Tuesday Q&A Series – Required Minimum Distributions

This week’s question comes from Mike who is turning 70.5 this year, and he has questions over when he needs to take a distribution from his retirement account – especially with the changes that were made in 2009.

Q. I just received your latest Tax and Business Alert. On page 4 is a brief article about Minimum Required Distributions from IRAs and defined contribution plans. I think that it says in the example that a person who reached 70.5 in 2009 is required to take a Required Minimum Distribution (RMD) by the end of 2010. If that is the case, and I reached 70.5 in 2010, then could I postpone the first distribution until the end of 2011?

A. This is a question that would not normally come up, but with the changes that were made for 2009 only, I can understand the confusion.

In any year other than 2009, if you turn 70.5, you must take your first distribution by April 1 of the following year. This one-time caveat is to allow people to be notified and understand that they must take the distribution. If this happens though, you must take two distributions – one for the 70.5 year and one for the current year.

At Rollins Financial, we always instruct clients to take a distribution in the year that they turn 70.5. This gets the first distribution out of the way, and it also makes sure that two distributions are not necessary in one year thus creating even more taxable income.

So where is the confusion? Well, at the end of 2008 Congress decided to change the law for 2009 as to not require a distribution. Thus for anyone that was 70.5 or older in 2009 there was not a mandatory distribution.

If someone turned 70.5 in 2009, they were allowed to “skip” the first distribution, if they wished, so the first RMD that they must take would be by December 31, 2010.

For Mike, since he turns 70.5 in 2010, he must take a RMD by April 1, 2011, but once again, we recommend taking it before the end of 2010.

**Note** - At Rollins Financial, we work with our custodians (Schwab and Fidelity) to check the RMD and status of distributions for our clients. For those clients that do not take monthly distributions that meet the RMD, we send out distribution forms around Thanksgiving. This gives the client ample time to understand what is going on and most like the added “Christmas money” for presents.

Mike, I hope the answer above has cleared up some of the confusion that was caused by 2009, and we certainly thank you for your question.

We encourage our clients and readers to send us questions for our Tuesday Q&A series at contact@rollinsfinancial.com. And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Robby Schultz

Tuesday Q&A Series – Boosting Your Social Security Income Through Planning

This week’s question comes from Robert and Natalie, married clients who are wondering if there is anything that they can do to increase their Social Security income. Robert, who will turn 66 soon, is a full-time employee that contributes to Social Security, and Natalie, who will be 62 in a few short months, is currently a full-time employee, but she is thinking of retiring. Full Retirement Age (FRA) for each is 66.

Q. We have been trying to understand the best way for us to receive current and future income from Social Security. We are both in great health, so are there different strategies for us to employ?

A. This is a very good and very tricky question. Most people simply take Social Security as soon as possible since they want to make sure that they receive every penny, but for each year you delay Social Security, your benefit grows between 7-8%. If one or both spouses are in poor health, taking the benefits sooner may be the best choice, but there are others to consider if you are looking for increased income later and are in good health.

• Suppose that Robert had started receiving Social Security (SSA) benefits when he turned 62, but now he wanted to increase his benefit. Robert could essentially ask for a “do-over.” In this case, Robert would have to pay back all of the money he had received from SSA, but there is no penalty or interest charged. Plus, Robert would get a credit or deduction on the tax he paid on those benefits.
  
  The upside is that Robert’s benefit would be calculated on his current age instead of his previous age. If he waits until his FRA, this would be a 33% increase in benefits. The downside is that Robert would have to make a lump sum payment to the SSA now for the do-over, so it would be costly in the short term.
  
  Note: There have been discussions of closing the “do-over” loophole or reducing it to just 12 months from the beginning of your benefits. If this is something you want to consider, it is best to look into it now.

