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Little-Known IRA Penalty Could Cost A Lot

A 2015 ruling by the Tax Court can affect your flexibility in moving from one Individual Retirement Account (IRA) to another, and it's still catching people by surprise today. It's easy to become confused, because the Internal Revenue System's own Publication 590 took awhile to catch up with the new ruling and gave contradictory recommendations. It's important to understand the stricter interpretation of the law, because making a mistake can subject you to unnecessary taxes and penalties, and could cause you to lose your IRA.

A couple of years ago, moving money from one IRA to another was fairly straight-forward, as long as you followed the "60-day rule". What this meant was, you could withdraw money from an IRA, but as long as you deposited the money into another IRA within 60 days, you would not be taxed on the distribution, and your money would continue to grow tax-deferred in the new IRA. This gave valuable flexibility to many people -- they could take money out of their IRAs and use for 60 days tax-free. If they put it back into an IRA within 60 days, it was like it never even happened. 

Before 2015, the understanding was that you could apply the "60-day rule" to multiple IRAs in the same year. Let's say you have $50,000 in IRA 1, and $100,000 in IRA 2. You decide to liquidate the $50,000 IRA, and within 60 days, you put it back into another IRA. Later that year, you liquidate the $100,000 IRA. Same as with the first IRA, you deposit the money back into an IRA within 60 days. No taxes, and no penalties. 

That was under the old rules. Unfortunately, the Tax Court felt this was a loophole they needed to close. Now, you can only apply the "60-day rule" to ONE IRA within a 12-month period, no matter how many IRAs you have. Using the same scenario above, the first IRA transfer of $50,000 would be allowed, but the second IRA transfer of $100,000 would be disallowed. The IRA owner would have to pay tax on $100,000, and the IRA would come to an end. To make matters worse, the IRA owner could also incur a 6% annual penalty for excess contributions because annual IRA contributions are limited to $5,500 ($6,500 if you're over 50 or older). The penalty would continue until the excess contribution was corrected.

You should also be aware that there are many different types of IRAs -- there are Traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. Among all of these IRAs, only ONE rollover can occur every 12 months, NOT one rollover for each type of account.

The good news is that there is a way to move from one IRA to another IRA that avoids the restrictions and penalties. It's called a "trustee-to-trustee" (also known as a "custodian-to-custodian" transfer). Every IRA has a trustee or custodian.  The trustee-to-trustee transfer is not considered a distribution because the IRA owner doesn't have direct access to the money. And because it's not considered a distribution, it's not subject to the only-1-per-12-month limit. 

The trustee-to-trustee transfer is best done by direct transfer. This means the money goes directly from Trustee A to Trustee B and never touches your hands. From the IRS' point of view, this is clearly not a taxable issue. Another way to do the trustee-to-trustee transfer is to have the check written payable to the trustee. For example, the check might read "Payable to Charles Schwab, custodian FBO Your Name." FBO means "For the Benefit Of." Unlike the IRA-to-IRA rollover, there are no limits on the number of trustee-to-trustee transfers that can be made each year.

Because the consequences can be dire if you make a mistake, and there is little recourse once you've made an error, it may be wise to consult with a CPA or Certified Financial Planner™ when you want to do an IRA rollover or transfer.

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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Penalties Retirees Can Avoid

For those of you who are contemplating retiring soon, you will be joining the approximately 10,000 Baby Boomers who are turning age 65 every day. By 2060, there will be 98 million Americans age 65 or older, making up 25 percent of the general population.¹

This large group of retirees will have to make many important decisions. You only get one chance to make some of these decisions. The errors can be costly, but are easily avoided. I'd like to explore some of these danger areas, as well as ways to stay out of trouble.

DON'T CLAIM SOCIAL SECURITY BENEFITS TOO EARLY

Although it's possible to start receiving Social Security benefits as early as age 62, it might not be the best thing to do, depending on your circumstances. When you start taking Social Security benefits at age 62, you receive a reduced level of benefits permanently for your lifetime. This is because you're triggering benefits before your Full Retirement Age. If you were born between 1943 and 1954, your Full Retirement Age is 66. If your birthday falls between 1955 and 1959, your Full Retirement Age is 66-67. Finally, those born in 1960 or later have a Full Retirement Age of 67. 

As a rough rule-of-thumb, your Social Security benefits increase by about 8% for every year that you wait to start benefits. Therefore, if you start Social Security at age 67, your benefit will be about 40% higher than if you started it at age 62. This can make a significant difference in your lifestyle if you live a long time.

If you wait to age 70 to collect Social Security, your benefit will be about 64% higher compared to age 62. However, it doesn't pay to wait beyond age 70, because there are no increases after that point.

