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2017 IRA Contribution Reminder

It's not too late to make an IRA contribution for 2017. The deadline is the tax filing date which is Tuesday 4/17/2017 this year however we recommend not waiting until last minute.

Individual Retirement Accounts (IRA) are tax deferred, or in the case of a Roth IRA, tax-free savings/investment accounts. Tax deferral allows your money to grow faster without losing some of the growth annually to taxation. Having investments in an IRA also allow you greater investment flexibility to make changes without having to worry about generating any taxable capital gains transactions.

The IRA contribution limit for 2017 is $5,500 to any combination of IRAs and/or Roth IRAs as long as the total doesn't go above $5,500 unless you qualify for the catch-up contribution which is an additional $1,000 if you reached age 50 by year-end 2017.

Anyone is eligible to make a Traditional IRA contribution as long as you have earned income and you are under 70 1/2; whether you can take a deduction for a traditional IRA depends of a few factors described below. Eligibility to contribute to a Roth IRA depends on income which is also described below. Many are not aware that there is no age limit to make Roth IRA contributions, so if you are still working and your income is below the limit, then you can contribute to a Roth IRA.

 

Phase-Out Range for IRA Deductibility

If you are considered an active participant in a company retirement plan, your deductibility for an IRA may be limited. If you are married filing jointly the phase-out for deductibility begins for adjusted gross income between $99,000- $119,000; above that there is no deduction. If you are a single or head of household filer the phase-out for deductibility begins for adjusted gross income between $62,000- $72,000; above that there is no deduction. If you are not covered by a company plan but your spouse is, the phase-out range for you is $186,000 - $196,000. If you file married-separate, your phase-out range is $0 - $10,000. If your income falls between the phase-out range, your ability to deduct your IRA contribution will be limited. There is a specific calculation to determine the amount you can deduct so if this applies to you, consult your tax advisor to determine how much you can deduct.

Even though you may not participate in the company plan, you may be considered an "active participant” so it is important to verify before attempting to take a deduction. If you and your spouse (if applicable) are not covered by a company plan, then there is no income limitation to take a deduction for an IRA contribution. SEP and SIMPLE IRAs are considered company plans for these purposes but are not included in the maximum contribution amount as they have their own limits.

 

Eligibility for Roth IRA Contribution

If you are married filing joint, the phase-out of eligibility to contribute to a Roth IRA is between $186,000 - $196,000 of adjusted gross income; above that you cannot make a Roth IRA contribution. For single or head of household filers, the phase-out for eligibility is $118,000- $133,000. If you file married-separate, your phase-out range is $0 - $10,000. As mentioned above, if your income falls between the phase-out range, then your ability to contribute to a Roth IRA is limited. If you are above, then you cannot contribute directly to a Roth IRA however you are still able to convert IRA funds to a Roth IRA which is discussed below.

 

Non-deductible IRAs

If you wish to make a deductible IRA contribution but make too much income to be eligible to take a deduction, consider a Roth IRA instead. If your income is above the threshold to make a Roth IRA contribution, you can still make a regular IRA contribution however that contribution will not be deductible. In such a case of a non-deductible IRA contribution, your money goes in after tax but still grows tax deferred and your contributions when withdrawn are not taxable however the interest/gains will be taxable upon withdrawal.

These non-deductible contributions create "basis” in your IRA which when withdrawn come out tax-free in a pro-rata distribution relative to the amount of pre-tax money in your IRA. For example, if you have $100,000 in your IRA, $10,000 of which is after-tax basis, your ratio would be 10%. If you then took a distribution/conversion of $25,000, $2,500 of that would be considered a return of your basis tax-free while the $7,500 would be taxable.

 

Traditional IRA vs. Roth IRA

The question of whether to contribute to a Traditional IRA or a Roth IRA is very common. The basic difference is that a Traditional IRA contribution can entitle you to a tax deduction for the amount contributed, unless your income is above the limits to take a deduction. Deductible or not, the earnings grow tax deferred which means that when the money comes out, the earnings will be taxable at your top marginal tax rate prevailing at the time. A Roth IRA on the other hand is a tax-free account. Contributions are made with funds that have already been taxed and so when the contributions come out there is no tax to pay. The earnings also grow tax-free which is what makes the Roth IRA so great.

The common thought is that we will have less income in retirement and thus a lower marginal tax bracket so it makes sense to get a tax break now and pay it later. But what if your tax rate is not lower in retirement? This can happen if you have enough taxable income from Social Security, pensions, required minimum distributions from IRA, and other taxable income sources. The other possibility is that tax rates in general are higher than they are now. For those who believe the government debt is out of control, and cannot get out of it just through growth might believe that taxes must go up in the future to pay for the massive debt we have. If either of these might apply to you then a Roth might be a good decision. If you think your tax rate may be higher in retirement then we can make the case that a Roth IRA is better for you. There is also a case to be made for tax diversification if you do not have a strong conviction on which direction taxes will go. Estimating this requires some analysis so if you're not sure give us a call and we'll help you make that decision.

