Should I convert my Traditional IRA to a Roth IRA?

Tax Diversification

Picture Courtesy of U.S. News

This is a common question we face as financial planners. Popularity doesn’t necessarily make something a good financial decision for your personal situation. There are a few important factors to consider when determining if a Roth Conversion is for you.
1) What is your current tax bracket?
A big consideration of whether or not to convert your Traditional IRA to a Roth Ira should be dependent on your current tax circumstances. With clients having widely varying effective tax rates, it’s important to know your current tax rate and your potential tax rate should you decide to convert your IRA. All conversion proceeds from your IRA will be considered taxable dollars. When you contributed to your 401k, IRA or other qualified plan, you were given a tax deduction for your contribution. So, you never paid taxes on the money you invested. Now as you move funds out of your traditional IRA you will begin to pay taxes. If you have a tax rate of 15%, then maybe the conversion could be beneficial to you. If you have a tax rate of 25%, then maybe it won’t be. The best advice is for you to gain an understanding of the tax consequences pertinent to you.
2) What is your future tax bracket going to be?
This is much more difficult to determine. However, most people will find themselves in a lower tax bracket when they retire than their current tax bracket. This is the primary reason a person would consider not converting the Traditional IRA to a Roth IRA. If you have to pay more money today than you would pay in the future, why would you want to pay the extra tax? In the words of one of my clients, “Who said, yes I’d like to pay more taxes please? Nobody Ever!” Her words, not mine.
3) What is the growth difference between my traditional IRA and potential Roth IRA after taxes?
Now that we know your current tax bracket and your potential future tax bracket, we can begin to make calculations that will determine the potential value of both decisions for the future and for today. Here is a sample scenario for you:
Kate (65) has $300,000 in her Traditional IRA which she rolled over from her former employer’s 401K plan. Kate lives a fairly simple life, has no debt and she anticipates being able to live off her social security and supplement income from her IRA as she needs it. We’ll assume she needs $20,000 of extra income every year from her IRA. This extra income is to ensure Kate can do the special things she like to do like traveling, attending trade shows, and spoiling her grandchildren.
In our current scenario, Kate is mostly in the 15% tax bracket. She is earning a return of about 6.5% on her investments and has already begun withdrawing the $20,000 from her IRA.
The results:
If Kate were to convert her entire IRA today, then she would find herself in the 33% tax bracket paying almost $90,000 in taxes to the IRS. Since Kate is only withdrawing $20,000 per year from her Traditional IRA, it probably doesn’t make sense for Kate to convert this IRA at this time. The future compounding growth of her Traditional IRA is worth more than taking the tax hit today for the potential tax savings tomorrow. Maybe the conversion makes sense if Kate had 30 years to allow her money to grow, but for today’s illustration, she’s better off leaving the money in her account.
Is the Roth Conversion a financial strategy you’ve been considering? If so, let’s talk.

Jose Cuevas
Wisdom Investments
jose@wisdominvestments.com

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I’m Trying, But My Spouse Isn’t

 

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Picture Courtesy of P.C. Vey Readers Digest

 

I can’t tell you how many times I’ve heard a variation of the phrases “I’m trying, but he isn’t”,  “I’m sticking to my budget but she’s not”, and “I’m ready to retire, but he’s not”.  There are many things my spouse and I don’t agree on. As an example, I am a risk-taker and my wife is not.  My wife doesn’t like to look at the budget but I do. She is perfectly fine shopping cheap and I’m not.  The list can go on and on.  But, one thing we do as we navigate through some of life’s most difficult challenges, is talk and come up with a plan.  Marital unity is absolutely critical when making important financial decisions and also dealing with the day to day minutiae of budgeting, shopping & other daily spending decisions.

 

For many of us, we weren’t modeled how to manage money well as children. Worse yet, we weren’t modeled how to talk about money with our significant others. Some of us may even have searing images implanted in our brains of our parents screaming and fighting in the kitchen over money.  So, it’s no surprise that many of us don’t know how to talk with our spouses about money.  For that matter, some of us don’t really know how to talk to our spouses at all. If this is true, how do we begin to have dialogue with our husbands and wives that will be beneficial for the whole family.

It’s no secret to some of you reading this article that I’m going to quote the Bible. And, for some of you who don’t know that I do that…YES!!! The Bible!. 🙂 I think the first thing I will share is that if your spouse “doesn’t want to listen to you”, you should probably consider what you’ve been saying and how you’ve been saying it. Sometimes your spouse just feels too much pressure from you when it comes to accomplishing the goals you’ve set forth. Maybe you come across as a dictator.  Maybe you’re an Ephesians 22-24 guy and you love these verses:

“Wives, submit yourselves to your own husbands as you do to the Lord. 23 For the husband is the head of the wife as Christ is the head of the church, his body, of which he is the Savior. 24 Now as the church submits to Christ, so also wives should submit to their husbands in everything”. 

