Prepare Now for a Year-End Investment Review
Getting organized for your year-end investment review with your financial professional may help make the review process more efficient. Here are some suggestions for making your meeting as productive as possible.
Decide what you want to know
One of the benefits of a yearly investment review is that it can help you monitor your investment portfolio. A key component of most discussions is a review of how your investments have performed over the last year. Performance can mean different things to different people, depending on their individual financial goals and needs. For example, an investor who’s focused on long-term growth might define “performance” slightly differently than an investor whose primary concern isn’t overall growth but trying to maintain a portfolio that has the potential to produce current income needed to pay ordinary living expenses.
Consider in advance what types of information are most important to you and why. You may want to check on not only your portfolio’s absolute performance but also on how it fared compared to some sort of benchmark. For example, you might want to know whether any equity investments you held outperformed, matched, or underperformed a relevant index, or how your portfolio fared against a hypothetical benchmark asset allocation. (Remember that the performance of an unmanaged index is not indicative of the performance of any specific security, and indices are not available for direct investment. Also, asset allocation cannot guarantee a profit or eliminate the possibility of loss, including the loss of principal.)
Almost as important as knowing how your portfolio performed is understanding why it performed as it did. Was any overperformance or underperformance concentrated in a single asset class or a specific investment? If so, was that consistent with the asset’s typical behavior over time? Or was last year’s performance an anomaly that bears watching or taking action? Has any single investment grown so much that it now represents more of your portfolio than it should? If so, should you do a little profit-taking and redirect that money into something else?
Are any changes needed?
If your goals or concerns have changed over the last year, you’ll need to make that clear during your meeting. Your portfolio probably needs to evolve over time as your circumstances change. Making sure you’ve communicated any life changes will make it easier to adjust your portfolio accordingly and measure its performance appropriately next year.
If a change to your portfolio is suggested based on last year’s performance–either positive or negative–don’t hesitate to ask why the change is being recommended and what you might reasonably expect in terms of performance and potential risk as a result of a shift. (However, when looking at potential returns, remember that past performance is no guarantee of future results.) Don’t be reluctant to ask questions if you don’t understand what’s being presented to you; a little clarification now might help prevent misunderstandings and unrealistic expectations that could have a negative impact in the future.
Also, before making any change, find out how it might affect your investing costs, both immediate and ongoing. Again, a few questions now may help prevent surprises later.
Think about the coming year
Consider whether you would benefit next April from harvesting any investment losses before the end of the year. Selling a losing position could generate a capital loss that could potentially be used to offset either capital gains or up to $3,000 of ordinary income on your federal income tax return.
If you’ve amassed substantial assets, you could explore whether you might benefit from specialized assistance in dealing with issues such as taxes, estate planning, and asset protection. Finally, give feedback on the review process itself; it can help improve next year’s session. Note: All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.
Retiring and Relocating? Don’t Neglect State Taxes!
If you’re retired, or about to retire, you may be thinking about relocating to a state that has low tax rates or provides special tax benefits to retirees. Here’s a survey that may jump-start your search for a tax-friendly state in which to spend your golden years.
State income taxes in general
State income taxes typically account for a large percentage of the total taxes you pay. So you may consider yourself lucky if you live in one of the seven no-income-tax states: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. (New Hampshire and Tennessee impose income tax only on interest and dividends.)
But if you’re considering a state that does impose an income tax, as a retiree you’ll want to know how that state treats Social Security and retirement income.
State income taxes and Social Security
Social Security income is completely exempt from tax in 28 of the states with an income tax (as well as the District of Columbia): Alabama, Arizona, Arkansas, California, Delaware, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia, and Wisconsin.
Some states (for example, Connecticut, Kansas, Missouri, and Montana) don’t tax Social Security benefits if income is less than a specified dollar amount (Nebraska joins this list in 2015). And at least three states (Colorado, Utah, and West Virginia) provide a general income exclusion or credit for seniors that takes Social Security into account. Most of the remaining states tax Social Security benefits to the same extent they’re taxed under federal law.
State income taxes and retirement income
Of the states with an income tax, most provide at least some relief for retirement income, but this can range from a credit of less than $500 (Ohio and Utah) to an exclusion for all or most retirement income (Hawaii, Illinois, and Mississippi). Only a handful of states, including California, Nebraska, North Carolina, North Dakota, Rhode Island, and Vermont, currently tax all retirement income and don’t provide any general income exclusion for seniors.