 

IRA to Roth Conversions

Since 2010 anyone regardless of income can convert an IRA to a Roth IRA. This also means that you could make a non-deductible IRA contribution and convert it to a Roth thereby getting after-tax funds in a Roth IRA which is in essence the same as making a Roth IRA contribution. This strategy is referred to as the “Back Door Roth.” It only works if you do not have other IRA funds because if you do, the pro-rata rules described above would apply. It is unknown if this loophole will be closed by congress or if they will allow anyone regardless of income to make a Roth IRA contribution; only time will tell. For now it is still there and people who this applies to should consider taking advantage of this great tax planning opportunity.

Roth conversions can only be done for the calendar year in which the conversion is made which means there are no more 2017 Roth conversions. Also with the updated tax law, congress has removed the ability to recharacterize (unwind as if it never happened) a Roth conversion, so going forward, if you want to convert to a Roth IRA, be sure it is the right decision and the right amount because you're stuck with it once it's done, no do-overs.

 

Spousal IRA Contributions

What if you or your spouse does not work, can you still make an IRA contribution? The answer is yes! As long as one spouse has enough earned income to make the IRA contribution, then you can make a spousal contribution. This means $5,500 for you and $5,500 for your spouse. The $1,000 catch-up contribution applies here as well.

Many are familiar that when they reach age 70 ½ they cannot contribute to an IRA anymore which is true for a Traditional IRA, but not a Roth IRA. If you are over 70 ½ but your spouse is still working, they can make a Roth IRA contribution for you.

 

Mega Backdoor Roth

The “Mega Backdoor” Roth is similar to what is described above however it is related to employer plans. There are many rules and details to be aware of but the basic idea is this: if the employer plan allows for after tax contributions, you can theoretically contribute after tax funds up to the maximum Defined Contribution plan limit which is $54,000 for 2017 plus $6,000 catch up contribution if over 50. Then, if the plan allows, you can request a distribution of only the after-tax funds paid to you and then deposit to a Roth thereby completing a Roth conversion of after-tax funds which means getting a whole lot of money in a Roth IRA, far more than the statutory annual contribution limit which also is limited by income levels.

For example, suppose you are maxing out your 401k at $18,000 and your employer provides a $6,000 contribution for you. That means $24,000 has been contributed leaving an additional $29,000 that could be put in using after tax funds ($35,000 if over 50). If you had the ability to, you could contribute that $29,000 from your paychecks and at some point then request a distribution of those after tax funds and convert to your Roth IRA. That would mean getting $29,000 in a Roth IRA in one year! Well you might say, “I have bills to pay and can’t take that much out of my checks.” Well obviously if you don’t have the funds you can’t do this but suppose you do have $29,000 in a savings or taxable investment account. In that case you would increase your contributions to the plan and use your savings to pay the bills and essentially shifting those taxable savings/investments into tax-free Roth IRA accounts. That’s why this is called the “Mega” backdoor Roth. Certainly many details are left out but this is the basic idea. If you think this could apply to you be sure to give us a call to discuss.

 

2017 IRA Limits

For 2017, IRA contributions limits stay at $5,500 if under 50 with the additional $1,000 catch-up contribution if you reach age 50 by year end. The phase-outs for IRA deductibility and Roth IRA stayed mostly the same from 2016 with a few exceptions:

  • IRA deduction phase-out for active plan participants
    • Single $62,000-$72,000
    • Married filing jointly $99,000-$119,000
    • Married filing separately $0-$10,000
    • Spouse is not covered by a plan $186,000-$196,000
  • Roth IRA phase-out
    • Single $118,000-$133,000
    • Married filing jointly $186,000-$196,000

For more information, download a copy of the 2017 Retirement Plan Contribution Limits chart.

Grow and protect your valuable hard-earned assets by staying up-to-date and informed on the latest changes in the tax laws and regulations. Click here to subscribe to our new monthly updates on the latest Tax, IRA and/or Estate planning strategies. Also follow us on Facebook, Twitter, and LinkedIn for the most up-to-date notifications.

If you have any questions about IRA contributions or wish to make an IRA contribution for 2017 give us a call.

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Update on repeal of Roth Conversion Recharacterization

On 12/22/17 I sent out an update regarding the changes in the new tax law that eliminate the ability to recharacterize (undo) a Roth conversion. The short version is that the bill eliminated the recharacterization provision starting in 2018 but it was unclear whether conversions that occurred in 2017 would still have the option to recharacterize up to what would have been the normal deadline of 10/15/2018. The bill was ambiguous at best with respect to this issue because it stated that there would be no more recharacterizations in 2018. This has been up for debate but now we have clarification from the IRS.