• A different strategy that has been popular is where one spouse was the majority breadwinner. In this scenario, Robert was the majority breadwinner and Natalie was a homemaker. Robert files for benefits at FRA (as long as Natalie is 62 or when she turns 62). Natalie immediately files for spousal benefits, then Robert suspends his benefits. Natalie starts receiving her spousal benefit while Robert continues to work and his benefit grows. At age 70, Robert starts receiving his increased benefit which is probably 35% or so higher than it would have been at FRA.
  
  Note: If Robert were to die, Natalie would start receiving the larger benefit.

• One last strategy that is frequently used fits Robert and Natalie fairly well. In this scenario, Natalie retires at age 62 and starts drawing her SSA benefit. Since Robert is at FRA (66), he then files for spousal benefits on Natalie’s benefit while he continues to work. His benefit continues to grow while Natalie receives her benefit and Robert receives half of her benefit. At age 70, Robert files for SSA benefits where he receives his full benefit.
  
  Note: If Robert dies, Natalie would receive his higher benefit

Obviously, these are complex scenarios that should be well researched before being implemented, but you start to see the various options that a couple like Robert and Natalie have to choose from before filing for SSA benefits.

Robert and Natalie, I hope the answer above has shown you some of the various options that we research and consider when advising you on your retirement income planning.

We encourage our clients and readers to send us questions for our Tuesday Q&A series at contact@rollinsfinancial.com. And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Robby Schultz

Tuesday Q&A Series – Retirement Income

This week’s questions come from Ken, a client who is concerned about how much of his portfolio he can afford to live on in retirement and how long that portfolio will last.

Q. I want to ensure adequate income for living expenses in the future. What percentage of my assets can I plan on using each year? How long will my money last?

A. This is a great question and continues to be a debatable concept within the financial planning community as well as among investors.

There are several questions to consider before embarking on the appropriate strategy for your situation: Do you prefer a higher level of income in the early years of retirement or do you prefer more certainty of your assets lasting your entire life? Can you sustain your lifestyle if you choose a lesser amount of income from your retirement assets initially? Do you want to leave your heirs a significant inheritance?

“Longevity Risk” can be described as the risk of living longer than your retirement assets can sustain. Cultural shifts in longevity risk can put strains on social security, public and private pensions and personal retirement assets. This concept is gaining some more attention, especially considering the funding status of Medicare and social security, but is probably under-discussed by the financial media and planners alike.

The upside to employing a spending plan that allows your portfolio to last forever is that you will likely never fear or experience a complete drawdown of your retirement assets. The obvious problem with this approach is that many savers are not able to employ this strategy without seriously affecting their current standard of living. Accepting less income early on in retirement, when most are healthier and able in exchange for a substantial income after the age of 90 is not the tradeoff everyone is willing to make.

Let’s consider three examples all with different withdrawal rates and investment strategies and the advantages and the risks associated with each. We will assume Ken has a $1 million dollar portfolio and wants to see how long those funds will last under a few different assumptions. We will also assume that Ken is retiring at age 65 in each scenario. For retired couples, keep in mind that there is about a 50% chance that at least one of you will survive into your 90’s.

Scenario 1

Starting Annual Income: $40,000
Annual Return Requirement: 6%
Portfolio Characterization: Moderately Conservative
Annual Income at Age 90: $61,000
Portfolio Value at Age 90: $1,573,000

This first scenario is the most conservative on two fronts: First, Ken is taking a modest annual distribution calculated at 4% or the prior year end balance; Second, because of the relatively low distribution requirement, he can afford to invest more conservatively. This less risky portfolio has a greater chance of performing to the stated expectations. This portfolio supports a nearly 2% annual distribution increase, while the portfolio value is also able to grow, keeping pace with some inflation. This expected increase in value over time will provide financial security and flexibility should unforeseen spending requirements arise.

