Why You Should Consider ROTH Conversions During a Bear Market

Why You Should Consider ROTH Conversions During a Bear Market

 

 

We expect most people have a grasp on how to make money in a bull market, but it can be far more challenging to contemplate how to make money during a bear market, when emotions are running high.  It’s not all about making money, though.  Some of it involves figuring out how to put oneself into a better financial position for the future so that you can heal faster from the losses.  There are a handful of key strategies to engage in during a bear market that will help your finances as much as your future, and one of the most important of these is ROTH conversions.

Believe it or not, bear markets represent the best environment into which to make an IRA-to-ROTH conversion.  The more negative the equity losses are, the more attractive the conversion becomes.  When making a conversion to ROTH, you can either move cash or you can move shares of the stocks or mutual funds that you own in the IRA.  When we make a conversion, we choose to move shares for our client families.  The tactical benefit here is that we actually get to pick the specific funds to move from the IRA to the ROTH.  Whichever funds have the deepest losses for the given year are the ones with the highest priority to move over first.

Think of it this way: if we found ourselves in a sharp bear market, we would expect several equity asset classes to be down, but maybe inside our IRA the US small cap fund went down the most with a -35% loss.  Although it may not feel like it, bear market losses are temporary, so it is important to take action and make the conversion to the ROTH while the markets and the news are negative and remain temporarily distressed.  If we were to hypothetically move $50,000 of the US small cap fund in our example, we would actually be moving shares that were previously 35% higher in value at $77,000.  If we convert the $50,000 of small cap shares right now, we incur the tax liability on those shares on the day they are moved over.  Once the shares have arrived in the ROTH, it then becomes a matter of exercising patience.  It might take six or nine months for the current bear market to pass; but when the economy improves, those distressed shares should bounce back in value.  In a relatively short number of months, the $50,000 that was converted and that you paid tax on might be worth $65,000 or $70,000—but remember, you only paid tax on $50,000.  Much like a spring being compressed and then subsequently released, the idea behind the conversion is to move the shares to the ROTH while the spring is compressed.  Simply put, the bear market represents a tax-savings opportunity in disguise, so acting now is highly important BEFORE things improve in society.  Effectively, ROTH conversions and bear markets coupled together give us a way to legally cheat the IRS out of tax dollars.

The benefits of ROTH conversions are not just effective during a severe bear market but can be utilized nearly every year.  If you employ a highly diversified portfolio with multiple asset classes held in your IRA and ROTH, there are lots of opportunities to take advantage of the up and down stock market movements, as many asset classes move at different rhythms.  There are a host of financial planning advantages to ROTH accounts and gradually converting IRA money into ROTH each year.  Keep in mind, ROTH accounts contain post-tax money; they do not have required minimum distributions, which do apply to traditional IRAs; and all of the future growth on the assets in the ROTH are considered post-tax.  All withdrawals from ROTHs are voluntary, and all of the dividends, interest, and earnings in the ROTH are shielded from taxes.  Another advantage of a ROTH account is that it can be viewed with your IRA using an overall investment approach that we call Asset Location.  Essentially, Asset Location seeks to view the IRA and ROTH accounts as if they were one account holding one investment portfolio but divvies the funds between the accounts to the greatest advantage.  Reach out to your advisor if you are curious about conversions and ROTH accounts and learn more about how we advocate for our families.

Merriman INSIGHT – Using Qualified Charitable Distributions to Maximize Charitable Gifts

On December 18, 2015, the president signed into law the Protecting Americans from Tax Hikes (PATH) Act of 2015. One of the popular tax provisions in this bill was to permanently extend the ability for IRA owners to make qualified charitable distributions (QCD) from their IRA to a qualified charity of their choice. Prior to the PATH Act, this provision expired multiple times since its debut in 2006, only to be temporarily extended by Congress each time, often at the last minute or retroactively. This uncertainty made charitable planning more difficult, but now we finally have clarity!

For those who are charitably inclined, a QCD can really maximize the effectiveness of charitable gifts.

Here’s how it works

IRA owners who are 70½ or older and would otherwise have to satisfy a required minimum distribution from an IRA may donate any portion up to $100,000 of the required distribution directly to qualified charity. The IRA owner can exclude the amount of the QCD from his or her gross income (thereby reducing their adjusted gross income), but any donation made via a QCD is not eligible for a charitable deduction. From a tax perspective, an exclusion from income is preferable over a deduction from income — particularly for those who don’t meet the itemized deductions threshold in the first place.

As with many IRS provisions there are a number of fine print items to keep in mind.