I read several opinions on this matter and the consensus seemed to be that there just wouldn’t be any recharacterizations in 2018. This didn't sit well with me in particular because the language used stated, "…conversion contribution establishing a Roth IRA during a taxable year can no longer be recharacterized…" and the effective date is "…for taxable years beginning after December 31, 2017." My interpretation was that it would apply to conversions starting in 2018 and thus a conversion from 2017 would retain the ability to be recharacterized up to the normal deadline of 10/15/2018. Anything other than this would simply be unreasonable because anyone who did a conversion in 2017 wouldn't have had enough time to do a recharacterization before the end of the year because the law was passed so late in the year. Well, the verdict is in and the IRS said that I was right!

Well the IRS didn't say specifically that "I" was right, rather my interpretation was right. On the IRS website under the FAQs for Roth IRA recharacterizations (https://www.irs.gov/retirement-plans/ira-faqs-recharacterization-of-ira-contributions) is the question "How does the effective date apply to a Roth IRA conversion made in 2018?" The answer is:

A Roth IRA conversion made in 2017 may be recharacterized as a contribution to a traditional IRA if the recharacterization is made by October 15, 2018.

So let me just take a moment to gloat a little bit for being right when all the experts seemed wrong….ok I'm done. So if you did a conversion in 2017 and were worried that you might need to recharacterize, you can rest easy now because you do in fact still have this option. It is important to note, that this does not affect 2018 Roth conversions, which will not be able to be recharacterized. From the same FAQ:

A Roth IRA conversion made on or after January 1, 2018, cannot be recharacterized. For details, see “Recharacterizations” in Publication 590-A, Contributions to Individual Retirement Arrangements (IRAs).

This is a great example of how things can and do change and often times aspects of changes may be up to interpretation. Usually, when this happens, we get a pronouncement or clarification from IRS, but that is not always the case. There have been and still are many things in the tax code and specifically in the IRA realm that are ambiguous. If you have any questions on how this may apply to you, give us a call

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Introducing our new Logo!

I was having a conversation with my brother-in-law a couple of years ago about how a professional chooses to dress shouldn't matter because there are a lot of slick people out there that have fancy offices and talk a big game but have no real education behind whatever it is they are selling or advising on. This is very prevalent in the financial advice business where obtain securities and insurance licenses is somewhat easy. Securities and insurance licenses are not advanced education and credentials but they have given the appearance of such. What is really scary is that one can study and pass the Investment Advisor exam in just a couple of months and then all of a sudden call themselves a "Financial Advisor" and advise people on their hard-earned life savings and the client assumes they are an "expert" because they are licensed.

If you are choosing to work with a professional in any field, wouldn’t you want to know they are an expert with advanced education and credentials in their field? I know I would. Imagine if medical school was not required for someone to become a doctor; you'd have your choice between doctors that have gone to medical school and those that have not. Wouldn't you be more likely to choose the doctor that you know went to medical school and demonstrated through rigorous examination that they know what they are doing? In the financial planning field, there is no required "Financial Planning School," because the minimum requirements are these securities exams. Well, this is where a governing body such as the Certified Financial Planner™ Board of Standards comes in, to establish a standard of minimum level of competency for giving personal financial planning advice. So in continuing with my analogy, financial advisors who have earned the CFP® would be analogous to the doctors that went to medical school and the advisors that have not earned it are those who haven't.

So I said to my brother-in-law that one of these days I'm going to show up to an introductory meeting with someone I've never met before wearing regular ol' jeans and a t-shirt and then tell them they should "hire the brains, not the suits." The thought was to make a statement that they should choose to work with me because they recognize that advanced education and credentials along with critical thinking and putting the client's best interests first are what is most important, not how I dress or what I look like. While I've never been able to bring myself to actually do this, it was the spirit of the idea that led me to change my logo.

I wanted to convey that the difference between myself and the average, so-called "Financial Advisor" is my advanced education and credentials such as having specifically studied financial planning in college, completing a masters degree specific to financial planning, to earning the CFP® (CERTIFIED FINANCIAL PLANNER™) and CIMA® (CERTIFIED INVESTMENT MANAGEMENT ANALYST®) credentials, among others. I am a member of Ed Slott's Master Elite IRA Advisor group which provides ongoing, advanced education related to IRAs/retirement planning that I don't even get CE credits for but I do it anyway because I value the education and I know it helps me better advise my clients. From this, the new logo was created.

A lightbulb is often used to represent an idea so that was the basis of the logo; to represent the ideas and intelligence derived from obtaining advanced education. The shape of the lightbulb with the right side being open is designed to retain the "P" for Portnoff. The brain is a nod to the original slogan to "hire the brains not the suits" which really wouldn't have been a useable slogan but would have conveyed the point perfectly. Ultimately I decided on "Because you Deserve an Educated Advisor" as my new slogan which ties into the logo because everyone does deserve an educated advisor right?

