An old stock market dictum says that spring is for profit-taking, or at least a time to reduce your exposure to equities.
In the classic market psychology, you “sell in May and go away” with the belief that stock prices will plateau or retreat in spring and summer, and then you return to stocks in the fall, taking advantage of bargains and factors that will encourage a hot fourth quarter.
In the last several years, we have seen all kinds of stock market behavior, some of it extraordinary. So is there any credence to this approach now?
The argument for “going away”
Over the last 12 months, investors who held to this belief made out pretty well. From May 1-November 1, 2011, the Dow lost 6.7%. From November 2011 through April 27, 2012, it gained 10.7%. Looking back to 1926, we see the S&P 500 rising 4.3% on average during May-October and gaining an average of 7.1% from November-April. A principal advocate of this strategy is Sam Stovall, who is the chief equity strategist at S&P Capital IQ. As Stovall just noted to Forbes, since 1945 the S&P 500 has gained just 1.2% during the average May-October run yet advanced 6.9% during the average November-April period.
While these numbers are pretty compelling, you know what they say about statistics.
Is the argument principally flawed?
If you do sell in May, where do you put your money after dumping those stocks? The strategy assumes you know of a better place – an alternative to equities offering greater yield and less risk.
Money managers tend to be convinced that this strategy is pretty much a consequence of data mining and randomness. If you look at calendar years from 1950-2007 with the hypothesis of reinvesting money pulled out of equities into 30-year Treasuries during the assumed 6-month market lull, those that held an S&P 500 index fund would have outperformed the “sell in May” crowd in the time frames 1950-2007, 1980-2007 and 1990-2007, with the “sell in May” adherents triumphing in the time frames of 1960-2007, 1970-2007 and 2000-2007.
The case for staying in the market
Even if the performance numbers were absolutely predictable annually, what would the compelling argument be for ditching stocks? Gains have occurred in spring and summer; are just lesser gains.
Let’s go from hypothesis to reality, specifically what is occurring right now. An investor wanting a divorce from risk for the next six months could decide to bail from stocks and put the assets into short-term Treasuries and money market accounts. Would it be worth it? Probably not. The best money market accounts are yielding no more than 1%. Throw in brokerage charges and taxes you might incur from selling, and getting in and out of equities looks much less attractive.
Once you’re out, when do you get back in? What if mid-October brings a rally? Do you jump in and buy? What if the bears show up at the start of November? How long do you wait for what might be the market low?
There’s also strong reason to believe that U.S. economic indicators (or even global ones) might be better than expected this summer? What if the EU arranges a manageable fix for Spain’s debt dilemma? What if the real estate market shows signs of heating up in the coming quarters? What if the Fed opts for more easing?
If the “sell in May” strategy sounds more like market timing to you than anything else, it does have some history supporting it – history worth considering. The fact remains, however, that history is no barometer of future stock market performance.
As always, please don’t hesitate to reach out.
A number of significant federal income tax provisions expired at the end of 2011, a fact that might be easily overlooked with so much attention being focused on the “Bush tax cuts” that are still in effect, but scheduled to expire at the end of 2012. And new Medicare-related taxes, effective in 2013, have received surprisingly little coverage. Of course, new legislation could always extend some or all of these provisions, but here’s a quick summary of how things stand.
Already expired
Alternative minimum tax (AMT)–A series of temporary legislative “patches” over the last several years has prevented a dramatic increase in the number of individuals subject to the AMT–essentially a parallel federal income tax system with its own rates and rules. The last such patch expired at the end of 2011. Unless new legislation is passed, your odds of being caught in the AMT net greatly increase in 2012, because AMT exemption amounts will be significantly lower, and you won’t be able to offset the AMT with most nonrefundable personal tax credits.
Qualified charitable distributions–This popular provision allowing individuals age 70½ or older to make qualified charitable distributions of up to $100,000 from an IRA directly to a qualified charity expired at the end of 2011. These charitable distributions were excluded from income and counted toward satisfying any required minimum distributions that you would have had to take from your IRA for the year.
