Monday, February 23, 2015

Winter isn’t the only season before spring

We’re about to close the chapter on the shortest month of the year. Of course, there’s plenty more winter to endure, but I’d much rather look ahead to springtime activities. Especially baseball. The reports on the Tigers coming in from Florida are a daily reminder that winter will soon be a distant memory.

But there’s a season between winter and spring that’s my least favorite. Perhaps yours as well. Tax season. Every year I receive more and more inquiries from readers asking about various provisions of the tax code.

Most of the questions start out something like this: “I don’t have a complex situation, but I don’t understand why…” The questioner then goes into depth about why they’re confused.

Let me remind readers that most financial advisers, including me, can answer tax questions in a general manner. But when you get into specific detailed information about your tax return, I suggest you meet directly with your tax preparer, accountant or CPA.

True, there are some financial advisers that prepare tax returns and some CPAs that are financial advisers. Nonetheless, I suggest most would be better served by not combining the two professions.

Why? Because I believe using both a tax preparer and a financial adviser gives you the benefit of checks and balances. Even though the vast majority of advisers and preparers are people of integrity, if a financial adviser did something inappropriate it would be relatively easy for them to hide it if they also filed your tax return.

Over the years, during the financial planning process, I have also uncovered some tax preparation errors that required attention. That’s why I often encourage meetings with my client, their CPA and myself working as a team. This practice has led to many tremendous solutions to some complex tax planning and investment concerns.

This also works at the corporate level. Some years ago, the giant company, ENRON, collapsed. Their adviser and tax firm were one and the same. In hindsight, perhaps the checks and balances might have prevented or caught the fraud earlier.

In general, I believe most are better served by separating tax preparation and financial services. That being said, I’m deeply concerned that our tax system is far beyond complex. If it’s not already broken, it’s on life support.

For example, most people understand dividends. But there are various kinds of dividends that are taxed differently. I doubt that most people know the difference between an ordinary and a qualified dividend.

And how many really understand the difference between tax credits and tax deductions? There are many more examples of confusing items and terminology in the existing tax code. For example, healthcare is on the tax returns this year. I believe that’s going to add to the confusion.

Historically, there have been many attempts to overhaul our tax system that have never materialized. While there’s no solution that will please everyone, I believe reasonable steps can be taken to simplify the system. Persons who don’t have a complex situation should be able to get through their returns with minimal stress.

Personally, I enjoy various aspects of both seasons. It’s the season between winter and spring- tax season- that I disdain. I find it to be long, stressful and tedious. And I’m confident that many others would agree.

Monday, February 9, 2015

The federal government should not tax 529 programs

With the formation of the Michigan Education Trust in the late 1980s, Michigan was one of the first states to help encourage families to save for college. The Trust is a prepaid tuition program for Michigan families for Michigan universities.

In the early 1990s, Michigan once again was at the forefront of encouraging college educations when it formed the Michigan Education Savings Program, offering what are commonly called 529 College Savings Programs.

In 1994, the Sixth Circuit Court of Appeals upheld the tax- exempt status of these plans. The ruling opened the door for college savings not only for in-state colleges, but also for most universities throughout the nation.

Since then, virtually every other state has followed Michigan’s lead and created 529 College Savings Programs. There are minor differences from state to state, but basically these accounts are started for the benefit of a child.

Most states offer a menu of investment choices ranging from conservative to growth. The invested money compounds tax-deferred and if properly used for educational purposes, withdrawals are tax-free.

In some states, including Michigan, you might be eligible to receive some minor tax benefits on your state tax return. But for the most part, the plans are a disciplined and organized way for families to save for the extremely high cost of education.

One of the reasons I like them so much is that most programs allow small deposits. In an investment environment where many firms won’t even talk to investors unless they have at least $50,000, most 529 College Savings Programs will accept as little as $50.

From personal experience, I have seen birthday money from grandma and grandpa gifted to a child’s account. Think about it, $50 added for future college savings versus a gift card for more stuff that will be long forgotten by the time the child reaches college age.

Contributing to the college savings of a grandchild, niece, nephew or anyone with college aspirations is one of the best things you can do for their future.

At the risk of touching some political nerves, there has been an abundance of proposals geared to helping jump start middle class America. But while many of these “free programs” are for the benefit of the middle class, the fact is that those tax payers in the top tax brackets will be paying for them.

Now understand, I neither agree nor disagree with the proposed shift in taxes to the wealthier. The reason I bring this up is because 529 College Savings Programs are among the casualties of the proposed changes.

