Citigroup trained him well. If prospective investors used Brokercheck, they would have steered clear of Marty Blazer III.
Hidden Costs – Revenue Sharing and Self Dealing
Your friendly neighborhood wire-houses like Edward Jones, Morgan Stanley and others have seen a outbreak of lawsuits by their own employees over hidden 401k fees. The key issue behind the lawsuits is that the brokerage firms profit from the plan’s investments by retaining for itself revenue sharing payments paid by product partners and self-dealing. In other words, the employees are investing in funds where the employer, e.g Edward Jones, receives financial benefits from the fund family. This amounts to millions of dollars in so-called “revenue sharing” payments from their “partners” or “preferred partners”.
How Much Money are We Talking About?
From the employee lawsuits filed and settled, here’s a quick summary:
Edward Jones – $13 million in excessive fund fees and $8 million excessive record keeping fees from August 2010 to present.
Morgan Stanley – $150 million in excessive fund fees from 1/11 to 4/14.
New York Life – $3 million in excessive fund fees from 2010 to present.
Mass Mutual – $31 million settlement to employees over fees.
Ameriprise – $27.5 million settlement to employees over fees.
Fidelity – $12 million settlement to employees over fees.
Given the recent lawsuits (and more sure to come), it’s no surprise that the brokerage industry is suing The Department of Labor over its decision back in April that broadened the definition of a fiduciary to anyone who receives direct or indirect compensation for providing advice to retirement plans, plan participants or beneficiaries and IRA owners.
There’s enough money changing hands behind these 401k plans to make International Olympic Committee executives envious.
Here’s a Fee Disclosure Form that will ferret out Hard Dollar Fees, Soft Dollar Fees, Revenue Sharing and Direct/Indirect Compensation that is otherwise very difficult to get disclosed. https://brownwm.com/the-f-word/types-of-advice/
The Nasty Tax
Here we are, 2 years after getting rooked with a 5 dimensional tax system, and many people are still unaware of the Nasty Tax: 3.8% Net Investment Income Tax (NIIT). I think the IRS used Wal-Mart pricing strategy with 8’s when they derived the number so it the smell would go un-noticed. But since it’s tax time, let’s talk about what’s in the baggie.
The NIIT is a surtax of 3.8% that covers a broad category of investment income sources. Determining how the tax is applies involves a fairly simple two step calculation. But first, let’s cover what’s included.
What’s Included: interest, dividends, annuities, royalties, rents, income from a business that is a passive activity with respect to the taxpayer, and net capital gain on the sale of non-business assets, reduced by any deductions properly allocable to such income.
Does not include salaries, wages, bonuses, distributions from IRAs or qualified plans, or self-employment income.
Are You Affected?
3.8% surtax that applies to the lesser of: 1. Net investment income (NII) or 2. The excess of your modified adjusted gross income (MAGI) over $200,000 (Single) or $250,000 (Married filing jointly). Remember, your MAGI is the amount reported on the last line one page 1, Form 1040.
First, add up your income subject to the Surtax.
|Subject to Surtax||Exempt from Surtax|
Next, look at the Threshold Amount
• Single taxpayers – $200,000
• Married taxpayers – $250,000
• Estates/trusts – $12,150
Example: Tammy, a single taxpayer, has $225,000 of net investment income and no other source of income. The 3.8% surtax would apply to $25,000 of income. (the lesser of investment income of $225,000 or the excess of $225,000 MAGI over $200,000 “threshold amount”).
Example: David & Darla, married filing jointly, have $200,000 of salaries and $150,000 of net investment income for total MAGI of $350,000.
The 3.8% surtax would apply to $100,000 of income because the excess of $350,000 MAGI over $250,000 threshold amount is $100,000 and LESS than their NII of $150,000.
How to Reduce NIIT
1. Look at Your Dividends. There can be a meaningful difference in the tax rate on ordinary versus qualified dividends (43.4% versus 23.8% highest brackets).
- Review your 1099 statements.