Make sure you understand how your particular type of retirement income is treated. Some states exempt public pensions, but tax private pensions; or exempt public pensions earned in that state, but not public pensions earned in another state. Some states exempt employer retirement benefits, but not IRA income. Others exempt a specific dollar amount of retirement income, but only if you’ve reached a certain age or have income within certain limits. In some states, military pensions are partially or fully exempt, while in others they’re fully taxable. Some states exempt defined benefit pension payments, but tax 401(k) distributions. A good source for information is your state’s Department of Revenue website.
Can the state I’m moving from tax my benefits?
What happens if you spent your working life in a state like California that fully taxes retirement income, but you relocate after you retire to Florida, a state that has no income tax? Can California tax your pension benefit? While the answer used to be unclear, federal law now clearly prohibits states from taxing certain retirement income unless you’re a resident of, or domiciled in, that state.
Whether you’re considered a resident of, or domiciled in, a state is determined by the laws of that particular state. In general, your residence is the place you actually live. Your domicile is your permanent legal residence–even if you don’t currently live there, you have an intent to return and remain there. So in our example, if you’re no longer a resident of, or domiciled in, California, that state cannot tax your pension benefit under federal law.
The law applies to all qualified plans (for example, 401(k), profit-sharing, and defined benefit plans), IRAs, 403(b) plans, 457(b) plans, and governmental plans.
The law provides only limited protection for other (nonqualified) deferred compensation plan benefits. So-called “top-hat” plan benefits that are paid over an employee’s lifetime, or over a period of at least 10 years, are covered by the law. But stock options, stock appreciation rights (SARs), and restricted stock are not; states are free to tax these benefits even after you relocate.
Remember that states impose many other kinds of taxes (for example, sales, real estate, and gift and estate taxes). Some states offer special tax breaks to seniors, like property tax reductions or additional exemptions, standard deductions, or credits based on age. For an accurate comparison among the states, you’ll need to consider your total tax burden. A tax professional can assist you in this task.
Leaving Assets to Your Heirs: Income Tax Considerations
An inheritance is generally worth only what your heirs get to keep after taxes are paid. So when it comes to leaving a legacy, not all property is created equal–at least as far as federal income tax is concerned. When evaluating whom to leave property to and how much to leave to each person, you might want to consider how property will be taxed and the tax rates of your heirs.
Favorable tax treatment for heirs
Assets in a Roth IRA will accumulate income tax free and qualified distributions from a Roth IRA to your heirs after your death will be received income tax free. An heir will generally be required to take distributions from the Roth IRA over his or her remaining life expectancy. (Of course, your beneficiaries can always withdraw more than the required minimum amounts.) If your spouse is your beneficiary, your spouse can treat the Roth IRA as his or her own and delay distributions until after his or her death. So your heirs will be able to continue to grow the assets in the Roth IRA income tax free until after the assets are distributed; any growth occurring after funds are distributed may be taxed in the future.
Note: The Supreme Court has ruled that inherited IRAs are not retirement funds and do not qualify for a federal exemption under bankruptcy. Some states may provide some protection for inherited IRAs under bankruptcy. You may be able to provide some bankruptcy protection to an inherited IRA by placing the IRA in a trust for your heirs. If this is a concern of yours, you may wish to consult a legal professional.
Appreciated capital assets
When you leave property to your heirs, they generally receive an initial income tax basis in the property equal to the property’s fair market value (FMV) on the date of your death. This is often referred to as a “stepped-up basis,” because basis is typically stepped up to FMV. However, basis can also be “stepped down” to FMV.
If your heirs sell the property with a stepped-up (or a stepped-down) basis immediately after your death for FMV, there should be no capital gain (or loss) to recognize since the sales price will equal the income tax basis. If they sell the property later for more than FMV, any appreciation after your death will generally be taxed at favorable long-term capital gain tax rates. If the appreciated assets are stocks, qualified dividends received by your heirs will also be taxed at favorable long-term capital gain tax rates.
Note: If your heirs receive property from you that has depreciated in value, they will receive a basis stepped down to FMV and will not be able to claim any loss with respect to the depreciation before your death. You may want to consider selling depreciated property while you are alive so that you can claim the loss.
