Traditional or Roth IRA…Which is best for you?

PICIf given the option, would you rather defer taxes or pay them now? That seems like a fairly straightforward question with a no-brainer answer. In fact, most of us would probably take advantage of the chance to defer any type of payment. People work hard for their money and want to hold onto it for as long as possible. Unfortunately, the answer to that question isn’t as simple when determining which type of Individual Retirement Account (IRA), traditional or Roth, to use for retirement.

There are a handful of differences between traditional IRA’s and Roth IRA’s, but the core differences are in how the accounts are funded and how the contributions and earnings are taxed upon withdrawal. Traditional accounts are funded using pre-taxed dollars, which allows for a current year deferral of taxes by reducing your taxable income. Later, when the funds are withdrawn in retirement, the accumulated contributions and earnings are subject to income tax. On the other hand, Roth accounts are funded using after-tax dollars. Although no current tax break is received, the accumulated earnings and contributions are not subject to tax in retirement.  There is also an annual Required Minimum Distribution (RMD) that the traditional account owner must adhere to upon reaching age 70.5.  Roth accounts do not require any scheduled distributions and can be withdrawn at any time in retirement without a tax penalty.

Choosing a traditional or Roth account depends on many factors, most of which relate to an individual’s current and expected future income tax rates. A key question to consider is whether or not an individual’s income tax rates will be lower or higher in retirement. If income tax rates are higher now than in retirement, the individual is generally better off in a traditional account. Conversely, if income tax rates are lower now than in retirement, the individual is generally better off in a Roth account. Furthermore, if income tax rates are expected to be the same in retirement as they are now, both a traditional and a Roth account will result in the same purchasing power. In addition, another key factor is whether or not a legacy will be left for descendants, as Roth accounts can be “stretched” for decades for children and grandchildren without taxes being incurred.

So, for many, the decision may seem rather simple – just calculate future income. However, predicting future income is difficult, much less guessing whether or not Congress will increase tax rates within the next 10, 20 or 30 years. Instead of trying to predict the future, consider other factors that are more easily determined. Individuals are more likely to earn larger salaries and bonuses as they progress through their career. For a young professional or even a child, their tax rate is likely to be lower than when they would retire. Perhaps a Roth account would be more beneficial initially. It’s important to keep in mind income levels as a person progresses through their career as it may become advantageous to change to a traditional retirement account.

Another factor to consider is where does the individual plan to live upon retirement. States, like New York, have significantly high state tax rates, whereas states like South Carolina and Illinois offer deductions for retirees or even excluded retirement income from state taxes. Better yet, you can choose to retire in states like Florida or Texas, which do not have any state income taxes.

Just because a person is projecting a certain tax rate in retirement or plans to live in a state with minimal or no taxes, an individual can never make a completely wrong decision. Couples often times will look at other factors when choosing the right account for them. If an older couple would like to give a tax-free inheritance to their children, even if it means paying a higher tax rate for the contributions, a Roth account or back-door Roth may be the right fit for them. Or if a young couple is just starting a family and could use the extra tax savings now rather than later, a traditional account may be their best fit.

Whether a person or a couple chooses to defer current taxes using a traditional IRA or waits to receive a benefit upon retirement using a Roth IRA, they can’t go wrong. In either case, they are contributing to their future in an account designed to help them achieve long-term growth of retirement savings. In addition, funds can be converted from traditional to Roth in the future, especially in years of a lower tax bracket. Here at DWM, we strive to give our clients the information they need to make the best decisions for themselves and their family. If you are having trouble deciding which type of account to use or want to review your current strategy, we would be glad to assist.

Brexit- A Surprise?

brexit first starThe Brexit vote Thursday was a big surprise to some. As voting closed, some London bookies were putting the odds of a vote to leave at less than 10%.   Pollsters and “experts” had shown a 10 point margin 24 hours earlier for “Remain” yet “Leave” prevailed 52%-48%.   Stock markets don’t like surprises and responded with declines of 3% to 9% worldwide before markets closed for the weekend. With the flight to safety, as expected, most fixed income and some alternatives, especially gold and some managed futures, were up.

