Tag Archives: income

Expanding the dictionary to deal with bond challenges

Posted on April 5, 2013 | Leave a comment

Calvert, a mutual fund company that specializes in socially responsible investments, has trademarked a new financial term – Thincome™. “Thin” and “Income” are combined to create a word which describes what is now happening to income-oriented investors. Namely, that low interest rates have made it difficult for the average retiree to live on the income that is paid by bonds, savings accounts and other fixed income investment options that they hold.

Over the past few years many retirees have had to fundamentally change their investment allocations to try to overcome Thincome. The Federal Reserve’s commitment to a very low interest rate environment has forced investors to take a couple steps up the ladder of risk in order to receive the same income they had become accustomed to with more conservative investments. Many investors have moved money into international and emerging markets bonds which pay higher rates. Some have increased exposure to higher yielding “junk” bonds which have also provided more attractive returns. They have increased the duration and maturity of the bonds in their portfolio to increase yields.

These steps can reasonably be expected to increase income and total return from bonds, but it’s important that investors understand that this Thincome environment has led to our new contribution to the investment dictionary – Riskcrease. Riskcrease is the increase in risk that Thincome investors have taken on in search of higher yields.

The problem with Riskcrease is most investors are unsure how much additional risk they have taken on by making these changes to their fixed income investments. Five years ago, their fixed income portfolios were probably fairly conservatively managed. Now, many of these fixed income portfolios are subject to a broader range of risks than before.

We suggest that investors understand the specific risks of each of their fixed income holdings to properly address both Thincome and Riskcrease.

~ Brooks, Hughes & Jones — Partners in Wealth Management — Tacoma, WA

www.BHJadvisors.com

If you liked this post, please share it
Email Forward to a friend

→ Leave a comment

Posted in Investments

Tagged , , , , , , , ,

Financial fitness from the viewpoint of personal fitness

Posted on February 1, 2013 | Leave a comment

This post was provoked by a comment I read in a financial industry publication from Stuart Ritter of T. Rowe Price’s retirement services division.

Ritter said “saving 3% for retirement is like going to the gym for six minutes.” Acknowledging low rates of savings for many retirement plan participants, Ritter’s contention is that just as 30 minutes of exercise should be a minimum daily routine, savings for retirement should also be done at five times his example. Instead of saving 3% of annual salary, most people should save 15%.

I think Ritter’s quote goes a bit too far. There are some people who couldn’t manage a decent quality of life (even without living beyond their means) if they deferred 15% of their income into retirement savings. An important thing to consider when determining how much to save for retirement is how much of the heavy lifting you want to rely on investment markets to do and how much of it can you do by managing a prudent financial life that pays yourself first via retirement savings.

If you are saving just 3% of annual income, investment markets will be forced to do much more of the heavy lifting to get you to a point where you can come reasonably close to replacing your earned income in retirement by combining Social Security and withdrawals from investment accounts.

For the dwindling few (mostly government employees) who will receive an employer-funded stream of pension income in retirement, saving just 3% of income in addition to the pension may actually be adequate for living lean in retirement. For the majority, it won’t – especially if the savings is not invested in aggressively enough over the long-term to generate a meaningful rate of return.

Consider if at age 30 – possibly after paying off student loans and saving for a down payment on a home, a couple (or even a single wage earner) make $80,000 per year and their income grows at 2.5% per year. If they saved 3% of income in a pre-tax employer retirement plan and earned a 7% average annual investment return for 35 years, retiring at 65, they would have $473,846 of savings. This balance, assuming it continued to earn 7% returns for 30 years of retirement could reasonably be expected to generate approximately $1,400 per month of inflation-adjusted after-tax income to age 95. Add that to the average Social Security benefit and the couple (or individual) has to learn to live on a lot less than while they were working.

I think a more prudent minimum retirement savings is 10% of annual income. Apply the same scenario as before with 10% savings (perhaps through both personal and employer match contributions) and the balance after 35 years is $1,457,633 pre-tax. It would have about a 70% probability of supporting  $4,400 per month of after-tax spending for 30 years to age 95.

Of course, many people can’t afford to save 10% of their annual income early in their career but they expect to increase their contributions over time. What if someone upped their retirement plan contribution by 1% every two years. They start at 3% for two years, then 4% for two years and so on until they reach 15% of their income for the final 10 years of their career. Would they ever catch up to the person who saved 10% throughout? No. Even though they would have contributed approximately $58,000 more dollars to the retirement plan, saving much more during the peak earnings years, they would end up a bit less than $200,000 behind the consistent 10% saver. This is due to the missed opportunity to have more money growing and compounding returns in the early years.

