Life Timing: What Did Lynn Hopewell Teach Us?

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Harold Evensky CFP® , AIF® Chairman

You’re not average, so don’t plan the quality of the rest of your life based on averages.

I was sitting front row center in a big conference room at our national planning symposium; I’d been looking forward to this talk for a while. The speaker, financial planner Lynn Hopewell, was a good friend and one of the most thoughtful practitioners I knew. My partner, Deena, and I had been responsible for planning this program and we invited Hopewell to speak because he told us he had a few major concepts he wanted to share with his peers. Here’s what he shared that day:

And End Not So Near

Welcome, everyone. I have few stories to tell that I hope will be a wake-up call for the financial planning profession. The first is about my planning for an engineering client, Ms. Jane. She is sixty-three, a very successful and accomplished civil engineer, and president of a major structural engineering firm. She hired me to work with her in developing a comprehensive retirement plan. Well, since I too am an old engineer, I know how they think—detail, detail! So I worked very hard to provide Ms. Jane a plan that would resonate with her. Finally, I was sitting down with her, ready to blow her socks off, and after going through my complete analysis, I thought I had.

“Mr. Hopewell,” she said, “I’m very impressed with the thoroughness and depth of your plan. I have only one small question.”

Well, needless to say, I was beaming at the compliment and looked forward to answering her “one small question.”

She went on, “I understand that selecting a mortality age—the age the plan assumes I die and will no longer need income—is a critical element in the planning process.

“Obviously,” I said, “if we arbitrarily use a very old age, such as one hundred, we’re likely to have to tell you to reduce your spending so that your nest egg will last to that age. Of course, if you die before one hundred, you’ll be leaving a lot of money on the table that you could have enjoyed spending while you were alive. If we assume a much younger age and you’re long-lived, the consequences could be even worse because you’d run out of money before you ran out of time. As a consequence, we work hard to select a reasonable planning age.”

“That makes sense to me,” she said, “and I understand that the age you selected for the plan is based on the projected age of my death from a national mortality table.”

“Correct! And not just any mortality table. We spent quite a bit of time consulting with actuaries to determine which table reflected the most current actuarial data.”

“I understood that. What I’m still a little confused about is the meaning of that age. As I understand it, if the table says my mortality age is eighty-eight, that means half the people will have died by eighty-eight and half will still be alive.”

“Correct.”

“Well, doesn’t that mean if I plan to age eighty-eight, I’ll have a 50 percent chance of outliving my plan?”

That question hit me like a Mack truck. Ms. Jane was correct. Even worse, in thinking about it, I realized that anyone with the resources to need the advice of a financial planner was likely to have had better health care and nutrition than the average of the universe of individuals making up the mortality table. That means Ms. Jane had better than a 50 percent chance of outliving my plan. This was a major wake-up call for me and should be for any practitioner relying on a traditional mortality table. Lynn said, “After acknowledging Ms. Jane’s point and scheduling a follow-up visit to give me time to consider the ramifications of her simple question, I hunkered down in my office to consider how I might resolve this problem.”

So, I went back to my own office and did the same. After additional conversations with my actuary friends, I concluded that a reasonable solution would be to use more customized actuarial tables—those that allowed me to factor in whether the client is a smoker, nonsmoker, her current health, and whether the lifespan of her immediate family is long, average, or short. Then, using the appropriate customized table, we would select an age that represented only a 30 percent chance of her outliving the age indicated in the table.

Here’s an example that shows how big a range the mortality age can be depending on these factors:

Life Timing Chapter Image file - mortality age range

Obviously, there is no guarantee that the age selected will coincide with the client’s mortality; however, following this process is likely to provide a much more realistic estimate.

Well, Lynn was right. That was a major wake-up call, because I’d been using a standard actuarial table and mortality age for my planning assumption. That was about to change.

Even if Lynn had stopped there, this information would have justified all of the time and cost of attending the three-day symposium, but there was more. Lynn’s next story was about the ah-ha moment he had one day when developing a college funding recommendation.

College Calculations

Not long ago I was preparing a simple college funding recommendation for a client. You know how that goes. It’s a simple time-value calculation that requires input on how many years until college, how many years of college the client wants to pay for, the annual cost, and the college tuition inflation rate. My input looks something like this:

Life Timing Chapter Image file - college calculations

A financial calculation would result in a recommendation that the client set aside about $145,000 to fund this expense. When I presented this to the client, he asked how confident I was about my number. When I thought about his question, I realized the answer was not very. My estimate was what we refer to as a “point estimate.” This means that unless every assumption I made was exactly right, my recommendation would either over- or underfund the college tuition bill.

As a former engineer, I remembered that when trying to estimate the probability of uncertain events, we used a technique known as a “Monte Carlo simulation.” Developed at Los Alamos National Laboratory during the Second World War for the design of nuclear weapons, Monte Carlo is really a simple concept. Rather than making a single guess regarding a possible outcome, we make guesses about the likely ranges of the outcomes. We then simulate thousands of possible futures with different combinations of those possible outcomes.

Let’s expand the table I showed a minute ago to more realistically reflect the uncertainty in our estimates.

What we know with some certainty:

  • Years to college 4
  • What we’re making an educated guess about
  • Tuition somewhere between
  • Annual cost $30,000 to $50,000
  • College costs inflation 5 to 7 percent
  • Investment return 6 to 10 percent

With these ranges, there are many thousands of possible outcomes, for example:

Life Timing Chapter Image file - college calculations no. 2

The Monte Carlo simulation calculates for each of these examples how much money that investors would need to set aside today if they want to fully fund four years of education. If the analysis ran a thousand examples, the results, listed in order of decreasing savings, might look something like this:

Life Timing Chapter Image file - college calculations no. 3

In this case, the question was how much should you put away now if you want an 80 percent probability of meeting your goal? The answer would be $167,000, because 80 percent (800/1,000) of the simulations would have succeeded with that amount of savings or less.

Well, this was another major wake-up call for me. In hindsight, it seemed obvious that a point estimate was inappropriate and that a Monte Carlo simulation could provide a more meaningful answer. In wrapping up his discussion, Lynn reminded us that expanding the input matrix meant making more guesses. Despite the mathematical rigor of a Monte Carlo simulation, adding more guesses does not justify adding two more decimal places to the answer. His point was that we should use Monte Carlo as an educational tool and not suggest it is a mathematically accurate answer.

The Takeaways

When planning retirement, don’t assume average mortality—you’re not average.

When attempting to quantify an uncertain future, don’t default to a single estimate. Use a Monte Carlo simulation to develop an understanding of the likelihood of possible outcomes, but don’t take the results as gospel.

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

Market Timing for Fun and Someone Else’s Profit – Don’t Do It

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Harold Evensky CFP® , AIF® Chairman

A broker stands looking out of the window of his sumptuous office down at the marina thirty stories below with his client at his side. “See those yachts down there?” says the broker to his client. “The one on the left is mine, the one in the middle is my partner’s, and the one on the right is our office manager’s.”

“Where are your clients’ yachts?”

David Samuel: Hello, Harold. It’s David Samuel again. I know you have that AAII meeting coming up next week, but this can’t wait. My brother said he just got a call from his broker, who told him to bail out of the market at least for the next few months because the firm’s technicians said they see a major correction coming within weeks. I assume you’ve probably seen the same and agree, but I just wanted to double-check.