The result shouldn’t have been a surprise. We said the referendum was “too close to call” a month ago in our blog.  http://www.dwmgmt.com/brexit/.  In large numbers, the “Leave” supporters were expressing their anger with the status quo and a desire to return to the “good old days.”  They haven’t benefited personally from globalization and now their homeland is being “taken over by immigrants.”

The issue isn’t just Britain leaving; it’s really about the future of the EU.  EU institutions have failed in a number of key areas; including lack of planning and administration relative to the integration of the various member nations and migration of people among the countries.   Now, Britain and the EU have two years to work out what could be a highly acrimonious divorce.  And, while this is happening, all across Europe countries, including Germany, France and Spain, will be holding national elections debating the question of whether sovereignty and nationalism outweighs economics.  These same issues frame the U.S. Presidential election and others around the world.

Despite Friday’s selloff, Brexit is no Lehman.  Back in 2008 after the collapse of Lehman Brothers, investors indiscriminately fled all assets connected to the American housing bubble.  Subprime mortgages had been sold to investors worldwide and panic spread like a virus.  This time, the trouble is more identifiable.  London’s ambition to be the world’s most important city is over.  The pound has lost some luster.  The EU will likely continue to splinter and perhaps disband.  If nations reject globalism and free trade, world economic growth will likely be reduced.  In 2008, central banks did not recognize nor prepare for the mounting disaster.  Today, the financial systems in the U.S. and Europe are less leveraged and better capitalized than eight years ago. Just last week, all major American banks passed the new stress test requirements.  The CBOE, Market Volatility Index, or VIX, remains far below the level of past panics.

The U.S. economy should weather the Brexit storm. American companies remain more insulated from global developments than any other country.  U.S. companies generate 70% of revenues domestically.  U.S. corporate balance sheets are strong, interest rates are low and the U.S. economy is on a pace for a 2.5% growth in the second quarter.  Consumer sentiment remains strong in the U.S., coming in at 93.5.

However, expect more volatility. Britain’s decision to leave the EU could cause more fault lines in Europe.  Elections across the globe could reverse globalization’s trend.  Chinese growth could continue to decline. There is always a list of potential fears, many of which never materialize (e.g. the “hyperinflation” predictions of 2010 due to Quantitative Easing).

Some investors have not recovered financially and/or cognitively from their losses of 2008.  They are dedicated to making sure that never happens again.  No drawdowns for them-every market blip is cause for concern. “Another collapse is coming.” This risk aversion has led them to miss a huge run-up in U.S. equities (200% since 2009) , as well as decent returns for fixed income and alternatives in the last seven years.

Certainly, one day the expansion will end and investors will feel some temporary pain.  But, trying to determine when and how that will happen is a money-losing proposition.  Maintaining a well-diversified portfolio is a better approach than having a fearful, concentrated one.  Equities, in the long run, will outperform fixed income and alternatives.  And, as we discussed in our seminar last October, the equity “premium,” obtained for taking on risk, will continue- impacted greatly by inflation and economic growth.  Lower inflation and/or lower growth, means lower equity returns.  Your risk profile determines your appropriate asset allocation and the volatility of your portfolio.

Hold on tight, the road ahead may be bumpy, but, since no one knows the future (not even the “experts” as demonstrated above), it’s the best route we have to accomplish our goals for the long term.

 

 

Your Health Matters

healthcare_costs_2[1]How are you feeling today?  At DWM, we hope you are feeling your best and enjoy robust good health every day.  As financial advisors, we certainly pay attention to your financial health and look for ways to maintain and improve your overall financial well-being.  And with the cost of health care these days, the state of your physical health has become inextricably linked with your financial well-being.  A recent WSJ article about health expenses in retirement noted that excellent health can actually raise an individual’s lifetime health spending needs because of the likelihood that they will live longer.  So good health may actually cost you more!  At DWM, we want to make sure we help you plan for these costs and analyze ways to save.

