Newsletter - August 2013


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The Wealth Chronicle, a monthly newsletter detailing current strategies for your finances and investments. This month's edition has articles on 401k fees, College planning, and strategies for best handling the new Medicare tax.

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Newsletter - August 2013

  1. 1. 9/19/13 1/9 Issue: # 56 AUGUST 2013 Dear , Welcome to August 2013 issue of The Wealth Chronicle! Are Fees and Poor Performance Destroying your 401k and Retirement? Last year I wrote a paper, Top Reasons to Rollover Your 401k, describing the options available that you have with your 401k once you retire or leave the company you are working for. Because of the high fees and poor investment choices associated with most 401k plans I wrote that it usually makes sense to roll it over into an IRA. Recently the media and some prominent financial industry groups have made the shortcomings of 401k plans more prominent. In April, PBS Frontline produced a special titled The Retirement Gamble, primarily focusing on 401k plans and their inadequate performance. What's Inside? 401k Fees and Performance Rules for Education Funding The New Medicare Tax Watercooler Summer Key Planning Dates MEET MARC Marc Bautis is a Wealth Manager specializing in working with young families as well as retirees and those nearing retirement. He understands that everyone wants to not only protect their principal, but also be sure that their money lasts. He is committed and proud to deliver independent advice, always in the interest of his clients. Marc is the creator of the Retirement Fitness Challenge™, a program designed to be sure his clients enjoy the retirement years as they have always envisioned them. Marc's program is designed to prevent
  2. 2. 9/19/13 2/9 The special is a great watch, but if you don't have the time to view it, two of the main points in the video are: Costs Matter You do not receive a bill for the fees and expenses in your 401k plan, but rest assured they are being deducted and have an overall impact on how much money you wind up with when you retire. Some of the fees you are being charged include fund expenses, administration, and asset management expenses. A recent AARP study concluded that 70% of Americans did not even realize there were fees associated with their 401k. One of the reasons that I recommend IRA's over 401k plans is that most IRAs have no fees associated with them and you can add almost any type of investment in an IRA versus the 10-15 choices that you are usually limited to in a 401k plan. Fiduciary Responsibility If you are going to invest in a 401k plan ensure that you use a provider that agrees in writing to act in your company's 401k plans best interest. The unfortunate reality is that firms in the brokerage, banking, and insurance industry have no legal fiduciary obligation to their clients that would require them to place the interests of those clients ahead of all others, including their own. Instead they operate on a much lower "Suitability" standard. Their representatives are commissioned salespeople who are incentivized to sell products, especially the ones that generate the highest earnings for themselves and their companies. You may think that you do not have any input on the decision your company makes with its 401k plan, but you would be surprised if you and other employees bring your concerns to your HR and finance department of your company. Frontline is not the only outlet talking about 401ks. Jim Cramer, the host of CNBC's show Mad Money is not the biggest fan of 401k plans either. In a CNBC article, 401k Dirty Little Secrets, Cramer said "One of the basics of retirement planning - outliving your money but also to minimize expenses during retirement and find the best time to start taking Social Security benefits. Marc is also the author of a recent book The Retirement Fitness Challenge: Shape Up Your Finances and Make Your Money Last a Lifetime, which is available on Marc is a graduate of Seton Hall University. He is a Bergen County native, from Lyndhurst, where much of his extended family still resides. He currently lives in Hasbrouck Heights with his wife Katie, new daughter Charlotte and Old English Bulldog, Winnie. Quick Links
  3. 3. 9/19/13 3/9 contributing to a tax deferred 401k plan - could come with a serious downside." "As much as I like the tax-favored status of 401k plans, I need to tell you something heretical, something almost nobody else will come out and say: Most company 401k plans stink." Many people think Cramer is a maniac for acting like he drinks a gallon of redbull right before he goes on the air on his show Mad Money, but he is spot on with his assessment of 401k plans. Dan Solin of the Huffington Post recently wrote an article, 401k Participants Pay Dearly for the Crime of Underperformance on how 401k plans are usually loaded with actively managed funds which often underperform. It's no coincidence that actively managed funds almost always come with higher fees. Corporate