Harold Evensky: David, I just want to be sure I have this straight. You’re saying the broker is confident enough in his crystal ball to say that everyone should run to cash?

DS: You got it.

HE: Hum, I know he works for a big wire house; I wonder if that firm has moved all its money to cash? I don’t think so, because a move of that magnitude would have made the papers, and none of the managers we monitor have made significant liquidations recently. It somewhat makes you wonder what your brother’s broker knows that no one else does.

DS: Well, I understand that he’s been in the business for decades and he’s a senior VP at the firm, so he must know something.

HE: I’m sure he knows how to sell, because the impressive title comes with generating big commissions for the firm. There are many quality SVPs who earn their commissions from long-term quality advice.

Unfortunately, there are some who succeed by focusing on generating commissions independent of the client’s needs. That’s the basis for the old joke: “How do you make $1,000,000 in the market? Start with $2,000,000.” In deciding whether market-timing advice is something you want to follow, remember, when market timing, a broker earns a commission for the sale of each and every one of the positions their clients sell and another commission when they repurchase those positions. Here are a few things you might want to consider:

Can you name the top ten musicians of all time? The top ten baseball players? The top ten presidents? Of course, you can. We might argue about the list but most people can make up a list.

Now, tell me the top ten market timers of all time? Can’t even name one, can you? Your brother’s broker may be the first, but do you really want to bet on that?

What do market reality and statistics tell us? There are innumerable problems with market timing, including transaction and tax drag. But there are two major problems. You have to make two correct calls: 1) when to get out and 2) when to get back in. Factoring in transactions and taxes, research indicates you need to be correct about 70 percent of the time.

Markets don’t just drop precipitously, but they recover quickly, so waiting for confirmation of the end of a bear market usually means missing a significant part of the recovery. That makes for a tough hurdle.

For example: In a study covering the period 1987–2007, research found that the annualized return for someone invested for 5,296 days was 11.5 percent. Unfortunately, if you missed the ten best days (less than 2/10 of 1 percent), your return would have dropped to 8 percent,

Why would you be likely to miss those best days? Because those best days occurred within two weeks of a worst day 70 percent of the time. And they occurred within six months of a best day 100 percent of the time!

In an industry study in 2008, researchers found that although the annualized market return for the prior twenty years was 11.6 percent, the average stock fund investor earned a paltry 4.5 percent. It turned out that for most investors, market timing was mighty expensive. And, David, unless you’ve recently obtained a working crystal ball, it’s likely to also prove costly for you.

To make money in the market, you have to be in the market through thick and thin. In fact, if you remember our discussion on rebalancing, you’ll remember that bear markets are great buying opportunities for long-term investors. So, my advice is to stop listening to so-called experts spouting nonsense and go back to making money in your business.

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

Start Thinking about End-of-Year Tax Planning Now

David Garcia

David L. Garcia, CPA, CFP®, ADPA® Principal, Wealth Manager

Most folks hate to think about paying taxes, let alone end-of-year tax planning strategies. Unfortunately, ignoring tax planning can lead to paying Uncle Sam more than is required. The last four years have seen the introduction of new income-based Medicare premium increases along with increases in the top income tax, capital gains, and dividend rates. Starting to plan as early as possible is crucial since most strategies need to be completed prior to year end. Depending on your situation, it may make sense to either accelerate or delay deductions and income. This blog post briefly discusses some of the most often used tax planning strategies, but is by no means an exhaustive list. Tax planning strategies can be complex and should always be considered in close consultation with your accountant and financial advisor to make sure decisions are made with your unique tax situation in mind.

Harvesting Losses

At first glance, it may seem silly to intentionally sell an investment for a loss. However, opportunistic tax loss harvesting can boost after-tax returns. Suppose you have a $50,000 investment in the U.S. stock market via a broad market index fund that loses 10% of its value this year. You can sell this index fund and turn around at the same time and buy a very similar U.S. index investment, losing no market exposure but banking a $5,000 loss for tax purposes. This can be a beneficial tool for reducing taxes while maintaining your asset allocation and risk/return profile. Even if you do not have any gains to apply the loss to in the year of sale, up to $3,000 can be used against ordinary income items such as wages. Further, any excess unused loss is carried forward to be used in future tax years.

There are some important limitations to tax loss harvesting that should be kept in mind. The IRS will not let you sell an investment and at the same exact time buy back that identical investment just to create a tax loss. IRS rules state you must wait 30 days to purchase the identical investment sold for the loss or you violate what is commonly referred to as the “wash sale rule.” A wash sale disallows the loss for tax purposes. However, IRS rules do allow you to purchase a very similar investment, preferably one that is highly correlated with the investment sold for a loss, without breaking the wash sale rule. For example, selling the S&P 500 SPDR and replacing it with the Vanguard total stock market index would give almost identical market exposure while not violating the wash sale rule.

The bottom line is that actively managing capital gains and losses near year end can increase after-tax returns over time. Just be sure to consult with your accountant or investment advisor to make sure you do not run afoul of any limitations.

Medicare Premiums for High-Income Earners

In 2016, some Medicare recipients began to see an additional 16% base premium increase set into motion by two different laws. One law says that ordinary recipients can’t have their standard premium go up by more than the Social Security cost of living increase for that year. Since there was no cost of living increase in 2016, this benefited about 70% of beneficiaries. Unfortunately, another law shifted the burden of increasing Medicare costs onto the remaining 30% of beneficiaries. This unlucky 30% includes folks who don’t deduct Medicare premiums from their Social Security checks, those who didn’t receive Social Security in 2015, and high-income earners.

If that wasn’t bad enough, on top of the 16% base increase, Medicare also penalizes about 5% of high-income beneficiaries with premium surcharges. The surcharges begin at adjusted gross income levels above $85,000 for singles and $170,000 for married folks filing jointly. To make matters worse, the income thresholds are currently not indexed for inflation, so more people will be affected by the surcharges in coming years. Tax planning can help reduce the bite of surcharges.

The Medicare surcharges are determined by a taxpayer’s modified adjusted gross income (MAGI). For most folks, this is adjusted gross income plus tax-exempt interest. This number is calculated before itemized deductions, so the usual deductions like charitable donations and mortgage interest won’t help. However, if you are charitably inclined, there is one strategy that might help reduce your MAGI. If you have to make a required minimum distribution (RMD) from your IRA every year, the distribution goes on your 1040 as ordinary income and increases your MAGI. The IRS allows you to give up to $100,000 of your RMD to charity and have it avoid your 1040 all together, thereby directly reducing your MAGI. Other strategies beneficiaries may want to consider include harvesting capital losses to offset gains that increase MAGI, moving forward or putting off income events in the current tax year, and utilizing Roth accounts for income. The bottom line is that a little planning could save you a lot in Medicare premiums.

Roth Conversions

In 2010 Congress repealed the income limit on Roth IRA conversions affording taxpayers, regardless of their income, the opportunity to pay off the embedded tax liabilities in their IRAs. Taxpayers who take advantage of Roth conversions should consult with their tax professionals and financial advisors to make sure converting to a Roth IRA makes sense for their particular situation. Even though converting traditional IRA assets to a Roth IRA creates current income tax, there are several situations where it may make sense to perform a Roth conversion. Perhaps you have retired recently and find yourself in a low tax bracket, making a Roth conversion less expensive. Many people convert IRA assets because they want to create a tax-free retirement asset for their heirs or to use up operating losses from their business. Whatever your reason, your future tax bracket, time horizon, estate plans, and whether you have cash outside of your IRA to pay the conversion taxes should all figure into your decision.

