January-February 2017 Newsletter

Quiz: How Much Do You Know About Social Security Retirement Benefits?

Social Security is an important source of retirement income for millions of Americans, but how much do you know about this
program? Test your knowledge, and learn more about your retirement benefits, by answering the following questions.

Questions
1. Do you have to be retired to collect Social Security retirement benefits?

a. Yes
b. No

2. How much is the average monthly Social Security benefit for a retired worker?

a. $1,360
b. $1,493
c. $1,585
d. $1,723

3. For each year you wait past your full retirement age to collect Social Security, how much will your retirement benefit increase?

a. 5%
b. 6%
c. 7%
d. 8%

4. How far in advance should you apply for Social Security retirement benefits?

a. One month before you want your benefits to start.
b. Two months before you want your benefits to start.
c. Three months before you want your benefits to start.

5. Is it possible for your retirement benefit to increase once you start receiving Social Security?

a. Yes
b. No

Answers
1. b. You don’t need to stop working in order to claim Social Security retirement benefits. However, if you plan to continue  working and you have not yet reached full retirement age (66 to 67, depending on your year of birth), your Social Security retirement benefit may be reduced if you earn more than a certain annual amount. In 2017, $1 in benefits will be deducted
for every $2 you earn above $16,920. In the calendar year in which you reach your full retirement age, a higher limit applies. In 2017, $1 in benefits will be deducted for every $3 you earn above $44,880. Once you reach full retirement age, your earnings will not affect your Social Security benefit.

2. a. Your benefit will depend on your earnings history and other factors, but according to the Social Security Administration, the average estimated monthly Social Security benefit for a retired worker (as of January 2017) is $1,360. Social Security Fact Sheet, 2017 Social Security Changes

3. d. Starting at full retirement age, you will earn delayed retirement credits that will increase your benefit by 8% per year up to age 70. For example, if your full retirement age is 66, you can earn credits for a maximum of four years. At age 70, your benefit will then be 32% higher than it would have been at full retirement age.

4. c. According to the Social Security Administration, you should ideally apply three months before you want your benefits to start. You can generally apply online.

5. a. There are several reasons why your benefit might increase after you begin receiving it. First, you’ll generally receive annual
cost-of-living adjustments (COLAs). Second, your benefit is recalculated every year to account for new earnings, so it might increase if you continue working. Your benefit might also be adjusted if you qualify for a higher spousal benefit once your spouse files for Social Security. For more information, visit the Social Security Administration website, ssa.gov.

 

Grandparents Can Help Bridge the College Cost Gap

For many families, a college education is a significant financial burden that is increasingly hard to meet with savings, current income, and a manageable amount of loans. For some, the ace in the hole might be grandparents, whose added funds can help bridge the gap. If you’re a grandparent who would like to help fund your  grandchild’s college education, here are some strategies.

529 college savings plan
A 529 college savings plan is one of the best vehicles for multigenerational college funding. 529 plans are offered by states and managed by financial institutions. Grandparents can open a 529 account on their own — either with their own  state’s plan or another state’s plan — and name their grandchild as beneficiary (one grandchild per account), or they can contribute to an existing 529 account that has already been established for that grandchild (for example, by a parent). Once a 529 account is open, grandparents can contribute as much or as little as they want, subject to the individual plan’s lifetime limits, which are typically $300,000 and up. Grandparents can set up automatic monthly contributions or they can gift a larger lump sum—a scenario where 529 plans really shine. Contributions to a 529 plan accumulate tax deferred (which means no taxes are due on any earnings made along the way), and earnings are completely tax-free at the federal level (and typically at the state level) if account funds are used to pay the beneficiary’s qualified education expenses. (However, the earnings portion of any withdrawal used for a non-education purpose is subject to income tax and a 10% penalty.)

Under rules unique to 529 plans, individuals can make a lump-sum gift of up to $70,000 ($140,000 for joint gifts by a married couple) and avoid federal gift tax by making a special election on their tax return to treat the gift as if it were made in equal installments over a five-year period. After five years, another lump-sum gift can be made using the same technique. This strategy offers two advantages: The money is considered removed from the grandparents’ estate (unless a grandparent were to die during the five-year period, in which case a portion of the gift would be recaptured), but grandparents still retain control over their contribution and can withdraw part or all of it for an unexpected financial need (the earnings portion of such a
withdrawal would be subject to income tax and a 10% penalty, though).

