Eaglestone Tax & Wealth Newsletter – March 2014

The Spring Equinox gave us more hours of daylight, but where is Mother Nature with the Mid-Atlantic region’s typically gorgeous Spring Season and warm weather? I don’t think there is one person in the DC or Baltimore areas who isn’t ready for warmer temperatures, baseball (even if you don’t like it – that’s how badly you want spring!) and sunny, leisurely weekend hikes. Well, until those days arrive, we have put together a few articles to help you get a jump start on your financial spring cleaning. This month’s topics focus on Reevaluating Your Financial Plan and the Retirement Planning for Business Owners. Please don’t hesitate to contact me or any of my team members with any questions.

What Baseball Can Teach You about Financial Planning

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Spring training is a tradition that baseball teams and baseball fans look forward to every year. No matter how they did last year, teams in spring training are full of hope that a new season will bring a fresh start. As this year’s baseball season gets under way, here are a few lessons from America’s pastime that might help you reevaluate your finances.

Sometimes you need to proceed one base at a time

There’s nothing like seeing a home run light up the scoreboard, but games are often won by singles and doubles that get runners in scoring position through a series of base hits. The one base at a time approach takes discipline, something that you can apply to your finances by putting together a financial plan. What are your financial goals? Do you know how much money comes in, and how much goes out? Are you saving regularly for retirement or for a child’s college education? A financial plan will help you understand where you are now and help you decide where you want to go.

It’s a good idea to cover your bases

Baseball players minimize the odds that a runner will safely reach a base by standing close to the base to protect it. What can you do to help protect your financial future? Try to prepare for life’s “what-ifs.” For example, buy the insurance coverage you need to make sure you and your family are protected–this could be life, health, disability, long-term care, or property and casualty insurance. And set up an emergency account that you can tap instead of dipping into your retirement funds or using a credit card when an unexpected expense arises.

You can strike out looking, or strike out swinging

Fans may have trouble seeing strikeouts in a positive light, but every baseball player knows that striking out is a big part of the game. In fact, striking out is much more common than getting hits. The record for the highest career batting average record is .366, held by Ty Cobb. Or, as Ted Williams once said, “Baseball is the only field of endeavor where a man can succeed three times out of ten and be considered a good performer.”

In baseball, there’s even more than one way to strike out. A batter can strike out looking by not swinging at a pitch, or strike out swinging by attempting, but failing, to hit a pitch. In both cases, the batter likely waited for the right pitch, which is sometimes the best course of action, even if it means striking out occasionally.

So how does this apply to your finances? First, accept the fact that you’re going to have hits and misses, but that doesn’t mean you should stop looking for financial opportunities. For example, when investing, you have no control over how the market is going to perform, but you can decide what to invest in and when to buy and sell, according to your investment goals and tolerance for risk.

Warren Buffett, who is a big fan of Ted Williams, strongly believes in waiting for the right pitch. “What’s nice about investing is you don’t have to swing at pitches,” Buffett said. “You can watch pitches come in one inch above or one inch below your navel, and you don’t have to swing. No umpire is going to call you out. You can wait for the pitch you want.”

Note: All investing involves risk, including the possible loss of principal.

Every day is a brand-new ball game

When the trailing team ties the score (often unexpectedly), the announcer shouts, “It’s a whole new ball game!” Or, as Yogi Berra famously put it, “It ain’t over ’til it’s over.” Whether your investments haven’t performed as expected, or you’ve spent too much money, or you haven’t saved enough, there’s always hope if you’re willing to learn both from what you’ve done right and from what you’ve done wrong. Pitcher and hall-of-famer Bob Feller may have said it best. “Every day is a new opportunity. You can build on yesterday’s success or put its failures behind and start over again. That’s the way life is, with a new game every day, and that’s the way baseball is.”

Test Your Knowledge of Financial Basics

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Working with a trusted financial professional is one of the best ways to help improve your overall financial situation, but it’s not the only thing you can do. Educating yourself about personal finance concepts can help you better understand your advisor’s recommendations, and result in more productive and potentially more prosperous financial planning discussions. Take this brief quiz to see how well you understand a few of the basics.

Questions
1. How much should you set aside in liquid, low-risk savings in case of emergencies?
a. One to three months’ worth of expenses
b. Three to six months’ worth of expenses
c. Six to twelve months’ worth of expenses
d. It depends

2. Diversification can eliminate risk from your portfolio.
a. True
b. False

3. Which of the following is a key benefit of a 401(k) plan?
a. You can withdraw money at any time for needs such as the purchase of a new car.
b. The plan allows you to avoid paying taxes on a portion of your compensation.
c. You may be eligible for an employer match, which is like earning a guaranteed return on your investment dollars.
d. None of the above

4. All of the money you have in a bank account is protected and guaranteed.
a. True
b. False

5. Which of the following is typically the best way to pursue your long-term goals?
a. Investing as conservatively as possible to minimize the chance of loss
b. Investing equal amounts in stocks, bonds, and cash investments
c. Investing 100% of your money in stocks
d. Not enough information to decide

Answers

1. d. Conventional wisdom often recommends setting aside three to six months’ worth of living expenses in a liquid savings vehicle, such as a bank savings account or money market mutual fund. However, the answer really depends on your own individual situation. If your (and your spouse’s) job is fairly secure and you have other assets, you may need as little as three months’ worth of expenses in emergency savings. On the other hand, if you’re a business owner in a volatile industry, you may need as much as a year’s worth or more to carry you through uncertain periods.

2. b. Diversification is a smart investment strategy that helps you manage risk by spreading your investment dollars among different types of securities and asset classes, but it cannot eliminate risk entirely. You still run the risk of losing money.

