Increasing Your Return on Life.®

Frank Talk - 2nd Quarter Newsletter (2015)

Published: 04/01/2015

Table of Contents

Editorial

Written by: Frank Fantozzi

As the long, cold winter of 2015 draws to a close, it’s hard to believe that we are a full quarter into the year. Personally, I think I spent half of it just shoveling the snow out of my driveway—and we had it easy compared to our friends in Boston! Yet, we have much to be thankful for and look forward to as the temperatures warm in the coming months. Of particular note is our upcoming Seventh Annual Cleveland Economic Summit which we hope you and a guest will plan to attend.   

Save the Date

This year’s complimentary Luncheon and Economic Summit will take place on Thursday, May 21st from 11am – 2pm at the Music Box Supper Club, a spectacular two-story concert venue designed to dazzle audiences. Located on the west bank of Cleveland’s historic Flats district, the Music Box Supper Club features riverfront dining and large outdoor decks overlooking downtown Cleveland.

This year’s event features two distinguished speakers. Securities industry veteran, David F. Lafferty, CFA, will provide keen insight for Ohio investors, taxpayers and business leaders on today’s economy with a focus on the global and domestic equity markets, the Feds’ latest thinking and expectations for interest rates, and the potential impact of geopolitical events on economic growth, among other topics. Performance consultant and motivational speaker, Dr. Kevin Elko will share his Vision for Victory, focusing on five key steps for recognizing and seizing opportunities that enable you to live your ultimate life.  Register today!  

Join the conversation #ClevelandEconomicSummit.  

We look forward to seeing you there!  

PFS Recognized as Seven-Time NEO Success Award Recipient

We’re proud to announce that Planned Financial Services was named an NEO Success Award Winner for the seventh time. Presented by Inside Business Magazine and established in 1995 as a way to showcase the success of businesses in the region, the NEO Success Awards program annually recognizes the top-performing companies in Northeast Ohio, reflecting the region’s determination to expand and revitalize its economic status. This Award is unique in its combined measurement of success in sales, growth and profitability, and represents the breadth and depth of business in Northeast Ohio. PFS was recognized for achievement amongst its peers, professionals and other award winners at a luncheon on March 26th at Executive Caterers at Landerhaven in Mayfield Heights, Ohio.

Beachwood Office Renovation

We’re very excited about the renovations to our Beachwood office.  The result is an even more inviting and contemporary space for our team members and clients to relax, interact and benefit from innovative technology and systems designed to enhance your financial and investment planning experience. 

Watch for More from PFS in the Months Ahead

Our focus on technology continues in 2015 with plans of a website upgrade and relaunch planned for the second half of the year, as well as the introduction of a Smart Phone App. Stay tuned…

As we expand our 401(K) PLUSTM corporate retirement plan offering, we seek to add additional talent in this area to serve a growing number of corporate clients and their employees seeking to retire with the money they need to live the life they desire in retirement. Don’t hesitate to contact us if someone you know may be qualified and interested in joining the PFS team as a Corporate 401(k) and Retirement Plan Specialist.  

Market News & Outlook

A key event for financial markets in the first quarter of 2015 was the Federal Reserve’s (Fed) decision to remove the word “patient” from its policy statement, putting market participants on watch for a rate hike later this year. But, as always, the devil is in the details. While the Fed’s policymaking arm, the Federal Open Market Committee (FOMC), signaled that it is ready to raise rates when members are “reasonably confident” that inflation will move back toward its 2.0% target, FOMC members substantially lowered their forecast for the level of the fed funds rate over the next several years. In addition, the FOMC lowered its forecast for gross domestic product (GDP) growth and inflation over the next few years.

On balance, the Fed’s recent inclinations have confirmed our long-held view that the Fed would keep rates “lower for longer.” Fed Chair Janet Yellen’s recent post-FOMC meeting press conference confirmed the “lower for longer” theme, reminding viewers around the world that although the FOMC removed “patient,” it did not mean that the FOMC was going to raise rates at the next FOMC meeting in April. Yellen also stressed that a rate hike was not a sure thing and remained “data dependent,” i.e., they would need to see the labor market continuing to improve, inflation stabilizing, and inflation expectations moving higher for the period ahead. We will continue to watch what the Fed is monitoring (the labor market, inflation, and inflation expectations) and will provide updates on the progress of these key metrics as needed. The minutes of last week’s FOMC meeting will be released this month and the next FOMC meeting is April 28–29, 2015.  