There are many changes occurring in the healthcare industry.  Aging populations and longer life-spans will strain the existing resources.  The industry is evolving to invent strategies and plans for preventive medicine and new technology to make healthcare more efficient.  As consumers, we are able to be pro-active in managing our own health care.  We can now download health apps, consult a medical practitioner by email and use strap on devices to monitor our own vitals.  Technological health advances in diagnostic tools and treatment options are ever-changing and, when we have medical questions, we will likely hit the internet and educate ourselves before calling the doctor.  As consumers in the marketplace, we can select from a vast menu of insurance options and many health care providers are offering innovative ways to finance even traditional medical services.  Welcome to the new health economy!

There is also a cost to new medicines, better technology and a shift from traditional strategies.  According to reports by the Centers for Medicare and Medicaid Services, which published its projections last August in the policy journal Health Affairs, spending on healthcare is expected to grow at an average annual rate of 5.8 % over the next decade.  Another report from the Pricewaterhouse Coopers (PwC) Health Research Institute estimates those costs growing at 6.5% per year.  Some estimates for Medicare Part B and Part D are over 7%!  WSJ quoted a report by HealthView Services Inc that says a healthy 65-year old couple can expect to pay, on average, $266,589 for insurance premiums and $128,365 for related expenses (dental, vision, copays and out-of-pocket bills) over their lifetime.  These figures show that healthcare costs are far outpacing cost-of-living increases of 1-3% and have made us take notice of how these increasing healthcare costs will affect your future financial health.

With these rising health care costs, mandatory Medicare premiums can account for a larger share of retirement spending than even recreation or housing.  And few people realize that your annual Medicare premiums are based on your retirement income, according to Mary Beth Franklin of Investment News.  It makes good financial sense, therefore, to understand your modified adjusted gross income (MAGI) and plan withdrawal strategies with income targets in mind.  Even moving one tax bracket can result in significant savings in Medicare costs.  You really need to put the ‘microscope’ on your health care expenses and make sure you are doing everything you can to minimize their impact on your financial plan.

Recently, we discussed the upgraded, newly released version of MoneyGuidePro – MGP4- and highlighted some of the new features in our blog (http://www.dwmgmt.com/mgp-4-).  MGP4 has added a new healthcare spending goal, a tool which allows us to isolate the rising health care spending needs in your financial plan results and make sure that your plan can successfully accommodate this spending.  There is a worksheet for including your actual expenses or estimates for Medicare Part B, Part D for prescriptions, supplemental or Medigap policies and out-of-pocket spending.  This will be a great tool for us to use to make sure our clients are prepared.

At DWM, we can help you manage and budget for a changing health care environment and the costs you will face in the future.  So get enough sleep, eat right and exercise…we want you to stay healthy and enjoy your life.  Your health matters!

Consumer Sentiment: “Good, but Concerned About the Future”

Measuring-Consumer-ConfidenceOverall, Americans are feeling pretty good. Their total net worth is now $88 trillion.  That’s a major increase since 2009 when total wealth bottomed at $55 trillion.

In simple math, that’s an average of about $270,000 of wealth per person, obviously impacted in a major way by the 1% at the top.  The median amount (half the people have more and half have less) is about $50,000 per person.  And, on average, roughly 75% of that wealth is in one’s home.  The Federal Reserve report last week showed that mortgage balances are growing slowly, while home prices are increasing steadily.  Many homeowners who were underwater seven years ago now have some equity.

In fact, rising home prices have set off fears that real estate will become more expensive.  In the year ended March 31, 2016, cities like Denver, Seattle and Portland had employment growth more than 3% and double-digit increases in home prices.  At the same time, according to the Case-Shiller indexes, Boston, Cleveland and New York have had subdued growth and home price increases.  Pittsburgh and Dallas are facing housing affordability challenges as demand lately has moved toward central cities, where land is scarce, rather than more spacious distant suburbs. This month, McDonald’s announced its move from Oakbrook to the West Loop in Chicago to appeal to the younger, metropolitan workforce.

