanding just how different investment professionals operate and who they’re really dealing with.

There are three basic service model environments where investment professionals can be found; but, what can make these environments even more difficult to understand is that it’s possible for two to be combined… or one can be masqueraded to look like something else entirely!   When you add to all that the alphabet soup of credentials and designations – some excellent and most meaningless – it’s no wonder the average investor has trouble figuring it all out.

While it would be impossible to address everything without writing a book, here’s an admittedly cursory overview of the three environments.  All have their selling points and negatives – and none is intrinsically better than the other –  but, since I’ve worked in all three, maybe I can help shed a little light on this and make them a little easier to understand.

1.      The Captive Registered Representative

This is how many, including yours truly, began their careers; and, in fact, many never leave!  The captive RR is someone you may know as a stockbroker, although the broker-dealer is actually the employer firm and the person you’re thinking of is a Registered Representative of the broker-dealer firm.   These firms can be the well-known large ‘wire houses’ with widely-recognized names or they can be smaller regional or even local firms.  In all captives, the RR is an employee of the firm and it is the firm that must sign ‘selling agreements’ with outside product providers if the RRs are going to offer anything other than in-house product.

I began my career in such a firm that provided all the services and infrastructure.  The job of an RR was is to generate revenue for the firm.  The hierarchy looked something like this:

What you may not know:  In the old days, these large firms made most of their money from their own packaged in-house proprietary product, including mutual funds, unit investment trusts (UITs), and other offerings.  I don’t know how true that is today – my guess is it’s probably much less so than in those days.   The reason I think this is because the wirehouse industry’s margins have been declining steadily over the years, indicating fewer proprietary product sales and evidenced by (1) a greater number of mergers that never seem to end, and (2) the fact that broker payouts – the percentage they pay their RRs on generated revenues – have been declining.  Brokers throughout the industry are having a tougher time ‘keeping their desks’ as margins have put pressure on RRs to increase revenue production.  This may be a reason why some, if not all, within that community are resisting the adoption of a fiduciary standard.

As I said, some RRs never leave the large wirehouses, for a variety of reasons, including the large in-house back-office infrastructure support, etc.   And, let’s face it, some may not be cut-out for self-employment.  For those who are, they often take the next step.

2.     The Independent Registered Representative

Some RRs who don’t want to remain ‘captive’ often want to set-out on their own and open up a private practice.  When a RR makes the decision to ‘break free’, they have to pay their own bills.  In my early days, that meant getting office space, phones connected, office furniture, supplies, and paying for my own insurance and a thousand and one other things; but, I could now select my own broker-dealer (BD) to function as my back-office and process all the paperwork through the various providers, etc.   

There are hundreds of BDs available to the independent RRs and they come in all shapes and sizes with different attributes.   Since my need was primarily for back-office processing, I wanted one that had (1) prompt and quality personal service, and (2) good relationships with quality custodians and other service providers.  Today, almost all can probably fit that bill.   While the RR is not an employee of the BD, the BD must still have Selling Agreements with product providers before the RR can access them for his/her clients.

One of the things about independence that independent RRs like is that the hierarchy can be flipped, which, to my mind, creates more of a ‘client first’ environment.

What you may not know:  An independent RR may be operating out of a small office in your local community; but, don’t let that fool you.  That independent likely has access to a huge array of institutional money managers and widely respected and recognized asset custodians and other service providers.   In fact, it wouldn’t be at all surprising if your local RR office actually had a wider menu of availabilities than the major wirehouse down the street, since many BD operations have provided their RRs with greater access to the marketplace.   An independent is far more likely able to provide you with a choice of custodians, etc., than a captive whose employer itself may want to be the custodian.

Something else you may not know:   Ever walk into your local bank branch and see the investment desk sitting somewhere in the lobby or off to the side?   When you sit down at that desk, you may think you’re still in the bank; but, guess again.  There’s no FDIC insurance there!  The likely scenario:  Some BD has signed a deal with the bank to private-label a brokerage service.  Not bad; you should simply be aware.

3.  The Independent Fiduciary Model:  The “pure” fee-only Registered Investment Advisor (RIA)

Some independent RRs finally decide to complete the process:  They want to drop all sales and commissions and gain access to the entire world of products and service providers, including those who don’t work through sales channels.  In my case, since I had already been in business in my own office for fifteen years, it was a simple process to register as an advisor and simply drop all the selling licenses.  An RIA must avoid conflicts of interest and operate under a fiduciary standard:  The clients’ interests must be paramount.

The model, however, looks much like the independent RR:

What you may not know:   Captive RRs and independent RRs both very likely work for or with a BD that is dually-registered, making the RRs also RIA representatives.  This allows them to work on a fee basis, as well as on commission.  Some will tout their fiduciary status during the planning stage; but, you should ask if they will operate under that status during the investment implementation stage.  It’s one thing to “adopt a fiduciary standard’ and quite enough to accept fiduciary status in writing.  From what I’ve observed, few, if any, BDs will allow their RRs to accept this status, whether they’re captive or independent.   That doesn’t mean they aren’t honest or that they don’t do good work; it’s just something you should be aware of.

Also be aware that some RIA firms provide investment management, asset custody, and portfolio reporting services all in-house while others prefer to work in a purely advisory capacity using third-party providers for the various services. 

Example:  In my own practice, most clients’ assets receive custody services from Pershing (owned by Bank of New York-Mellon).  All institutional managers are independent of the custodian and all portfolio reporting is provided by third-party services independent of the managers.  All parties are compensated by client fees only, as are my advisory services.   While it may sound like more fees, it’s often actually less.  All these services are usually ‘bundled’ by investment providers; I just unbundle them and ‘shop’ them individually, which can result in savings.

While this overview just scratches the service, it might give you some idea of the playing field.  In the final analysis, choosing an advisor is a personal choice.  You should find someone you’re comfortable with… and someone who will talk with you like an adult.  Avoid the ‘glad handers’ who tell you what you want to hear; find one that will talk straight and tell you what you need to hear, even if you think you’re an investment genius.  

Good luck!

Jim Lorenzen, CFP®, AIF®

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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.

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?

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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 retirement and wealth management services for individual investors.

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Written by Jim Lorenzen, CFP®, AIF®

June 21, 2012 at 8:00 am