Retirement Contribution Limits

LAST WEEK, THE INTERNAL REVENUE SERVICE (IRS) released its cost of living adjustments for contributions to a variety of retirement saving vehicles. The limits affecting 401(k) plans, the federal government’s Thrift Savings Plan (TSP), and other similar programs provided for by Section 402(g)(1) remain the same at $15,500. However, the limitation for defined contribution plans under Section 415(c)(1)(A) increased from $45,000 to $46,000 and the annual benefit limitation for a defined benefit plan under Section 415(b)(1)(A) increased from $180,000 to $185,000. Other increases include:

The applicable dollar amount under Section 219(g)(3)(B)(i) for determining the deductible amount of an IRA contribution for taxpayers who are active participants filing a joint return or as a qualifying widow(er) increased from $83,000 to $85,000. Additionally, the applicable dollar amount under Section 219(g)(3)(B)(ii) for all other taxpayers (other than married taxpayers filing separate returns) increased from $52,000 to $53,000. The applicable dollar amount under Section 219(g)(7)(A) for a taxpayer who is not an active participant, but whose spouse is an active participant, increased from $156,000 to $159,000.

The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(I) for determining the maximum Roth IRA contribution for taxpayers filing a joint return or as a qualifying widow(er) increased from $156,000 to $159,000. The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(II) for all other taxpayers (other than married taxpayers filing separate returns) increased from $99,000 to $101,000.

These aren’t exactly huge changes…but every little bit helps.

The Retirement Red Zone

IN THE RETIREMENT RED ZONE, the period five years before and five years immediately following retirement, even a short-term market downturn can have a significant impact on your future retirement income stream. Accordingly, to extend the football metaphor, just as they do when a team approaches the goal line and threatens to score, emotions tend to run high.

In fact, a new study entitled “Behavioral Risk in The Retirement Red Zone” identifies five dominant emotions – fear, regret, inertia, susceptibility, and aggressiveness – that can cause you to react to market uncertainty in ways that could harm your portfolio. Specifically, 80% of survey respondents registered high or moderate degrees of regret and 71% reported high or moderate degrees of fear, emotions that could cause you either to hesitate to take action or be less likely to take on necessary, managed risks.

Significantly, although the report sponsored by Prudential Financial, Inc. found that three of four investors are affected by their emotions to a moderate or high degree, only 35% believe emotions impact their investment decisions. Clearly, although behavioral finance, the study of how emotions affect financial decision-making, has gained ground since Daniel Kahneman was awarded the Nobel Prize in 2002 for his work in the field, there’s still work to be done.

According to the study results, for most investors, the first step may be the most difficult. Because you are less likely to be swayed by emotions if you recognize that emotions can influence your decisions, simply understanding more about your decision-making can mitigate the effects of behavioral risk on your portfolio. So, open up to your spouse, friend, or family member, and, remember, we’re always ready to listen or answer questions.

Happy Anniversary

Twenty years ago today, the Dow Jones Industrial average experienced its worst one day loss in history. What became known as “Black Monday,” the Dow lost a whopping 22.6% in one day. Panicked sellers, who couldn’t control their emotions, sold as much as they could on that day locking in their losses.

We always like to use these terrible events as a point of education for clients. For instance, what if you had the unfortunate experience of investing $10,000 in the market on Friday, October 16, 1987? You would have watched your investment drop to $7,739 by the end of the trading day on Black Monday. That alone would be enough for most people to swear off stocks for the rest of their life.

However, if you managed to keep your emotions in check and not sell your stocks you would have broken even by the end of January, 1989. And today, your initial investment would be worth over $61,800 for a total gain of 518%.

But what if you had the fortitude to invest another $10,000 on Black Monday? You would have broken even on your total investment in two days and, although the value fluctuated for some months, you would have permanently been in the black by February, 1988. Your $20,000 investment would be worth $141,698 today, a total gain of 608%.

The simple lesson is the markets will go down from time to time. However, as history has shown, they always come back and continue to new highs. When you experience an inevitable downturn in the market, your best bet is to stay put. Better yet, consider adding more money to your investments!


*Source: Yahoo! Finance. Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly.

The Impending Alternative Minimum Tax Nightmare

Most of us would have stood up and applauded the government when they created the Alternative Minimum Tax (AMT) in 1969. Originally, the AMT was established to prevent the wealthiest taxpayers from taking enormous deductions to reduce their taxable income. Unfortunately, recent changes to the tax code will have the unintended results of ensnaring millions of unsuspecting middle and upper-middle class families.

Coexisting with the traditional income tax system, the AMT is essentially a flat tax. It has earned the nickname of the “stealth tax” as many taxpayers are unaware of its existence until they must pay it. For those of you who are unfamiliar with the AMT, it is useful to examine how it works.

Put simply, the IRS requires two tax calculations: your normal tax liability and your AMT liability. AMT starts with your original taxable income and then adds certain “preference” items that normally have favorable tax treatment under the traditional system. After an exemption amount, the tax is levied at up to 28% to arrive at your AMT liability. If the AMT liability is higher than the regular tax liability, you must pay the higher amount. For most of you, the AMT liability has always been lower than your regular liability. Things are about to change!