Despite a weak May labor report showing only 38,000 nonfarm jobs and some politicians claiming the economy is a disaster, overall consumer sentiment is up.  Home prices and wages are up, interest rates and gas prices are low and people are starting to spend more.  Consumer spending jumped 1% in April, the fastest pace in nearly 7 years.

In addition, everyone likes to hear that the stock markets are rallying, which they have done since February. And, daily media blasts about approaching or hitting new market highs, which are happening lately, prompt positive consumer sentiment as well.

The University of Michigan’s next “Index of Consumer Sentiment” due on Friday, is expected to be good.  Economists have forecasted it to come in at 93.5, down slightly from May.  However, it would still be above average for economic expansions.  What we are seeing, though, is a growing gap between the favorable Current Economic Conditions sentiment and the renewed downward drift of the Expectations Index.

Since the late 1940’s U of M has been interviewing households.  In early June, the 500 respondents who answered the 50 core questions, rated their current financial situation as the best since 2007.  And, their prospects for gains in inflation-adjusted income for the year ahead were also most favorable in 9 years.  However, these respondents did not think the economy was as strong as a year ago nor do they expect the economy to do as well in the year ahead as it has done.

The next six months will be quite interesting.  While the economy has posted steady job growth for most of the past six years, May’s disappointing labor report begs the question:  “Have things changed?”  In addition, what happens if the UK decides on June 23rd to leave the EU, and Brexit occurs? And, how about China’s big slowdown from double digit economic growth just a few years ago?

Certainly, there are lots concerns and uncertainties.  So, what’s new?  We all deal with uncertainty and change every day.

As our regular readers know, our advice is to focus on what you can control:

Investments-

  • Create an investment plan to fit your needs and risk tolerance
  • Identify an appropriate asset allocation target mix
  • Structure a diversified portfolio
  • Reduce expenses and turnover
  • Minimize taxes
  • Rebalance regularly
  • Stay invested

Other Key Metrics-

  • Separate your goals into needs, wants and wishes
  • Review your expected longevity
  • Target a date of financial independence
  • Use realistic targets for investment returns and inflation in your planning
  • Review all assets and make sure they are performing appropriately
  • Review all debt and determine if it is appropriate
  • Review all insurance for coverage and cost
  • Review your estate plan to make sure it meets your wishes and that assets are titling appropriately
  • Monitor your plan regularly and make appropriate changes

We encourage you to focus on the above.  And, of course, if you need some help or have a question, give us call.  At DWM, we’re here to increase family wealth by adding value.

Career Crossroads: The Right Path for My Future in Wealth Management

Fork roads in steppe on sunset background

I’d like to start by introducing myself.  My name is Nick Schiavi and I recently joined the Detterbeck Wealth Management team in the hopes of learning wealth management and becoming a Certified Financial Planner.  As I approached the end of my college days, I thought I had everything figured out.  I was about to graduate from Northern Illinois University with a Bachelor’s degree in Finance, Marketing Minor, and a Professional Sales Certificate.  I studied these subjects with the intent of pursuing a career in wealth management.  This seemed like a fairly straight forward career path at the time with the thinking that strong advisors are good with numbers, comfortable with communication and receive the proper training.  I had no idea there were so many different routes this career path offers.

Out of school, I accepted a job with an insurance company and thought I was on my way to becoming a financial planner.  On the first day of training, we were required to cold call and set up meetings with the goal to sell life insurance.  The company did a great job selling the in-training representatives on the idea a whole-life insurance policy is the best place to put your money for retirement.  The other trainees and I were impressed when learning a policy and reinvested dividends grow tax free and can (somewhat) diversify a portfolio.  It made me wonder how many other/better approaches there are in the field.  If a whole life insurance policy is the answer to everyone’s long term financial needs, then why doesn’t everyone just do that?  Why is the field so complex and difficult?  Why do hundreds of books and dozens of TV shows analyze this topic to no end?  I knew there was more to it and I wanted to learn.  So… I decided on a new path and set out to interview at as many financial services companies as possible, and this time, do as much due diligence as I could before making a decision.