- Lines 9a and 9b on your 1040:
Tax-inefficient mutual funds can generate short-term capital gains, which are classified as ordinary dividends. Consider a tax-managed implementation, or if dividends are not needed for cash flow again, consider asset location.
- Taxation of Traditional Dividends- Ordinary Income
- Taxation of “Qualified Dividends” – Capital Gains Rate of 15%
2. Taxable Interest: Interest Income is taxed at ordinary income rates. Consider ways to reduce taxable interest with municipal bonds versus taxable bonds.
Consider asset location; placing tax-inefficient asset classes in tax-deferred and taxfree accounts.
- Lines 8a and 8b on your 1040:
3. Capital Gains: Long-term Gains are Taxed at Lower Tax Rates
Reduce the capital gains by using these tools:
- Tax-lot accounting: A method of accounting for a securities portfolio that tracks the purchase, sale price and cost basis of each security. This allows the manager to “swap” a batch of stocks with long-term gains for a batch with smaller, short-term gains.
- Loss harvesting: Holding a stock at a loss to sell all or part of it to realize the loss and create an “asset” that may help offset some future gain.
- Gain-loss offset: Involves selling securities at a loss that have dropped in price at year-end to help offset gains from selling securities that have increased in price.
- Charitable donations through gifting low basis stock.Line 13 on your 1040: In most cases, the optimal amount that should be here is -$3,000. The law allows a taxpayer to take losses equal to gains and then an additional $3,000 against ordinary income. If a positive number is reported here, were tax loss harvesting opportunities missed?
- Master Limited Partnerships (MLP’s): Deduction pass-throughs, lower taxable income, and tax deferral on distributions.
Got Questions? firstname.lastname@example.org
If you haven’t heard of Brené Brown, watch this excellent 20 minute video. I just finished listening to her book “The Power of Vulnerability”. Brown’s insights resonate with truths that help breakdown the superficial beliefs that our culture imposes on us. She shows us the healthy definition of vulnerability and how being authentic can enrich your relationships and life. http://www.amazon.com/The-Power-Vulnerability-Authenticity-Connection/dp/1604078588
“Something is rotten in the state of Denmark.” Hmmm.. The New Yorker is promoting the Federal Reserve Chair Janet Yellen as the protective grandmother for the middle class and unemployed. Conspicuously absent in Nicholas Lemann’s profile in the magazine is her track record.
Yellen’s Clinton Era and Recent Highlights:
- Backed the repeal of the landmark Glass-Steagall bank reform;
- Supported the 1993 North American Free Trade Agreement;
- Endorsed establishing a new statistical metric that would allow the federal government to reduce Social Security payments over time, by revising the consumer price index;
- Advocated cutting veterans’ benefits;
- Rejected concerns that increased concentration in banking as an antitrust risk;
- Supported cap and trade;
- Complained about deadbeat borrowers declaring bankruptcy in 1997.
Does this seem like someone who is concerned with unemployment and the middle class?
Senator Elizabeth Warren (D-Mass.) proves to be our Marcellus. During a congressional hearing on the compliance of our oligopoly banks with the “too-big-to-fail” laws requiring them to craft plans for their own orderly breakups, Warren takes Yellen to the mat. Warren points out that at the time of its bankruptcy, Lehman had $639 billion in assets; today, JPMorgan has nearly $2.5 trillion in assets. In addition, Lehman had 209 subsidiaries when it failed; today, JPMorgan has 3,391 subsidiaries, or more than 15 times the number Lehman had when it went under.
Yves Smith at Naked Capitalism has an excellent critique exposing the cozening grandmother that has no accountability to 146 billion voters.
Argentina: Playing the Odds.
In today’s World Cup Final, Argentina is a 3 to 1 underdog. Maybe enticing odds for soccer fans, but miniscule for a world famous hedge fund guru’s bet on the land of Patagonia.
Paul Singer launched a hedge fund in 1977. He is known as one of the first high profile “vulture investors,” and his fund, Elliott Management, invests opportunistically, with more than a third of its portfolio in distressed debt across the industrial and real estate industries, as well as on that of sovereign nations.
