The holiday season is almost upon us. Before we all get caught up in the spirit of the season (or mayhem, depending on your perspective), consider taking time to get your fiscal house in order with these tips.
The Year of the RMD
Last year, required minimum distributions (RMDs) were not required as Congress granted a reprieve to not force clients to take distributions from severely depressed retirement accounts.
That free pass is not available this year. So if you or someone you know is over age 70 1/2, you have to take a distribution from your IRAs. This also applies to those who are beneficiaries of inherited IRA accounts as well.
Distributions don’t have to be taken from each IRA account but a calculation must be made based on the value of all accounts at the end of last year. Then a withdrawal can be made from one or more accounts as long as it at least equals the minimum amount.
Think Ahead for Higher Taxes
In all likelihood, taxes will be higher next year. As things stand, the Bush-era tax cuts are set to expire and marginal income tax rates and estate taxes will increase.
So look to booking capital gains this year if possible since tax rates on both long-term and short-term gains are certainly lower this year.
There’s obviously enough going on to distract any investor but what I’m talking about here is concentrated stock positions. Many clients may take advantage of company-sponsored stock purchase plans or have inherited positions concentrated in just a few stock positions.
Regardless of one’s age, this is risky. This is especially risky to concentrate your income and your investments with your employer. Remember Enron? How about WorldCom? Or maybe Alcatel-Lucent?
So given the lower capital gains tax rates that exist definitely now (versus a proposed but illusory extension later), it makes sense to reduce the highly concentrated positions in one or more stocks.
I know a widow who inherited the stock positions that her husband bought. These included AT&T and Apple. While AT&T was once a great “widow and orphans” stock paying out a reliable dividend because of the cash flow generated from its near monopoly status in telephone services, it broke up into so many Baby Bells. The dividends from these have not matched the parent company and the risks of these holdings have increased as the telecom sector has become more volatile.
And while Apple has been a soaring success for her (bought very low), it represents over one-third of her investment holdings.
Like most people I come across, she has emotional ties to these holdings. And while she and others like her would not think of going into a casino to put all their chips on one or two numbers at the roulette wheel, they don’t find it inconsistent to have a lot of their eggs in just one or two investment baskets.
Since she relies on these investments to supplement her income, she needs to think about how to protect herself. Although people may recognize this need, it doesn’t make it any easier to get people to do what is in their best interests when their emotions get in the way.
‘Tis the Season for Giving
Right now the highest marginal income tax bracket is 35% which is set to rise to 39.6%. And capital gains tax rates are set to rise as well. And come January 1, the capital deduction on gifts will be reduced from 35% to 28%. All of this makes giving substantial gifts to charities a little more costly for your wallet. So if you’re planning to make a large charitable donation, it pays to speed it up into this year.
This year provides high-earners an opportunity to convert all or part of their tax-deferred accounts to Roth IRAs which offers an opportunity to pay no income tax on withdrawals in the future.
The decision to take advantage of this opportunity needs to be weighed against the availability and source of cash to pay taxes now on previously deferred gains in the tax-deferred IRAs or 401ks. It also must consider the assumptions about future income tax rates and even whether or not future Roth IRA withdrawal rules might be changed by Congress.
Create an Investment Road Map
To really help gain clear direction on your investing, you really should consider sitting down with an adviser who will help you draft your personal investment road map (an Investment Policy Statement) that outlines how investment purchase and sale decisions will be made, what criteria will be used to evaluate proposed investments and how you will gauge and track results toward your personal benchmark.
This exercise helps establish a clear process that minimizes the impact of potentially destructive emotional reactions that can lead you astray.
Rebalance and Diversify
Just as you might plan on changing the batteries in your smoke detectors when you reset the clocks in the spring and fall, you should rebalance your investments periodically as well.
Now is as good a time as any to reassess your risk tolerance. Research has shown that an investor’s risk tolerance is dynamic and influenced by general feelings about yourself, your situation and the world around you. With the world’s stock markets showing many positive gains, this may lead some to become more willing to take risks. This may not be a good thing in the long run so really question your assumptions about investing.
Armed with your investment road map and a risk profile, you will be in a better position to determine the mix of investments for diversification. Don’t be afraid of adding to the mix investment asset classes that may not be familiar. The idea of diversification is assembling investment assets that complement each other while potentially reducing risk. And just as the economy has changed and the types of industries that are dominant rise and fall, it’s fair to say that what is “in” now may be “out” later making it important to reconsider your mix.
For this reason, this is why looking abroad to developed and emerging markets still makes sense. Many of these economies are not bogged down by the after-effects of the great financial meltdown. And the rise of their consumerist middle classes means the potential to take advantage of demographics favoring growth sectors like natural resources, telecom, agriculture and technology.