America has shifted the burden retirement to individuals. Companies offering guaranteed pensions are on the decline and ensuring a secure and safe retirement is up to you. The wrong decisions or not making a decision can cost you hundreds of thousands of dollars over your career. College Planning: Know the Rules for Education Funding As college tuition continues to skyrocket, it's becoming more important than ever to know how the various savings plans work. The following is a link to a handy reference that outlines the latest rules on the most popular college savings programs (529 plans, Coverdell savings accounts, and the Education Savings Bond program) and how to use them to save money on your children's education In addition to details of each of the plans, the reference also contains information on Student loan availability and limits, Education tax credits, and Student loan interest and Tuition and fees deduction. Whenever I have a discussion with someone about 529 plans and saving for their child's college costs I am almost always asked the same couple of questions. What if my child doesn't go to college? You have a couple of options if your child does not go to college. Another family member can use the funds for education. That can include another child, yourself, or even nieces and nephews. There is no time limit to use the funds so you can keep the money in the 529 plan and use it to finance your grandchildren's education. Having the money compound tax free for 30+ years can generate a substantial amount of money. If you decide to take the money out of the account and not use it for education you will have to pay tax and a 10% penalty on the earnings in the account. What if my child receives a scholarship? You can withdraw money from a 529 up to the amount of the tax-free scholarship without paying the 10% penalty. You still have to pay income taxes on earnings, but contributions can always be withdrawn tax and penalty free. You still may be able to find some qualified expenses that you could use the 529 money for and avoid some of those taxes. In addition to tuition, you can use the money for tuition, room, board, books and mandatory fees there.
  4. 4. 9/19/13 4/9 Should I prioritize saving for retirement or my child's education? Retirement is probably many years away and we want to do everything for our children, but my advice is almost always to secure your retirement first. You can borrow to pay for college, but you cannot take out a loan to finance your retirement. How to Handle the New Medicare Tax Last year's 5-4 Supreme Court ruling left the Patient Protection and Afordable Care Act (PPACA) intact and questions have been swirling on everything as to how the chronically uninsured will receive insurance, and how some small businesses will be compelled to wade through a sea of new rules and regulations. Moreover, high-income earners and investors are also asking questions, since they will likely be forced to grapple with a new set of taxes. One major source of new revenues that will be imposed by PPACA, is centered around two new Medicare taxes. The Net Investment Income Tax A 3.8% surtax on unearned income The Additonal Medicare Tax. An additional 0.9% Medicare tax that will be levied on wages Net Investment Income Tax A 3.8% surtax on unearned income that took effect on January 1, 2013 The tax will be applied against the lesser of the taxpayer's net investment income or modified adjusted gross income (MAGI) in excess of the threshold amounts. Keep in mind that the 3.8% surtax is in addition to ordinary income tax and any alternative minimum tax. Income subject to surtax
  5. 5. 9/19/13 5/9 Let's look at which types of income are subject to the tax and which are not. Unearned income will be subject to the tax. This includes gross income from: Taxable interest Dividends Rent Taxable annuities Royalties Net Capital gains Passive activity - income from businesses in which the taxpayer does not actively participate The net gain from property held for investment, including taxable portion of a gain from selling a personal residence that is above the $500,000/$250,000 exclusion. Examples Tom is single, earns $120,000 , and has dividends and capital gains of $40,000. His MAGI of $160,000 is below the threshold of $200,000. Tom avoids the 3.8% surtax. Noah and Tina, married filing jointly have wages of $240,000 and net investment income of $40,000 (MAGI of $280,000). The 3.8% surtax applies to $30,000. Strategies that should be considered 1. Bulk up on tax-exempt interest. Consider tax-exempt municipals in lieu of other income-producing securities. 2. Increase contributions to tax-deferred retirement plans. Maximize the contributions to IRAs, 401(k)s, or 403(b)s. Consider setting up a SEP-IRA if you are self employed which has more beneficial contribution limits. 3. Defer taxes. Whenever possible, place investments that generate unearned income into tax-deferred accounts. 