11 years ago, Singer invested $84 million in Argentina bonds that subsequently went into default. After three major legal victories and searching the world for missing assets, Singer is just weeks away from collecting $832 million on his original investment. If this happens, he will realize a tidy 1,600% return on his investment.
Singer is also an activist investor, where he battled to win three board seats on Hess Corp in efforts to unlock value and increase returns to shareholders. Since inception, Elliot Management has delivered annualized returns of 14%.
Elliot Management Holdings: I use a service called Insiderscore.com to track insider buying of companies and funds. Here’s the current holdings for Elliot Management.
Crowdfunding and Drinkable Meals
I have a soft spot for start-ups and supplements. Crowdfunding is a way for someone to raise money for their idea or cause by putting it on the net for prospective investors.
I’m on site called Indiegogo and come across Ambronite, a real food drinkable supplement. The investment proposition is to invest by pre-ordering the meals. So, I put in for $79 in hopes that someday 10 drinkable meals will arrive at my door. They more than doubled their $50,000 goal.
If youre not familiar with crowdfunding, here’s a list of crowdfunding sites. I must warn you that this could become a real time suck. You come across so many interesting ideas, and most appealing to me, is the strong sense that the entrepreneurial spirit is alive and growing!
Heartbleed is serious.
What is it?
The Heartbleed Bug is a vulnerability in the popular OpenSSL cryptographic software library. It allows stealing the information protected, under normal conditions, by the SSL/TLS encryption used to secure the Internet. SSL/TLS provides communication security and privacy over the Internet for applications such as web, email, instant messaging (IM) and some virtual private networks (VPNs). The Heartbleed bug allows anyone on the Internet to read the memory of the systems protected by the vulnerable versions of the OpenSSL software. This compromises the secret keys used to identify the service providers and to encrypt the traffic, the names and passwords of the users and the actual content. This allows attackers to eavesdrop on communications, steal data directly from the services and users and to impersonate services and users.
NSA Knew About Heartbleed
From Tyler Durden at Zerohedge.com: “It is one thing for the NSA to spy on everyone in the world, especially US citizens because all of them are obviously potential “terrorizers” just waiting for their opportunity to blow shit up (except for anything in close proximity to the Boston marathon – those things the NSA promptly filters out), but when the NSA itself is found to have not only known and itself abused the prevalent and widespread Heartbleed bug, but left consumers exposed, then it may be time to finally launch a class action lawsuit against Obama’s favorite means to eavesdropping on the entire world.” http://www.zerohedge.com/news/2014-04-11/nsa-abused-heartbleed-bug-years-left-consumers-exposed-attack
You Are at Risk
Even the big anti-virus folks have been affected. 95% of the detection tools failed. “Symantec has identified that some of its products may be impacted by the OpensSSL vulnerability, dubbed Heartbleed. We have begun issuing advisories to our customers to alert them and provide mitigation solutions while we work to deploy any necessary patches.” http://www.symantec.com/outbreak/?id=heartbleed&sl=QWHND-0000-01-00
What To Do
Reset ALL YOUR PASSWORDS. Ask your provider to confirm they have patched BEFORE resetting your password. If you re-set prior to the patch you are just increasing the chance of handing out your username and password . They may have a public statement, or you can contact them to check. How to tell which passwords you need to change because of Heartbleed
Check Websites You Use
- To find out if a site was vulnerable first see the Heartbleed Hit List on Mashable or type out the site in question in LastPass. Also Google “[site] heartbleed” to find information directly from the source. I started with my most important accounts (email, finance, anything I entered a credit card into).
- You’ll see if they patched the SSL bug from the step above. If they haven’t, wait until they do before you change your passwords. (Most sites already have done this.)
- To find out if they’ve reissued their SSL certificates, check the issue date in the tools above. For example, the LastPass Heartbleed checker usually shows when the certificate was issued. If there’s no date, look it up in digicert.
The clearing firm for many of my clients accounts is Pershing. Pershing, has reviewed all of the client-facing systems, which include NetX360, NetX360.com and NetXInvestor, and determined that these systems are not vulnerable to the Heartbleed Security Bug. It is also important to note that Pershing spends a significant amount of time and money each year focused on protecting their systems in an environment of evolving and increasing security threats.