What happens at college time if a grandchild gets a scholarship? Grandparents can seamlessly change the beneficiary of the 529 account to another grandchild, or they can make a penalty-free withdrawal from the account up to the amount of the scholar-ship (though they would still owe income tax on the earnings portion of this withdrawal). Finally, a word about financial aid. Under current federal financial aid rules, a grandparent-owned 529 account is not counted as a parent or student asset, but withdrawals from a grandparent-owned 529 account are counted as student income in the following academic year, which can decrease the grandchild’s eligibility for financial aid in that year by up to 50%. By contrast, parent-owned 529 accounts are counted as parent assets up front, but withdrawals are not counted as student income — a more favorable treatment.

Outright cash gifts
Another option for grandparents is to make an outright gift of cash or securities to their grandchild or his or her parent. To help reduce any potential gift tax implications, grandparents should keep their gift under the annual federal gift tax exclusion amount—$14,000 for individual gifts or $28,000 for joint gifts. Otherwise, a larger gift may be subject to federal gift tax and, for a gift made to a grandchild, federal generation-skipping transfer tax, which is a tax on gifts made to a person who is more than one generation below you. An outright cash gift to a grandchild or a grandchild’s parent will be considered an asset for
financial aid purposes. Under the federal aid formula, students must contribute 20% of their assets each year toward college costs, and parents must contribute 5.6% of their assets.

Pay tuition directly to the college
For grandparents who are considering making an outright cash gift, another option is to bypass grandchildren and pay the college directly. Under federal law, tuition payments made directly to a college aren’t considered taxable gifts, no matter how large the payment. This rule is beneficial considering that tuition at many private colleges is now over $40,000 per year. Only tuition qualifies for this federal gift tax exclusion; room and board aren’t eligible. Aside from the benefit of being able to make larger tax-free gifts, paying tuition directly to the college ensures that your money will be used for education purposes. However, a direct tuition payment might prompt a college to reduce any potential grant award in your grandchild’s financial aid package, so make sure to ask the college about the financial aid impact of your gift.

 

Growth, Value, or Both

The terms growth and value are often used to describe two different investment strategies, yet many investors may want both qualities in an investment. Famed investor Warren Buffett put it this way in a 2015 interview: “I always say if you aren’t investing for value, what are you investing for? And the idea that value and growth are two different things makes no sense…. Growth is part of the value equation.”  (CNBC.com, March 2, 2015) Even so, analysts may look at specific stocks as offering more growth potential than value, and vice versa. And these concepts are used to construct many mutual funds and exchange-traded funds (ETFs). So it’s helpful to understand the opposing ideas, even if you want the best of both in your portfolio.

Poised to grow?
As the name suggests, growth stocks are associated with companies that appear to have above-average growth potential. These
companies might be on the verge of a market breakthrough or acquisition, or they may occupy a strong position in a growing industry. Growth companies may place more emphasis on reinvesting profits than on paying dividends (although many large growth companies do offer dividends). Investors hope to benefit from future capital appreciation of growth stocks, which tend to be considered higher risk than value stocks. However, it’s equally important for growth and value stocks to have strong
fundamentals.

Undervalued?
Value stocks are associated with companies that appear to be undervalued by the market or are in an industry that is currently out of favor. Unlike growth stocks, which might seem expensive and overvalued, value stocks may be priced lower in relation to their earnings, assets, or growth potential. Established companies are more likely than younger companies to be considered value stocks, and these firms may emphasize paying dividends over reinvesting profits. An investor who purchases a value stock typically expects the broader market to eventually recognize the company’s full potential, which may result in rising share prices. One risk with this approach is that a stock considered to be undervalued because of legal or management difficulties or
tough competition might not be able to recover from the setback.

Focused funds
Identifying specific growth or value investments requires time, knowledge, and experience to analyze stock data. A more convenient and accessible way to add growth or value stocks to your portfolio may be through mutual funds or ETFs that focus on these categories. Such funds often have the word “growth” or “value” in their names. However, there could be a wide variety of objectives and stock holdings among funds labeled growth or value. Also keep in mind that you might find growth, value, or both in a broad range of investments that do not employ growth or value strategies.