As it now stands, any dollars that are withdrawn from a 529 program come out tax free, provided they’re used for legitimate college expenses. One of the proposed changes would make withdrawals taxable.

How that helps middle America is beyond me. Over the years, I have seen young parents, grandparents and even family friends make deposits into college savings programs for a loved one.

Most of us understand the importance of education and are keenly aware of how incredibly expensive it is to get a young adult through college. Unfortunately, many of them will carry their college debt for years.

In my opinion, we should do everything we possibly can to encourage college savings. Making them taxable is not one of them.

NOTE: Prior to the printing of this column, in response to public outcry, the government withdrew any attempt to tax 529 savings.

Monday, January 26, 2015

The NFL and the IRS: Birds of a feather

As a lifelong Detroit Lions fan, I can still envision the game-winning touchdown catch Calvin Johnson made in Chicago in September of 2012. You can watch the replay over and over and 99 out of 100 people will say, “Wow, that was a fantastic catch.”

Unfortunately for the Detroit Lions, the one person that didn’t call it a catch was an NFL referee. Consequently, the Lions lost.

Fast-forward to this season with the Detroit Lions and Dallas in the playoffs. A critical penalty was called against Dallas and announced on the public address system. Seventeen seconds later it was suddenly not a penalty and play resumed as if the flag were never thrown.

Football experts claimed they had never seen anything like this before and Dallas won the game. One week later, a Dallas player made what appeared to be a phenomenal winning touchdown catch. Again, everybody but the referees saw a spectacular catch and the pass was ruled incomplete.

So why am I bringing this up in a personal finance column? Because fans are being turned off by the NFL. Not because it isn’t exciting, but rather, because the rules have become overly complex. What appears logical or common sense isn’t happening on the field of play.

In today’s overly complex world, I think people want the rules simple and straightforward and they want them applied fairly across the board.

Segue to the real world. People are just beginning to receive the documents they need to complete their 2014 tax returns. Some taxpayers will soon be opening up the tax programs on their computers. Others will be calling the IRS for clarification or looking up tax information online. And many will bring shoeboxes full of papers to their tax preparers.

The point is simple; the tax code isn’t. Nor is it logical. What makes sense to you and how you interpret the tax code isn’t the issue. Your interpretation of the tax code is irrelevant. Just as your take on a touchdown catch doesn’t matter. The only opinions that matter are those of the NFL referees and the IRS.

A recent example of the overly complex IRS tax code is the new health care law. The IRS published a twenty-one-page booklet that explains the new law. There is also a booklet with a dozen pages with instructions on how to claim one of the 19 exemptions.

If by chance you’re eligible for a health care subsidy, there’s a two-page Premium Tax Credit form with thirty-six simple steps to complete. Also new to the 1040 form this year is a box labeled “full year coverage.”

The NFL is exciting, but the rulebook is becoming so overly complex the television analysts now have rules experts to explain to the fans why the catch they saw really wasn’t a catch.

The IRS has pages and pages of rules and regulations that often defy logic. While growing up, many youngsters dream of playing in the NFL in front of all the fans. Nobody grows up with the goal of being in front of even one IRS agent.

I believe the time has come for both the NFL and IRS to re- examine their rules with the objective of simplifying and bringing logic and common sense back into the entire process.

Monday, January 19, 2015

How many baskets are your eggs in?

Over the years I have frequently stated that most investors would be well served by maintaining a diversified portfolio. While I am certainly not alone in this opinion, I want to highlight exactly why I’m a strong proponent of diversification.

First, I have to acknowledge that some investors have indeed made a lot of money by focusing their investment dollars into one category, such as stocks or real estate. Others have garnered significant returns by putting all their money into just one stock.

So, yes, there is the potential to make a lot of money by putting all your investing dollars into a narrow category. But there is also significantly more risk.

Throughout my career, I don’t believe there’s a point of view I haven’t heard. One good example is real estate. How many times have you heard the “experts” claim that you could never lose money in real estate?

Recent history has proven that opinion inaccurate as both commercial and residential real estate have actually decreased in value. Unfortunately, many people learned the hard way by not only losing money, but also their residence.

It was a sad and expensive lesson, but it did conclusively prove that real estate values could fluctuate.

Gold is another poster child for fluctuation. For a long time infomercials flooded the airwaves advising everyone to buy gold for portfolio stability.

But it wasn’t stable. It’s down substantially, whether it was purchased in its physical form or as a stock or ETF. And investors who bought at the peak are a long way from getting their heads above water.

