Financial Planning Assistance
Understanding 401(k) Percentage Contribution
If so, you may be reducing your company matching contribution unknowingly. This scenario is best explained by example. John’s annual wage is $155,000 and elects a 15% weekly 401(k) contribution. John will reach his $15,500 maximum contribution when his earnings reach $103,333. His employer’s matching contribution is 4%. Once John’s wages reach $103,333 his employer’s contribution cease. If John lowers his election to 10%, the $15,500 contribution will not be achieved until year-end. The effect of this change is to allow matching to continue throughout the entire year. The bottom line—matching contributions will increase by $2,067. Check with your 401(k) administrator to learn about your specific plan options.
How to Safely Safeguard Capital
For retirees anxious about outliving their money, not spending principal can seem like a sensible strategy. However, if your aim is never to touch your capital and instead spend only the income that it generates, you could end up making three fundamental investment mistakes; ignoring inflation, avoiding stocks, and reaching for high yield mutual funds.
If you buy bonds, hold them to maturity and always use the proceeds from the maturing bonds to buy new bonds, the portfolio will maintain its value in current dollars, but with every passing year, the bonds are worth less, due to inflation. During a 20-year retirement with 3% inflation, the portfolio's real, inflation adjusted value would be halved. The real value of the interest generated may suffer a squeeze of similar proportions.
If you avoid dipping into capital to get spending money, you are unlikely to buy stocks. After all, with most stocks, now yielding less than 3%, you would have to be mighty rich or frugal to live off the dividends from a stock portfolio. If you protect your investments against inflation, stocks are a critical addition to your portfolio. Yes, stocks bounce around a lot in value, but if your portfolio is to grow---and combat the threat of inflation, you need the long-run capital appreciation that only stocks can generate.
If, instead you stick to no-growth investments like bonds and money-market funds, keeping inflation at bay becomes far more difficult. Each year you have to reinvest enough interest to offset that nasty consumption of capital---inflation. After protecting your assets against inflation and paying taxes, you may have little leftover. Why do apparently risk-averse investors end up buying questionable, high-yielding mutual funds? They are trying to be conservative. They don't want to draw down their principal, but they need more income from their portfolio. So what happens is an end-around Treasury and high quality corporate bonds into riskier funds, promising return of capital and much higher yields. Reaching for yield alone can be devastating, as proven by mutual fund disasters during the last ten years. Many of these failed funds lured investors by promising handsome dividends, at the expense of buying risky securities and following risky strategies.
What to do? Don't aim to preserve capital while investing for yield. Instead, focus on your portfolio's total return, which includes the dividends, and interest you receive, as well as the increases/decreases in the value of your portfolio's securities. Watch that the total return you earn is above the inflation rate, after taxes. Try combining stocks with more conservative investments. For individuals unwilling or unable to spend the time researching the optimum mix for their retirement needs, Chicago fund researcher, Morning Star Inc., can provide extensive data on thousands of funds and fund families encompassing all types of investment vehicles.
Private Mortgage Insurance
If you put less than 20% down on your home and have a private mortgage, you probably make monthly payments for private mortgage insurance (PMI). Some homeowners continue to pay such premiums long after their equity has risen substantially. The Homeowners Protection Act gives homeowners the right to cancel their mortgage insurance once the equity in their homes reaches 20%. Cancellation should be automatic if your equity reaches 22%. Check with your mortgage company if you qualify for the PMI exemption.
Received Stock in Your Insurance Company?
Many life insurance companies are "demutualizing" or changing from a mutual company (a company owned by the policyholders) to a stock company. If you hold a policy with the company you'll probably receive stock in the changed corporation. There's generally no tax consequence on the receipt of the shares, but you'll have a capital gain on the sale of the stock. And, generally, since you have no basis in the shares received, the entire amount received on the sale will be a taxable gain. If the transaction qualifies as a tax-free reorganization under Sec. 368(a)(1) (that's the most common situation), then your holding period starts when you first held an equity interest as a policy holder.
Exercising Incentive Stock Options
If you’re looking to exercise your incentive stock options - but lack the funds to complete the purchase - consider a stock swap. Employer plans often permit employees to pay for ISO stock with your existing portfolio. The stock swap leverages the appreciation in your existing shares and defers any tax liability on the swap. The tax deferral is accomplished by simply reducing the cost basis of the ISO shares acquired. Also, if the option price is lower than the fair market value of the stock, the swap pyramids a small number of shares into a much larger amount. Keep in mind, this transaction, like any ISO acquisition may trigger alternative minimum tax.