But, if you’re forgetting Ephesians 5:25 that goes along with these verses, then maybe you should consider re-reading this passage.

25 Husbands, love your wives, just as Christ loved the church and gave himself up for her. 

Last time I checked, Christ’s love is the most absolutely sacrificial kind of love ever demonstrated to mankind. Are you showing your wife this kind of love when “she’s not submitting” to what you say? Just a thought…

Now, maybe your the wife saying “My husband just won’t lead. He should be taking charge of this.”  I find no scripture verse that says your husband has to be perfect at everything and take the lead on every single matter that comes up in your house. As a partner in your marriage you are capable to take the lead in many areas and help manage the finances.  I say finances as that is what I’m writing about today.  What’s the point of all this?  Using the title of a new tv drama…., THIS IS US.  This is how we sometimes relate to each other. This is how we sometimes speak to each other. When it comes to goal planning, I’m quite certain God’s intention wasn’t for one person to handle everything and the other person to be completely in the dark or complacent about matters.

So, what can you do? What can you say? The answer is I have absolutely no idea! I don’t know you. I don’t know your financial situation and I don’t know exactly why “you’re trying, but your spouse isn’t”. But, I could recommend a few ideas that you might find helpful. First, we must speak kindly to each other and not blame one another when things don’t go right. When it comes to making good money decisions and being on the same page as your spouse, it’s important to have clear and peace filled dialogue.  Ask your spouse questions like “what’s important to you right now about our finances?”, “where do you see us in 5 years and how do we get there together?”, “how does this purchase help us with our goal of funding education for our children?” “what do you think about talking to a financial planner?”. I had to throw that one in….;-) Kidding aside, you must find a way to communicate with your spouse about money in a way he or she understands. A couple of resources I could recommend… Find a “Financial Peace University” class in your area. Find a good counselor who can help you process some of the issues you need to address with marriage and finances.  I’m partial to good Christian counseling and I can recommend a few good counselors if you’d like.  Go have a talk with your Pastor.  Read Randy Alcorn’s book “Money, Possessions, and Eternity”.  There is so much you can do.

Most importantly, you aren’t alone. I’m writing about this topic today because it’s been a recurring theme in my practice lately.  I’ve sat with couples as tears have overflowed because one spouse has plan A while the other spouse is focused on plan B. I’ve sat and heard stories of marriages on the brink of divorce because the two couldn’t agree on a financial direction. It doesn’t have to be that way. There are things you can do to make your marriage and your financial situation better!  If you need help, please don’t hesitate to reach out and ask.  Please share with us a story of how your marriage and finances have improved! We’d love to hear it.

Jose Cuevas
Vice President
Wisdom Investments
847-290-0753
jose@wisdominvestments.com
www.wisdominvestments.com

10 Books to Help You Make Smart Choices With Your Money

 

money book

Books are valuable, expecially books about money.

 

When you think about successful money management, what comes to mind? Where do you receive good information? How do you know what books to read to help guide you down the right path?  Most people don’t just obtain wealth out of the blue sky.  If you were to ask most successful people how they obtained their money, they would tell you they worked hard, had some luck/blessing, and they read voraciously. When I first entered the financial planning business, my mentors assigned me a list of books to read to help me understand more about money and how it works.  Since that time 15 years ago, I’ve come across many great financial books and I’d like to share ten books to help you make smart choices with your money.  I’m sure 15 years from now, I’ll have a different list of books that every successful investor should read, but for now, please enjoy.

Disclosure: While I find these books helpful, I don’t agree with every concept illustrated in every book. On your quest for knowledge, you need to determine what works for you and your family.  These book recommendations are not considered to be a solicitation of advice.

If you need help making smart choices with your money, please email me at jose@wisdominvestments.com

Visit our website at www.wisdominvestments.com

 

10) Rich Dad Poor Dad By Robert Kiyosaki:

This was the first book I read when I entered the financial planning industry. Robert Kiyosaki describes how he had two dads. He takes the time to describe each father’s financial and life philosophies and how each dad is deemed with the names Rich Dad and Poor Dad.  The book does a great job of detailing financial ideas and concepts that allow Rich Dad to be rich and Poor Dad to be poor.  The book would be great for the person who is paying their bills first and feels like there is nothing left to save at the end of the paycheck.