Conclusion

Tax planning is an important part of everyone’s financial plan. Most people approach tax issues in a reactive manner instead of being proactive. By starting to think about your current tax circumstances before year end, you may save yourself taxes and take advantage of opportunities on which you may otherwise miss out.

Feel free to contact David Garcia with any questions by phone 305.448.8882 ext. 224 or email: DGarcia@EK-FF.com.

 

Kitces, Michael E. “Planning for the New 3.8% Medicare Tax on Unearned (Portfolio) Income.” Nerd’s Eye View. N.p., Apr. 2010. Web. <www.kitces.com>.

“Medicare Premiums: Rules for Higher-Income Beneficiaries.” Social Security Administration. N.p., Jan. 2016. Web. <www.socialsecurity.gov>.

“Advanced Tax Strategies Using a Roth IRA Conversion.” Putnam Investments. N.p., n.d. Web. 19 July 2016. <www.putnamwealthmanagement.com>.

Cubanski, Juliette, Tricia Neuman, Gretchen Jacobson, and Karen E. Smith. “Raising Medicare Premiums for Higher-Income Beneficiaries: Assessing the Implications.” Kaiser Family Foundation. N.p., Jan. 2014. Web. <www.kff.org>

The Three Ps of Investing: Philosophy, Process and People

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Harold Evensky CFP® , AIF® Chairman

In Real Estate, it’s location, location, location. In investing, it’s philosophy, process, and people. Most investors look at past performance when evaluating a manager. That’s a rearview mirror approach. If you’re driving forward, keeping your eyes on the rearview mirror is dangerous. Looking backward is equally dangerous for investors. You can’t buy past performance, so don’t invest based just on looking backward. To avoid that mistake, here’s a simple process that works for any investment manager you might hire—mutual funds, separate accounts, or alternatives.

Philosophy

When you are evaluating money managers, find out what their  investment philosophy is. What is their unique view of the investment world? How is it different from those of their competitors? Is it credible that a manager can overcome the drag of expenses and taxes and provide risk-adjusted returns better than other alternatives? Basically, you’re looking for a good and credible story. How might you find it? Read the manager’s letters, prospectus and marketing material; look for something more than “we buy low and sell high.”

Process

A good story is nice, but how does the manager make it work in the real world? Answers to this question may be harder to pin down, but remember, it’s your hard-earned money at risk.

People

Philosophy and process are essential, but ultimately it’s people who make the difference. People will be making investment decisions about your money.

Don Phillips is a managing director and board member of Morningstar. He is a good friend of mine and one of the most-respected professionals in finance. He has some simple advice regarding people: “You want people with passion for the job of money manager.”

Did the managers you are considering invent the firm’s philosophy and process or have they at least been around long enough to have developed a passion for it? If not, even if the investment passes the test of the first two Ps, move on to your next investment alternative.

Testing the Ps

In this conversation with a gentleman I will call Happy Promoter, I put the three Ps to the test.

Happy Promoter (HP): Good morning, Mr. Evensky. My name is Happy Promoter. I’m familiar with your firm and I appreciate your taking the time to see me this morning.

Harold Evensky (HE): Mr. Promoter, it’s my pleasure. I understand you represent Sophisticated Hedge Fund Strategies and you have a new offering available. My friend Mr. Jones suggested I meet with you; I’m always interested in learning about new potential investments for our clients. Please tell me about your program.

HP: It’s a very sophisticated long-short strategy based on an evaluation of a myriad of market dynamics that guide our trading algorithms to ensure that we provide consistent alpha in all markets. Because we can profit in both rising and falling markets, we can mitigate downside risk, and by the judicious use of margin, we can provide returns that significantly exceed the S&P 500. We’ve backtested our strategy for the last ten years and the results substantiate the success of our strategy.

Well, at this point, I’m thinking I need to know a lot more before I take Mr. Promoter’s pitch seriously. Backtesting is a common but questionable way of evaluating a new investment strategy. It mathematically simulates how the strategy would have fared if it had existed in the past. One obvious problem is that unless the strategy is 100 percent automatic—no active decisions or modifications are made by the manager along the way—there is no way of knowing if the simulation is a fair representation of how the strategy will be implemented in the future. An even bigger problem is that there’s no reason to believe that future markets will mirror the historical environment used for the backtesting. Bottom line: because it theoretically would have worked in the past is no reason to believe it will succeed in the future. The financial world is full of failed investment strategies that had wonderful backtest results.

So, I decide I need to take Mr. Promoter through the process I call the “three Ps.”

HE: Mr. Promoter, what you’ve said sounds good, but I need more meat to the story. Can you tell me what your basic investment philosophy is? What do you see in the financial markets that the thousands of other professional investment managers don’t? After all, the market is a zero-sum game. For everyone who makes a buck, there has to be someone else losing one.

HP: Harold—may I call you Harold?

HE: Certainly.

HP: We believe that our sophisticated algorithms will provide the edge.

HE: I understand that, but can you be more specific?

HP: No, I’m afraid that our process is quite confidential and proprietary.

HE: Well then, can you at least give me some details about the procedures you use to implement your sophisticated process?

HP: Good lord, no! Our system is a black box and all the details are carefully guarded secrets. It’s the “secret sauce” that enables us to provide the low-volatility, high returns your clients are seeking.

HE: I see. Then I guess I’d have to look to the experience and quality of the intellectual capital behind your strategy. Will you tell me who developed your sophisticated strategy and what experience they have in implementing it?

HP: Harold, I’m the lead creator of the strategy and I’m supported by a two-man team of MBAs. My educational background is a master’s in History; however, I’ve been fascinated by the market for decades and I spent the last few years studying market movements. I finished developing my strategy just last month. I know that as a sophisticated practitioner you’re aware that alternative managers with well-established track records work only with large institutional clients and have no interest in dealing in the retail market, so a new manager such as I can provide your clients with the best alternative.

Mr. Promoter seemed like a nice guy, but he miserably failed the three Ps, so I thanked him for his time. My only thought after this brief meeting was, “What a waste of time; wait until I get hold of Jones!”

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

Pascal’s Wager: The 0.1 Percent Risk

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Harold Evensky CFP® , AIF® Chairman

Playing Russian roulette with a thousand-chamber gun might not seem so risky, until you consider the consequence of that 0.1 percent risk.

I’ve been working with Linda, my client, for the last hour entering data into MoneyGuide, our planning program. We’re now discussing the plan’s time horizon—how long her nest egg needs to last so she can keep groceries on the table.

“Linda,” I asked her, “one of the major guesses we need to make is how long you will need money.” (That’s my tactful way of asking what age she thinks she’ll die.)

Years ago, we used a standard actuarial table to estimate how long someone might live. Unfortunately, as a thoughtful friend pointed out, that means you’d have a 50 percent chance of outliving your nest egg, so today we use an age that, based on your current health, your family’s health history, and if you are or are not a smoker, represents a 30 percent chance of your reaching that age. (Chapter 15, Life Timing. What Lynn Hopewell Teach Us?”)