Tax Planning to Avoid ATRA-phy
The American Taxpayer Relief Act. Brought to you by the same people who ushered in Super PACs guised as “campaign finance reform” and unleashed the Orwellian flood by calling it “The Patriot Act”. The relief is comes in the form of 20% top tax rate on dividends and long-term capital gains, and 39.6% top tax rate on ordinary income and short-term capital gains. Throw in net investment income tax (NIIT), and the top rates could be as high as 23.8% and 43.4%, respectively. Plop, plop, fizz, fizz…
Now, more than ever, tax bracket utilization strategies have become key planning issues with my clients. Bracket utilization is a term to describe flying under the radar of higher tax brackets. You start by calculating your long-term tax rate (out to 15 years), assuming it’s below the 39.6% threshold, and use strategies to keep it below the higher brackets. In addition, you look for ways to fill up the current year tax bracket right up to the last dollar. Why? Suppose your income moves your tax bracket up 10% next year, then you will need to beat 10% to make it a good deal for deferring that income.
This wasn’t always the case. In the past, I would focus on harvesting losses and deferring income and gains where possible in order to reducing the current year’s tax liability. Today, I focus on ways to help clients avoid having to pay taxes at those higher marginal rates and phase-outs in the future by harvesting gains today and filling up tax brackets in the current year.
Using Roth Conversions for Bracket Management – If you have traditional IRAs and your tax brackets will be higher in the future, you may want to convert some of those funds into Roth IRAs. This is often referred to as “filling-up” the 10% and 15% tax brackets. As an example, Ms. Jones will make $220,000 this year, so she has a $30,000 gap before jumping into the surtax. Next year it looks like her income might reach $270,000. If she does a Roth conversion now and picks up that income, she will smooth out some of the surtax.
15 Impactful Bracket Management Ideas
As part of my quest to increase my knowledge on bracket management, I’ve become a student of Robert S. Keebler, CPA. I read as many of his articles as I can, as well as purchased his fantastic tax charts. Keebler shares these 15 good tax strategies than you can use to keep out of higher tax brackets and reduce or eliminate NIIT.
Strategies for Staying Out of Higher Tax Brackets and Avoiding NIIT
- Harvesting Capital Losses. The taxpayer sells assets at a loss and uses these losses to offset capital gains realized on other assets. This strategy might be particularly useful if capital gains realized for the tax year would otherwise push the taxpayer into a higher tax bracket or cause the NIIT to apply.
- Harvesting Capital Gains. If the taxpayer has a lower capital gains bracket now than he expects to have in the future, the taxpayer may wish to recognize gain now instead of later. Note, however, that selling early introduces a trade-off between paying less tax and losing tax deferral. Thus, a quantitative analysis should be performed to see if gain harvesting is advisable. Note also that if the taxpayer is currently in the 10% or 15% ordinary income tax bracket, the loss of tax deferral is not a factor. Long-term capital gains for these taxpayers are taxed at 0%, so there is no trade-off for the lower rate.
- Roth IRA Conversions. There have always been important advantages to Roth IRA conversions, but now they can also be used to smooth income. Traditional IRA distributions are not NII, but they are included in MAGI and this could increase exposure to the NIIT. To illustrate, suppose that Tina is a single taxpayer with $150,000 of salary income and $50,000 of interest income. Although Tina has $50,000 of NII, she is not subject to the NIIT because her income does not exceed her ATA of $200,000. If she receives a $60,000 distribution from a traditional IRA, her MAGI increases to $260,000. The full $50,000 of NII becomes subject to tax and Tina pays NIIT of $1,900 (.038 x $50,000). By contrast, if the distribution was from a Roth IRA, Tina’s MAGI would stay at $200,000 and there would be no NIIT payable. Tina could eliminate all future NIIT on IRA distributions by converting the traditional IRA to a Roth IRA, assuming a conversion otherwise made sense. This strategy would also have an income smoothing effect if the taxpayer expected to be in a higher tax bracket when distributions were received than when the conversion (or series of conversions) was done.