Another commodity that’s dramatically plummeted in market value is oil. If you invested in oil, you’re very likely to be hurting badly at the moment. My condolences.

Most investors are aware of the inherent risk in stocks. In the 1950s GM President Charles Wilson stated, “…because for years I thought what was good for the country was good for General Motors and vice versa.” At the time GM had an aura around it much as Apple does today.

Unfortunately, far too many people had a significant percentage of their nest egg tied up in GM stock. I’m not trying to pick on GM, but it is further substantiation that it’s inherently risky to put all your eggs in one basket.

Locally, there are two recent examples that even bonds carry risk. Going back to GM, during the bankruptcy bondholders who thought they were first in line took a back seat to the unions. And when the City of Detroit went bankrupt, city bondholders also took a significant hit.

I don’t want to come off sounding like a purveyor of doom and gloom, but the point is, to a certain degree, everything carries an element of risk. Most investors would be better served being diversified not only among various asset classes, but also diversified within each class.

For example, in a category such as domestic stocks, rather than putting the entire amount into just ABC stock, consider adding DEF. And maybe even XYZ as well.

Simply stated, in our unpredictable, constantly changing economic environment, I firmly believe that most investors will be better served in the long term by utilizing a well-balanced, diversified portfolio. But even that requires periodic review and modifications.

Monday, January 12, 2015

Did you lose out by playing it safe? How to lose money by playing it safe

One of the most common measuring sticks of the investment world is the often mentioned and frequently quoted Dow Jones Industrial Average. As you may have noted, it ended 2014 just under 17,900 after having broken the 18,000 mark.

Six years ago, in January 2009, the DJIA was just over 9,000. In other words, it was up roughly 100 percent. Yes, it dipped down to 6,000 along the way before bouncing back. And the uncertainty probably caused a lot of people to lose sleep during that stretch.

Nonetheless, as we kick off a new year, most investors who are equity investors are significantly better off today than they were at this point in 2009.

Of course, nobody knows what the future will bring and, as I always like to point out, historical performance is no assurance of what the future will bring.

So, while some equity investors saw their portfolios more than double, others may not have fared as well. But everyone had the opportunity for gains that were at least respectable.

The bottom line is that equity investors who had an iron stomach and stuck with the investment world’s ups and downs are likely to be further ahead than they were six years ago.

There were plenty of skittish investors back then. Many panicked in March of 2009 when the Dow was in a free fall. Several said goodbye to the market, cashed in their chips and parked their dollars in a bank or credit union.

In other words they were on the sidelines and missed out on a pretty amazing run up. On top of that, the financial world rubbed a little salt in their wounds. That’s because in addition to missing out on the run up, they also earned extremely low interest while their dollars were sitting on the sidelines in a bank or credit union savings account.

I feel badly for these people. In all likelihood they let their fear and emotions drive their investments. As a result they’ve made little headway since 2009.

I’m a firm believer in setting aside funds for emergencies and other short term needs. But having your investment portfolio perform barely above flat line is a recipe for problems in the years ahead.

With gasoline prices falling, they’re just a stone’s throw away from their January 2009 levels. However, with the exception of gasoline, just about every thing else costs significantly more than it did in 2009. College tuition and health care are just two areas that have seen skyrocketing costs.

We live, today, in a world of financial uncertainty. It can be gut wrenching to invest in the markets, but being on the sidelines can also be dangerous.

Nobody knows what the world will look like six years down the road. But the likelihood is high that the costs of goods and services will continue to escalate. A static dollar cannot keep pace with the increasing costs of goods and services.

I don’t believe in extremes. Investing entirely in equities carries too much market risk. At the other end of the spectrum, depositing everything into cash makes you vulnerable to rising costs. Most investors would be best served to have a diversified well-balanced portfolio and to avoid the emotions of fear and greed.

Monday, December 15, 2014

The end of a tradition? Traditional pensions plans on their way out

In the summer of 2012, General Motors offered many of its employees the opportunity to receive a lump sum payment in lieu of a monthly pension check. After crunching the numbers for a retiree client and highlighting both the pros and cons of taking the lump sum, my client chose to continue with the traditional pension format.

In fact, more than half of those who were offered the choice in 2012 selected to remain with the pension format. Clearly then, this particular retiree’s decision was not unusual. It was actually the majority decision.

My intent is not to say that my client’s decision was right or wrong. What has remained in my thoughts, though, was his reasoning for turning down the lump sum and continuing with the monthly pension.