So I'm now officially introducing this new logo and I hope you like it, but if you don't like it, well that's ok because logos don't matter any more than slick suits and fancy offices do 😊. I've also completed a refresh of my website which is now mobile responsive, meaning it will look much better and be much easier to use on mobile devices such as tablets and phones. Throughout the year I'll also be working diligently on adding educational content such as the Roth IRA information to acknowledge the 20th Anniversary of the Roth IRA so keep a lookout for that. Much of the content will go out via social media channels Facebook, Twitter and LinkedIn, so if you are not subscribed to one or more of those, go ahead and do that now so you don't miss anything. You can follow us on Facebook by going to https://www.facebook.com/PortnoffFinancial, @JeremyPortnoff for Twitter, and https://www.linkedin.com/in/jeremy-portnoff-81b79a6 for LinkedIn. 

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20th Anniversary of the Roth IRA

This January marks the 20th anniversary of the Roth IRA which became available to investors in 1998. A Roth IRA in an individual retirement account that accepts after-tax contributions and tax-free distributions (income) for retirement. To celebrate this Roth IRA anniversary, I'll be sending out a variety of Roth IRA info throughout the year. This 20th anniversary is a good reminder to take a look at the Roth IRA to see why it might be right for you.

Funds that accumulate in a Traditional IRA are not completely owned by the IRA owner because every retirement account has a partner, and can you guess who that partner is? That's right, Uncle Sam is the partner in your Traditional IRAs, SEP and SIMPLE IRAs, 401k, 403(b), etc., and he is waiting to take his cut. Imagine you have $1,000,000 in a Traditional IRA…looks great right? Unfortunately, most people will only end up getting about 2/3rds to ½ of their IRA with the other portion going to taxes. The advantage of the Roth IRA is that you fund it with after-tax dollars which will help you avoid a tax time bomb when retirement rolls around.

“I am a big proponent of Roth IRAs, as contributions today lead to tax-free money in retirement, when you need it most,” said Ed Slott, CPA, founder of Ed Slott and Company and a nationally-recognized IRA expert who was named “The Best Source for IRA Advice” by The Wall Street Journal. “Unfortunately, the rules surrounding these retirement accounts are as confusing as ever, so it is important to work with someone who specializes in them.”

In 2008 I became a member of Ed Slott’s Master Elite IRA Advisor Group℠, an exclusive membership group dedicated to the mastery of advanced retirement account and tax planning laws and strategies. Members of Ed Slott’s Elite IRA Advisor Group℠ attend semiannual live training events and have year-round access to Ed Slott and Company’s team of retirement experts for consultation on advanced planning topics.

To figure out whether a Roth IRA or Roth conversion is right for you, it may be beneficial to work with a financial professional who receives specialized training in the ‘second half’ of the retirement game, the distribution phase. As a member of Ed Slott’s Master Elite IRA Advisor Group℠, I take pride in taking necessary steps to understand the intricacies of retirement accounts and the tax laws that impact them and knowing that I am up to speed on the latest retirement strategies so that I can confidently provide my clients with the help they need to plan for a successful retirement.

“Over the last 20 years, a lot has changed for Roth IRAs,” said Slott. “With ever-changing laws, including Congress’s recent decision to eliminate Roth recharacterizations, it is more important than ever for financial professionals to receive ongoing training."

ABOUT ED SLOTT AND COMPANY, LLC: Ed Slott and Company, LLC is the nation’s leading provider of technical IRA education for financial advisors, CPAs and attorneys. Ed Slott’s Elite IRA Advisor Group℠ is comprised of nearly 400 of the nation’s top financial professionals who are dedicated to the mastery of advanced retirement account and tax planning laws and strategies. Slott is a nationally-recognized IRA distribution expert, bestselling author and professional speaker. He has hosted several public television specials, including his latest, “Retire Safe & Secure! With Ed Slott.” Visit www.irahelp.com for more information.

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New Tax Law Changes Roth IRA Conversion Strategy

Probable Repeal of Roth IRA Recharacterizations at Year-End

The Senate and House of Representatives have both passed versions of the new tax reform law that eliminates the availability of Roth IRA recharacterizations after December 31, 2017.

 

Benefits of Recharacterization

Recharacterization gives taxpayers a "do-over" opportunity. One use is when a Traditional IRA that is converted to a Roth IRA afterward declines in value – forcing the IRA owner to pay income tax on a converted amount that now exceeds the value of the IRA. Recharacterizing reverses the transaction to eliminate the excess tax.