“Linda,” I continued, “based on your current health and your family health history, we should consider using age ninety-three for planning.”

“Harold, you must be kidding. I’ll never make it to ninety-three! Let’s use eighty-five.”

“Sounds like a nice number. How did you decide on eighty-five?”

“Well, actually no particular calculation. It just seems like a reasonable age to use and I want to be reasonable in my planning.”

“Tell me, Linda, are you familiar with Pascal’s wager?”

“Pascal’s what?”

“Pascal’s wager is a philosophical construct devised by the seventeenth-century mathematician, Blaise Pascal. Here’s my version: If you knew for certain there was only a 10 percent chance that God exists, you would have two ways to live your life: You could conclude the probability of God’s existence was so low you’d elect to ignore morals and ethics and live a totally outrageous life. If, when you died, it turned out that there really is no God, hence no consequences for your immoral life, you lucked out. Of course, if, when you died, you discovered God was not a myth and you found yourself chest high in fire and brimstone, where you’d be roasting for eternity, you might not be very pleased with your choice.

“On the other hand, suppose you decided that, even with the low odds, you would live a moral and ethical life. If, when you died, you discovered there is no God, you would still have lived a comfortable life. If there is a God and you’re rewarded in heaven for your exemplary life, you will have won the eternal lottery.”

“So, what’s this got to do with retirement planning?”

The answer is everything! All too often in planning, we get caught up with the power of probability. Live until ninety-three? Possible, but not likely, so I want to make plans based on living until age eighty-five. Based on probabilities, that’s not an unreasonable response. However, as Pascal taught us, that conclusion is missing an important half of the equation, namely, the consequences. Often the terrible negative consequence of coming out on the short side of the probability overwhelms the low probability.

Let’s suppose Linda does live only until age eighty-five. That means she can spend more between now and then because her money doesn’t have to last for another seven years. Good outcome.

Suppose she lives well beyond eighty-five. If we use eighty-five, as a planning age, that means by eighty-six, if her plan works out as expected, her nest egg will be approaching $0! The consequences of living another seven years supported solely by her Social Security income? That means reducing her standard of living by about two-thirds, which may not be on a par with fire and brimstone forever but it’s high on the quality-of-life disaster scale. The moral? Don’t just consider probabilities when planning—consider the consequences.

“Still want to plan only to eighty-five, Linda?”

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

Navigating the Death of a Loved One

Josh Mungavin

Josh Mungavin CFP®,  Principal, Wealth Manager

Click Here to download a PDF of this check-list.

The death of a loved one can be devastating and emotionally overwhelming. Over the coming weeks and months, you will be faced with unfamiliar but important decisions. Employ the help of loved ones and trusted advisors to assist with these responsibilities. Please remember that many people, such as family, friends, and professional and spiritual advisors, are here to support you and allow you to focus on the most immediately important issue — the well-being of yourself and your family.

Unfortunately, you will almost certainly encounter financial or other decisions that require urgent attention. This guide will help you organize and prioritize matters that are in direct need of resolution and suspend those issues that can wait until you are personally better prepared to overcome challenges that now seems daunting. We want to encourage you to give this list to anyone it may be able to help. Please do not hesitate to reach out to Josh Mungavin and Evensky & Katz / Foldes Financial Wealth Management at (305) 448-8882 or jmungavin@ek-ff.com, if you have any questions or if you have any suggested changes/additions to this document that you think may help improve navigating other families through this difficult time.

Within the First 48 Hours

  • Arrange care. Should the deceased have dependents, pets, or a need for security at his or her premises, establish who will tend to these responsibilities.

 

  • Keep records and notes. Keep a log with detailed notes of people you speak to, including their contact information and pertinent conversations regarding your loved one’s passing. This will help the process proceed smoothly and completely. Keep all receipts! You may also find it helpful to keep records of people who lend assistance or send gifts, flowers, cards, donations, or food to your home so you can thank these supporters at a later time.
    • You may find it helpful to keep all post-death matters in a dedicated account or find a way to separate these expenses in order to maintain organized records to settle the estate.

 

  • Provide notice. Those you wish to contact may include family, friends, employer, executor, powers of attorney, or religious advisors.
    • Lean on family during this time. Allow others to help you make the decisions that follow in the days and months to come; you do not have to take on all duties alone.

 

  • Locate documents.
    • The deceased’s attorney, CPA, or financial planner may be an invaluable resource in helping to locate documents such as deeds, titles, tax returns, will, and estate plan.
    • Remember to consider where the deceased typically kept important papers such as a safe-deposit box, file folder, or electronic storage device.
    • Other helpful or necessary documents are the birth and marriage certificates, military discharge papers, etc. Hopefully you can easily access an Emergency Binder that the deceased had compiled.

 

  • Refer to the deceased’s wishes. Consult any wishes the deceased may have provided for his or her passing such as organ donation, cremation, or location of burial, which you can also find in the documents section of his or her Emergency Binder.

 

  • Preparing for the remembrance. Depending on the detail of instruction left, the initial matters may be left to your discretion. These include:
    • Bereavement leave may be available from your employer. If so, notify your employer and arrange for care of children and pets in order to give yourself time to focus on the arrangements that need to be made.
    • Prepare and arrange for an obituary for those who would like to pay their last respects.
      • Depending on the known wishes of the deceased, you may indicate that donations to a specific charity can be made in lieu of flowers or other gifts.
    • If the deceased didn’t document his or her wishes for final resting, with the assistance of family and friends, contact funeral homes and plan final arrangements. Set up appointments to research various funeral home options to evaluate and compare services and costs.
      • Be aware that funeral homes can vary drastically in cost and funeral costs often are shockingly high. If you feel uncomfortable with a decision, do not feel rushed or pushed into deciding. Just sign nothing, walk away, and either ask for the assistance of a loved one or take time to think before deciding. It may help to ask around to see how other peoples’ experiences have been with specific funeral homes.
    • Check for potential VA burial benefits. Veterans may be eligible for funeral benefits that can drastically reduce cost, such as burial at a national cemetery or financial assistance toward burial elsewhere.
    • If your loved one was a veteran, please visit the website http://www.benefits.va.gov/compensation/claims-special-burial.asp and follow the instructions provided. This website will go into further detail about the claim process. You will notice there are different burial compensations the surviving spouse, children, or executor may or may not be eligible for, so read carefully. The heirs will need to locate the veteran’s original or certified copy of the DD-214, Award Letter (list of service/nonservice connected disabilities), and username and password for eBenefits (applying through eBenefits is the most efficient way to file a claim), an original death certificate, and a funeral receipt that has the veteran’s name on it. If you cannot locate the eBenefits information or have any other questions, please contact your local VA Disabled American Veterans office (DAV) to help you file a burial claim.
      • Steps if you have the eBenefits information:
        • Visit the eBenefits homepage at https://www.ebenefits.va.gov/ebenefits/homepage and log in.
        • Click on Apply for Benefits.
        • Scroll to the bottom and open burial benefits to start the claim process.
        • NOTE: The burial compensation is a reimbursement and depending on if the circumstances of the death (service or nonservice-connected), the benefits will only cover a portion of the funeral expenses. The reimbursement process could take up to six months.