Callout: The LEI (Leading Economic Index) suggests the risk of recession in the next 12 months is negligible (4%), but not zero.

Looking Ahead with the LEI   

A report that may have been overlooked by financial market participants in late March was the Conference Board’s monthly LEI. The LEI is one of our “Five Forecasters” and provides a valuable guidepost as to where we are in the economic expansion each month. The Index is a measure of economic variables, such as private-sector wages, that tends to show the direction of future economic activity.  

As we noted in our earlier Market Noise, when the economy has not been in recession, the S&P 500 has been positive 82% of the time and provided low-double-digit returns. When the economy has been in recession, the S&P 500 has been positive just 50% of the time, with average returns in the low single digits.

The latest reading on the LEI for February 2015 revealed that the LEI was up 6.2% from February 2014. The LEI is designed to predict the probable future path of the economy, with a lead time of between 6 and 12 months. On balance, the LEI says the risk of recession in the next 12 months is negligible (4%), but not zero. And while the odds of a recession increase when looking out 18 months and 2 years, they remain low—but again, not zero.  

We would agree, and note that economic recoveries do not generally die of old age, but end due to excesses building up in one or more sectors of the economy. In the past, overbuilding in housing or commercial real estate, building up too much inventory, or borrowing too much to pay for overbuilding or overspending have all led to overheating and recession. The current recovery has been relatively lackluster by historical standards, and the excesses that have triggered recessions in the past are not present. Still, a dramatic deterioration of the fiscal and financial situation in Europe, a fiscal or monetary policy mistake here in the United States or abroad, or an exogenous event (a major terror attack, natural disaster, etc.), among other events, may cause us to change our view.

Helping You Move Closer to Your Goals 

Among the many ways we make our clients’ Return on Life® our top priority is by helping families move forward with their financial and investment planning. In recent months we have focused on helping families gain a deeper understanding of their tax-managed investment strategies, providing objective advice and guidance on tax-advantaged opportunities aligned with their needs and goals. Our experienced team would be happy to help you understand how 2015 tax changes, including new tax rates and contribution limits, may impact your retirement and investment strategies.

By sharing our knowledge with clients and educating them on the factors that influence their Return on Life®, we help our clients take greater control of their future.  In closing, we are always honored to help the friends and business associates of our clients to pursue their own Return on Life® and we welcome and are sincerely grateful for the many referrals our clients continue to provide.   

Continued health, happiness and prosperity,     

Frank Fantozzi, President
CPA, MT, PFS, CDFA, AIF
Planned Financial Services
Registered Investment Advisor


Stress Test Your Investment Portfolio

Written by: Sarah Horrigan

As anyone who held investments during 2008 can attest, even careful planning doesn’t necessarily protect your portfolio from unforeseen events. Your investments are particularly vulnerable to painful losses, especially if you’re near or already in retirement.  
In many cases, unexpected events are beyond your control. But what you can do is give yourself a head start on preparing for challenges by conducting a “stress test” to understand the sensitivities in your portfolio.  

Test a variety of scenarios

A stress test gauges how your investments might perform under various circumstances. The results can tell you how resilient your portfolio may be in the face of different types of risks. Some of the scenarios your stress test should consider include:

Changes in the market environment. Rising inflation and higher interest rates are particularly important to consider if you have a bond- or cash-heavy portfolio. Inflation erodes your purchasing power, which is detrimental to the value of your savings and can hurt bonds with yields lower than the rate of inflation. And, as interest rates increase, bond prices fall, particularly for longer-term bonds.  

In this scenario, your financial advisor can help you determine whether to add bonds with lower inflation sensitivity, or other investments such as:

  • Shorter-maturity bonds or Treasury Inflation-Protected Securities, 
  • Inflation-hedging hard assets, such as precious metals or real estate, and 
  • Stocks, which have tended to beat inflation during the long term.  