While saving just 3% of income for retirement won’t sustain the same standard of living as pre-retirement, saving 15% throughout a career could be oversaving for some people, sacrificing a little bit too much today for the opportunity to use it in retirement.

The most important point is to take the time (or hire an independent financial advisor) to determine what amount of savings you will likely need to live on in retirement. This will inform your level of needed savings throughout the remainder of your working life and also be a guide for the appropriate investment strategy.

  • What can you do to increase your rate of savings in retirement plans?
  • Do you know how much money you need to save today to replace your income in retirement?

~ Gary Brooks, CFP® – Brooks, Hughes & Jones – Partners in Wealth Management – Tacoma, WA

www.BHJadvisors.com

If you liked this post, please share it
Email Forward to a friend

→ Leave a comment

Posted in Financial planning, Investments, Retirement

Tagged , ,

Important College Financial Aid Tips

Posted on February 1, 2013 | Leave a comment

For those of you with college-age kids or kids who will soon be in college, one of the annual rights of passage is the completion of the Federal government’s “FASFA” (Free Application for Federal Student Aid) form. For many, this form should be completed as early in February as possible.

The information on the FASFA is used by college financial aid offices to determine how much the expected contribution towards annual college costs should be from the family (parents and child(ren)) and how much should come in the form of scholarships, grants and loans. This information is presented in snapshot format — it measures all assets and debts as of the date that it is completed.

Even if you don’t expect to qualify for much aid, the FAFSA process is necessary to be eligible for Stafford Loans (for the student) or PLUS loans (for the parents.)

Mark Kantrowitz, the publisher of Fastweb and FinAid, recently made a presentation to financial advisors about some of the techniques that parents could use to lower the “expected family contribution” (EFC) towards college costs from parents. His talk included these strategies:

  • Minimize income. Parents should work to minimize their income during the base year (the year before their oldest child goes to college) and the other years that they have children in college. This can be done by deferring income (perhaps into your employer retirement plan) or avoiding taxable distributions from retirement plan and using capital losses to offset taxable capital gains where possible.
  • Actively reduce reportable assets. The FASFA form looks at the parent’s income, savings, taxable investments, trust assets, 529 or Coverdell Education savings accounts and value of any business holdings. It also asks for the total savings of the student. It does not look at the value of the parent’s home, the assets in retirement accounts or their debt. Because of this, parents who want to minimize their EFC should use assets in savings or other taxable investment accounts to pay down loans, credit card balances or mortgages and lines of credit before completing FASFA.  They should also work to maximize their retirement plan contributions for those years. Finally, it is better to save in the parent’s name and not the name of their child because a much smaller percentage of the parent’s assets are counted towards the EFC than the child’s assets.
  • Spend down assets smartly. Parents should spend down the assets of the child (buy buying computers for college or other supplies for the child) before they file the FASFA. This will lower the expected contribution rate of the child.
  • Maximize student overlap. The EFC for a family is reduced if more than one child is in college. This is the one case where it pays to have triplets.

For more information on FASFA, see the fastweb website at this link: http://www.fastweb.com/content/fafsa

  • How are you saving for college expenses?
  • What has your experience been like dealing with financial aid offices?

~ Allyn Hughes CFP®, ChFC®, CLU® — Brooks, Hughes & Jones – Partners in Wealth Management – Tacoma, WA

www.BHJAdvisors.com

If you liked this post, please share it
Email Forward to a friend

→ Leave a comment

Posted in Financial planning

Tagged , , , , , , , ,

Tax law changes for 2013 eliminate uncertainty

Posted on January 3, 2013 | Leave a comment

The last few weeks have been difficult for the American consumer.  Constant bickering about the “fiscal cliff” and unknown changes in the personal financial landscape made it difficult for the average American to make proactive decisions about his or her financial future.

On January 1st the American Taxpayer Relief Act of 2012 (ATRA) was passed. Certain provisions of it have answered some of our questions about areas of tax policy that have been very unclear to us.  Here is a list of five tax issues that now have some clarity:

1)      Estate taxes – The 2012 estate tax laws, which provided for a $5 million (indexed) estate tax exemption for each spouse in a marriage, were supposed to sunset back to $1 million on January 1, 2013.  ATRA made these exemptions permanent so the $5.12 million (2012) estate tax exemption will continue for each spouse.   Maybe more importantly, new exemption portability rules allow the unused estate tax exemption of a deceased spouse to be used by the living spouse.  This will reduce the requirements for bypass trusts for all but a few very wealthy families.