Bonus depreciation and IRC Section 179 expense limits– If you’re a small business owner or self-employed individual, you were allowed a first-year depreciation deduction of 100% of the cost of qualifying property acquired and placed in service during 2011; this “bonus” depreciation drops to 50% for property acquired and placed in service during 2012, and disappears altogether in 2013. For 2011, the maximum amount that you could expense under IRC Section 179 was $500,000; in 2012, the maximum is $139,000; and in 2013, the maximum will be $25,000.
State and local sales tax–If you itemize your deductions, 2011 was the last tax year for which you could elect to deduct state and local general sales tax in lieu of state and local income tax.
Education deductions–The above-the-line deduction (maximum $4,000 deduction) for qualified higher education expenses and the above-the-line deduction for up to $250 of out-of-pocket classroom expenses paid by education professionals both expired at the end of 2011.
Expiring at the end of 2012
Federal income tax rates–After December 31, 2012, we’re scheduled to go from six federal tax brackets (10%, 15%, 25%, 28%, 33%, and 35%) to five (15%, 28%, 31%, 36%, and 39.6%).
Long-term capital gains rate–Currently, long-term capital gain is generally taxed at a maximum rate of 15%. And, if you’re in the 10% or 15% marginal income tax bracket, a special 0% rate generally applies. Starting in 2013, however, the maximum rate on long-term capital gains will generally increase to 20%, with a 10% rate applying to those in the lowest (15%) tax bracket (though slightly lower rates might apply to qualifying property held for five or more years). And while the current lower long-term capital gain rates now apply to qualifying dividends, starting in 2013, dividends will be taxed at ordinary income tax rates.
2% payroll tax reduction–The recently extended 2% reduction in the Social Security portion of the Federal Insurance Contributions Act (FICA) payroll tax expires at the end of 2012.
Itemized deductions and personal exemptions–Beginning in 2013, itemized deductions and personal and dependency exemptions will once again be phased out for individuals with high adjusted gross incomes (AGIs).
Tax credits and deductions–The earned income tax credit, the child tax credit, and the American Opportunity (Hope) tax credit revert to old, lower limits and (less generous) rules of application. Also gone in 2013 is the ability to deduct interest on student loans after the first 60 months of repayment.
Marriage penalty relief–Tax changes that were originally made to address a perceived “marriage penalty” expire at the end of 2012. If you’re married and file a joint return with your spouse, you’ll see the effect in the form of a reduced 2013 standard deduction amount, as well as in lower 2013 tax bracket thresholds in the tax rate tables (i.e., couples move into higher rate brackets at lower levels of income).
New taxes effective in 2013
Two new Medicare-related taxes created by the health-care reform legislation passed in 2010 take effect in 2013:
Additional Medicare payroll tax–The hospital insurance (HI) portion of the payroll tax–commonly referred to as the Medicare portion–increases by 0.9% (from 1.45% to 2.35%) for those with wages exceeding $200,000 ($250,000 for married couples filing jointly, and $125,000 for married individuals filing separately). The rate for self-employed individuals increases from 2.9% to 3.8% on any self-employment income that exceeds the dollar thresholds above.
Medicare contribution tax on unearned income–A new 3.8% Medicare contribution tax is imposed on the unearned income of high-income individuals. The tax generally applies to the net investment income of individuals with modified adjusted gross income that exceeds $200,000 ($250,000 for married couples filing jointly, and $125,000 for married individuals filing separately).The above is based on sources deemed reliable, but we cannot guarantee it’s accuracy. Bradley & Company, LLC does not provide tax or legal advice. Please consult your tax or legal adviser for guidance.
New participant disclosure rules apply to self-directed 401(k) plans. Employers generally must begin complying with these rules no later than August 30, 2012.
You may have heard about new participant disclosure rules that will soon apply to 401(k) plans. While we don’t anticipate any significant challenges for employers to comply, there are several changes of which plan decision-makers should make themselves aware.
Background
Before describing what’s ahead, a look back may be helpful. (While we’ll refer to 401(k) plans, these rules also apply to certain other plans, known as self-directed plans, which allow participants to direct their own investments.)