Typically, we don't know exactly what our total taxable income will be until the end of the year. Because of this, a common strategy is to convert more than you think you will need to “fill the [tax] bracket” or up to whatever the target amount is. If that amount is overshot, we would do a partial recharacterization to bring your taxable income to exactly where it needs to be. Recharacterization can also be done if the taxpayer simply changes their mind and doesn't want to pay the tax.

According to Ed Slott, “It is like betting on the horse after the race is over!”

Until now, the law has allowed recharacterizations to be made as late as October 15 of the following year.

 

The New “Do It or Lose It” Date Could Change to December 31st

The Final version of the Senate and House bills eliminate this extra time to recharacterize a Roth conversion. Under both versions of the law, it seems that December 31, 2017, may be "the do it or lose it date" for recharacterizations of conversions made in 2017.

If this provision is interpreted in this way this would eliminate the strategy mentioned above for conversions done in 2017. This could pose a problem for those that planned to take advantage of recharacterizing after the New Year.

It seems to me however that there may be room for interpretation here. The following is the excerpt from the final bill regarding the removal of the Roth recharacterization provision:

The House bill repeals the special rule that allows IRA contributions to one type of IRA

(either traditional or Roth) to be recharacterized as a contribution to the other type of IRA. Thus,

for example, under the provision, a conversion contribution establishing a Roth IRA during a

taxable year can no longer be recharacterized as a contribution to a traditional IRA (thereby

unwinding the conversion).276

Effective date.−The provision is effective for taxable years beginning after December 31,

2017.

This still seems unclear to me whether it applies to conversions that were already done in 2017. It references the conversion “during the taxable year” that can no longer be recharacterized and the provision is effective for “taxable years beginning after December 31, 2017” which to me means that you can no longer recharacterize Roth conversions done in the taxable year after this date which is 12/31/2017. So then a conversion done in 2018 cannot be recharacterized which is very clear, however, a conversion done in 2017 occurs in the taxable year before the provision ends, so then wouldn’t it stand to reason that a 2017 conversion can still be recharacterized up to the deadline in 2018 as it normally would have in the past? Furthermore, it seems unreasonable that this bill could be signed into law just days before the end of year closes giving effectively no practical time to unwind any conversion before the end of the year to which it is supposedly to apply. For many custodians, we have already passed the cutoff date for guarantee that such transactions can be completed before year end which just doesn’t seem fair or reasonable. But then again when is congress fair or reasonable?

The full bill can be found by going to http://docs.house.gov/billsthisweek/20171218/CRPT-115HRPT-%20466.pdf.

 

The Unknown May Cost You

In my sole opinion, It is possible that this provision will be effective ONLY for Roth conversions done in 2018 and beyond. However, that is a risk and it may be some time before we receive any clarification

If you have done a Roth conversion in the year 2017, you need to address this with your financial adviser immediately to know whether you should reconsider doing a full or partial recharacterization before year-end assuming it is even possible. If you are confident that there is no reason you'd need or want to recharacterize then there is no action necessary

 

Contact us ASAP!

The end of the year is very busy. It is critical that you contact us as soon as possible so that we can ensure we have enough time to review your conversion thoroughly. Click here to contact the office nearest you.

Please also keep in mind that all requests to recharacterize a Roth conversion will need to be submitted to the IRA custodian enough in advance to ensure it is accepted and completed before the end of the year and effectively this time may already have passed.

No More Roth IRA Recharacterizations After 2017

Beginning in 2018, it is clear that all Roth conversions will be irrevocable so if you plan to do any Roth conversions, it will require more careful review and possible change in strategy

At Portnoff Financial, we thoroughly review and carefully evaluate your financial situation to make sure a Roth conversion makes sense for you and to be ready and able to pay the expected tax bill. With that being said, when it comes time to discuss future Roth conversions, know you are in good hands.

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Jeremy E. Portnoff, MSFS, CFP®, CIMA® was recently quoted in this article from USA Today about Roth 401ks: 

https://www.usatoday.com/story/money/columnist/powell/2017/11/04/many-unaware-roth-401-k-benefits/797361001/

Roth 401k is not quite the same as a Roth IRA and it is important to know the difference. If you have any questions about Roth type accounts give us a call. 

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Certified Investment Management Analyst® (CIMA®)

It has been 10 years since I earned my CFP® (Certified Financial Planner™) credential. Since then I have completed a number of education/credential programs to continue my life long pursuit for knowledge, to be an accomplished and trusted advisor whose education and training exceeds that of the average advisor. I decided it was time to work towards an advanced investments certification, something that would really challenge me, and so I decided to embark on a journey to earn the Certified Investment Management Analyst® (CIMA®) program offered through the Investment Management Consultants Association® (IMCA).

From IMCA: "CIMA professionals integrate a complex body of investment knowledge, ethically contributing to prudent investment decisions by providing objective advice and guidance to individual investors and institutional investors. The CIMA certification program is the only credential designed specifically for financial professionals who want to attain a level of competency as an advanced investment consultant."