- Substantial Sale Charitable Remainder Trust (Charitable Remainder Annuity Trust or Charitable Remainder Unitrust). This strategy is very favorable for a taxpayer who expects to recognize a large capital gain during the tax year that would push him into a higher tax bracket or cause the NIIT to apply. The taxpayer transfers the appreciated asset to the charitable remainder trust (CRT) and the CRT sells it. Because the CRT is a tax- exempt entity, no gain is recognized. Gain on the annuity or unitrust payments are subject to tax only as annual distributions are received by the donor, spreading the income out over a period of time.
- Charitable Lead Annuity Trust (CLAT). Direct charitable contributions do not reduce MAGI because they are taken below the line. When a CLAT makes its annual annuity or unitrust payments to charity, however, the charitable deduction reduces the trust’s MAGI, possibly also reducing the NIIT payable and leaving more in the CLAT to pass to the donor’s heirs at the end of the trust term.
- Oil & Gas Investments. These investments can create a large deduction in a tax year. Therefore, they can be used in a high income year to keep a taxpayer out of higher brackets or to avoid the NIIT.
- Two-Year Installment Sales. Installment sales from parents to children or a children’s trust can spread out gain over a period of time, thereby smoothing income. The children or the trust must wait more than two years to resell the assets to avoid having the sale proceeds included in the parents’ income at the time of the second sale under IRC Section 453(e).
- Retirement CRT. A net income with make-up charitable remainder unitrust (NIMCRUT) can be used as a supplement to a qualified retirement plan. The NIMCRUT minimizes trust distributions during a taxpayer’s high earning work years, while investing for tax-deferred growth. After the taxpayer retires and has lower annual income, the appreciated assets are invested to generate the maximum amount of income possible, producing an income smoothing effect.
- Income shifting CRT. This is a CRT in which the donor’s children receive the lead annuity or unitrust payments. By transferring income producing assets to the trust, the parents can reduce or eliminate their exposure to high tax brackets and/or the NIIT during high earning years.
- Deferred Annuities. During higher tax bracket years, the taxpayer invests income- producing assets in deferred annuities to reduce taxable income. Annuity payments begin when the taxpayer is in a lower tax bracket, thereby smoothing income.
- Borrowing From Permanent Life Insurance Policies. The taxpayer pays into a permanent life insurance policy in high income years, reducing taxable income. If the taxpayer needs additional income in later years, she can borrow from the policy on a tax- free basis instead of selling assets and perhaps pushing income into a higher tax bracket or creating NIIT exposure.
- Incomplete Gift, Non-Grantor Trusts. Taxpayers in high tax states may be able to reduce or eliminate state tax by creating a trust in a state that does not tax income. Over time, such a trust could produce impressive state tax savings. At present, Nevada appears to be the most favorable state for creating such trusts.
- Grouping Business Activities to Create Material Participation. A taxpayer may want to group business activities to create material participation so that the income from those activities is not considered passive and, as a result, is not subject to the NIIT.
- Choice of Filing Status. For married couples, the amount of NIIT payable may vary depending on whether they file jointly or file single returns. Such taxpayers should run the numbers to see which filing status would be preferable.
- Tax-Efficient Investing. Tax-aware investing can substantially reduce taxable income and increase after-tax returns, perhaps keeping a taxpayer in a lower tax bracket. Tax-aware investing includes the following components: (1) increasing investments in tax-favored assets; (2) deferring gain recognition; (3) changing portfolio construction; (4) after-tax asset allocation; (5) tax-sensitive asset location; (6) managing income, gains, losses, and tax brackets from year-to-year; and (7) managing capital asset holding periods.
Learn more from the Robert Keebler here: http://www.keeblerandassociates.com/tax-estate-planning
NIIT – For individuals, the NIIT is a 3.8% surtax that applies to the lesser of (1) net investment income (NII) or (2) the excess of a taxpayer’s modified adjusted gross income (MAGI) over an applicable threshold amount (ATA). NII generally includes interest, dividends, annuities, royalties, rents, income from a business that is a passive activity with respect to the taxpayer, and net capital gain on the sale of non-business assets, reduced by any deductions properly allocable to such income. It does not include salaries, wages, bonuses, distributions from IRAs or qualified plans, or self-employment income.