 

  • Be cautious of cost. Final resting arrangements can prove costly. Carry a note pad during this time to keep a current accounting of cost; many services will ask for a deposit in advance. If, at any time, you feel uncomfortable with deciding immediately, do not feel forced into any decisions, especially a potentially costly one; take your time and ask a trusted advisor for assistance.
    • PLEASE BE AWARE: When financial institutions obtain proof of death, in almost all cases, the institution will freeze the assets owned by the deceased, so plan accordingly.

 

  • Temporary death certificates. Official death certificates can take a few weeks or months to receive. Temporary certificates are sufficient to deal with many pressing matters. An official copy, however, will likely be required to process insurance claims. Ask the funeral director to assist you with this matter. The funeral home also has the ability to prepare and issue a statement of death; obtain at least ten of these as well.

 

Within the First Week

  • Household Matters.
    • All expenses such as mortgage, taxes, insurance, utilities, and maintenance must remain current if the deceased owns real estate. If no one is living in the house for the immediate future, it may be sensible to suspend unused services and utilities.
      • Should your family be faced with the decision to sell assets, you may choose to consult an attorney first.
    • Check the deceased’s mail for items that may require immediate attention.

 

  • Contact the Deceased’s Employer. Collect all belongings that may remain at the work place and inquire about outstanding wages and group insurance plans.
    • If the deceased was self-employed, locate related ownership documents and arrange for short-term business continuation. The deceased’s business partners or attorney may be able to help facilitate this transition.

 

  • Evaluate Contents of Safe-Deposit Box. Assets held in this fashion should be distributed to the intended beneficiary quickly, as the printed death notice will trigger a hold on the contents to be used to satisfy debts of the deceased’s estate. Should you not be an authorized key holder or you are unable to access the box, you may need to petition the court to issue an order to open the box if it contains important documents.
    • Although creditors of the deceased must be paid, do not pay for or sign anything without obtaining a professional opinion on the matter.

 

  • Take Care of Yourself. Don’t forget to take time for yourself. Find a way to rest; everyone must grieve in his or her own way and on his or her own time.

 

Within the First Month

  • Official Death Certificates. Order a minimum of ten — but as many as twenty is advisable — original certified copies of the deceased’s death certificate. You will be asked for an official death certificate in countless instances such as transferring bank accounts or safe-deposit boxes, transferring title to vehicles and real estate, claiming insurance proceeds, redeeming investable assets, and filing final tax returns. The funeral home can ensure the forms are filed with the state. Your state’s vital statistics office can help you obtain as many duplicates as needed, for a fee.

 

  • Submit the Will to Probate. An estate attorney can assist you with submitting the will to probate or state district court. Because probate is governed by state law, states vary on the permitted time period for filing, but often this must be done within thirty days following death.
    • If a will exists, identify the executor to distribute the property and assist with other instructions for the estate.
  • If the party died intestate (without a will), state law will often govern who can manage the distribution of the estate.
  • Probate does not encompass those assets that are owned by a trust, held as property of tenants-in-common, or pass by operation of law. Consult your attorney regarding assets not included in the probate process, but common examples are:
    • life insurance proceeds,
    • retirement accounts that have named beneficiaries, pension distributions, and unpaid wages,
    • trust-owned property,
    • assets specified as transfer-on-death (TOD) or payable-on-death (POD), or
    • property held in joint tenancy with right of survivorship, community property with right of survivorship, or tenants by the entirety with a spouse.

 

  • Life Insurance. Remember that proceeds from life insurance are probably not part of the probate process. Often, collecting death benefits can be as simple as completing the necessary claims forms and submitting them with an original or certified copy of the death certificate. Each company will have a slightly different process for claiming death benefits. Therefore, attached you will find a letter template that you can use to notify the insurance company of the death and request specific instructions on how to properly file the claim.
    • If you are unsure of a potential group policy provided by an employer, you may need to contact companies in the deceased’s employment history to inquire. Additionally, in the case of a group policy, you will find a sample letter attached to use for your convenience.
  • Medical Bills. If an ailment preceded the passing of your loved one, health insurance may cover part or all of the medical costs. Begin by contacting the business office at the hospital or clinic where he or she was treated and request outstanding balances. Then compare bank records and insurance to determine which have been reimbursed or paid. Reconciling all billing and payment information will help in completing the required claim documents.
  • Discontinue Amenities. Cancel those services that are no longer necessary or were only utilized by the deceased (e.g., cable and Internet service or gym, club, or fraternity memberships) while continuing certain services (e.g., electricity, water, or lawn service) that may be necessary to maintain his or her property.
  • Social Security. Contact the Social Security Administration at ssa.gov or 800.772.1213 to report the death and file for survivor benefits. Additional or different benefits may be available for the surviving spouse or minor children. You must, however, contact the Social Security office to request information as these benefits are not automatically issued. Be sure to have Social Security numbers on hand before calling and, should you qualify for benefits, it may be necessary to make an appointment to visit the Social Security office. Be sure to get explicit instructions on what you will need to bring with you to your appointment. The funeral director will often inform the Social Security office of your loved one’s passing as the Social Security Administration needs to know as soon as possible to ensure the relatives of the deceased receive all benefits to which they are entitled. Keep in mind that not all survivors are eligible for benefits, so do not accept benefits that you are not certain about after the death of your loved one.
  • Notify Financial and Lending Institutions. (The following will all likely require a death certificate and letters testamentary.)
    • Pension administrators; be sure to ask about specific survivor benefits of which you may not be aware.
    • Banks, savings, and investment institutions and custodians (notification needs to be provided for all joint and individually-owned accounts).
      • Be aware that the contents of these accounts may be frozen, so you should plan accordingly so as to avoid the need for such funds.
      • New accounts in the names of the heirs will likely be required.
    • Credit card companies
      • Occasionally credit cards offer accidental death insurance which will relieve any outstanding balance upon the cardholder’s death.
    • Mortgage or other debt obligations
      • Debts are now the responsibility of the estate and outstanding balances must be paid utilizing the assets of the estate. In the case of a married survivor, the debts often transfer to the surviving spouse, so consult an attorney with questions about potential creditor claims and protection.
    • If the deceased’s child is at a university, the school may be able to offer different financial aid options due to the change in circumstances.

 

Within the First Three Months

  • Notify credit bureaus, the Veterans’ Administration (if you have not done so already for burial benefits), and other government agencies for potential death benefits.
    • Credit bureaus: it is a good idea to request a copy of the descendant’s credit report and notify each entity of the individual’s passing. If the Social Security Administration has been notified of the passing, his or her Social Security number will be flagged to help prevent identity theft.
      • Equifax,
      • Experian, or
      • Trans Union
    • Cancel the deceased’s driver’s license.