Scenario 2

Starting Annual Income: $60,000
Annual Return Requirement: 7%
Portfolio Characterization: Moderately Aggressive
Annual Income at Age 90: $69,000
Portfolio Value at Age 90: $1,162,000

Ken has a higher income requirement of $60,000 per year, or a 6% withdrawal rate, in this scenario. This spending and investment plan can support a smaller annual increase in spending of only 0.5% annually. The investment allocation is going to have to take a slightly more aggressive bent to achieve a 7% annualized return, which increases the chances of falling short of those expectations. But significantly higher income in the early years will help maintain the desired standard of living. The account value is basically being maintained on a nominal basis, but not maintaining value on an inflation adjusted basis.

Scenario 3

Starting Annual Income: $90,000
Annual Return Requirement: 8%
Portfolio Characterization: Aggressive
Annual Income at Age 90: $0.00
Portfolio Value at Age 90: $0.00
Note: Portfolio likely exhausted by age 86

Clearly, Scenario 3 is the most aggressive option. Ken is starting with significantly higher distributions which will almost certainly exhaust the accounts within a 20 year period. In this scenario, his spending requirement had not been adjusted to compensate for inflation and continues at $90,000 annually until the account is exhausted. Given the increased volatility with an aggressively invested account, the funds under this scenario have a relatively high probability of providing income for fewer years than we expect.

Each of the foregoing scenarios has its own distinctive advantages and weaknesses. Each investor will have their own unique objectives and risk tolerances that need to be considered in order to find the right solution. Some may prefer a more or less aggressive investment allocation based on some of the factors discussed above or other factors specific to their situation.

Ken, I hope my answers above have given you a better understanding of our thoughts about withdrawal rates and some considerations for various scenarios.

We encourage our clients and readers to send us questions for our Tuesday Q&A series at contact@rollinsfinancial.com. And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Eddie Wilcox

Tuesday Q&A Series – China

This week’s questions come from Gus, a client who is interested in learning more about China as it relates to business.

Q. Even with the Chinese economy slowing down, it is still growing at a faster rate than ours. Is it wise to have a large percentage of our portfolios invested in their economy?

A. China’s current economic situation is compelling: According to the 2nd quarter numbers, China just recently passed Japan as the second largest economy in the world and it is also scheduled to surpass the U.S. GDP in nominal terms by 2027 according to Goldman Sachs projections. China’s ascent in world rank has taken place faster than most had estimated just a few years ago in part because of stagnating developed economies in the wake of the financial crisis of 2008. Even with the increases in nominal GDP, China ranks far down the list, barely scratching the top 100 nations in per capita GDP and producing only 10% of that of the United States on a per capita basis. So, there is still more potential in this growth story.

Rollins Financial approaches investments in China’s economy differently for each and every client, as each client will have a different acceptable allocation to Chinese securities. We do make investments directly in Chinese stocks through mutual funds and ETFs, but the majority of our Chinese investments are made through diversified emerging markets funds. Some academics, like Jeremy Siegal who was referenced in a recent blog, have suggested that because over half of the economic activity takes place outside of the United States, investors should allocate 50 percent of their portfolios to overseas investments. China’s GDP currently accounts for nearly 10% of worldwide economic activity. However, most investors are not comfortable with the idea of having over 50% of their investments targeted to overseas investments, with 10% specifically allocated to China.

Typically, a Rollins Financial portfolio allocation averages about 25% toward international investments while 5 to 10% is allocated to emerging markets like China. The main drawback to a more significant allocation to China is the added volatility inherent in Chinese securities. In 2008, the most widely traded Chinese ETF saw even more significant losses than the broad U.S. markets, but in-turn, the Chinese ETF rebounded more sharply than the S&P 500 in 2009. Investors, especially the more mature variety, will find that added volatility inherent in Chinese and other emerging markets uncomfortable and, therefore, deserving of a smaller share or their overall portfolio.