ATA – For most taxpayers, MAGI is the amount reported on the last line of Form 1040, page 1. The ATAs are $250,000 for married taxpayers filing jointly, $125,000 for married taxpayers filing separately, and $200,000 for single filers.
For these well-known financial companies, their proprietary funds really mean “Cooking so good, we sell it to clients, but not eat it ourselves! Irony is good food almost anywhere you find it, unless of course, you’re forced to eat your own. After Ameriprise Financial Advisors successfully sued Ameriprise over their dog food funds in their 401k, employees of Fidelity and Massmutual file their own “hypocrisy lawsuits”.
MassMutual employees filed suit against their employer because 37 of the 38 funds in their 401k are MassMutual proprietary funds.
$15 million in fees! Fidelity advisors/employees suit alleges that the company failed to act in the plan participants best interest by only providing Fidelity funds, and plan fees should have been $550,000 rather than $15 million.
Makes you think twice about eating at these restaurants.
Are you part of the walking dead? Did you make that mistake this year and hold a diversified portfolio? Before you go running to the “All You Can Eat S&P” buffet, take two minutes and read about it.
Asset allocation is the process of diversifying your portfolio by investing in different asset categories like Large Cap Equity, Small Cap Equity, International Equity, Core Fixed Income and High Yield Bonds. This strategy is used because each asset class has different return and risk characteristics. Most importantly, some asset classes may perform well in one market while others lag. How these asset classes react to one another is called correlation.
Studies Prove that Asset Allocation beats Stock Picking and Market Timing
In 1986, a ten year study of 91 pension plans showed that asset allocation dominated security selection and market timing, explaining 93.6% of variation in a plans’ return. (Beebower, Brinson, Hood “Determinants of Portfolio Performance”). The study was conducted again in 1991 and confirmed that asset allocation was superior.
Why Diversification Hasn’t Worked in 2013?
If diversification has proven successful overtime, why are we questioning it today? Simply, diversification works over time, not every time.
Why has 2013 been a very difficult year for diversification?
•Domestic stocks are exhibiting strong positive performance
•Fixed Income is in a challenging environment, with rates being at an all-time low and speculated to rise
•Commodities and inflation related assets are performing poorly, because inflation does not seem to be on the horizon
In short, one asset class is driving the market. Concentrated portfolios can and often do outperform their diversified counterparts.
The chart below plots the year-to-date performance of a number of asset classes versus the S&P 500 as of September 30, 2013. It shows why diversification hasn’t been popular this year.
Why Not Just Buy the Asset Class that will Outperform?
Market timing is difficult, if not impossible, to execute successfully. Look at the chart showing asset class returns for the last 10 years. As you can see, it is anybody’s guess to what asset class will lead the pack in any given year. This reinforces why diversification is so important.
Everybody hates bonds today, so let’s pick on the worst performing asset class this year relative to the S&P 500, Long-Term U.S Treasuries.
Below is a chart of the S&P 500 vs Long Term Treasuries for the last 11 months.
Based on the last 11 months, who would want to be in Treasuries? Looks like a sucker’s bet.
But..many retail investors have forgotten what happened in 2007?
Remember we diversify to reduce risk, because you don’t want all your eggs in one basket. Or do you? Treasuries returned 12.6% annually over that period while the S&P 500 went down -37% and took several years to recover. Asset allocation wasn’t the walking dead back then.
Certainly, this year has been one of those times where we are compelled to abandon diversification and jump on the S&P 500 train, but doing so carries significant risk. Investment success is all about finding the best opportunities, blending them to create efficient portfolios and remaining invested long term. Holding an attractive long-term portfolio, however, is not always easy over shorter time frames.
Staying vigilant with a well-rounded asset allocation strategy has proven its worth over time. Unless you believe that this time is different.