I started my search by applying to all of the major wirehouse and brokerage firms with the assumption they were the best at what they do and train their employees to be the best in the industry.  That is what I had heard and believed.   However, the more I interviewed, the more it dawned on me all of these companies are similar in practice to the insurance company that first employed me.  The business model they use is to have their employees pass the licensing test, start selling the products and achieve required sales goals to keep their job.  Many times I was told I could give it a shot, but it would be better to get a sales job for a couple of years and come back when I was ready.  Why would I get a random sales job to become a better financial advisor?  If anything, it seemed I might forget most of what I just spent four years studying in school.

What I really felt was most important was to find someone to mentor me in the industry. I was ready to work long and hard to learn the complexities of investing, planning and overall comprehensive wealth management.  I wanted to believe there are advisors who succeed by being investment experts and wealth managers, instead of being great salesmen.  Don’t get me wrong, sales is great and arguably the most important aspect to any business.  I just felt a financial planners’ best skill should be financial planning, not sales.  The tides turned when I received the advice to look on NAPFA.com and search fee-only advisors in my area, ultimately leading me to exactly what I had been looking for at Detterbeck Wealth Management.

Since starting at DWM, I have learned a lot and now respect how many different hats a strong wealth management team must wear in order to best serve clients.  One of the first things I learned is how little people know about the industry and how easy it is to believe that the big firms are the best place to invest your money.  It reminds me of golf, it is a game of opposites; if you swing left, the ball curves right- swing right, the ball curves left.  Wealth management is similar.  It is normal to think having your money with a big firm is a good idea, it makes sense to think they are the best at what they do (given all the marketing dollars they have to convey that message).  In reality, it is the RIA (Fee-Only Advising) firms who typically have the best client-centric culture rather than a company-centric mentality.  At DWM, it’s about providing value to customers.  These are the advisors who place their clients’ interests first in a fiduciary manner and do not make commissions on sales.  RIA firms like DWM bring clients on slowly to fully understand their needs and create the best possible plan.

All in all, the start to my career has been great.  Coming out of school I wanted to learn this industry and had no interest in “faking it until making it.”  There is no faking at DWM; every time I am given an increase in responsibility it is because I have been trained and fully understand what I am doing.  I’m new to the real world, but this seems like the proper way to run a business – especially one focused on helping people achieve their personal and financial goals.

Nickolas SchiaviEditor’s Note:  Please join us in welcoming Nick Schiavi to our DWM team.  Nick joined our firm in late April as a service associate and is training/learning/working toward becoming a junior advisor. Welcome aboard, Nick!

Have You Saved Enough For Your (Grand)Child’s College Expenses?

 

anatomy of piggy bankHappy May 29th – a few days past – otherwise known as 529 day. According to the College Board’s “Trends in College Pricing” report, the cost of attending a four-year university rose roughly 3.5% from 2015 to 2016. Costs just keep going up. Have you done enough educational planning for Junior? Take a breath of fresh air and then check out how much college will cost at these schools for the upcoming 2016-2017 school year:

Average Cost of College 2016 2017 final

For those of you with younger ones or planning for a family, fortunately, there is still time! Read on as this blog is for you as it focuses on what may be the best college savings program out there: 529 College Savings Plans!

The 529 is a great opportunity for parents, grandparents, or other family members looking to help a child make college a reality someday. Studies show that children with money set aside for college are seven times more likely to actually go there.