To help target the right taxpayers to pay AMT, the federal government uses an exemption amount to reduce the AMT liability. That exemption amount generally keeps the AMT lower than the normal tax for most taxpayers. In 2006, the exemption amount for married taxpayers filing joint returns was $62,550. The exemption is reduced to $45,000 for 2007 and the foreseeable future. For millions of taxpayers, this change will single-handedly result in paying AMT for the first time. For those who are already subject to AMT, the instantaneous result is an added $4,900 or so in taxes due.

Families who own homes and have children are vulnerable to AMT exposure. For many taxpayers, most tax deductions and exemptions are from items such as personal exemptions for children, deductions for property tax paid, interest on home-equity loans not used for home improvements, just to name a few. Taxpayers must add these items back to their income for AMT calculation purposes. Also, anyone who has or will have employee incentive stock options should contact a financial professional before executing those options.

When planning for taxes, it pays to act sooner rather than later. Even with a professionally planned strategy, a wise taxpayer, regardless of their socio-economic status, should prepare to pay more tax in April of 2008.

What is the market going to do?

I’ve long realized that when someone I meet casually finds out I’m a financial advisor, they nearly always ask me the same question: What is the market going to do? I’ve also become accustomed to the strange looks I get when I answer, “Over the next year, the market will either go up, go down or stay the same. No one knows for sure.”

This question, while simple, reveals a lot about the public view of financial advisors. It’s clear that a significant portion of the public view financial advisors as forecasters and think we should always know what the market is going to do (or at least have an opinion). They believe the role of an advisor is to predict future events and position their assets to take advantage of current and future trends. Many think a shrewd advisor will move their assets to technology ahead of a big boom or, perhaps, wisely sell their stocks ahead of a predicted market decline.

Sadly, I know exactly why this mind-set is prevalent in the investing public. It is simply based on how this industry has worked in the past and how most financial institutions still run today.

Most financial institutions are aligned to profit from the transactions of investors. Stockbrokers, who now call themselves “financial advisors," recommend trades for which they receive commissions. From the brokerage firm’s view, the more trades the better. Brokers must continually rationalize their trade recommendations to clients and their recommendations can come in various forms:

“I predict that stock XYZ will have a good quarter, and stock ABC is going to fall so we should buy and sell.”

“I predict that emerging markets are going to have a good year so let’s sell your domestic large growth fund and buy the emerging markets fund.”

“I predict that interest rates are going to fall this quarter so you need to buy this annuity before rates drop.”

Unfortunately, brokerage firms and the financial media have conditioned the investing public to believe that a successful investment experience calls for out-guessing the market. I’m not suggesting the public is unsophisticated. They are simply bombarded by brokers seeking commissions and the financial media seeking ratings using phrases like looming crisis, positive economic indicators, potential for explosive growth, grossly undervalued, etc. This language would make any investor that takes it seriously think they need to move their assets around in response to easily forecasted future events.

The irony here is that I view my job as optimizing my clients’ financial lives so they don’t get hurt by trying to predict the future or by emotionally moving their money based on the “noise” of the day. My responsibility is to make sure clients ignore the hair-brained forecasts of those trying to make top ratings in the financial media. The fact is if the financial media told you the truth, that proper asset allocation, diversification and risk control are the key to your long-term investment results, people would stop watching and buying media. Then, of course, the media wouldn’t be able to sell advertising to other firms who promote market timing and constant money movement.

I want you to be an ever-vigilant skeptic and keep constantly before you the motivations behind what you read and watch. When notorious author Harry Dent says the Dow is going to hit 40,000 by 2009 it’s because he wants to sell books, not because he wants to help you with your portfolio. He knows that many brokers working for the big Wall Street firms love flagrant, unfounded speculation and will use it to sell products to their clients. When Jim Cramer yells and screams on national television about the best place to put your money, it’s ratings he seeks, not your best interests. When you see “Seven stocks you have to know for Monday” on Yahoo Finance their intent is to produce clicks and sell advertising space, not to help us kick-start your portfolio this week.

In my view, fiduciary standards and the pursuit of moral high ground (not to mention the best portfolios) dictate that we consider the entire financial life of a client when developing a portfolio for a specific risk level. We cannot abandon that well-grounded perspective for so-called intuition. The role of a professional advisor is to ensure that clients earn the returns to which they are entitled for the risks they are taking as investors in the global capital markets. The amateur advisor is the one who speculates, forecasts, or tries to add value through showmanship and asset repositioning.

The simple reality is that you don’t have to correctly forecast the future to enjoy investment success. Investment success is not the result of a sequence of well-timed movements. Your odds of consistently and correctly out-guessing the market are low, but your odds of creating excessive fees and tax consequences while you try are high. Amateurs spend their time rationalizing the legitimacy of market forecasts. Professionals build tax-efficient, risk controlled, low-expense portfolios and work hard to make sure their clients don’t have to pay attention to forecasts made by those whose sole intent is to sell magazines, airtime, or financial products.