2)      Alternative Minimum Tax (AMT) – For many years congress has had to pass a new law each year to patch the inequalities of the AMT so that most tax filers would not have to pay taxes at the higher AMT rates.  ATRA created a more permanent fix for this issue by creating an AMT exemption of $78,750 for married couples and $50,600 for singles.  This fix is retroactive back to 2012, and is indexed for inflation, so relatively few Americans will be subject to AMT in the future.

3)      Tax Rates – For married couples with joint incomes of $450,000 or individuals with incomes of $400,000 per year, income above these amounts will be subject to a new marginal tax rate of 39.6%. This is the same highest tax rate as during the Clinton administration.  There is still a 35% tax rate in effect – it is just for a very small tax bracket as it only applies to income levels of $388,350 to $450,000 for married filing jointly tax payers.

Tax payers in this highest tax bracket also will pay higher long-term capital gains tax rates (20% instead of 15% of the gain).  Their qualified dividend income will also be taxed at 20% rather than 15%.  Finally, this group will also be subject to a new 3.8% Medicare tax on their net investment income, so the tax rates for qualified dividends and long-term capital gains will be 23.8%.

4)      Deduction phaseout – The itemized deduction phaseout will return for 2013.  For married couples with Adjusted Gross Income (AGI) of $300,000 or individuals with AGI of $250,000 (indexed for inflation), the phase out for itemized deductions is 3% of income over this threshold.

5)      Personal Exemption Phaseout – For taxpayers with the same AGIs as 4) above, the phaseout of the personal exemption is 2% of the total exemption for every $2,500 of excess income over these thresholds.  So if a married couple filing jointly had an income of $400,000 then 80% of their personal exemption would be phased out for that year.

~ Allyn Hughes, CFP®, ChFC®, CLU® — Brooks, Hughes & Jones – Partners in Wealth Management, Tacoma, WA

www.BHJadvisors.com

 

If you liked this post, please share it
Email Forward to a friend

→ Leave a comment

Posted in Financial planning, Taxes

Tagged , , , ,

Retirement decisions timeline

Posted on December 14, 2012 | Leave a comment

Age 49 and under. 401K contributions are limited to $17,500 in 2013. Traditional IRA and Roth IRA contributions limits are $5,500.

The income limit (AGI) for contribution to a Roth IRA in 2013 has a phaseout range from $178,000 to $188,000 for married-filing-jointly taxpayers and $112,000 to $127,000 for single taxpayers.

The income limit to make a tax-deductible contribution to a Traditional IRA in 2013 has a phaseout range from $95,000 to $115,000 for married filing jointly (if covered by an employer retirement plan also) and $59,000 to $69,000 for singles. If you are not covered by an employer retirement plan, tax-deductible contributions can be made up to $178,000 of AGI for married filers.

Age 50 and over. 401K contributions are limited to $23,000 with catch up provision. IRA or Roth IRA contributions levels are $6,500 with catch up provision.

Age 55. If you leave your job after age 55, you can begin to take 401K distributions from your former employer’s plan without paying any penalties. Income tax will still be due on the amount of the distribution.

Age 59½. Distributions from IRAs may be made without penalty. Income tax will still be due.

Age 61. Think about when you want to retire and determine when you want to start receiving Social Security if you will be eligible for it. The most likely reasons to start receiving it are: lack of employment or under-employment, lack of income from investments, or a shorter-than-average life expectancy.

Age 62. Eligibility for Social Security begins. The Social Security Administration no longer sends an annual estimate of your expected benefits. You will have to access the estimate at www.ssa.gov. Your Social Security benefit will be permanently reduced by 25-30% if you begin payments at 62 instead of your Full Retirement Age (FRA). Keep in mind that starting Social Security early may also reduce benefits available to your spouse by as much as 35%. And if you continue to work while you receive Social Security, your benefits will be reduced by one dollar for every two dollars you earn over $15,120 in 2013.If you were born on January 1st, you should refer to the previous year.

  1. If you were born on the 1st of the month, we figure your benefit (and your full retirement age) as if your birthday was in the previous month. If you were born on January 1st, we figure your benefit (and your full retirement age) as if your birthday was in December of the previous year.
  2. You must be at least 62 for the entire month to receive benefits.
  3. Percentages are approximate due to rounding.
  4. The maximum benefit for the spouse is 50% of the benefit the worker would receive at full retirement age. The % reduction for the spouse should be applied after the automatic 50% reduction. Percentages are approximate due to rounding.