CIMA Certification is a rigorous multi-step process that typically takes about 9 months to complete. Once you submit the application and pass a background check you are eligible to take the 2-hour, 50 question multiple-choice Qualification Exam (QE) proctored at an AMP testing center, which typically takes approximately 100 hours of study time. The pass rate for the most recent quarter of first-time takers of the QE was 54% and 61% over the past two years; for re-testers it is only 44%. For the Core Topics list see below.

One you have passed the Qualification exam, then you are eligible to enroll in the education component; a graduate-level executive education course (packed into one grueling week) taught at The University of Pennsylvania's Wharton School of Business Executive Education Program. Successful completion of the course requires passing a 4-hour 25-question essay exam at the end of the program. From there you are then eligible to take the final Certification Exam which is a 4-hour 100 question multiple-choice exam held at the testing center during 4 testing windows each year. The pass rate in the most recent quarter for first-time takers of the CE was 69% and 63% over the past two years; for re-testers it is only 48%. There is no doubt this is a challenging program; According to IMCA, only 1 in 3 who start the program successfully finish!

I began seriously studying in April and passed the Qualification Exam on my first try on June 9th. Since then I've been preparing for Wharton which starts Monday 10/3/2016. If all goes well then I expect to take the final Certification Exam sometime in November. No doubt the next two months will be challenging so I appreciate your understanding and support. I look forward to sharing will all of my client the many things I have and expect to learn through the completion of this program.

CIMA Core Topics

  • Governance
    • IMCA Code of Professional Responsibility and Standards of Practice
    • Regulatory Considerations
  • Fundamentals
    • Statistics and Methods
    • Applied Finance and Economics
    • Global Capital Markets History and Valuation
  • Portfolio Performance and Risk Measurements
    • Attributes of Risk
    • Risk Measurements
    • Performance Measurement and Attribution
  • Traditional and Alternative Investments
    • Traditional Global Investments (Equity and Fixed Income)
    • Fixed-Income Vehicles
    • Foreign Exchange Market
    • Alternative Investment
    • Options, Futures, and Other Derivatives
    • Tools and Strategies Based on Technical Analysis
  • Portfolio Theory and Behavioral Finance
    • Portfolio Theories and Models
    • Behavioral Finance Theory
  • Investment Consulting Process
    • Client Discovery
    • Investment Policy Statement (IPS)
    • Portfolio Risk Management Strategies
    • Manager Search, Selection, and Monitoring
    • Perform Portfolio Review and Revisions Process

For detailed information on the CIMA certification process, go to https://www.imca.org/cima

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IRAs 401ks or both?

I  just answered a  question on www.Nerdwallet.com  which was "You can have a Traditional IRA and a Roth IRA; but can you also have a 401k and a Roth 401k, all 4 at the same time?" and thought I'd put this on my blog since it is a common question. Here is my answer:

Yes, you most certainly can have a Traditional IRA, a Roth IRA, a 401k, and a Roth 401k all at the same time. The issue will be which you can contribute to and how much.

For example, the annual contribution limit for IRAs is $5,500 plus $1,000 catch up (CU) if over 50. Let’s assume you are under 50 for my explanation. You can contribute any combination of amounts between a Traditional IRA and a Roth IRA as long as the total does not go over the limit, $5,500. So you could put $3,000 in your Traditional IRA and $3,500 in your Roth, or $1,000 in your Traditional IRA and $4,500 in your Roth.

Anyone can contribute to an IRA regardless of income but your ability to deduct it would be limited if your Adjusted Gross Income (AGI) is over $98,000-$118,000 if you file a joint tax return ($61,000-$71,000 Single/Head of Household) being that you are covered by an employer plan. If you make too much to make a deductible contribution then you might want to look to the Roth IRA however your ability to contribute to a Roth IRA is limited if your Modified AGI is $184,000 to $194,000 for joint filers ($$117,000 to $132,000 single/HOH). If you are over this amount then you would consider a non-deductible IRA and potentially convert it to a Roth (no income limit to convert) supposing you have no other IRA funds (if you do a pro-rata rule applies and may not be worthwhile).

The 401k contribution limit is $18,000 with a $6,000 catchup if you are over 50 (which I’ll assume you are not for purposes of this answer). Similar to the answer above on contributing to a Traditional IRA and a Roth IRA, you can contribute to both your 401k and your Roth 401k as long as the total does not go over $18,000. The amount you contribute to the 401k or Roth 401k has no impact on the amount you can contribute to an IRA (but does affect whether you can deduct it or not).

So if you have the money you can put $5,500 ($1,000 CU) to any combination of IRA and Roth IRA plus $18,000 ($6,000 CU) to any combination of 401k and Roth 401k for a total of $23,500 ($30,500 if over 50).