Diversification
Holding growth and value stocks and/or funds is one way to diversify the stock portion of your portfolio. Over the past 20 years, the average annual return for value stocks was about 1.5 percentage points higher than that of growth stocks (8.54% versus 7.02%). Yet growth stocks outperformed value stocks in eight of those years — in some years by large margins. This suggests that growth and value stocks may respond differently to varying market conditions. (Thomson Reuters, 2016, for the period
9/30/1996 to 9/30/2016. Growth stocks are represented by the Russell 3000 Growth Index. Value stocks are represented by the Russell 3000 Value Index. The performance of an unmanaged index is not indicative of the performance of any particular investment. Individuals cannot invest directly in an index. Rates of return will vary over time, particularly for long-term investments. Past performance is not a guarantee of future results.)  Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against investment loss. The return and principal value of stocks, mutual funds, and ETFs fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost. Supply and demand for ETF shares may cause them to trade at a premium or a discount relative to the value of the underlying shares.

Mutual funds and ETFs are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

What’s the difference between a direct and indirect
rollover?

If you’re eligible to receive a taxable distribution from an employer-sponsored retirement plan [like a 401(k)], you can avoid current taxation by instructing your employer to roll the distribution directly over to another employer plan or IRA. With a
direct rollover, you never actually receive the funds.

You can also avoid current taxation by actually receiving the distribution from the plan and then rolling it over to another employer plan or IRA within 60 days following receipt. This is called a “60-day” or “indirect” rollover. But if you choose to receive the funds rather than making a direct rollover, your plan is required to withhold 20% of the taxable portion of your distribution (you’ll get credit for the amount withheld when you file your federal tax return). This is true even if you intend to make a 60-day rollover. You can still roll over the entire amount of your distribution, but you’ll need to make up the 20% that was withheld using other assets.

For example, if your taxable distribution from the plan is $10,000, the plan will withhold $2,000 and you’ll receive a check for $8,000. You can still roll $10,000 over to an IRA or another employer plan, but you’ll need to come up with that $2,000 from your other funds. Similarly, if you’re eligible to receive a taxable distribution from an IRA, you can avoid current taxation by either transferring the funds directly to another IRA or to an employer plan that accepts rollovers (sometimes called a “trustee-to-trustee transfer”), or by taking the distribution and making a 60-day indirect rollover (20% withholding doesn’t apply to IRA
distributions).

Under recently revised IRS rules, you can make only one tax-free, 60-day, rollover from any IRA you own (traditional or Roth) to any other IRA you own in any 12-month period. However, this limit does not apply to direct rollovers or trustee-to-trustee transfers. Because of the 20% withholding rule, the one-rollover-per-year rule, and the possibility of missing the 60-day deadline, in almost all cases you’re better off making a direct rollover to move your retirement plan funds from one account to another.

 

Can the IRS waive the 60-day IRA rollover deadline?

If you take a distribution from your IRA intending to make a 60-day rollover, but for some reason the funds don’t get to the new IRA trustee in time, the tax impact can be significant. In general, the rollover is invalid, the distribution becomes a taxable event, and you’re treated as having made a regular, instead of a rollover, contribution to the new IRA. But all may not be lost. The 60-day requirement is automatically waived if all of the following apply:

• A financial institution actually receives the funds within the 60-day rollover period.
• You followed the financial institution’s procedures for depositing funds into an IRA within the 60-day period.
• The funds are not deposited in an IRA within the 60-day rollover period solely because of an error on the part of the financial institution.
• The funds are deposited within one year from the beginning of the 60-day rollover period.
• The rollover would have been valid if the financial institution had deposited the funds as instructed.

If you don’t qualify for this limited automatic waiver, the IRS can waive the 60-day requirement “where failure to do so would be against equity or good conscience,” such as a casualty, disaster, or other event beyond your reasonable control. However, you’ll need to request a private letter ruling from the IRS, an expensive proposition — the filing fee alone is currently $10,000.
Thankfully, the IRS has just introduced a third way to seek a waiver of the 60-day requirement: self-certification. Under the new
procedure, if you’ve missed the 60-day rollover deadline, you can simply send a letter to the plan administrator or IRA trustee/custodian certifying that you missed the 60-day deadline due to one of 11 specified reasons. To qualify, you must generally make your rollover contribution to the employer plan or IRA within 30 days after you’re no longer prevented from
doing so. Also, there is no IRS fee. The downside of self-certification is that if you’re subsequently audited, the IRS can still
review whether your contribution met the requirements for a waiver. For this reason, some taxpayers may still prefer the certainty of a private letter ruling from the IRS.

 

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