Age 65. Medicare eligibility begins. From three months before you turn 65 to three months after you turn 65 you may sign up for Medicare Parts A, B and D. Sign up for Medicare Part D (prescriptions) from October 15 until December 7. If you (or your spouse) are covered by an employer-paid health plan, you have eight months after you retire before you will have to pay a penalty to join Medicare.

Age 66 or 67. Considered Full Retirement Age (FRA) for Social Security recipients. If you were born before 1954, you are eligible at age 66. From 1955 to 1959, your FRA increases from 66 years and 2 months to 66 years and 10 months. If you were born in 1960 or later, the FRA is 67. At FRA you can still continue to work without receiving reduced Social Security benefits.

Age 70. Last year to receive deferral credit for postponing receipt of Social Security benefits. There is no reason not to take Social Security at this point. If you continue to work, and your earnings are higher than previous inflation-adjusted earnings, your Social Security benefit will continue to be increased even if you are already receiving it.

The year you reach 70½. (Or, more precisely, April 1st after the year that you turn age 70 ½). Distributions from IRAs, and other tax-deferred retirement plans like 401K and 457 plans (except Roth IRAs) must be started. The distribution amount will be determined by dividing the total value of all tax-deferred retirement accounts as of the previous December 31 by your life expectancy using IRS tables. If you fail to take this distribution, or your distribution amount is less than the minimum required, the tax penalty is 50% of the amount you failed to remove from the account.

~ Allyn Hughes, CFP, CLU, ChFC — Brooks, Hughes & Jones, Partners in Wealth Management — Tacoma, WA

If you liked this post, please share it
Email Forward to a friend

→ Leave a comment

Posted in Financial planning, Investments

Tagged , , , , , , , , , , , , , ,

Bond risk escalates rapidly below investment grade

Posted on September 28, 2012 | Leave a comment

Through September 12, 2012, year-to-date investments into U.S. taxable bond funds totaled over $324 billion according to the Investment Company Institute. At the same time, over $237 billion flowed out of U.S. stock mutual funds.

Essentially, many investors decided that the prospect of continuing to invest in bonds at historically low interest rates is more appealing than the risk of owning more U.S. stocks should another recession or bear market occur.

Many investors, aware of the negative real return presented by owning U.S. Treasury bonds with payments lower than inflation, have chosen to invest in corporate bonds instead, expecting higher income payments. According to a note in the Sept. 25 Wall Street Journal, even corporate bond payments are near record lows. The rate of high-yield, or “junk” bonds, above comparable maturity Treasuries was 5.42 percentage points, down from 9.1 percentage points just a year ago.

The search for higher yields makes it very important to understand the risk inherent in corporate bonds.

According to research from Asset Dedication, LLC, from 1970-2009 the default rate on U.S. corporate bonds by rating class over the first 10 years after issuance was:

Bond Rating Default Rate Moody’s Comment
Aaa .5% Highest quality, minimal credit risk
Aa .54% High quality, very low credit risk
A 2.05% Upper-medium grade, low credit risk
Baa 4.85% Medium grade, moderate credit risk
Ba 19.96% Have speculative elements and substantial credit risk
B 44.38% Speculative and high credit risk
Caa – C 71.38% Poor standing or in default and very high credit risk

This table shows the non-linear nature of the risks of owning corporate bonds of different qualities.  High-quality bonds (Aaa and Aa) have similar default rates that have been historically very low. As you get lower on the quality ladder, however, the risks of owning these bonds tends to go up very quickly, so when you get to high-yield bonds (generally B and below) the default rates are above 50% on average.

These default rates go up and down based on the performance of the overall U.S. economy.  If earnings are pretty good, and the U.S. economy is doing OK, the default rates of lower-quality bonds are usually lower than the table above.  When the economy hits a rough patch the performance of these companies suffers, and more of them are unable to cover the interest payments that they owe.  They default and provide no or reduced payments to shareholders.

We suggest that before you buy a bond mutual fund you learn more about the rating of the bonds held within the fund. With this information you can get an idea of how much risk you are taking with this portion of your investment portfolio.

BEWARE OF AVERAGE CREDIT QUALITY

Be careful not to place too much weight in your evaluation on the average credit rating of a bond mutual fund or exchange-traded fund. As referenced above, the advancement of default risk is not linear. However, when determining average credit quality, most fund firms and research organizations treat the calculation as if there were a linear progression of risk.