Most 401(k) plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA) (governmental plans, single participant plans, certain 403(b) plans, and certain church plans are not). One of the reasons Congress enacted ERISA was to protect retirement plan assets, and one of the important ways ERISA does so is through its rules governing the conduct of plan fiduciaries. Plan fiduciaries must discharge their duties with respect to the plan prudently and solely in the interest of participants and beneficiaries. In general, the plan fiduciaries include the plan administrator, anyone providing investment advice for a fee (such as Bradley & Company, LLC), and anyone who exercises discretionary authority or control over the plan or plan assets. A fiduciary that breaches his or her duty to the plan may be personally liable for any losses that occur as a result of that breach.
The investment of plan assets is a fiduciary act governed by ERISA’s fiduciary standards. But who is responsible when a plan allows participants to direct the investment of their own accounts? In 1992, the Department of Labor (DOL) issued regulations that allow 401(k) plan fiduciaries to avoid responsibility for losses in self-directed plans that occur as a result of a participant’s exercise of investment control over his or her own account. To avoid liability, plans must provide participants with a diversified choice of investments and very specific information about the plan and its investments (and comply with certain other requirements). While these rules are voluntary, many (if not most) 401(k) plans choose to comply in order to shift liability away from the plan fiduciaries. A 401(k) plan that complies with these rules is known as a “404(c) plan,” after the section of ERISA that governs self-directed plans. A plan’s summary plan description (SPD) should indicate if a plan intends to be a 404(c) plan.
However, as self-directed plans have grown more popular, the DOL became concerned that participants were becoming increasingly responsible for making their own retirement savings decisions, and might not have access to, or might not be considering, information critical to making informed decisions about the management of their accounts–particularly information on investment choices, fees, and expenses. As a result, in October 2010, the DOL issued new regulations that require that all self-directed 401(k) plans–both those that choose to comply with Section 404(c) and those that do not–provide the same detailed information to participants about the plan and its investments, on a regular and periodic basis, so that participants can make informed decisions with regard to the management of their individual accounts. Some information must be provided on an annual basis, and some information must be provided quarterly. For calendar year plans, the initial annual disclosure must be furnished no later than August 30, 2012. The first quarterly statement must be furnished no later than November 14, 2012 (for July through September 2012).
Overview
Participants in 401(k) plans that comply with Section 404(c) are already receiving most of the information required by the new regulations. In general, more detailed information about investment fees and expenses must now be disclosed to participants. Another change is that plan investment information must be provided in a chart, so that participants are better able to compare investment alternatives. And plans will no longer be required to automatically provide a prospectus to participants, although one must be provided upon request.
These new disclosure rules apply to 401(k) plans and other plans that allow participants to direct their own investments, but they do not apply to IRAs, SEPs, or SIMPLE IRA plans. They also do not apply to plans that are not covered by ERISA, including governmental plans, owner-only plans, certain 403(b) plans, and certain church plans.
The following is a DOL outline of the information that must be provided under the new rules. Note that employers have some flexibility in how this information will be provided (electronically, via the Web, on paper, in SPDs, in currently provided quarterly statements, etc.).
Plan-Related Information
The first general category of information that must be disclosed is plan-related information. This general category is further divided into three subcategories:
General Plan Information. Information about the structure and mechanics of the plan, such as an explanation of how to give investment instructions under the plan, a current list of the plan’s investment options, and a description of any “brokerage windows” or similar arrangement that enables the selection of investments beyond those designated by the plan.
Administrative Expenses Information. An explanation of any fees and expenses for general plan administrative services that may be charged to or deducted from all individual accounts. Examples include fees and expenses for legal, accounting, and recordkeeping services.
Individual Expenses Information. An explanation of any fees and expenses that may be charged to or deducted from the individual account of a specific participant based on the actions taken by that person. Examples include fees and expenses for plan loans and for processing qualified domestic relations orders.
The information in these three subcategories must be given to participants on or before the date they can first direct their investments, and then again annually thereafter.
In addition to the plan-related information that must be furnished up front and annually, participants must receive statements, at least quarterly, showing the dollar amount of the plan-related fees and expenses (whether “administrative” or “individual”) actually charged to or deducted from their individual accounts, along with a description of the services for which the charge or deduction was made. These specific disclosures may be included in quarterly benefit statements currently provided to plan participants.