529 Plans are state-sponsored investment programs that qualify for special tax treatment under section 529 of the Internal Revenue Code. These plans typically involve an agreement between a state government and one or more asset management companies. The contributor (e.g. parent, grandparent, etc.) of the account typically becomes the account owner and the account owner controls withdrawals of assets. The person for whom the plan is set up becomes the beneficiary (e.g. Junior).

Tax-Free Growth.  Earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for college. The 529 account remains under the control of the account owner rather than transferring to the child at the age of majority as in the case of an UTMA/UGMA. Any U.S. citizen can participate in a 529 and the funds can be used at any accredited college or university.

Quality investment options.  Most 529 programs have a couple dozen quality equity and fixed income investment choices to choose from. Most programs will also allow you to choose an age-based asset allocation model which makes the underlying portfolio become more conservative as the beneficiary approaches college age. Or you create your own portfolio to match your risk tolerance (whether it be more conservative or aggressive) and expected timing of funds. A wealth manager like DWM can help you decide.

Contribution limits.  Unlike other tax-advantaged vehicles, 529 have no income limitations on who can contribute, making them available to virtually anyone. Contribution limits to 529 are determined by each 529-sponsoring program independently, but most are quite attractive with limits over $300,000 per beneficiary. To reach that total, a married couple can contribute as much as $140,000 within a single year (the limit is $70,000 for individuals) and, as long as no more is contributed in the following four years, the entire amount qualifies for five years of the gift-tax exclusion. (This type of 5year “front running” can be a great estate planning strategy for grandparents as well.)

Tax benefits.  There is no federal tax deductions or credits for 529s, but there typically is at the state level. Contributions to a 529 are fully deductible in South Carolina and up to $10,000 per year by an individual, and up to $20,000 per year by a married couple filing jointly in Illinois assuming you use an in-state program – Bright Start & Bright Directions in Illinois & Future Scholar in SC are all excellent choices. Contributions remain tax-free if used for qualified education expenses.

What’s a Qualified Education Expense?

-Tuition

-Required books, equipment, supplies

-Computer technology

-Room and board for ½+ time student

-Special needs expenses of a special needs beneficiary

Non-Qualified Withdrawals. Non-qualified withdrawals will not get the special tax treatment. With a few exceptions, such as when the beneficiary receives a scholarship, the earnings portion of non-qualified withdrawals will incur federal income tax as well as a 10% penalty.

Effect on Financial Aid. A 529 account is counted as an asset of parent if the owner is the parent or dependent student. This is typically more beneficial than other vehicles when calculating the expected family contribution figure.

What happens if the beneficiary decides not to attend college?

The tax laws make it easy on the family if the beneficiary for some reason doesn’t go to college or use the 529 earmarked funds. The account owner can simply change the beneficiary by “rolling over” the account to a “family member” of the original beneficiary with no penalty whatsoever. The definition of “family member” includes a beneficiary’s spouse, children, brothers, sisters, first cousins, nephews and nieces and any spouse of such persons; but typically and most logically it’s one of the original beneficiary’s siblings. Or the account owner can use the funds themselves – it’s always fun to go back to school and learn! Or the least likely option is “cash out and pay”, where the account owner can redeem assets for himself/herself as a non-qualified withdrawal and pay ordinary income taxes and a 10% penalty.

529s vs other college savings plans. Downsides of the others:

  • UTMA/UGMA: 1) Control/custodianship within an UTMA/UGMA terminates at age of majority (21 in Illinois & 18 in South Carolina), and 2) kiddie tax considerations and capital gain considerations upon liquidation
  • Coverdell Education Savings Accounts (“ESAs”) – maximum investment is only $2,000 per beneficiary per year combined from all sources within ESAs whereas 529s are typically $300K+ per beneficiary.

Conclusion. There is over $230 Billion in 529s now up from less than $10B in 2001. The reason for this growth is people catching on to what really is a great tax-free funding vehicle for an important future educational need. Prepare for that financial burden today by saving early and saving often with a 529 account. Give us a call to help get you started or talk more about educational planning in general.