Now whether you should put more in the pre-tax versus the Roth (tax-free) is essentially a function of what your marginal tax bracket is now versus what you think it will be when you take the funds out. If you think you will be in a lower bracket in the future then pre-tax is the way to go, however if you think you will be in a higher bracket and/or you think tax rates are going up (due to terrible government debt) then Roth can be the way to go. If you’re not sure you can diversify to both which is not a bad idea. The pre-tax vs. Roth is really like any other investment except that you are betting on tax rates. One will be better than the other but you won’t know until the future arrives which is the same reason we diversify between stocks and bonds, between US and international and emerging markets, and Large cap and small cap, and growth and value, etc. 

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Dave Ramsey and the proposed Fiduciary rule by the Department of Labor

Dave Ramsey the financial author, radio host, television personality, and motivational speaker, recently  publicly criticized the proposed Fiduciary rule by the Department of Labor (DOL). Ramsey posted on Twitter “This Obama rule will kill the middle class and below['s] ability to access personal advice.”

To read the article from Investment News go to http://www.investmentnews.com/article/20160223/FREE/160229982/adviser-twitter-fight-erupts-when-dave-ramsey-bashes-dol-fiduciary.  

I think it is simply ridiculous to suggest that if all “financial advisors” were fiduciaries and required to act in the best interests of their clients and disclose all conflicts of interest that would somehow hurt middle class access to financial advice. While I am a fee-only advisor and prefer the model of full disclosure of compensation I do not think commissions are inherently bad. I don’t see anything wrong with selling financial products as long as all compensation, direct and indirect, are fully disclosed so that the client can make an informed decision. Therefore I see no reason why a commission based advisor could not put their clients interest first.

To suggest a fiduciary standard for all advisors would hurt access for middle class investors is like saying doctors who take the Hippocratic Oath (“…With regard to healing the sick, I will devise and order for them the best diet, according to my judgment and means; and I will take care that they suffer no hurt or damage…”) would reduce access to doctors by the middle class and the poor. Absolutely Not! This would be akin to doctors who do serve middle class and the poor not having to act in the best interests of their patients based on their judgement, etc. The idea is simply nonsense and I agree with (probably) most who have criticized Dave Ramsey in that those who are against this are so because they have a vested interest in not being required to put their clients’ interests first.

My view might be different in that I don’t think all “financial advisors” should be held to a fiduciary standard, rather that all advisors of any kind should be required to disclose all compensation, direct and indirect, as well as all conflicts of interest so that if the client wants to work with that broker/salesperson and buy their products they can at least make an informed decision. I personally might still choose to purchase a commission based product from a salesperson if they disclosed that they are not required to act in my best interest because I may feel that purchase is in my best interest and as long as I’m aware of that I can make a fully informed decision. For example if I go to buy a car the salesperson is not required to act in my best interest but as long as I have all the information I need (research on the car, truth in lending, etc) I can make a fully informed decision.

So I don’t think applying a fiduciary standard to all “advisors” will fix the problems in the industry nor do I think getting rid of all commission products will either. Rather if we had simple common sense regulations that require the full and clear disclosure on compensation, direct and indirect, as well as conflicts of interest in a manner that is understandable to the clients then we’d make some progress towards protecting the public and people could then choose who they want to work with.

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2015 IRA Contribution Reminder

It's not too late to make an IRA contribution for 2015. The deadline is the tax filing date which is Monday 4/18/2015 this year however generally it is not a good idea to wait until last minute.

Individual Retirement Accounts (IRA) are tax deferred, or in the case of a Roth IRA, tax-free savings/investment accounts. Tax deferral allows your money to grow faster without losing some of the growth annually to taxation. Having investments in an IRA also allow you greater investment flexibility to make changes without having to worry about generating any taxable capital gains transactions.

The IRA contribution limit for 2015 is $5,500 to any combination of IRAs and/or Roth IRAs as long as the total doesn't go above $5,500 unless you qualify for the catch-up contribution which is an additional $1,000 if you reached age 50 by year-end 2015.

Anyone is eligible to make an IRA contribution as long as you have earned income and you are under 70 1/2; whether you can take a deduction for a traditional IRA depends of a few factors described below. Eligibility to contribute to a Roth IRA depends on income which is also described below; there is no age limit to make Roth IRA contributions.

 

Phase-Out Range for IRA Deductibility: If you are considered an active participant in a company retirement plan, your deductibility for an IRA may be limited. If you are married filing jointly the phase-out for deductibility begins for adjusted gross income between $98,000- $118,000; above that there is no deduction. If you are a single or head of household filer the phase-out for deductibility begins for adjusted gross income between $61,000- $71,000; above that there is no deduction. If you are not covered by a company plan but your spouse is, the phase-out range for you is $183,000 - $193,000. If you file married-separate, your phase-out range is $0 - $10,000. If your income falls between the phase-out range, your ability to deduct your IRA contribution will be limited. There is a specific calculation to determine the amount you can deduct so if this applies to you, consult your tax advisor to determine how much you can deduct.