Investment-Related Information
The second general category of information that must be disclosed is investment-related information. This category contains several subcategories of core information about each investment option under the plan, including:
Performance Data. For investment options that do not have fixed rates of return, such as mutual funds, 1-, 5-, and 10-year historical returns must be provided. For investment options that have a fixed or stated rate of return, the annual rate of return and the term of the investment must be disclosed.
Benchmark Information. For investment options that do not have a fixed rate of return, the name and returns of an appropriate broad-based securities market index over 1-, 5-, and 10-year periods (matching the Performance Data periods) must be provided. Investment options with fixed rates of return are not subject to this requirement.
Fee and Expense Information. For investment options that do not a have a fixed rate of return, the total annual operating expenses expressed as both a percentage of assets and as a dollar amount for each $1,000 invested must be provided, along with any shareholder-type fees or restrictions on the participant’s ability to purchase or withdraw from the investment. For investment options that have a fixed rate of return, any shareholder-type fees or restrictions on the participant’s ability to purchase or withdraw from the investment must be disclosed.
Internet Website Address. Investment-related information includes an Internet website address that is sufficiently specific to provide participants access to specific additional information about the investment options for participants who want additional, or more current, information.
Glossary. Investment-related information includes a general glossary of terms to assist participants in understanding the plan’s investment options, or an Internet website address that is sufficiently specific to provide access to such a glossary.
Investment-related information must be furnished to participants on or before the date they can first direct their investments, and then again annually thereafter.
Comparative Format Requirement
Investment-related information must be furnished to participants in a chart or similar format designed to facilitate a comparison of each investment option available under the plan.
Miscellaneous
After a participant has invested in a particular investment option, he or she must be provided any materials the plan receives regarding voting, tender, or similar rights in the option.
Upon request, the plan administrator must also furnish prospectuses, financial reports, and statements of valuation and of assets held by an investment option.
Information required to be provided to plan participants must also be provided to beneficiaries receiving benefits from the plan.
Should you “like” it?
In one of the most widely expected and anticipated transactions in stock market history, Facebook filed an S-1 form with the Securities and Exchange Commission on February 1, taking its first big step toward going public. It aims to raise $5 billion through its upcoming IPO. Some of the information in the document surprised investors and analysts:
Mark Zuckerberg will enjoy an unprecedented amount of control over the company after it goes public, maintaining a majority share regardless of future transactions. This is virtually unprecedented – particularly in light of the fact that he will even retain the ability to select his successor.
Facebook’s revenue is lower than was widely believed. It generated about $3.7 billion in sales, not the $4.5 that was widely expected.
The company’s revenue climbed from $777 million in 2009 to $3.71 billion in 2011.
Its annual profits went from $229 million (2009) to $1 billion (2011).
Its profits grew by 65% last year alone.
Unsurprisingly, its top source of revenue is advertising. (12% of Facebook’s 2011 revenues came from Zynga, a social network gaming company.)
This transaction will be the largest in technology sector history. The Google IPO raised $1.9 billion, and this IPO will likely dwarf that.
Will this IPO live up to all the hype?
It might; it might not. Let’s examine some other key tech IPOs and see how those shares have done since.
Google. The IPO set the share price at $85. Here in early February 2012, the share price is now around $580. A home run by any definition.
LinkedIn. On the day of the IPO, the share price climbed from $45 to a peak of $122.70 and settled at $94.25. At the start of February, LinkedIn was trading for about $72.
Pandora. Shares were offered at $16 in June 2011; eight months later, they were trading at $13.
Zillow. Shares were offered at $20 in July 2011 and ended at $35.77 on the day of the IPO; in early February, Zillow traded at around $30.
The individual investors get to get in after the shares take off; sometimes they pay a price.
IPOs are initially allocated to large, institutional investors and select individual clients. They usually enjoy a 15% discount to the initial price that the stock begins to trade on. That having been said, most IPOs tend to experience tremendous volatility in their initial days of trading, as many investors “flip” their shares and enthusiastic retail clients overpay due to a lack of sophistication in their trading strategy.
And while, the 1990s may seem like ancient history, yet there are examples from the past worth noting when it comes to IPOs.