RichDadPoorDad

9) The 7 habits of highly effective people By Stephen Covey:

While this book isn’t necessarily about money, I believe this book gives a great blueprint of how to achieve success in your life.  The 7 habits help you to obtain structure to achieve the goals you are looking to achieve in life.  I have found that while the 7 habits aren’t necessarily financial principles, they can be used in almost any financial situation.

7Habits

8) The Millionaire Next Door By Thomas Payne

The Millionaire Next Door is one of the best books I’ve read that smacks American Consumerism right in the face.  This book details for you what a normal Millionaire looks like, what she might drive, and how he might live.  With today’s images of what it looks like to be a millionaire, this book is a breath of fresh air describing how most millionaires are made and live.

millionairre next door

7) The Investment Answer By Daniel Goldie & Gordon Murray

The Investment Answer helps give every investor an idea of what they should be looking for when they invest money. The book addresses concerns such as how to understand the markets, how to pick a financial advisor, & how to make great financial choices. We love to give this book to potential clients.  Even if a client doesn’t choose to work with us, this book will help them make the best decision possible about whom they should hire.

The Investment Answer

6) How to Think Like Benjamin Graham and Invest Like Warren Buffet By Lawrence Cunningham

This again is one of my personal favorites. This book showcases some of the great ideas of Benjamin Graham and Warren Buffet.  If you don’t have time to sit down and read the 725 page book Security Analysis by Benjamin Graham, then this book is for you. This book challenges some of the stereotypical types of investing methods and dives into value investing.  We again like this book because it compliments some of our own investment management philosophies.

How to think like benjamin graham and invest like warren buffet

“Wisdom Investments has been helping individuals and businesses make smart choices with their money since 1999”.

5) Values-Based Financial Planning By Bill Bachrach

This book describes the need for financial planning according to your unique values. Investing according to your unique values allows you to determine what is really most important to you when planning for your future. We all have values that are important to us. Why would you not consider those values when you are planning for your most important goals in life?

valuesbasedfinancialplanning

4) Total Money Makeover By Dave Ramsey

Dave’s advice focuses on living a life free of debt and investing money for the long-term. Many people focus on utilizing debt to achieve the things they want in life.  Dave’s radical concepts of approaching all situations without debt can help the individual who has become too reliant on credit cards and bank loans.

totalmoneymakeover

3) The Financial Wisdom of Ebenezer Scrooge By Ted Klontz, Rick Kahler, & Brad Klontz

The Five principles to transform your relationship with money” will help you understand the love affair you’ve had with money and how to change it.  Some people tend to focus on attaining more of this and more of that. This book suggests that if we are constantly seeking for more when it comes to money, we may need to start doing some things differently.

financial wisdom of ebeneezer scrooge

2) The Treasure Principle By Randy Alcorn

Where is your treasure? What kind of riches are you seeking? We’ve all heard it is better to give than to receive. The Treasure Principle seeks to show you how to experience joy through the giving of your money.  Maybe many of us haven’t thought about giving as being a gift, but some people have an inborn desire to give of their resources. How much better could your life be if you decided to “Discover The Secret of Joyful Giving”.

the treasure principle

1) Master Your Money By Ron Blue

Ron’s book shows individuals how to manage their money with a Biblical perspective in mind. Many of us who believe in the teachings of Christ already know the Bible has a great blueprint for money management. Master Your Money looks to describe those concepts in detail while giving real world applications and scenarios to help you understand how you can Master Your Money.

Master Your Money

 

I hope you make time to read some of these great books about money.

“My people are dying because of lack of knowledge”.    

If you need help making smart choices with your money, please give us a call.

Jose Cuevas
Vice President
Wisdom Investments
http://www.wisdominvestments.com
847-290-0753

Retirement Plans for Small Businesses

retirement-plan

Retirement Plans for Small Businesses

As a business owner, you should carefully consider the advantages of establishing an employer-sponsored retirement plan. Generally, you’re allowed a deduction for contributions you make to an employer-sponsored retirement plan. In return, however, you’re required to include certain employees in the plan, and to give a portion of the contributions you make to those participating employees. Nevertheless, a retirement plan can provide you with a tax-advantaged method to save funds for your own retirement, while providing your employees with a powerful and appreciated benefit.

Types of plans

There are several types of retirement plans to choose from, and each type of plan has advantages and disadvantages. This discussion covers the most popular plans. You should also know that the law may permit you to have more than one retirement plan, and with sophisticated planning, a combination of plans might best suit your business’s needs.