Q. Is there an increasing number of U.S. companies establishing their presence in China?

A. A common consequence of a financial crisis is an increased emphasis in protectionist policies as sovereigns try to insulate their economies from another crisis. Protectionism is largely a political reaction to constituencies who have been harmed or are under the perception that they have been harmed by other groups. This is evidenced by some actions China has taken to slow investments and progress by some well known U.S. corporations.

Coca-Cola tried to make an investment in the China juice market, but Chinese regulators rejected a takeover bid for a Chinese company. Had the deal been approved, Coke would only have had 20% of the total juice market there, so it seems the government was not concerned about a monopoly on the market. Google has also been grappling with how to expand their business in China since China still censors the internet. Early in 2010, Google announced that it may pull out of China because of a clash with the government only to seemingly reverse course this summer. And, of course, there is the never-ending issue of China manipulating its currency so their products will be cheaper in the rest of the world than they might be if the currency floated freely.

But the clear trend is for more free trade and more open markets, not less. Many well-known U.S. corporations have cited China as the fastest growing market despite some of the regulatory obstacles. McDonald’s has opened “Hamburger U.” in Shanghai where McDonald’s employees are given the opportunity to take business courses. Proctor and Gamble has cited China as the second largest consumer market in the world behind the U.S., as P&G plans multi-billion dollar investments in China. Currently P&G receives about 30% of its sales from the emerging economies like China. Apple recently opened its flagship China store in Shanghai and has plans to open 25 more stores in the next couple of years. Not all of Apple’s newest products are available yet in China, but they are just starting their endeavor in that burgeoning market.

Make no mistake: There have been a few instances of newly protectionist policies implemented in the wake of the crisis, but perhaps this is just a consequence of China’s communist legacy. However, companies from the U.S. and elsewhere are making significant investments in China as that still largely untapped market evolves.

Q. How is the Chinese totalitarian government relating to companies from democratic countries? Is there any danger of takeovers?

A. Anytime you are considering an investment in a communist country, there are always geopolitical risks to consider. The Chinese government is already a “partner” in most of the large publicly-traded Chinese companies listed on the exchanges. But there is a clear incentive for reasonable policies by Beijing. China relies on the U.S. and other foreign consumers to keep its population employed and manufacturing the products we want. Western consumers are in turn reliant on inexpensive goods from China. It’s debatable who has more to lose from a breakdown in this relationship, but we don’t envision any government moving too aggressively and jeopardizing this symbiotic relationship.

Gus, I hope my answers above have given you a better understanding of China and our views concerning investments there.

We encourage our clients and readers to send us questions for our Tuesday Q&A series at contact@rollinsfinancial.com. And as always, we hope you will keep Rollins Financial in mind when seeking professional advice on financial planning and investing.

Best regards,
Eddie Wilcox

Summer Doldrums and Economic Slowdown Affect August Performance

From the Desk of Joe Rollins

According to Joseph Wood Krutch, “August creates as she slumbers, replete and satisfied.” Let’s hope so, because this past August was basically a washout for the financial markets. Interestingly, the trading volume during August confirms it was one of the slowest trading months ever recorded. It seems the summer heat and gloomy economic figures got to everyone, causing a lack of interest in trading. This is unusual; September is historically the worst month for the financial markets, but perhaps we can look forward to good things happening in September since August was so awful.

For the month of August, the Dow Jones Industrial Average was down 4.1% and the S&P 500 index was down 4.5%. The more volatile Nasdaq was down 6.1% while the small-cap Russell 2000 index was down 7.3%. Indisputably, those are some terrible percentages, and in fact, it was the worst stock market performance during August since 2001. In 2001, the market was slammed due to the burst of the Internet bubble and the subsequent market sell off. Our current economic circumstance is vastly different and much better than that of August 2001, but the loss we just suffered was equally as bad.