University of Florida finance professor Jay Ritter has maintained a huge database on IPOs for decades. He did a study of 1,006 IPOs from 1988-1993 (these were all IPOs that raised $20 million or more) and found that the median IPO underperformed the Russell 3000 by 30% in the first three years after going public, and that 46% of the IPOs produced negative returns.
In 1999, 555 firms went public and the median share price gain for these issues on the day of the IPO was 30%. But what if you bought after the first day? If you did, the median gain after three months averaged 0%. Additionally, almost 75% of all U.S. Internet-related IPOs from mid-1995 to 1999 traded underneath their offering price at the moment of publication.
Does it make fundamental sense?
We’ve made select purchases for certain clients of Facebook shares through the secondary markets for about two years now, purchasing at valuations ranging from $50 to $80 billion in valuation. I fully expect that all of those investors will enjoy a positive return on their investment, but I think it’s far from certain that those who purchased at a $80 billion valuation will see their Facebook investment outperform their investments in other, less risky companies.
As MarketWatch columnist Mark Hulbert pointed out, Facebook’s IPO will be three times as expensive as Google’s and about 40 times as expensive as the average large IPO since 1975. As Hulbert found in the wake of a chat with Professor Ritter, Facebook’s price-to-sales ratio (PSR) looks to be about 26, with 2011 revenues of $3.71 billion and a reported IPO valuation of circa $100 billion. Google’s PSR was 8.7 at the time of its IPO.
Looking back, Ritter found 76 companies since 1975 with trailing 12-month sales from the date of their IPOs of $3 billion or more (in 2011 dollars), firms with more or less reliable revenue streams. Their average PSR: 1.0. AT&T Wireless was the highest of them at 8.9, and that was a 2000 IPO.
So in other words, Facebook would need staggeringly high revenues (or a consistently remarkable profit margin) for its shares to behave as well as Google shares did in those first few years out of the gate. Vastly in excess of the $1/per user profit that they currently make. This will likely compel them towards either being more intrusive or pervasive methods of generating income. We also expect that Facebook will also increasingly take advertising revenue from other firms, particularly Google, as their marketplace and ability to target advertising is generally superior to other online advertising venues. If we assume that Facebook should ultimately eclipse Google as an advertising medium (I do), then from a standpoint of comparables, Google’s market capitalization of approximately $200 billion seems appropriate relative to Facebook.
Could the tech sector see a “Facebook effect”?
Yes, remember the “wealth effect” of the Google IPO? Some of the “best and the brightest” in the tech sector became overnight millionaires and went off and founded their own profitable firms. That sort of thing could happen again; there are tens of thousands of start-ups now generating revenues off of Facebook’s platform, so you have a whole ecosystem of smaller firms that are anticipating the IPO as much as institutional investors.
What should I do?
We’re encouraging investors to avoid participating in the subsequent trading days following Facebook’s IPO. Individual investors have swung for the fences many times in situations like this, only to strike out. But many of the same criticisms were leveled at Google or LinkedIn ahead of their IPOs. We think that ultimately, Facebook will find a “reasonable” valuation in the markets in the weeks following its offering, and we fully expect to add it to our Growth model, once the stock has had a little while to mature. In short, tread carefully, but there’s much to “like” here.
Brokers must track and report cost basis to both you and the IRS
Part of the changes that came with the Health Care Act of 2011 is that cost basis information is now reported on 1099s, starting with the 2011 tax return due April 17. If you bought any stocks after January 1, 2011, and sold them later in the year, you should be receiving information from your broker shortly that tells you the adjusted cost basis of those stocks. Your adjusted cost basis, which affects the amount of tax you may owe on the sale, represents the original purchase price plus any commissions or other fees, and takes into account factors such as stock splits, corporate acquisitions or spinoffs, and reinvested dividends.
In the past, cost basis information has sometimes been available as a service; the Emergency Economic Stabilization Act of 2008 now requires all broker-dealers and other financial intermediaries to report the information on your 1099-B form. However, you won’t be the only one to receive that information; your broker also is required to report the same information to the Internal Revenue Service. Individual taxpayers (or their tax preparers) will still be responsible for accurately reporting the net proceeds of a sale on their federal income tax returns, but the IRS will now have a better way to double-check those figures.