  • You’re only eligible to make a QCD if you are 70½ or older.
  • Contributions can only be made to 501(c)(3) charities and 170(b)(1)(A) organizations.
  • Donor advised funds and private non-operating foundations are not eligible to receive QCDs.
  • The QCD must be made directly from your IRA to the desired charity, meaning the check issued from your IRA must be payable to the organization. If the check is made payable to you, then it counts as taxable income and will be considered a normal IRA distribution.
  • The QCD can be made from any IRA. SEP and SIMPLE IRAs are only eligible if they are not receiving employer contributions in the same year as the QCD is made. You cannot make the QCD from any employer retirement plans, such as a 401(k), 457 or 403(b), etc.
  • The QCD cannot be a split-interest gift, meaning 100% of the gift must go to a single charity and the gift cannot be shared with the donor or any other designee of the donor (for example, Charitable Remainder Trusts or Charitable Lead Trusts would not qualify). The donor cannot receive any economic benefit as part of the gift.

If you are interested in making a donation directly from your IRA to a charity, please reach out to your advisor to get started and make 2016 a year of giving!

Have you written your letter of instruction?

image036Maybe you’ve heard of this before. A letter of instruction is a document you write to your executor and family that contains your personalized wishes and instructions for settling your estate. Although it does not carry any legal authority, a letter of instruction can be used to provide tremendous added detail about your financial affairs that doesn’t fit within a will or trust.

One of the most important purposes of a letter of instruction is to lead the person in charge of settling your estate through the process step by step. A good letter of instruction should contain the following:

  • Detailed list of your assets and belongings.
  • Copy of your monthly budget.
  • Login ID and password list.
  • Contact information for financial professionals and beneficiaries.
  • Location of important documents such as the will, trust, deeds, birth certificate, tax returns, bank statements, bills, life insurance, etc.
  • Creditor statements for any mortgages, credit cards or other loans.
  • Location of keys for house, auto or safe deposit box.

A key function of the letter of instruction is to specifically indicate which household belongings go to which heirs. Your will and/or trust will generally only address big ticket items. Through the letter you can decide who receives the family albums, the silverware, stamp collection, artworks or family knickknacks. Providing clear guidance can keep your family from devolving into arguments and resentment when emotions and grief run high.

Burial Arrangements

You can also use a letter of instruction to tell your family how and where you would like to be buried or cremated. You can be as elaborate as you desire. If you want, you can choose funeral readings, pick your flowers, charitable donations, etc. You can even prewrite your own obituary here, so be creative. Whatever your desires, putting your wishes in writing will help reduce guesswork and potential arguments among those who will handle these arrangements when the time comes.

Other Advantages

If desired, you may use the letter of instruction to voice personal requests and your expectations for how your heirs use their inherited assets. After all, these were your possessions! Some people also include their personal values, in a section known as the “ethical will,” which allows you to pass your core values and beliefs down to your family and beneficiaries.

Another benefit of this letter is that you can augment your living will with regard to end of life care, providing more detail about the circumstances under which you want to be kept alive or taken off of life support. This can be very helpful in reducing stress or uncertainty for your family if the health care directive or living will lacks this detail.

Conclusion

Remember, a letter of instruction does not replace a will, durable power of attorney or living will. If you don’t already have these documents in place, you should have them drawn up by a qualified estate planning attorney. A letter of instruction can be a fantastic tool to articulate your final wishes and decisions for your executor and heirs. Be sure to update it periodically and file it along with your other estate planning documents. At its heart, the letter of instruction is a last gift of your voice that you leave to your family, so make it count.

Charitable IRA distributions renewed for 2013

We have great news for people making charitable gifts this year! Thanks to the American Taxpayer Relief Act of 2012 (ATRA), IRA owners can once again make a qualified charitable distribution (QCD) from an IRA to a qualified charity of their choice.

For those who are charitably inclined, a QCD can really maximize the effectiveness of charitable gifts.

Here’s how it works:

For this year, IRA owners who are 70 ½ or older and would otherwise have to satisfy a required minimum distribution from an IRA may donate any portion up to $100,000 of the required distribution directly to a qualified charity(ies). Additionally, the IRA owner can exclude the amount of the QCD from his or her gross income on their 2013 tax return. The amount of the QCD excluded from the gross income is not included when determining any deductions made to qualified charitable organizations.

As with many IRS provisions there are a number of fine print items to keep in mind.