Even though you may not participate in the company plan, you may be considered an "active participant” so it is important to verify before attempting to take a deduction. If you and your spouse (if applicable) are not covered by a company plan, then there is no income limitation to take a deduction for an IRA contribution. SEP and SIMPLE IRAs are considered company plans for these purposes but are not included in the maximum contribution amount as they have their own limits.

Eligibility for Roth IRA Contribution: If you are married filing joint, the phase-out of eligibility to contribute to a Roth IRA is between $183,000 - $193,000 of adjusted gross income; above that you cannot make a Roth IRA contribution. For single or head of household filers, the phase-out for eligibility is $116,000- $131,000. If you file married-separate, your phase-out range is $0 - $10,000. As mentioned above, if your income falls between the phase-out range, then your ability to contribute to a Roth IRA is limited. If you are above, then you cannot contribute directly to a Roth IRA however you are still able to convert IRA funds to a Roth IRA which is discussed below.

Non-deductible IRAs: If you wish to make a deductible IRA contribution but make too much income to be eligible to take a deduction, consider a Roth IRA instead. If your income is above the threshold to make a Roth IRA contribution, you can still make a regular IRA contribution however that contribution will not be deductible. In such a case of a non-deductible IRA contribution, your money goes in after tax but still grows tax deferred and your contributions when withdrawn are not taxable however the interest/gains will be taxable upon withdrawal.

These non-deductible contributions create "basis” in your IRA which when withdrawn come out tax-free in a pro-rata distribution relative to the amount of pre-tax money in your IRA. For example, if you have $100,000 in your IRA, $10,000 of which is after-tax basis, your ratio would be 10%. If you then took a distribution/conversion of $25,000, $2,500 of that would be considered a return of your basis tax-free while the $7,500 would be taxable.

IRA to Roth Conversions: Since 2010 anyone regardless of income can convert an IRA to a Roth IRA. This means that you could make a non-deductible IRA contribution and convert it to a Roth thereby getting after-tax funds in a Roth IRA which is in essence the same as making a Roth IRA contribution. This strategy is referred to as the “Back Door Roth.” It only works if you do not have other IRA funds because if you do, the pro-rata rules described above would apply. It is unknown if this loophole will be closed by congress or if they will allow anyone regardless of income to make a Roth IRA contribution; only time will tell. For now it is still there and people who this applies to should consider taking advantage of this great tax planning opportunity.

Mega Backdoor Roth:  The “Mega Backdoor” Roth is similar to what is described above however it is related to employer plans. There are many rules and details to be aware of but the basic idea is this: if the employer plan allows for after-tax contributions, you can theoretically contribute after tax funds up to the maximum Defined Contribution plan limit which is $53,000 for 2015 and 2016 plus $6,000 catch up contribution if over 50. Then, if the plan allows, you can request a distribution of only the after-tax funds paid to you and then deposit to a Roth thereby completing a Roth conversion of after-tax funds which means getting a whole lot of money in a Roth IRA, far more than the statutory annual contribution limit which also is limited by income levels.

For example, suppose you are maxing out your 401k at $18,000 and your employer provides a $6,000 contribution for you. That means $24,000 has been contributed leaving an additional $29,000 that could be put in using after-tax funds ($35,000 if over 50). If you had the ability to, you could contribute that $29,000 from your paychecks and at some point then request a distribution of those after-tax funds and convert to your Roth IRA. That would mean getting $29,000 in a Roth IRA in one year! Well you might say, “I have bills to pay and can’t take that much out of my checks.” Well obviously if you don’t have the funds you can’t do this but suppose you do have $29,000 in a savings or taxable investment account. In that case you would increase your contributions to the plan and use your savings to pay the bills and essentially shifting those taxable savings/investments into tax-free Roth IRA accounts. That’s why this is called the “Mega” backdoor Roth. Certainly many details are left out but this is the basic idea. If you think this could apply to you be sure to give us a call to discuss.

2016 IRA Limits: For 2016, IRA contributions limits stay at $5,500 if under 50 with the additional $1,000 catch-up contribution if you reach age 50 by year end. The phase-outs for IRA deductibility and Roth IRA stayed mostly the same from 2015 with a few exceptions:

  • IRA deduction phase-out for active plan participants
    • Single $61,000-$71,000
    • Married filing jointly $98,000-$118,000
    • Married filing separately $0-$10,000
    • Spousal IRA $184,000-$194,000 (you are covered but your spouse is not)
  • Roth IRA phase-out
    • Single $117,000-$132,000
    • Married filing jointly $184,000-$194,000

If you have any questions about IRA contributions or wish to make an IRA contribution for 2015 give us a call.

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