In some cases, you’re still on your own this year
The new reporting requirements don’t mean you can empty your files completely. Because they’re being phased in, the rules don’t apply to stocks bought before January 1, 2011, for which you’ll still need to do your own calculations, or to securities held in retirement accounts. Cost basis reporting does go into effect this year for mutual funds and stock bought as part of a dividend reinvestment plan; however, it will apply only to shares bought after January 1, 2012, and will be reported on the 1099-B that will be available in 2013 for the tax year 2012. And cost basis for bonds, options, and other securities won’t have to be reported until 2013, so those will still need to be monitored independently.
Brokers also will be required to report losses that are disallowed as a result of a wash sale (which occurs when shares are sold and then repurchased within 30 days). However, they only have to do so if the newly acquired securities are identical to the securities sold (meaning the securities share the same CUSIP identification number). They also are not required to report adjusted cost basis for wash sales when the purchase and sale transactions occur in different accounts.
You can tailor your reporting method to suit your tax situation
Investors sometimes use cost basis to help manage their tax liability on a securities sale. If you’re one of them, the reporting requirements make it more important to determine in advance what accounting method you wish to use for each sale. Most broker-dealers will designate a default option to use if you do not specify a method. That default will typically be the so-called FIFO method (an acronym for “first in, first out”), which means that the first shares of a security purchased are considered the first shares sold. However, your broker might also allow you to specify LIFO (“last in, first out”) or designate specific shares as the ones sold. In some cases, such as shares bought through a direct reinvestment program, using an average cost basis for all shares may be most convenient (most mutual fund companies already employ this method of calculating cost basis).
If you don’t want to use your broker’s default method, you may be able to put in a standing order specifying the method you want to use for all trades, or choose on a case-by-case basis; you may also authorize your financial professional to make that decision for you. The rules permit investors to change the designated method for a given trade until the settlement date (the date on which money actually changes hands, which for a typical stock sale is three business days after execution of the trade). After the trade settles, you cannot change your mind about the method used.
Brokers also will be required to report to the IRS the cost basis of a short sale in the year in which the short is closed (in the past, it was done for the year a short sale was opened).
Recordkeeping is more important than ever – at the custodian
For many clients who’ve been used to managing the information with records maintained at their financial advisor or personally, there are likely to be challenges that come with the new cost basis reporting regime. It’s important to review the data provided by your broker to make sure that the data is accurate and reflects your preferences.
Obligations and Opportunities
After you turn 70½, the IRS requires you to withdraw some of the money in your retirement savings accounts each year. These withdrawals are officially called Required Minimum Distributions (RMDs).
While you never have to make withdrawals from a Roth IRA, you must take annual RMDs from traditional, SEP and SIMPLE IRAs, pension and profit-sharing plans and 401(k), 403(b) and 457 retirement plans annually past a certain age. Failure to do so results in severe financial penalties.
If you are still working as an employee at age 70½, you don’t have to take RMDs from a profit-sharing plan, a pension plan, or a 401(k), 403(b) or 457 plan. Your initial RMDs from these accounts will only be required after you retire. (One exception: you must take RMDs from these types of accounts if you own 5% or more of a business sponsoring such a retirement plan.) IRAs are different; you must take RMDs after 70½ regardless of whether you are still working or not.
The annual deadline is December 31, right?
Yes, with one notable exception. The IRS gives you 15 months instead of 12 to take your first RMD. Your first one must be taken in the calendar year after you turn 70½. So if you turned 70½ in 2011, you can take your initial RMD any time before April 1, 2013. However, if you put off your first RMD until next year you will still need to take your second RMD by December 31, 2013.
Calculating RMDs can be complicated
Most clients have more than one retirement savings account. You may have several. So this gets rather intricate.
Multiple IRAs Should you have more than one traditional, SEP or SIMPLE IRA, the annual RMDs for these accounts must be calculated separately. However, the IRS gives you some leeway about how to withdraw the money. You can withdraw 100% of your total yearly RMD amounts from just one IRA, or you can withdraw equal or unequal portions from each of the IRAs you own. This is because the IRS considers all your IRA accounts to be the same “arrangement”. (This creates much confusion for clients with regard to Roth IRA conversions.)