4. Factor in retirement withdrawals. Qualified withdrawals from a Roth IRA are not included in MAGI and would not risk exposing investment income to the surtax. Consider converting a traditional IRA into a Roth. Be aware that the Roth conversion is a taxable event which will add to MAGI, and will possibly increase your exposure to the surtax. 5. Time the income. Can you spread out income payments over several years, minimizing or eliminating the impact of the tax. 6. Consider installment sales. Installment sales could defer income over several years and keep the seller under the MAGI limit or minimize the surtax. 7. Use College Savings accounts. Save for education using Section 529 plans and Coverdell Education Savings Accounts. 8. Make greater use of charitable trusts. Consider charitable remainder trusts to defer recognition of income, and non-grantor charitable lead trusts that shift income away from the grantor to the trust. The bottom line The new maze of complexity will create an extra level of frustration for many high- income investors. It's unlikely the levies can be completely avoided, but with prudent planning, you can face the 2013 tax season armed with knowledge that eliminates unwanted surprises. For additional information and before making any final decisions, please consult a tax
  6. 6. 9/19/13 6/9 advisor. Watercooler Riddle: Jim offers Bill the opportunity to select bars of fine chocolate from a large bowl filled with bars of Swiss chocolate and Danish chocolate. Bill randomly pulls out two chocolate bars. One of the bars is Danish chocolate. What is the probability that the other bar is also Danish chocolate? Assumptions - there are the same number of Swiss and Danish chocolate bars in the bar and Bill pulls one out with each hand. Answer below. Abbott and Costello talk about unemployment Costello: I want to talk about the unemployment rate in America. Abbott: Good Subject. It's 7.8%. Costello: That many people are out of work? Abbott: No, that's 14.7% Costello: You just said 7.8%. Abbott: 7.8% unemployed. Costello: Right 7.8% out of work. Abbott: No, that's 14.7%. Costello: OK, so it's 14.7% unemployed. Abbott: No, that's 7.8%. Costello: WAIT A MINUTE. Is it 7.8% or 14.7%? Abbott: 7.8% are unemployed. 14.7% are out of work. Costello: If you are out of work, you are unemployed. Abbott: No, Congress said you can't count the "out of work" as the unemployed. You have to look for work to be unemployed. Costello: BUT THEY ARE OUT OF WORK!!!
  7. 7. 9/19/13 7/9 Abbott: No, you miss his point. Costello: What point? Abbott: Someone who doesn't look for work can't be counted with those who look for work. It wouldn't be fair. Costello: To whom? Abbott: The unemployed. Costello: But ALL of them are out of work. Abbott: No, the unemployed are actively looking for work. Those who are out of work gave up looking, and if you give up, you are no longer in the ranks of the unemployed. Costello: So if you're off the unemployment rolls, that would count as less unemployment? Abbott: Unemployment would go down. Absolutely! Costello: The unemployment just goes down because you don't look for work? Abbott: Absolutely it goes down. That's how they get it to 7.8%. Otherwise it would be 14.7%. Our government doesn't want you to read about 14.7% unemployment. Costello: That would be tough on those running for reelection. Abbott: Absolutely! Costello: Wait, I got a question for you. That means there are two ways to bring down the unemployment number? Abbott: Two ways is correct. Costello: Unemployment can go down if someone gets a job? Abbott: Correct. Costello: And unemployment can also go down if you stop looking for a job? Abbott: Bingo. Costello: So there are two ways to bring unemployment down, and the easier of the two is to have people stop looking for work. Abbott: Now you're thinking like an economist. Costello: I don't even know what the hell I just said! Abbott: Now you're thinking like Congress. Think you Work a lot. The people in Singapore don't think so. France on the other hand ....
  8. 8. 9/19/13 8/9 Riddle Answer: The answer is one-third. If Bill places both hands in the bowl and draws two chocolate bars simultaneously, Bill has the following possible combinations: 1. Danish in left hand/Danish in right hand 2. Danish in left hand/Swiss in right hand 3. Swiss in right hand/Danish in left hand 4. Swiss in left hand/Swiss in right hand Since we already know that Bill has drawn a Danish chocolate bar with one hand, we can remove from consideration combination 4. Therefore, there is only one option remaining out of the three where Bill could have a Danish chocolate bar in the other hand. Summer Key Planning Dates
  9. 9. 9/19/13 9/9 Please contact me if you have any questions about the articles above or about your personal or business finances. Sincerely, Marc Bautis Wealth Manager office: 201-842-7655 cell: 201-221-6895 fax: 201-754-9760 Disclaimer:The information contained in this newsletter is for information purposes only and may not be suitable for your specific financial situation. You should consult a financial advisor before making any investment decisions relating to the information contained in this newsletter