Not as favorable tax treatment for heirs
Tax-deferred retirement accounts
Assets in a tax-deferred retirement account (including a traditional IRA or 401(k) plan) will accumulate income tax deferred within the account. However, distributions from the account will be subject to income tax at ordinary income tax rates when distributed to your heirs (if there were nondeductible contributions made to the account, the nondeductible contributions can be received income tax free). An heir will generally be required to take distributions from the tax-deferred retirement account over his or her remaining life expectancy. (Of course, your beneficiaries can always withdraw more than the required minimum amounts.) If your spouse is the beneficiary of the account, the rules may be more favorable. So your heirs will be able to defer taxation of the retirement account until distribution, but distributions will generally be fully subject to income tax at ordinary income tax rates.
Note: Your heirs do not receive a stepped-up (or stepped-down) basis in your retirement accounts at your death.
Even though distributions are taxable, your heirs will nevertheless generally appreciate receiving tax-deferred retirement accounts from you. After all, they do get to keep the amounts remaining after taxes are paid.
Toxic or underwater assets
Your heirs might not appreciate receiving property that is subject to a mortgage, lien, or other liability that exceeds the value of the property. In fact, an heir receiving such property may want to consider disclaiming the property.
Always nice to receive
Life insurance and cash
Life insurance proceeds received by your heirs will generally be received income tax free. Your heirs can generally invest life insurance proceeds and cash they receive in any way that they wish. When doing so, yours heirs can factor in how the property will be taxed to them in the future.
What factors could negatively impact my credit report?
Having a good credit report is important when it comes to personal finance, because most lenders use credit reports to evaluate the creditworthiness of a potential borrower. Borrowers with good credit are presumed to be more creditworthy and may find it easier to obtain a loan, often at a lower interest rate.
A number of factors could negatively impact your credit report, including:
- A history of late payments. Your credit report provides information to lenders regarding your payment history over the previous 12 to 24 months. For the most part, a lender may assume that you can be trusted to make timely monthly debt payments in the future if you have done so in the past. Consequently, if you have a history of late payments and/or unpaid debts, a lender may consider you to be a high credit risk and turn you down for a loan.
- Too many credit inquiries. Each time you apply for credit, the lender will request a copy of your credit history. The lender’s request then appears as an inquiry on your credit report. Too many inquiries in a short amount of time could be viewed negatively by a potential lender, since it may indicate that the borrower has a history of being turned down for loans or has access to too much credit.
- Not enough good credit. You may have good credit, but not enough of it. As a result, you may need to build up more of your credit history before a lender deems you worthy to take on any additional debt.
- Uncorrected errors on your report. Uncorrected errors on a credit report could make it difficult for a lender to accurately evaluate creditworthiness, and could result in a loan denial. If you have errors on your credit report, it’s important to take steps to correct your report, even if it doesn’t contain derogatory information.
Finally, if you are ever turned down for a loan, there is a way to find out the reason behind it. Under federal law, you are entitled to a free copy of your credit report as long as you request it within 60 days of receiving notice of a company’s adverse action against you. For more information, visit the Federal Trade Commission’s website.
I’m looking to buy a home. What are some common mortgage mistakes to avoid?
Navigating the complex world of mortgages can be difficult. As a result, it’s easy to make mistakes when applying for a mortgage loan.
Here are some common mortgage mistakes you should try to avoid:
- Taking on a mortgage that is too big for you to handle. The mortgage you are qualified or preapproved for isn’t necessarily how much you can afford. Be sure to examine your budget and lifestyle to make sure that your mortgage payment–including any extras, such as mortgage insurance–is within your means.
- Neglecting to read the fine print. Before you sign any paperwork, make sure that you fully understand the terms of your mortgage loan and the costs associated with it. For example, are you are applying for an adjustable-rate mortgage? If so, it’s important to be aware of how and when the interest rate for the loan will adjust.
- Overlooking your credit. A positive credit history may not only make it easier to obtain a mortgage loan, but potentially could also result in a lender offering you a lower interest rate. Be sure to review your credit report and check it for inaccuracies. You may have to take the necessary steps to improve your credit history, such as paying your monthly bills on time and limiting credit inquiries on your credit report (which are made every time you apply for new credit).
- Putting down too little. While it is possible to obtain a mortgage with a minimal down payment, a larger down payment may help you get more attractive mortgage terms. In addition to requiring private mortgage insurance, lenders generally offer lower loan limits and higher interest rates to borrowers who have a down payment of less than 20% of a home’s purchase price.
- Forgetting to shop around. Be sure to shop around among various lenders and compare the types of loans offered, along with the costs and rates associated with those loans. Consider each lender’s customer service reputation as well.
IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any matter addressed herein.
Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2014