401(k)s and other qualified retirement plans A separate RMD must be calculated for each qualified retirement plan to which you have contributed. These RMD amounts must be paid out separately from the RMD(s) for your IRA(s).
Inherited IRAs The same applies; a separate RMD must be calculated for each inherited IRA you have, and these RMD amounts must be paid out separately from RMD(s) for your other IRA(s).
Selecting which investments to liquidate can be important. Depending upon the nature of the investments, it can make sense to liquidate some – particularly more or less liquid investments than others. This is why you should talk to your financial and tax advisor about your RMDs. It’s important to have your advisors review all of your retirement accounts to make sure you fulfill your RMD obligation. If you skip an RMD or withdraw less than what you should have, the IRS will find out and hit you with a stiff penalty: you will have to pay 50% of the amount not withdrawn.
Are RMDs taxable? Yes, the withdrawn amounts are characterized as taxable income under the Internal Revenue Code. Should you be wondering, RMD amounts can’t be rolled over into other tax-deferred accounts and excess RMD amounts can’t be forwarded to apply toward next year’s RMDs.
What if you don’t need the funds?
If your current income meets your needs, you may come to see RMDs as an annual financial nuisance, but the withdrawal amounts may be redirected toward opportunities. While putting the money into a savings account or a CD is the usual route, there are other options with potentially better yields or objectives. That RMD amount could be used to:
Make donations to charities
Start a grandchild’s education fund.
Fund a long term care insurance policy.
Leverage your estate using life insurance.
Diversify your portfolio through investment into stock market alternatives.
There are all kinds of things you could do with the money. The withdrawn funds could be linked to a new purpose. Depending upon your objectives, the funds may come to fit well within your overall tax and financial strategies.
A look at some financial changes & the opportunities they may present.
This year is projected to be one of great financial change, as is 2013. So here are some relevant changes relating to investment, tax and estate planning for 2012. And some ideas on how to manage these changes.
Retirement plans. 401(k), 403(b) and 457 plan annual contribution limits rise slightly to $17,000, and you can contribute an additional $5,500 to these accounts if you are 50 or older this year. IRA contribution levels are unchanged from 2011: the ceiling is $5,000, $6,000 if you will be 50 or older in 2012.
You will probably notice some changes with the retirement plan at your workplace. In 2012, retirement plan sponsors (i.e., employers) will have to note all of the fees and expenses linked to the funds in the plan to plan participants. So if you have a 401(k) or 403(b), you may notice some differences in the disclosures on your statements and you will probably notice more information coming your way about fees. There is also a push in Washington, D.C. to have financial companies provide lifetime income illustrations on retirement plan account statements, projections of your expected monthly benefit at retirement age.
Income taxes. Americans in the top ordinary income tax brackets are set to face much greater income tax burdens in 2013, so 2012 may be the last year to take advantage of certain factors. For example, the top tax bracket in 2013 is slated to be at 39.6% instead of the current 35%. This year, capital gains and dividends will be taxed at 15% or less for everyone, 0% for those in the 10% and 15% tax brackets. In 2013, the qualified capital gains tax rate is scheduled to rise to 20% and qualified dividends will be taxed as ordinary income. So realizing a little more income in 2012 could be smart.
In 2013, Americans with realized gains and ordinary income are legislated to be hit with new Medicare taxes: a new 3.8% levy on “unearned” income (such as capital gains, income from real estate, dividends and interest) and a new 0.9% tax on ordinary income. So next year, the top bracket is expected to be in the neighborhood of 45% for federal taxes and average tax rates are likely to be higher than 50% after state taxes are factored in.
Additionally, the IRS is planning to limit itemized deductions for upper-income taxpayers in 2013. A phase-out will also apply for the personal exemption deduction.
Portfolio management. The upcoming tax environment makes reallocation, and an emphasis on long term investing all the more attractive in future years. Accordingly, 2012 is a good year to realize capital gains and adjust portfolios to prepare for the new tax environment. This also is a good year to consider selling highly appreciated investments. Conversely consuming capital loss carryforwards is less desirable in 2012, because they are a more valuable ‘tax asset’ in future years.