ENROLL IN MEDICARE AT THE RIGHT TIME

If you're already enrolled in Social Security and you're approaching age 65, you will automatically receive your Medicare card 3 months before your 65th birthday, and your coverage will start at the beginning of the month in which you turn 65. 

However, if you have not yet started Social Security when you turn 65, you have to remember to enroll yourself. You have to do it within a six-month window, starting 3 months before your turn 65, to 3 months afterwards. It's best to pay a visit to your Social Security office 3 months before your turn 65, so your coverage can start as soon as you turn 65. 

If you miss the six-month Initial Enrollment Period window, you will pay a penalty of 10% of the Part B premium for every year that you delay. This penalty is permanent, for as long as you receive Medicare.

DON'T FORGET TO TAKE YOUR REQUIREMENT MINIMUM DISTRIBUTION (RMD)

Want to avoid a 50% penalty? Don't forget to take your annual Required Minimum Distribution, starting at age 70 ½. If you don't take your RMD like you're supposed to, the IRS can take 50% of what you were supposed to take. 

This rule applies to the money in your retirement accounts, like Individual Retirement Accounts (IRAs), employer-sponsored plans like 401(k)s and 403(b)s, and those created by self-employed individuals, like Simplified Employee Pensions (SEPs). Because the Internal Revenue Service wants to collect taxes on this money, it requires you to start taking out some money (and being taxed) from these accounts every year starting at age 70 ½. 

The annual RMD is not a large amount, about 4% at age 70 ½. For example, if you were age 70 ½ this year, you would take the cumulative value of all of your retirement accounts on December 31, 2016, and divide this sum by a denominator based on your age. At age 70 ½ the denominator is 27.4, making your RMD about 4%. In reality, your investment management company or Certified Financial Planner™ should do this calculation for you each year, and make sure you receive your distribution before the end of each year. 

Fortunately, the rest of your money can continue to grow, tax-deferred. Many people are under the impression that once they turn 70 ½, the value of their retirement accounts will dwindle each year. This is certainly possible if you have your retirement accounts in a bank savings account or CD. If you have to take out 4% or more each year, and the account is earning 1% or less, the balance will eventually disappear. However, in a broad, globally-diversified portfolio of investments, it's very possible to get an average return higher than 4% per year. Even though you have to take Required Minimum Distributions, you retirement accounts can still grow. Potentially, you can pay for your retirement expenses and still leave a legacy for your children or grandchildren.

Of course, the best choice for you on these decisions depends on your personal circumstances and goals. Consult with your CPA, Certified Financial Planner™, or estate planning attorney for advice when you are entering retirement. They can help you make the right decisions to maintain your lifestyle in retirement, and avoid needless penalties and taxes.

¹ Population Reference Bureau 1/2016

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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Aren't Record Highs a Good Thing?

I hope you are enjoying the dog days of summer!  Global stock markets delivered robust gains in the second quarter of 2017 as stronger earnings growth, upswings in global economic data and diminished political uncertainty in Europe all buoyed markets around the world.  The S&P 500 rose 3.1%[i] while domestic economic data continued to plug along at a healthy, if not exciting, pace.  It’s wonderful to have positive economic data to reflect upon.  However, whether the headlines this week are about the new market high or a looming market correction, the most important takeaway is to stick to your long-term investment plan and concentrate on the big picture.

This week the Dow Jones Industrial, arguably the most frequently referenced stock market index in the world, reached an all-time high of 22,000.  Since the bottom of the recession in March 2009, the Dow has more than tripled in value, creating one of the strongest bull markets we’ve ever seen.  However, our current bull market reached a milestone 8 year run this March[ii].  While some are finally comforted to get back into the market, others are warning that the sky is falling and to lock in gains while you can.  While a typical market timer might move from stocks into bonds when they expect the market to pull back, other financial experts caution that bonds are the wrong move in a rising interest rate environment.  All the warnings and predictions make the initial exuberant Dow record a frightening position to be in.  

So what do you do? 

My father and mentor, Alan Kondo, has always liked the adage, “The market timer’s Hall of Fame is an empty room.”  It’s true that an 8 year bull market does give rise to concern.  However, perfectly timing the top of the market so you can sell to lock in gains and then predicting the exact time to reenter the market before it picks up again is as likely as winning the lotto – twice in a row.  

What has historically worked more effectively to provide reliable returns and protect your nest egg is to create a long-term investment plan that you can stick to, in both good and bad markets.  Construct a balanced portfolio of equities and fixed income (bonds) that will capture market growth when it occurs, but also provide you a measured amount of downside protection if the market has a pull-back.  The exact weighting of equities to fixed income depends on a variety of factors like your retirement date, the return you hope to achieve annually and your personal risk tolerance.  A Certified Financial Planner™ can help you customize an asset allocation that is tailored to you.  