 

  • File Final Tax Returns. An estate attorney or accountant can help you with filing the deceased’s final state and federal tax returns. Final tax returns are typically due within nine months of the date of death.
  • Evaluate Your Financial and Estate Situation. If not already resolved with the estate or probate proceedings, now is the time to approach potentially selling real or personal assets. Should you decide to keep real estate or other titled assets, you will need a death certificate to transfer the assets into the new owner’s name. This process may begin by evaluating and cataloging what the deceased owned.
    • For all assets that you will retain, such as real property, vehicles, or valuable personal property, you will need to transfer the insurance on those items to the new owner’s name. Occasionally, the insurance company will not allow changes to the owner of the policy but instead will require an entirely new policy.
      • The estate executor may need to catalog and appraise certain assets within ninety days of death to distribute on behalf of the estate.
    • Meet with your financial advisors and lawyers. Review all aspects of your own estate such as your estate plan, will, inheritance, financial needs, and investment options.
    • Try to organize your affairs to the best of your ability to help the next generation deal with your passing.
  • Send thank-you notes to those who have supported you since the loss of your loved one.

 

Other sources of helpful information include:

  1. County Clerk’s office for birth and marriage certificates
  2. National Personnel Record Center (for military discharge records)

https://www.archives.gov/st-louis/

https://www.archives.gov/veterans/military-service-records/index.html

314-801-0800

  1. Department of Veterans’ Affairs

http://www.va.gov/

800-827-1000

Feel free to contact Josh Mungavin CFP®, CRC® with any questions by phone 305.448.8882 ext. 219 or email: JMungavin@EK-FF.com.

 

Taxes: It Pays to Treat Them Right

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Harold Evensky CFP® , AIF® Chairman

I know how most people feel about taxes: don’t tax me, don’t tax thee, tax the man behind the tree. Unfortunately, ultimately we gotta pay. Everyone’s interested in minimizing the pain and that’s why I’m sitting here trying to put together a talk on tax planning for our local Rotary Club. It’s a great group of sophisticated professionals, and I don’t want to talk down to them, but I do want to provide some useful information.

Trying to balance those issues reminded me of a complaint one of my client’s accountant had about how we had selected some of his bond investments. I remembered that sophisticated doesn’t necessarily mean knowledgeable. So here’s what I came up with:

Don’t Let the Tax Tail Wag the Dog

The accountant’s complaint about our choice of bonds was a result of his focusing on the tax tail. Our client was in a moderately high tax bracket; however, we had his short-term, fixed-income investments in corporate bonds. “Move ’em to tax-free municipals” was the accountant’s advice. Well, it’s true, our clients would have paid less tax if we’d invested them in municipal bonds, but they would also have had a lower after-tax return. Why? At the time, taxable bonds were paying 5 percent and similar quality and maturity municipals were paying 3¼ percent. That meant our 30 percent marginal tax bracket client had a choice of earning 3¼ percent with no tax obligation or 5 percent with the obligation of paying 30 percent of his interest payments to Uncle Sam. Which would you choose? I hope the 5 percent.

Even if you peel off the 30 percent tax bite, that would leave 3½ percent in your pocket. It’s not rocket science to see that 3½ percent is better than 3¼ percent. The moral? When choosing between equivalent-quality taxable and tax-free investments, don’t worry about how much you’ll have to pay Uncle Sam (even if painful). Instead, keep your eye focused on how much you’ll have after paying taxes.

Turnover Doesn’t Tell All

It’s common for investors to use turnover as a measure of tax efficiency. Don’t do it. When you look at an investment’s turnover number, it’s natural to think it represents a pro-rata turnover of all the securities in the portfolio. For example, a 60 percent turnover would mean that 60 percent of the positions in the portfolio are sold in one year. Sound reasonable? As my brother, the economist, would say, au contraire. A 60 percent turnover doesn’t necessarily mean that 60 percent of the stocks have been traded. It might well mean 20 percent of the stocks have been traded three times. All of those trades may have been the sale of stocks with losses, not gains, so the manager not only generated no tax bite, he also realized losses that can shelter future gains.

And the Rest of the Story (the Most Important Part)

Taxes are a function of something called a holding period, not turnover. The holding period is the average number of years it would require to turn over all of the positions in the portfolio. To explain: let’s assume that the manager has a portfolio chock full of stocks with taxable gains and he is trading all of the stock in his portfolio pro rata. So a 20 percent portfolio turnover would mean one-fifth of the stocks would be sold each year, or 100 percent in five years. That means, on average, the manager holds stocks for two and a half years.

Obviously, a portfolio with a 90 percent turnover would realize pretty much all of the gains in the first year, which means lots of taxes; consequently, a 50 percent turnover sounds a lot better. But if you think about it, 50 percent means selling one-half this year and paying the taxes, and one-half next year with more taxes. The difference between paying all of the taxes in year one versus one-half of them in year one and one-half in year two is negligible. The graph below shows the relationship. Unless turnover is very low—less than 10–15 percent, there is no real tax efficiency.

The moral? Avoid the murky middle. A few years ago, my partner, Deena Katz, and I co-edited a book called the Investment Think Tank (Bloomberg Press). We invited several friends (practitioners and academics) to contribute chapters on subjects they believed were of vital importance for advisors.

Recognizing the importance of the holding period, Jean Brunel, managing principal of Brunel Associates, introduced the concept of the murky middle. He noted that the more active the manager, the more you’d expect him to add value. After all, why would you want to pay the trading cost and suffer the tax inefficiency of active trading if you weren’t rewarded with extra net returns? He also noted the reality of the elbow graph above: no matter the manager’s intention, as turnover increases a tax-efficient manager will be no more tax efficient than a tax-oblivious manager.

Brunel’s excellent advice is to avoid the murky middle—hire very low-turnover managers (indexes and ETFs) when you want to just capture market returns. Hire go-go, active managers with the funds you’re prepared to invest at higher risk to earn better-than-market returns. Stay away from those managers who, for marketing purposes, try to straddle the fence, going for both tax efficiency and extra return. They may have performance numbers that look good before taxes, but after taxes, the numbers don’t look so good. Here’s how Brunel depicts the murky middle:

I think my Rotary audience will like this talk. For more on the murky middle, check out Chapter 3, “Net, Net, Net: Expenses, Taxes, and Inflation Can Eat Your Nest Egg – What To Do?”

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

Real Cash Flow: A Fix for the Fixed Income

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Harold Evensky CFP® , AIF® Chairman

Charlie Jacobs (CJ): Hello, Harold. May I call you Harold?

Harold Evensky: I guess it depends. Who are you and how did you end up in my office?

CJ: My name is Charlie Jacobs. I’m a wholesaler for the Special Income Portfolio.

HE: Charlie, I have to ask you this: how did you get past the receptionist? I don’t normally take cold meetings with mutual fund wholesalers or fund salespeople. I prefer to speak to them after I’ve done my own preliminary analysis.

CJ: Actually, I waited until your receptionist was distracted by another guest, and then I crawled along the floor until I reached the hallway and slipped past the doors of your other coworkers as soon as they turned their heads away from the door.

HE: That’s quite remarkable. All right, Ninja wholesaler, now that you’re here, have a seat. What can I do for you?

CJ: I’m here to convince you to recommend the Special Income Portfolio to all of your clients. I even brought some golf balls as a nice gift to get the conversation started.

HE: You can keep the golf balls. Just tell me the facts about your fund. This could turn into a very quick visit.

CJ: It’s an income fund. Some of your clients are retired, aren’t they?

HE: Yes, they are.

CJ: And they need income from their investments to supplement their pension and Social Security to support their lifestyle. By the way, if you don’t play golf, I brought candy. Or maybe you’re interested in one of these cute little jump drives with our company’s logo on it.