Estate & gift taxes. At the end of 2012, several estate tax modifications could sunset. Barring action by Congress, 2013 could see a 20% leap in the federal estate tax rate from 35% to 55%. The individual estate tax exclusion (currently $5.12 million) is scheduled to be reduced to $1 million.
As we have unified gift and estate tax rates, those numbers and percentages also apply to gift taxes. That is, from 2012 to 2013 top federal gift tax rate is set to go from 35% to 55% and the lifetime gift tax exemption amount is scheduled to fall $4,120,000 per individual to $1 million. The annual gift tax exemption is $13,000 per recipient in 2012; there is an exemption limit for qualifying educational and medical payments. If you want to gift relatives or friends, you may want to avoid procrastinating for another very good reason: when you make such a gift early in a year, the recipient will gain both the principal and any appreciation tied to the gifted asset in that year.
Speaking of gifts, we said goodbye to charitable IRA gifts in 2011. The IRA charitable rollover, a boon to non-profits and a handy tax deduction option for taxpayers older than age 70½, was not extended into 2012, not even temporarily as a sweetener to the payroll tax extension bill. There is hope it will be back. Two bills have been introduced in Congress with that goal, one sponsored by Sen. Olympia Snowe (R-ME) and Sen. Charles Schumer (D-NY) and another by Rep. Wally Herger (R-CA) and Rep. Earl Blumenauer (D-OR). The proposed legislation would let IRA owners start making charitable IRA gifts at age 59½ and remove the $100,000 limit on the rollovers.
The limits on the generation-skipping transfer tax could change, too: assuming the Bush-era tax cuts do sunset, the GSTT rate would jump from 35% this year to 55% in 2013, with the GSTT exemption falling from $5,120,000 per person this year to roughly $1.3 million per person next year.
So given all these changes, it’s best to meet and discuss these matters with your wealth managers and start the year off on the right foot. Of primary importance is that your advisors have an appreciation of your capital loss carryforwards and your expectations of the performance of closely held, highly appreciated assets that may not be under their discretion.
While we always favor prudence in consumption, some times are better than others.
This is a great little piece on why there are times that one can benefit from car companies’ aggressive competition and artificially low pricing.
Giving appreciated stock can be a great way to support your favorite charity and reduce your tax bill. For shares you may have recently received from an option exercise, ESPP purchase, or restricted stock vesting, the tax treatment is the same as it is for donations of any stock to a qualified charity. When you have held the stock for more than one year, at the time of the donation you get a tax deduction for the fair market value of the stock (not for your cost basis). If the sale of the appreciated shares would have triggered long-term capital gains, your deduction is up to 30% of your adjusted gross income (20% for family foundations), and you can carry forward amounts over this for five years. Accordingly, for large donations, some planning may be appropriate.
When you donate stock, to implement the transfer you need the charity’s brokerage account information, with the DTC (Depository Trust Company) number and an account number. Your instructions to your brokerage firm should include this information and any specific lot identification. Many times the “default” setting on a brokerage firm is “HiFO” (highest cost basis first) but in this transaction you’ll want it to be “LoFO” (lowest cost basis first).
For year-end donations, be sure the stock transfer is completed by December 31 to make it count for the current tax year. For electronic transfers from your brokerage account, the donation is recorded on the day it is received by the charity/foundation (not when you approve the transfer). With increased year-end activity at brokerage firms, you should plan your year-end stock gifts as early as possible and have ongoing communications with your broker to ensure that the transfer takes place.
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An old stock market dictum says that spring is for profit-taking, or at least a time to reduce your exposure to equities.
Giving appreciated stock can be a great way to support your favorite charity and reduce your tax bill. For shares you may have recently received from an option exercise, ESPP purchase, or restricted stock vesting, the tax treatment is the same as it is for donations of any stock to a qualified charity. When you have held the stock for more than one year, at the time of the donation you get a tax deduction for the fair market value of the stock (not for your cost basis). If the sale of the appreciated shares would have triggered long-term capital gains, your deduction is up to 30% of your adjusted gross income (20% for family foundations), and you can carry forward amounts over this for five years. Accordingly, for large donations, some planning may be appropriate.
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