Bear in mind that stocks and many hard assets come with greater risk, so you also need to consider how a prolonged or severe stock market or sector-specific decline would affect your ability to reach your goals. Diversification and rebalancing are key strategies for withstanding market fluctuations. However, bear in mind that diversification doesn’t guarantee profit or protect against loss in declining markets.

Changes in your income needs. What if you have an unexpected and significant medical expense? Or if legislative changes reduce your Social Security income or tax laws become less favorable to your financial situation? Make sure your portfolio has a cash component (or an asset that can be easily converted to cash), in case of an immediate or short-term income need.

Outliving your money. You may fear losing money during market downturns, but taking too little risk can hurt you over the long term. Conservative investments may not outpace inflation and, by staying on the sidelines, you can miss important rallies that might otherwise bolster your returns. The key to a well-positioned portfolio is to consider how much growth and safety you need in order to maximize the odds of reaching your goals.

Factoring in surprise, improbable events. Also known as “black swan” events, these occurrences are significant, rare and impossible to predict — think natural disasters, the Sept. 11, 2001, terrorist attacks or the collapse of Lehman Brothers. You may not be able to plan ahead for these types of events, but you typically can reduce the impact of market volatility on your portfolio by diversifying sufficiently across multiple noncorrelated asset classes.  

Plan for the unexpected

All investors want to maximize returns. But to keep those earnings to help fund your retirement, you have to assess the risks. Finding the right risk-return balance today is the key to giving yourself the best opportunity to reach your retirement goals, while simultaneously making it possible for you to rest easy at night. Talk with your financial advisor about how to best prepare your portfolio.


Emerging Markets

Written by: Elisabeth Plax

Higher reward (and risk) potential for long-term investors

Emerging markets have gained a significant share of the global economy during the past few decades. According to the International Monetary Fund, by one measure of global output emerging markets represented half of the world’s economy in 2013, up from a third in 1993. China, the largest emerging market, overtook Japan in 2009 as the world’s second-largest economy and now, by some metrics, exceeds the U.S. economy.  

Such rapid growth can make emerging markets an exciting investment destination, but they also come with special risks. These nations may be modernizing their economies, but their financial markets tend to be volatile. That’s why you should consider the trade-offs carefully when evaluating the opportunities emerging markets offer to your investment portfolio.  

Into the developed world

Emerging markets, also known as developing markets, are countries whose economies are growing rapidly and possibly transitioning to developed-market (meaning more fully industrialized) status. Policymakers in these countries generally are taking steps to make their economies more attractive for investors, perhaps by enhancing productivity, improving business regulation, stabilizing currencies and strengthening financial markets.

While emerging-market economies may still be developing, their existing global importance shouldn’t be underestimated. For example, China has become a major trading partner with many developed and emerging nations, and commands an outsized influence on commodity prices. As China has become more integrated with the world economy, its cooling growth rate has been a big factor behind the world’s recent sluggish economic performance.  

Because emerging-market economies have tended to grow faster than developed-market economies, investing in them can offer both diversification and growth potential. This can make them an attractive proposition, as long as you’re mindful of their risks.

Think long term

A main benefit of having emerging-market stocks or bonds in your portfolio is increased diversification. Emerging-market economies can move in cycles different from those of developed markets, which means their stocks and bonds may similarly move out of sync. Granted, in some periods emerging and developed markets will move in tandem. But, over time, diversifying with emerging-market stocks or bonds can decrease your portfolio’s overall volatility.

Furthermore, if your time horizon is long term, emerging markets’ growth potential over time can make them attractive for certain investors. Faster economic growth doesn’t necessarily translate to faster appreciation in stock or bond prices. But there’s a correlation between strong economic growth and healthy corporate earnings, which in turn can be a positive factor for securities’ performance over an extended period. 

Proceed with caution

In exchange for their higher growth potential, emerging-market investments have unique risks. You should be prepared for substantially greater market volatility, as performance can vary dramatically over short time frames.