Success in Short-Term Fixed Income

For some, fixed income has been a difficult component to keep in their portfolio during the last 8 years as equities have climbed at a remarkable pace.  Further, with rising interest rates and inflation, long-term bonds may have a difficult road ahead.  We should be mindful of how we invest in fixed income these days.  The Federal Reserve has already increased interest rates twice this year and four times since 2015[iii], signaling that they believe the economy is still strong.  That means you don’t want to lock in a 10 year Treasury at 2.25% now if the going rate is going to be 2.50% by year-end and even higher next year.  Instead, now is the time to invest in short-term fixed income, with maturities of less than 5 years and preferably 1-3 years.  Employ a laddering strategy where multiple bonds are purchased, each with different maturity dates.  Having short-term laddered fixed income means that each quarter, some of the bonds in your portfolio or bond fund will mature.  The matured bonds will be replaced with new short-term fixed income at the going market interest rate, allowing your fixed income fund to keep up with rising interest rates and still provide you downside protection if the equity market dips.  

Why Market Pullbacks are Good

A market pullback is defined as a temporary market decline in what was otherwise an upward trend in the stock market.  Some are claiming that a market pullback is on the horizon that will wipe out the Trump Rally[iv] which has amounted to a whopping 3,000 points on the Dow since President Trump took office last November.  A market correction can be as much as a 10% decline, but it’s important to remember that market corrections happen often and are actually indicative of a healthy stock market.  Just as the economy has peaks and valleys, so too does the stock market.  When the market goes too long without a correction, the risk of stock prices deterring too far from their actual value grows.  

Keeping a big picture perspective, in a 20 or 30 year investment window, a market correction is hardly a blip on the retirement radar.  So if you have set up a good investment allocation, let your investment ride out that temporary trough and get back on track.   Don’t sweat the small stuff.  

In the last 20 years, the S&P 500 returned an annual average of 7.68%.  However, during that same window of time, the average U.S. stock investor earned just 4.79%. That is an almost 3% difference each year[v].  Mostly this is the detriment of market timing and locking in lows due to panic.  Many investors are smart people who could do a good job at investing their retirement funds if they dedicated themselves to it full-time.  The benefit of a good financial advisor is the experience, objective advice and guidance that can help keep investors on track and stop them from potentially cutting their long-term returns in half.  

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.


[i] http://www.marketwatch.com

[ii] http://fortune.com/2017/03/09/stock-market-bull-market-longest/

[iii] http://www.npr.org

[iv] https://www.cnbc.com/2017/03/24/a-health-care-bill-setback-may-create-a-great-buying-opportunity-raymond-james.html

[v] http://360.loringward.com/rs/303-IYC-235/images/Blog_Don%27t_Just_Do_Something.pdf

 

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Leaving Debts After Death

For many parents, the last thing they want is to leave their children debts after they are gone. However, this is becoming more and more common. The Federal Reserve's Survey on Consumer Finances showed that for families headed by seniors age 65 to 74, those that had debt rose from 50% in 1989 to 66% in 2013. Not only that, during the same period of time, the debt load doubled.

Some of the main reasons for this trend is the rising cost of healthcare, people living longer, and the reality that about 40% of your lifetime expenditure on healthcare occurs after age 70. For those seniors who don't have a Long Term Care policy or adequate healthcare protection, those costs are paid from credit cards, or from refinancing their homes.

It's not uncommon for surviving children to discover that their parents left dozens of credit cards with overdue payments, and large mortgage balances. What happens to unpaid bills when you die? What debts are passed onto the next generation? Here are some answers to these questions.

What happens to unpaid debts after you die?

Typically, when a person passes away, the person's estate owes the debt. If there is not enough in the estate to pay the debt, the debt goes unpaid.

What happens to credit card debt?

Children are usually not responsible for any remaining credit card debt that their parents owed, no matter what the reason is for the debt. However, a child who is a co-owner of the credit card would still be liable for the debt.

What about loans that were taken out by parents for the children's education?

For a parent's federal student loan, or Parent Plus loan, any balance remaining at their death is taken off the books. However, according to the Education Department, their estate could be required to pay taxes on the forgiven loan.

How do I protect retirement assets from creditors?

Many attorneys will advise their clients not to name their living trust as the beneficiary of their retirement accounts, such as Individual Retirement Accounts, 401(k)s, 403(b)s and 457 deferred compensation accounts. What can happen is that the Internal Revenue Service would tax these accounts, and only the net amount after taxes would be distributed to family members.