According to a note in the September 12 edition of ETF Report, “most data services assign each rating a grade: AAA=1, AA+=2, AA=3, and so on. The numeric values are summed up and averaged. With one bond in each tier, the average credit rating is BB+, one notch below investment grade.” This presents a problem because while the difference between AAA and AA may not be significant, the difference between CCC and C+ is massive. If you use actual default rates rather than just assigning a value to each tier, the expected default rate of the overall portfolio would climb from 0.63% for the simple math approach to 2.73% for the actual experience approach. That’s 333% increase in default rate.

How do you feel about investing in bonds in today’s market environment?

Have low interest rates forced you to change your investment approach?

~ Allyn Hughes, CFP®, CLU®, ChFC®, Brooks, Hughes & Jones – Partners in Wealth Management, Tacoma, WA — www.BHJadvisors.com

If you liked this post, please share it
Email Forward to a friend

→ Leave a comment

Posted in Investments

Tagged , , , , , , , ,

Keeping up with inflation – income vs. dividends

Posted on March 2, 2012 | Leave a comment

Inflation is a critical measure that determines whether our income (from employment and investment) allows us to keep up with our cost of living.

Two charts caught our eye recently, each using inflation to put financial security and investment opportunities in a relative context.

First, John Maudlin’s newsletter Outside the Box relays this chart from Greg Weldon (weldononline.com). It presents information from the Bureau of Labor Statistics comparing the Consumer Price Index and U.S. Disposable Income from 1996-2011. The copy is a bit blurry but the lines tell the story. Since 2005, disposable income (black line) has trailed inflation (pink line) and the difference grew significantly in 2011.

Personal disposable income, mostly generated by earned income from employment, is flatlining but another form of income is growing at a faster pace than inflation.

This next chart looks at the amount of dollars paid out as dividends by the stocks in the S&P 500 Index of large U.S. companies. The green bars show how the amount of dividend payments has easily surpassed the level of inflation over the past 20 years. The dollar amount of dividends came down during the 2008-09 recession when some companies reduced or eliminated their dividends. Even at the rate much lower than the 2007 peak, dividends offer an alternative that keeps up with the cost of living.

http://www2.blackrock.com/US/individual-investors/education/shareholder-magazine/article-1

Of course, dividend-paying stocks are not a risk-free asset and the stock prices of the companies paying dividends are more volatile than the bonds of high-quality companies. But for investors who expect to hold the dividend-paying stocks through market ups and downs and use the dividends to supplement their income, the ability to outpace inflation has been consistent.

~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

If you liked this post, please share it
Email Forward to a friend

→ Leave a comment

Posted in Investments

Tagged , , , , , ,

Retirement reality: when is not always your choice

Posted on June 29, 2011 | Leave a comment

Interesting chart here from the Employee Benefits Research Institute analyzing the frequency at which people are able to retire on their own terms compared to those who have been forced to retire earlier or later than planned.

Twenty years of survey data suggests that people retire about when they plan to 48% of the time. More than 42% of retirees on average over the past two decades have retired earlier than planned. And only 5% of those retiring early offered positive reasons for their decision, indicating that they could afford to do it. Over half of early retirees were forced to due to health or disability. It’s not always their own health. Many cases include children who retire in order to provide full-time care for a parent who does not have long-term care insurance or adequate retirement income.

MetLife’s Mature Market Institute indicates that the percentage of adults providing care to a parent has tripled since 1994.

“Nearly 10 million adult children over the age of 50 care for their aging parents,” said Sandra Timmermann, Ed.D., director of the MetLife Mature Market Institute. “Assessing the long-term financial impact of caregiving for aging parents on caregivers themselves, especially those who must curtail their working careers to do so, is especially important, since it can jeopardize their future financial security.”

Research suggests that the cost impact on the individual female caregiver in terms of lost wages and Social Security benefits equals $324,044. Leaving the labor force early because of caregiving responsibilities equated to $142,693 of lost wages. The estimated impact of caregiving on lost Social Security benefits is $131,351. A very conservative estimated impact on pensions is approximately $50,000. Men forced to retire early to become caregivers forgo approximately $283,176 of earnings and retirement income.

What financial planning and life planning decisions are you making to increase the probability that you’ll be able to retire on your terms?

~ Brooks, Hughes & Jones, Partners in Wealth Management, Tacoma, WA

If you liked this post, please share it
Email Forward to a friend

→ Leave a comment

Posted in Financial planning, Insurance, Retirement

Tagged , , , ,