Year-to-date, the Dow is down 2.3%, the S&P is down 4.6%, and the Nasdaq is down 6.3%. Comparatively, Rollins Financial’s entire portfolio of client accounts is slightly positive thus far for 2010. In Tuesday’s Q&A post, I indicated that we had shifted a portion of some of our clients’ portfolios into bond funds to reduce the volatility in the accounts. Since our portfolios are ahead of the S&P 500 performance by over 4.6%, it appears that this decision was a good move. A proper diversification of assets has once again proven to stabilize a portfolio in a volatile stock market environment.

As I write this post on September 1st, the stock market is performing dramatically higher for the day. Much has been said regarding the performance of the stock market and the economic situation in the U.S. today. However, there hasn’t been much news that has taken the market higher. Tuesday was the last trading day of August, and yesterday was the first trading day of September. Both days had very low trading volume. When certain investors are betting on the market to be down, they will sell the market short to control the performance in a given month. On the first trading day of the next month, they then have to cover those investments by buying them in the open market. So, even though the market was down for the month of August, it is so far up for the month of September. Frankly, however, this means absolutely nothing to us; none of us should be concerned with short-term trading patterns when we are focused on long-term investment goals.

Admittedly, I watch too many financial news programs which have probably made me almost as cynical as the analysts on those shows. Much has happened over the last 30 days, leading to a stock market sell-off, but the financial networks are seemingly convinced that the U.S. economy is at risk of entering the dreaded “double-dip” recession. I can assure you, however, that there is almost zero chance of this happening.

While it is true that Washington has not been very successful in stimulating employment, the economy has actually picked up very nicely. It hasn’t been a roaring improvement, but it is clearly positive and there is no evidence whatsoever that any economist is predicting a negative GDP growth in the upcoming quarters. In fact, since the GDP turned positive in the third quarter of 2009, it has continued improving nicely since then. It is true that the GDP was increasing rapidly through the first quarter of 2010 and has subsequently turned down (although it is still positive). However, it’s not likely that the GDP will continue to fall and will eventually slip back into negative territory. There is virtually no evidence to support that pessimistic theory.

From the economic data I have reviewed, the GDP will continue to grow at a slow pace for several years to come. The Stimulus Act may have saved jobs – who really knows? – but it is certainly not helping improve employee hiring. Truthfully, it doesn’t appear that employment will completely recover for a few more years; there is just too much risk for companies to hire new employees until they are absolutely sure the business they are doing makes it justifiable. With the new costs the government is forcing on employers, the reluctance to hire is understandable. However, it is also true that if a company’s performance justifies it, they would likely bite the bullet and add new employees to their payroll. Employers are cautious – but not stupid!

The government has now extended unemployment insurance for a staggering 99 weeks. At what point does unemployment compensation constitute a welfare program? How many people are receiving unemployment benefits that might have taken a job if they did not have the luxury of receiving government subsidies? How many people are receiving unemployment compensation that never intend on getting another job? I bet there are many. Clearly, deficit spending by the U.S. government has been ineffective in increasing employment, and therefore, it’s unlikely any new programs will come out of Washington this year.

I think that the U.S. economy will improve the old-fashioned way – with ingenuity and cost savings. Those items will increase productivity which will, in turn, increase profitability. Additional profitability will afford companies the ability to hire new employees. For all its efforts, the U.S. Congress has created $2 trillion in debt and has not improved the employment situation at all. It is now time for Congress to get out of the way of business and allow the economy to slowly but surely recover. When profitability justifies it, employment will be increased.

It may not be a good time for employment, but with the cost savings extended to corporations, it has been an excellent time for corporate profits. Corporate profits are at historic highs, and this will ultimately lead to higher stock prices. Year-to-date, we are basically at a break-even point, and therefore, substantial gains could still be made in the remaining four months of 2010. Perhaps the 2% gain we enjoyed on September 1st will be a positive omen for the remainder of the year. However, given the volatility we have suffered through over the last four months, it wouldn’t be surprising if the 2% gain were wiped out tomorrow. Again, we do not live or die by short-term trading, but a positive rally would be a welcome break to the heat of summer.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.