Because emerging markets tend to have less-liquid securities exchanges, lax regulation and political instability, their financial markets are more easily disrupted, making big losses a possibility. But by maintaining a longer time horizon, limiting your exposure to this volatile asset class and diversifying among different emerging markets, you can manage your portfolio’s volatility.

Growth or income opportunities

Emerging markets’ growth potential and diversification benefits are available through a variety of means. If you’re prioritizing growth over income, emerging-market stocks may be appropriate. Rather than buying shares of individual companies located in emerging markets — a strategy fraught with risk and complexity — most investors opt for the easier and more cost-effective option of a professionally managed portfolio, such as a mutual fund* or an exchange-traded fund (ETF). 

These funds can be focused purely on emerging markets, or may include an emerging-market component as part of a more broadly diversified regional or global portfolio.

Income-oriented investors may consider an emerging-market bond fund or an ETF. Emerging-market debt, not surprisingly, is riskier than that of developed markets, but it has historically offered higher yields in return. That said, not all emerging markets are created equal, and some issuers carry investment-grade credit ratings, making these bonds a potentially more appealing option for risk-averse investors.

Less can be more

Because of their greater risks and potential rewards, a little exposure to emerging-market investments can go a long way. Your financial advisor can help you determine the level appropriate for you.

* Mutual funds are sold by prospectus only. Before investing, investors should carefully consider the investment objectives, risks, charges and expenses of a mutual fund. The fund prospectus provides this and other important information. Please contact your representative or the mutual fund company to obtain a prospectus. Please read the prospectus carefully before investing or sending money.

Sidebar: The next frontier  

As emerging markets have matured considerably during the past 20 years, some intrepid investors looking for even higher-growth opportunities have turned to so-called “frontier” markets. Countries such as Kuwait, Argentina and Nigeria — to name only a few — may not yet have reached emerging-market status, but they’re considered on that growth path. Frontier markets are riskier, more speculative investments that aren’t for everyone. But depending on your needs and the size of your portfolio, a small allocation may provide valuable diversification benefits and growth opportunities. © 2015
 

 


Trusts and Taxes

Written by: Frank Fantozzi

An IDGT can shift income tax liability

Trusts often are a key component of an estate plan. But because trusts are considered separate legal entities, they’re subject to income tax. The income tax rate thresholds for trusts are low, so it’s important to consider the potential tax impact on your estate plan. An intentionally defective grantor trust (IDGT) can provide the estate planning benefits of a trust while avoiding its potentially negative income tax consequences.

2015 tax rates for trusts

For 2015, the top federal income tax rate for trusts is 39.6%, the same as for individuals. But the threshold for triggering this rate is low: It applies to trust income in excess of $12,300. In addition, trusts are subject to the 20% capital gains rate to the extent their taxable income exceeds that same threshold.

Finally, the 3.8% net investment income tax (NIIT) is imposed on the lesser of a trust’s net investment income or the amount of the trust’s adjusted gross income that exceeds $12,300. So trusts trigger the highest tax rates much more quickly than individuals do.

Strategies to minimize tax liability

How can an IDGT help? An IDGT is an irrevocable trust designed so that contributions to the trust are considered completed gifts for gift tax purposes — removing them from your taxable estate — even though the trust is considered a “grantor trust” for income tax purposes. (That’s the intentionally designed “defect.”)

This means that you, as the grantor, pay the income taxes on the trust’s earnings, rather than the trust paying them. As a result, you avoid the NIIT and the low thresholds for top rates that apply to trusts. Because the earnings stay in the trust rather than being used to pay taxes, you’re essentially making additional tax-free gifts to your beneficiaries. And, because a grantor trust is considered your “alter ego” for income tax purposes, payments you receive from the trust generally will be tax-free.

However, keep in mind that, if your personal income exceeds the applicable thresholds for triggering top tax rates and the NIIT, an IDGT won’t save income taxes. Still, the IDGT allows you to make the additional gift of paying income taxes on the trust assets, and thus enhances the estate planning benefits.