It's often better to name real people (like children or grandchildren) as beneficiaries of retirement accounts rather than the trust. This way, the children can create Inherited IRAs after the parents have passed away, the money can be transferred from the parents' IRAs to the children's IRAs tax-free, and the money is able to grow tax-deferred for another life expectancy. Even a modest IRA, when it benefits from 2 generations of tax-deferred growth, can balloon to an impressive value. The owner of the Inherited IRA has to take a Required Minimum Distribution each year, but it's age-weighted and can be quite small.

Similarly, if the living trust is named as the beneficiary of a retirement account, existing creditors can attach the estate even before it gets to the children. However, a retirement plan that has real people as beneficiaries cannot be touched by the creditors of the deceased.

Consult with an attorney that specializes in wills, trusts, or estate planning if your parents passed away with significant debt. He or she can give you advice for your specific circumstances and goals.

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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How to Prepare for a Downturn

This is an unusual time for the market. Our clients have been happy about how well their accounts have been growing, even in conservative portfolios. At the same time, many are unnerved about the daily chaos coming out of Washington, and worry about an impending crash if Trump should do something unexpected that would upset the U.S. market.

There is reason for concern. The U.S. market has been on a tear for the last 8 years, and we know that on the average, we have a market crash every 8 to 10 years.¹ A correction in the U.S. market would be a normal and healthy occurrence, and is overdue.

Moreover, U.S. companies are currently overvalued. The ratio of a company's share price to its per-share earnings, known as the Price-Earnings or P/E Ratio, is an average 23.8 for U.S. companies. Since 1988, the average P/E ratio has been 18.8.¹

However these statistics don't tell the whole story. When the media and pundits talk about the market, they tend to put the blinders on, and focus on the U.S. market alone. However, the U.S. market represents only 36% of the world’s total stock market capitalization.² An investment strategy that is based on broad, global diversification keeps this fact in mind. Under this approach, you are not invested just in the U.S. market, but in every market around the world -- just the opposite of putting all your eggs in one basket.

We saw first hand in the Great Recession of 2007 how lack of diversification can be a disaster. The Standard and Poors 500 Index, representing the 500 largest companies in the U.S. based on capitalization, fell 60%. Many investors who had only the S&P 500 or similar investments in their portfolio panicked and sold everything at the bottom of the market. They not only locked in their losses, but failed to benefit from the strong rally from 2009 to the present.

Yes, the U.S. market is overvalued, but the media has been saying that every year for the last 10 years, and the market has continued to rise. If you have a diversified portfolio, you would also have international investments that have reasonable valuations (the P/E for German companies is 16)², and also in emerging market investments (countries like China and India) where the P/E is even lower. In fact, emerging market investments were among the best-performing asset classes in 2016.

We learned valuable lessons from the Great Recession that we would do well to remember at this time:

•  Don't try to time the market and pick stocks. They say "the Hall of Fame for market timers is an empty room".

• Don't try to skew your investments in anticipation of expected future events, no matter how plausible they sound -- they might not happen for a very long time, if ever.

Warren Buffett stated it best when he said there are 3 certainties in life: death, taxes, and rising markets. The Great Recession was the worst crash we had seen since the Depression, but as long as you didn't panic and sell everything, you would have broken even in 4 years, 5 months.³ That would be just a blip, compared to the 25 to 30 years we are likely to spend in retirement. For many people, a diversified investment portfolio makes it possible to maintain their lifestyles in retirement. By comparison, avoiding all risk by keeping all your money in the bank could make running out of money a guarantee.

Buffett looks forward to market downturns as a buying opportunity. Remember when Bank of America stock was $3 a share in 2008? When you employ automatic quarterly rebalancing, you can buy low automatically. Here's how it works -- when you have a globally-diversified investment, you have about 15 distinct asset classes in your portfolio. They don't all go up and down at the same time -- they take turns. If any asset class increases 4% or more in a 3-month period, you sell some it while it's up high (like taking some of your winnings off the table in Vegas) and put the proceeds into another asset class that is a bargain at the time. Just doing quarterly rebalancing can make a dramatic difference in long-term performance.

In a volatile and uncertain market, diversification and rebalancing can be your best friends. Not only do they allow you to sleep better at night, but they will make it possible to stick to your plan, accomplish your long-term goals, have a comfortable retirement, and pass something on to your children and grandchildren.

¹ Investment News, 5/2017

² CNBC, 3/13/2017

³ Bloomberg, 6/2017

⁴ Business Insider, 11/6/2016

This commentary on this website reflects the personal opinions, viewpoints and analyses of the Kondo Wealth Advisors, Inc.  employees providing such comments, and should not be regarded as a description of advisory services provided by Kondo Wealth Advisors, Inc.  or performance returns of any Kondo Wealth Advisors, Inc.  Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Kondo Wealth Advisors, Inc. manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.

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