HE: My retired clients need cash flow from their investments to supplement their other income sources, and I don’t want or need candy or one of those jump drives.

CJ: Well, the Special Income Portfolio is carefully designed to give your clients exactly what they need in the form of dividends and interest. It’s invested in companies that pay high dividends and bonds that pay high income. I have a little form you can fill out so you can start moving your clients’ assets over right away—

HE: Hold on a minute. You just hit one of my hot buttons. Maybe you should sit back and relax. This could take longer than either of us expected.

CJ: What do you mean?

HE: I have to confess that I’ve got a lot of pet peeves about the kind of nonsense that gets foisted on the public as good investment advice. But one of my biggest is what I call the myth of dividends and interest.

CJ: I can assure you that our portfolio manager doesn’t invest in myths.

HE: What you’re saying probably sounds plausible to 99 percent of the investing public. Of course, many investors need cash flow from their portfolio. So you put the words income fund in the name of a mutual fund, and it sounds exactly like what people need.

CJ: It is what people need.

HE: I disagree. We plan for a lot more than a fixed income. We plan for a consistent real income.

CJ: I’m not sure I follow you.

HE: I’ll make it easy. Does the carton of milk you bought last week, your last doctor’s visit, or your last new car cost more than it did five, ten, or fifteen years ago?

CJ: Of course.

HE: And do you think all those things and everything else will cost more in the next twenty to thirty years?

CJ: Probably lots more.

HE: Today’s dollar isn’t what it used to be and tomorrow it won’t be worth what it is today. Do you agree? Don’t you think you and I and everyone else will need more of those greenbacks in the future just to hold our own?

CJ: Yes, I suppose we will.

HE: How long have you been doing this work as a wholesaler?

CJ: Oh, I have weeks of experience. I know my way around, let me assure you.

HE: Somewhere in your sales training, you heard that professionals use the term real dollars to mean an amount of money that will buy the same goods and services (milk, doctor’s visits, and cars) in the future as it will today. A real dollar means the same purchasing power going forward.

CJ: I think I have that somewhere in my notes, yes. But I think you’re missing the point. When someone retires, he or she needs a fixed income.

HE: What horsepucky!

CJ: Excuse me?

HE: Dangerous advice like that really infuriates me. If people plan a retirement based on a fixed income, they had better be planning on changing their diet from steaks to cat food throughout the balance of their lifetime. What retirees need is an income that will increase every year by the inflation rate. Other than winning the lottery, that’s the only way people can maintain their standard of living.

CJ: We also have a lottery fund that invests in a diversified portfolio of state lottery tickets that I could show you—

HE: Let’s go back to deciding what kind of investments my clients need to make in order to supplement their pension and Social Security income. Suppose they buy into this myth you’re selling and construct an “income” portfolio.

CJ: Great idea! That’s exactly the fund I want to talk to you about.

HE: Now they have a portfolio bond/stock allocation that is largely fixed by design—inappropriate design. In almost all cases, it will cause an inferior portfolio for two reasons: Not only will the portfolio not allow them to accomplish their goals in real dollars, but it will also be inefficient.

CJ: Okay, I understand that you have objections.

HE: What do you mean?

CJ: The sales training said that I should overcome your objections, and the first step is to get your objections out in the open. So tell me your objections.

HE: With pleasure. In fact, I’ll draw you a picture. Here’s an example I use when discussing this issue with my clients. Consider a simple world in which you have only three investment choices—a money market, Bond Fund A, and Stock Fund B. In this world, the investments will provide exactly the returns I’m writing down in this simple table:

Does that look right?

CJ: It could be.

HE: Now suppose you’ve saved $200,000 for retirement and you need $14,000 a year from your savings to add to your Social Security and pension income. If you planned to get your needed $14,000 cash flow from dividends and interest, you would have to invest 100 percent in the Bond Fund. The reason is because, as you can see from this table I’m now drawing, the cash flow from Stock Fund B’s dividend payments is so low, any amount invested in stocks would drop your cash flow to an amount less than the $14,000 you need.

 

Bond A Cash Flow Stock B Cash Flow

Allocation from Bond Allocation from Stock Total Cash Flow

90 percent $12,600 10 percent $ 600    $13,200

50 percent $7,000   50 percent $3,000  $10,000

40 percent $5,600   60 percent $3,600  $9,200

CJ: Doesn’t that make my point?

HE: No. Because if you look at the future, then the purchasing power of that $14,000 starts to decline. Let’s say you’re retired, and I recommend the all Bond Fund. You might feel good today receiving the $14,000 you need; however, how would you feel ten years later if inflation had been 3 percent and your $14,000 only bought $10,417 worth of stuff?

CJ: I’d be calling my attorney to see if I had grounds for a lawsuit against you.

HE: And what happens twenty years later, when your diet has switched from steak to cat food, because that’s all you can afford?

CJ: I don’t like where this is going.

HE: I don’t want to give my clients fixed income when they need real income from a long-term portfolio that has an allocation to investments that are likely to rise in value and provide protection against inflation. In other words, I don’t want to guarantee that my clients will suffer losses in real-dollar terms. And that’s what you’re offering me.

CJ: Is that your objection?

HE: My objection is that investors do not need dividends or interest—they need real cash flow. So they shouldn’t fall for this myth that you’re selling about dividends and interest. Now you can feel free to overcome my objections, if you want. And please put those golf balls away.

CJ: Actually, I was wondering if I should move my money out of the fund.

HE: If you’re planning to live more than a couple of years, you might think about it.

CJ: Thanks, Harold. Thanks for the advice. Are you sure you don’t want one of these jump drives?

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.

 

 

Pay Taxes Now or Later? Traditional 401k vs. Roth 401k

Katherine Sojo

Katherine Sojo, CFP® Financial Advisor

If your employer offers you a traditional 401k and a Roth 401k, you might find yourself wondering what the difference is and why it matters. Traditional and Roth 401ks have several similarities such as that they are only offered by employers, the contribution limits are the same ($18,000 for 2017 plus $6,000 if you are over the age of 50), and the employer match is always pretax regardless of which option you choose. The biggest difference between a Traditional 401k and a Roth 401k is the timing of payment of taxes. In a Traditional 401k, your contribution is termed as pre-tax dollars; you receive an upfront tax break, reduce your taxable income, and pay the taxes when you take the funds out during retirement. The money withdrawn at retirement from a Traditional 401k is taxed as ordinary income using your tax rate at that time. A contribution to a Roth 401k is termed as after-tax dollars; this means you pay taxes on the contribution now, at your current tax rate, and therefore during retirement you withdraw the money and the earnings tax-free.

How do I decide? Ask yourself the following questions:

  1. Do I want to pay taxes now or later? What is my tax rate differential? If you believe you are in a lower tax bracket today and will be in a higher tax bracket during retirement, then paying the taxes now by funding a Roth 401k is a good option. If you believe you are in a higher tax bracket today and will be in a lower tax bracket during retirement, then funding a Traditional 401k and paying the taxes later is a good option.
  2. Can you afford to pay the taxes now? Knowing what the actual tax dollar benefit of a pre-tax or after-tax contribution means for your pocket is also a deciding factor (your tax advisor can help with this calculation). If you pay the tax now (Roth 401k), then your paycheck will decrease; therefore, you will have less money to cover expenses and/or less money for additional outside savings. A traditional 401k provides for a current tax deduction that results in some extra cash in your pocket now.
  3. Do you distrust future tax regulations? Do you believe taxes will increase in the future? If so, then taking advantage of a lower tax bracket now will signify contributing to a Roth 401k. Do you believe taxes will decrease in the future? If so, then hold off on paying taxes on the contribution until retirement and utilize a Traditional 401k.