Seek your advisors’ help

If you’re using trusts in your estate plan, be prepared for the potential tax bill associated with them. An IDGT can ease the tax burden, but the trust will require the proper drafting when it’s set up. Discuss your options with your tax and legal advisors before taking any action.
© 2015
 


Managing Retirement Savings After a Job Change

Written by: Jeremy Bok

When Jane decided to make a career change and resign from her employer of 20 years, it wasn’t without much consideration. This included meeting with her financial advisor. Noting the sizable balance in her 401(k) plan, he said it was important to effectively manage this retirement nest egg. If you’re in a position similar to Jane’s, you have a few options.

Taking no action 

If your qualified retirement plan with your previous employer has a balance of at least $5,000, the plan is required to allow you to leave your money there. This is the simplest course of action, but it might not be the best.

Your ex-employer may restrict your ability to make changes to your portfolio, to take distributions or to update beneficiaries. As a nonactive participant, you may incur higher fees and receive less-effective communications about plan changes than active participants do. And you’re limited to whatever investment options the plan offers.

However, if the plan offers an appealing and hard-to-duplicate investment option, it could make sense to keep your money there. Such options might include a high-yielding guaranteed investment contract or a stable value plan.

Rolling over funds

Rolling over your savings to your new employer’s plan can help you avoid the potential downsides of sticking with your old plan or the complications of keeping track of multiple plans. But first review the investment options available in your new employer’s plan. In addition, be aware that you may incur a sales charge on the rollover.*

If the investment options from your new employer’s plan aren’t very attractive, you might be better off keeping your existing savings in the old plan — or rolling them over to an IRA (see the next option) — while also contributing to your new plan.

If a rollover to your new employer’s plan seems like the best option, confirm that the new plan accepts rollovers. If it does, request a direct trustee-to-trustee rollover. 

Otherwise, your old employer will mail a distribution check to you, minus mandatory tax withholding of 20% that you won’t need. You then have just 60 days to deposit these funds in your new plan. You also must deposit the 20% that was withheld for taxes, which means finding cash elsewhere, because you won’t get your withholding back until after you file your annual tax return. 

If you fail to meet the deadline, or if you don’t have the cash available to cover the taxes that were withheld, you must pay income tax on the amount that wasn’t rolled over. You may also incur a 10% early withdrawal penalty if you’re under age 59½.  

Opening an IRA

Transferring your retirement savings into an IRA offers several advantages. An IRA typically provides a wider array of investment options than most 401(k) plans do, such as mutual funds from a variety of companies, as well as individual stocks and bonds. Holding all of your assets in one account or with a single financial services company also makes it easier to get a clear view of your entire retirement savings portfolio.

Most financial services companies will accept a direct transfer of your retirement savings, which can streamline the process and avoid the potentially costly mistakes previously discussed. In many cases, assets can be transferred “in kind,” meaning you don’t need to sell the investments and then repurchase them in your IRA. Be aware, however, that you may be charged an annual fee.

Cashing out

Cashing out your retirement savings typically isn’t recommended. Any distributions you take will be taxed as ordinary income, and, if you’re under age 59½, you may have to pay an additional 10% penalty. 

There are exceptions to the penalty in cases of economic hardship or separating from service after age 55. But in either case, you’ll still owe the income tax. In addition, although IRA distributions are exempt from the 3.8% net investment income tax (NIIT), they’re included in modified adjusted gross income (MAGI) and could trigger or increase the NIIT on other income. This is because the thresholds for that tax are based on MAGI. 

Making the right moves

If you’re considering a job change or have changed jobs recently, don’t forget that a change to your retirement savings might also be warranted. Making the wrong move can significantly harm your retirement nest egg.

* When considering rolling over the proceeds of your retirement plan to another qualified option, such as an IRA, please note that you have the option of leaving the funds in your existing plan or transferring them into a new employer’s plan. You should consult with the Human Resources department of the applicable employer to learn about the options available to you under your plan and any applicable fees and expenses. Tax consequences might apply if you were to withdraw the funds, and there are additional tax consequences to transferring stock out of your retirement plan. Please consult with a tax advisor before taking such an option. You should also know that, depending on the state where you reside, assets held in a retirement plan may enjoy greater protection from creditors than in other types of tax-qualified vehicles. You should also consider the different fees and the different services that apply to your plan and compare them to any new option that you are considering.
© 2015

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