His rationale for staying with a pension was simply that he is a traditionalist. Now, there’s certainly nothing wrong with being a traditionalist.

But, as with so many things in our world these days, traditions are changing. Traditional pension plans that pay a lifetime of income along with a survivor’s benefit are disappearing fast.

There are a number of reasons why. One, of course, is that retirees are living so much longer than was the norm just a few decades ago. Another is the scary reality that many pension plans, public and private alike, are underfunded.

Unfortunately, word of the many pension crises our nation is facing rarely makes it into the headlines. But it’s a fact that there are a great number of public pension plans that are fast approaching crisis level. They just don’t have enough funds in their coffers to fulfil their pension obligations.

We all followed the city of Detroit’s bankruptcy proceedings. One of the key issues that needed to be resolved before bankruptcy was approved was how to settle the pension situation with retired city employees.

From coast to coast, there are state and municipal pensions that are terribly underfunded. In New York City alone there are more police officers collecting pensions than there are active police officers on the street.

In corporate America, 41 million employees and retirees have the comfort of knowing their pension is protected by the Pension Benefit Guaranty Corporation (PBGC). There are currently 10 million Americans whose pensions have already failed and their pensions are now handled by the PBGC.

That being said, what concerns me is that the PBGC itself is underfunded. It has a deficit of $62 billion. Signed into law by President Ford, the PBGC has run a shortfall for the past 12 consecutive years.

I believe that the traditional pension is on its way out. Not only is the writing on the wall, I think you could say that the wall is collapsing. I don’t see how public and corporate pension plans can meet their pension obligations.

Traditions do change. It used to be that department stores were closed on Thanksgiving Day and all the College Bowl games were played on New Years Day.

What I’m saying is don’t stay with your pension just because it’s “traditional.” If you have a lump sum offer, review it and analyze it. The world of a gold watch at retirement and a traditional pension is near extinction. The only constant in our ever-changing world is change.

Monday, December 8, 2014

Shadow banking steps out of the shadows

In a recent article I mentioned that former Federal Reserve Chairman Ben Bernanke initially had difficulty refinancing his mortgage. When I decided to downsize from my house to a condo, I opted to have a modest mortgage for tax planning purposes.

But after seeing the never-ending list of documentation that the bank required, I decided to forgo the tax benefits provided by a mortgage.

Since the meltdown of 2008, the banking industry lending standards have been significantly tightened. And there’s a long laundry list of new regulations including those in the Dodd-Frank bill.

You would think with interest rates at record low levels that businesses and households would be flooding the banks with loan applications. But, many have scars from the financial meltdown in the form of less than a stellar credit rating. Or perhaps they depleted their savings account in order to survive the downturn.

Because of such previous setbacks and the need for loans, a low credit rating is forcing many to seek alternatives to traditional banking for business and personal loans.

These banking alternatives are commonly referred to as shadow banking, which is becoming a booming enterprise and emerging from the shadows as real competition for traditional banks.

Many used to think of shadow banking as pawnshop loans and establishments that offered cash advances on paychecks. But today it’s much more.

It’s estimated that the non-traditional banking environment in this country has grown to more than $3 trillion. Small wonder. Because unlike the traditional banking system which is regulated and monitored by a plethora of regulators, the shadow banking industry is under the radar of watchdogs.

Some would argue that lack of regulation is a godsend. But others might fear that it could be the next big problem because nobody is paying attention.

I tend to be more of a traditionalist and favor traditional regulated banking. But I can certainly sympathize and understand those that turn to the shadow banks for help.

Shadow banking is serving a segment of the population that needs capital but doesn’t meet the strict guidelines that the banking industry follows.

Shadow banks can have significant differences and are all over the board. A typical transaction for a $1,000 loan, for example, might have a loan processing fee and an interest rate at around 6 percent.

Yes, their rates and fees are likely to be higher than a traditional bank, but if you had some financial problems in your recent past, this just might be the only way you can obtain a loan.

Recently, the well-known PayPal announced it would be entering this shadow banking space. The non-banking industry is not only looking for borrowers, they’re also seeking investors that have the money that is needed to make these loans.

I would be very careful from this end as well. I see a definite potential for investors to take it on the chin. Again, it’s the lack of regulation that concerns me.

As shadow banking moves from the shadows and closer to Main Street, I suspect we’ll hear from legislators after problems arise. Don’t get me wrong; traditional banks don’t serve the needs of everyone. But when you step into a game that lacks rules, don’t be surprised when you encounter a lot of problems.