3. c. Many employer-sponsored 401(k) plans offer a matching program, which is like earning a guaranteed return on your investment dollars. If your plan offers a match, you should try to contribute at least enough to take full advantage of it. (Note that some matching programs impose a vesting schedule, which means you will earn the right to the matching contributions over a period of time.)

Because 401(k) plans are designed to help you save for retirement, the federal government imposes rules about withdrawals for other purposes, including the possibility of paying a penalty tax for nonqualified withdrawals. You may be able to borrow money from your 401(k) if your plan allows, but this is generally recommended as a last resort in a financial emergency. Finally, traditional 401(k) plans do not help you avoid paying taxes on your income entirely, but they can help you defer taxes on your contribution dollars and investment earnings until retirement, when you might be in a lower tax bracket. With Roth 401(k)s, you pay taxes on your contribution dollars before investing, but qualified withdrawals will be free from federal, and in many cases, state taxes.

4. b. Deposits in banks covered by the Federal Deposit Insurance Corporation are protected up to $250,000 per depositor, per bank. This means that if a bank should fail, the federal government will protect depositors against losses in their accounts up to that limit. The FDIC does not protect against losses in stocks, bonds, mutual funds, life insurance policies, annuities, or municipal securities, even if those vehicles were purchased at an insured bank. It also does not protect items held in safe-deposit boxes or investments in Treasury bills.

5. d. To adequately pursue your long-term goals, it’s best to speak with a financial professional before choosing a strategy. He or she will take into consideration your goals, your risk tolerance, and your time horizon, among other factors, to put together a well-diversified strategy that’s appropriate for your needs.

Business Owners: Don’t Neglect Your Own Retirement Plan

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If you’re like many small business owners, you pour your heart, soul, and nearly all your money into your business. When it comes to retirement planning, your strategy might be crossing your fingers and hoping your business will provide the nest egg you’ll need to live comfortably. But relying on a business to fund retirement can be a very risky proposition. What if you become ill and have to sell it early? Or what if your business experiences setbacks just before your planned retirement date?

Rather than counting on your business to define your retirement lifestyle, consider managing your risk now by investing in a tax-advantaged retirement account. Employer-sponsored retirement plans offer a number of potential benefits, including current tax deductions for the business and tax-deferred growth and/or tax-free retirement income for its employees. Following are several options to consider.

IRA-type plans
Unlike “qualified” plans that must comply with specific regulations governed by the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA), SEP and SIMPLE IRAs are less complicated and typically less costly.

  • SEP-IRA: A SEP allows you to set up an IRA for yourself and each of your eligible employees. Although you contribute the same percentage of pay for every employee, you’re not required to make contributions every year. Therefore, you can time your contributions according to what makes sense for the business. For 2014, total contributions (both employer and employee) are limited to 25% of pay up to a maximum of $52,000 for each employee (including yourself).
  • SIMPLE IRA: The SIMPLE IRA allows employees to contribute up to $12,000 in 2014 on a pretax basis. Employees age 50 and older may contribute an additional $2,500. As the employer, you must either match your employees’ contributions dollar for dollar up to 3% of compensation, or make a fixed contribution of 2% of compensation for every eligible employee. (The 3% contribution can be reduced to 1% in any two of five years.)

Qualified plans
Although these types of plans have more stringent regulatory requirements, they offer more control and flexibility. (Note that special rules may apply to self-employed individuals.)

  • Profit-sharing plan: Typically only the business contributes to a profit-sharing plan. Contributions are discretionary (although they must be “substantial and recurring”) and are placed into separate accounts for each employee according to an established allocation formula. There’s no fixed amount requirement, and in years when profitability is particularly tight, you generally need not contribute at all.
  • 401(k) plan: Perhaps the most popular type of retirement plan offered by employers, a 401(k) plan allows employees to make both pre- and after-tax (Roth) contributions. Pretax contributions grow on a tax-deferred basis, while qualified withdrawals from a Roth account are tax free. Employee contributions cannot exceed $17,500 in 2014 ($23,000 for those 50 and older) or 100% of compensation, and employers can choose to match a portion of employee contributions. These plans must pass tests to ensure they are nondiscriminatory; however, employers can avoid the testing requirements by adopting a “safe harbor” provision that requires a set matching contribution based on one of two formulas. Another way to avoid testing is by adopting a SIMPLE 401(k) plan. However, because they are more complicated than SIMPLE IRAs and are still subject to certain regulations, SIMPLE 401(k)s are not widely utilized.
  • Defined benefit (DB) plan: Commonly known as a traditional pension plan, DB plans are becoming increasingly scarce and are uncommon among small businesses due to costs and complexities. They promise to pay employees a set level of benefits during retirement, based on a formula typically expressed as a percentage of income. DB plans generally require an actuary’s expertise.

Total contributions to profit-sharing and 401(k) plans cannot exceed $52,000 or 100% of compensation in 2014. With both profit-sharing and 401(k) plans (except safe harbor 401(k) plans), you can impose a vesting schedule that permits your employees to become entitled to employer contributions over a period of time.

For the self-employed
In addition to the options noted above, sole entrepreneurs may consider an individual or “solo” 401(k) plan. These types of plans are very similar to a standard 401(k) plan, but because they apply only to the business owner and his or her spouse, the regulatory requirements are not as stringent. They can also have a profit-sharing feature, which can help you maximize your tax-advantaged savings potential.

Cartoon: Do You Know the Way to Retirement?

Graph: The S&P 500 Month by Month in 2013

Past performance is no guarantee of future results, but stocks had an extraordinary run in 2013. The Standard & Poor’s 500 set 45 new all-time closing records during the year and by November had surpassed 1,800 for the first time ever. Despite some stumbles during the summer, by the end of 2013 the index had nearly tripled since its March 2009 financial-crisis low. Note: All investing involves risk, including the possible loss of principal.

 

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

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