There is also an argument for using a combination of both a traditional 401k and a Roth 401k to diversify your tax exposure. A combination of the two can provide some upfront tax benefit and also some protection on any tax rate changes in the future. It is not a simple decision, but truly thinking about your answers to the questions above can help you make the best decision possible for your retirement planning.

Feel free to contact Katherine Sojo, CFP® with any questions by phone 305.448.8882 ext. 243 or email: KSojo@EK-FF.com.

Advisors: Who’s Who Anyway?

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If you decide you’d like to get some professional advice, it would probably be nice to have some idea where to begin.

 

John Smith (JS): Hello, Harold.

Harold Evensky (HE): Hi, and who am I speaking with?

JS: I’m John Smith, a reporter with the Florida Times Journal Gazette. I need a sentence or two on who provides investment advice to consumers.

HE: A sentence or two? This is a pretty big topic. It’s often confusing even to us professionals.

JS: Maybe you can give me the gist of it.

HE: Well, I guess we could start with professionals known as money managers. They’re the people who know all about picking stocks and bonds. They may not know what kinds of stocks or bonds you should be buying or even if you should be invested in stocks or bonds at all, but if you need to make those investments, money managers are the experts to hire.

JS: Okay. Where would you go to find these people?

HE: For most investors, the best place to find an experienced money manager is a mutual fund.

JS: A what?

HE: If you’re a financial reporter, you must have heard of them. They’re portfolios of stocks or bonds or international stocks or sometimes other assets, sometimes in combination, managed by some of the world’s best money managers. They might not know a thing about you, the actual investor, but the better ones sure know about their portfolio.

JS: Okay, so I hire one of those—

HE: You don’t want just one. You need to diversify sectors and styles. The good news is you can hire lots of these managers, each one a specialist in a different area of the economy: one for big U.S. companies, another to pick stocks in small U.S. companies, a third to find you the best foreign stocks, and then others who specialize in government bonds, or municipal bonds, or different flavors of corporate bonds. When you check out those managers, keep an eye out for a CFA designation. That stands for Chartered Financial Analyst and is an internationally respected credential for money managers.

JS: I see. Okay. I want to thank you—

HE: Wait. That’s only one of many types of professionals you may need.

JS: What else could I want?

HE: Knowing how to pick stocks and bonds is terrific, but for individuals the most important question is how you decide how much to invest in stocks versus bonds.

JS: The money manager won’t help me with that?

HE: That’s the job of the expert known as the financial planner. That’s a professional who is educated and experienced in helping individuals—such as your readers—make good financial decisions.

JS: Let me write this down. This is good stuff. So how does this financial planner decide if I should be in whatever those international or small things were?

HE: Financial planners follow a six-step process to help advice their clients. A credentialing body called the CFP Board of Standards—which I chaired some years back—defines this process. Basically it means that the financial planner gathers your personal and financial data, helps you define your goals, and analyzes where you are today financially. Only then will this person make recommendations and give you alternatives. When do you want to retire? What kind of lifestyle do you want to be able to afford when you do?

JS: And then I hire the money manager?

HE: Again, it’s not manager but managers, and, yes, you could hire them on your own. However, with thousands of choices, most investors are better served letting a professional do the hiring for them. The financial planner will usually recommend a portfolio that will include several money managers in which he or she has confidence, in various investment sectors. Then the planner will monitor your progress toward your goals and watch over the money managers to make sure they’re doing the best possible job for you.

JS: I’m not totally sure I understand the difference.

HE: The money manager is an expert on portfolios, but doesn’t know a thing about you. For example, are you in a low or high tax bracket?

JS: I think I’m in a low one.

HE: Do you already have other investments that might overlap with the money manager’s stocks? Do you need current cash flow from the investments? Are you comfortable with market volatility?

JS: Even I don’t know the answer to these questions.

HE: The financial planner helps you understand and answer these questions. I could go on and on, but you get the point. It’s the financial planner—the expert on people’s financial needs—who will know all of that and much more about you.

JS: Do these financial planners also get the CFA designation?

HE: No, that’s the professional designation for a money manager. In my opinion, the certified financial planner (CFP®) credential represents financial planning’s highest standard. A professional holding the CFP mark has demonstrated not only knowledge of investments and planning but also an ability to apply that knowledge for your benefit.

JS: Does that mean that you’re a CFP planner?

HE: Yes. But in fairness, there are two other respected credentials in the profession: the insurance industry’s ChFC (chartered financial consultant) and the accounting profession’s PFS (personal financial specialist).

JS: I think I have more than my two sentences. If there’s anything else—

HE: There’s a lot else.

JS: [Sigh.]

HE: Tell me about it. It’s amazingly confusing for the poor consumer. Other types of designations reflect statutory registration or licensing requirements.

JS: Licensing? You mean like a licensed hair stylist?

HE: Some of these are actually sales licenses. Examples are the Series 7 licenses, which are required for advisors who earn commissions for selling investments, and the RIA (Registered Investment Advisor), a registration required of individuals who charge fees for providing investment advice. Depending on the business model used, a professional might be registered as an investment advisor as well as holding a securities license.

JS: I hope we’re finished. Please tell me we’re finished.

HE: Well, we haven’t actually talked about what kind of professional I happen to be.

JS: Sigh. Which is?

HE: A wealth manager. The term wealth manager, as we use it, was introduced in a book, by that same name that I wrote for other professionals in the late 1990s. I defined it as a financial planning professional whose business specializes in a client’s needs regarding investment and retirement planning.

JS: So that means you are—

HE: I’m a CFP licensee, and my firm is a financial planning firm specializing in what we call wealth management.

JS: I don’t think any sane person could keep track of all this.

HE: If you have to remember only one thing, then understand that current laws do not ensure that all professionals providing investment advice are looking out for your best interests.

JS: Don’t I want somebody serving my best interests? I don’t want to pay somebody to convince me to buy something that earns more for their company than it does for me.

HE: Now you’re getting it.

JS: So what do I do?

HE: If you want my best advice, no matter who you ultimately select to guide you, your best protection is to ask the advisor to sign a simple, “mom-and-pop” commitment acknowledging that they’re really looking out for your best interest.

JS: Can you send me a copy?

HE: I will. Be sure and use it for your own protection.

And I did. Below is the document I sent.

 

I believe in placing your best interests first. Therefore, I am proud to commit to the following five principles:

  1. I will always put your best interests first.
  2. I will act with prudence—with the skill, care, diligence, and good judgment of a professional.
  3. I will not mislead you, and I will provide conspicuous, full, and fair disclosure of all important facts.
  4. I will avoid conflicts of interest.
  5. I will fully disclose and fairly manage, in your favor, any unavoidable conflicts.

Advisor____________________________

This blog is a chapter from Harold Evensky’s “Hello Harold: A Veteran Financial Advisor Shares Stories to Help Make You Be a Better Investor”. Available for purchase on Amazon.