  • You are only eligible to make a QCD if you are 70-½ or older.
  • Contributions can only be made to 501(c)(3) charities and 170(b)(1)(A) organizations.
  • Donor advised funds and 30% public foundations are not eligible to receive the QCDs.
  • The QCD must be made directly from your IRA to the desired charity, meaning that the check issued from your IRA must be payable to the charity. If the check is made payable to you, then it counts as taxable income and will be considered a normal IRA distribution.
  • The QCD can be made from any IRA. SEP and SIMPLE IRAs are only eligible if they are not receiving employer contributions in the same year as the QCD is made. You cannot make the QCD from any employer retirement plans, such as a 401(k), 457 or 403(b), etc.
  • The QCD cannot be a split-interest gift, meaning that 100% of the gift must go to a single charity and the gift cannot be shared with the donor or any other designee of the donor. The donor cannot receive any economic benefit as part of the gift.

At this time, the QCD provision is only extended through the end of 2013. We do not know if the provision will be renewed in years beyond. If you are interested in making a donation directly from your IRA to a charity, reach out to your advisor to get started and make 2013 a year of giving!

Setting your spouse up for success

In our household we refer to my wife as the “Chief Domestic Officer,” which means she is the keeper of passwords, pays the bills, monitors and tracks our insurance and, as you can imagine, anything in between. Although I am a financial advisor, I do not pay our household bills. Seems a contradiction of terms, given my profession, but in our house this is how it worked out.

Like most households we have our basic monthly bills – electricity, water, cable…you name it. We also have our scheduled and unscheduled bills. Take for example, our medical expenses: We know when our prescriptions need to be refilled and have a good idea of the cost; those are scheduled. And we have the unscheduled medical bills for those late-night trips to the ER with an illness or injury.

We run our home with a color-coded budget that fits on to a single page. We created it together with the goal that either one of us can use it with ease. The colors represent how the bills are paid, whether by check, internet or automatic debit. On a quarterly basis we sit down together and talk about our finances. We discuss upcoming events, vacations, bills, our goals and house projects. We try to plan for the next 3 to 6 months and during this time we also update the budget.

The second important element to running our household smoothly is the password spreadsheet. In this time of computers and smart phones, each person has to have a username and password for just about everything. On this spreadsheet we keep track of our username, password, website it belongs to, who it belongs to and the security questions that are asked. I have no idea what my wife’s high school mascot was. But I don’t have to because the answer is on our spreadsheet. The only password I have to remember is the one that gives me access to the spreadsheet. Then I can check the balance in our bank account or order flowers for my grandmother.

In the event that my wife is unavailable or if something should happen to her, I have the tools I need to keep our household running smoothly with minimal effort. Life is full of unknowns and I firmly believe that chance favors those who are prepared. Granted, bill paying is not the most exciting thing you probably have ever done, nor is it necessarily that complicated. Why make things any harder than they need to be? With just a little effort and time we have set each other up for success. The question is: Have you set your spouse up for success?

Five reasons to track expenses before retiring

For individuals nearing retirement, one of the first things to consider is: How much money will I be able to withdraw from my portfolio on an annual basis? This is a very important issue and ideally should be determined before entering into retirement.

Whether you use spreadsheets, receipts in shoe boxes or a computer program to track your expenses, it is important to know how much you spend to support your lifestyle. Before considering how much equity you will need in your portfolio during retirement, you should track your expenses for a few years to give you a firm idea of your outflows.

There are a number of software solutions available to help, including Quicken, Microsoft Money and Mint.com. While I don’t recommend any particular software, I do think you should find and use one that suits your needs. Here’s why:

  1. You can easily view expenses broken down by category. Until you actually measure the monthly expenses in an accurate and systematic way, you may only have a vague idea of how much is being spent in each category.
  2. With financial software, it is much easier to prepare your tax return. This is especially true if you itemize. All of the good personal finance software options have preloaded categories that are set up to capture deductible items. Once entered, you can produce individual category reports.
  3. With the aid of software, you always have access to a current balance on your credit card and personal checking accounts. This data can also be downloaded into the software, making catching errors or fraud very easy.
  4. The personal financial software can make it easier to pay bills on time and keep track of your automatic payments. Since it is possible to automate some of your monthly bills to be charged to a credit card or auto-debit from your checking account, the software helps you track all the different payment transactions in one central location.
  5. It allows for a smoother transition in the event you become incapacitated. Your spouse, partner or other family member will have a much easier time assuming bill paying responsibilities if you are using expense software.

Personal expense tracking software will help give you accurate, reliable information about how much money you are likely to need in retirement. This will help you determine if your monthly expenses can be supported by your current portfolio and if any changes need to be made – either to your expenses or your portfolio. Remember, if you can track it, you can manage it.

The best way to begin retirement planning is to start early. The sooner you know if your annual requirements are out of sync with what a balanced portfolio can produce, the more options you will have to correct the situation.