Profit-sharing plans

Profit-sharing plans are among the most popular employer-sponsored retirement plans. These straightforward plans allow you, as an employer, to make a contribution that is spread among the plan participants. You are not required to make an annual contribution in any given year. However, contributions must be made on a regular basis. With a profit-sharing plan, a separate account is established for each plan participant, and contributions are allocated to each participant based on the plan’s formula (this formula can be amended from time to time). As with all retirement plans, the contributions must be prudently invested. Each participant’s account must also be credited with his or her share of investment income (or loss). For 2017, no individual is allowed to receive contributions for his or her account that exceed the lesser of 100% of his or her earnings for that year or $54,000 ($53,000 in 2016). Your total deductible contributions to a profit-sharing plan may not exceed 25% of the total compensation of all the plan participants in that year. So, if there were four plan participants each earning $50,000, your total deductible contribution to the plan could not exceed $50,000 ($50,000 x 4 = $200,000; $200,000 x 25% = $50,000). When calculating your deductible contribution, you can only count compensation up to $270,000 in 2017 ($265,000 in 2016) for any individual employee.

401(k) plans

A type of deferred compensation plan, and now the most popular type of plan by far, the 401(k) plan allows contributions to be funded by the participants themselves, rather than by the employer. Employees elect to forgo a portion of their salary and have it put in the plan instead. These plans can be expensive to administer, but the employer’s contribution cost is generally very small (employers often offer to match employee deferrals as an incentive for employees to participate). Thus, in the long run, 401(k) plans tend to be relatively inexpensive for the employer.
The requirements for 401(k) plans are complicated, and several tests must be met for the plan to remain in force. For example, the higher-paid employees’ deferral percentage cannot be disproportionate to the rank-and-file’s percentage of compensation deferred. However, you don’t have to perform discrimination testing if you adopt a “safe harbor” 401(k) plan. With a safe harbor 401(k) plan, you generally have to either match your employees’ contributions (100% of employee deferrals up to 3% of compensation, and 50% of deferrals between 3% and 5% of compensation), or make a fixed contribution of 3% of compensation for all eligible employees, regardless of whether they contribute to the plan. Your contributions must be fully vested immediately. You can also avoid discrimination testing by adopting a qualified automatic contribution arrangement, or QACA. Under a QACA, an employee who fails to make an affirmative deferral election is automatically enrolled in the plan. An employee’s automatic contribution must be at least 3% for the first two calendar years of participation and then increase 1% each year until it reaches 6%. You can require an automatic contribution of as much as 10%. Employees can change their contribution rate, or stop contributing, at any time (and get a refund of their automatic contributions if they elect out within 90 days). As with safe harbor plans, you’re required to make an employer contribution: either 3% of pay to each eligible employee, or a matching contribution, but the match is a little different–dollar for dollar up to 1% of pay, and 50% on additional contributions up to 6% of pay. You can also require two years of service before your contributions vest (compared to immediate vesting in a safe harbor plan). Another way to avoid discrimination testing is by adopting a SIMPLE 401(k) plan. These plans are similar to SIMPLE IRAs (see below), but can also allow loans and Roth contributions. Because they’re still qualified plans (and therefore more complicated than SIMPLE IRAs), and allow less deferrals than traditional 401(k)s, SIMPLE 401(k)s haven’t become a popular option. If you don’t have any employees (or your spouse is your only employee) an “individual” or “solo” 401(k) plan may be especially attractive. Because you have no employees, you won’t need to perform discrimination testing, and your plan will be exempt from the requirements of the Employee Retirement Income Security Act of 1974 (ERISA). You can make pretax contributions of up to $18,000 in 2017, plus an additional $6,000 of pre-tax catch-up contributions if you’re age 50 or older (unchanged from 2016). You can also make profit-sharing contributions; however, total annual additions to your account in 2017 can’t exceed $54,000 (plus any age-50 catch-up contributions). A 401(k) plan can let employees designate all or part of their elective deferrals as Roth 401(k) contributions. Roth 401(k) contributions are made on an after-tax basis, just like Roth IRA contributions. Unlike pretax contributions to a 401(k) plan, there’s no up-front tax benefit-contributions are deducted from pay and transferred to the plan after taxes are calculated. Because taxes have already been paid on these amounts, a distribution of Roth 401(k) contributions is always free from federal income tax. And all earnings on Roth 401(k) contributions are free from federal income tax if received in a “qualified distribution.” 401(k) plans are generally established as part of a profit-sharing plan.

Money purchase pension plans

Money purchase pension plans are similar to profit-sharing plans, but employers are required to make an annual contribution. Participants receive their respective share according to the plan document’s formula.
As with profit-sharing plans, money purchase pension plans cap individual contributions at 100% of earnings or $54,000 annually (in 2017; $53,000 in 2016), while employers are allowed to make deductible contributions up to 25% of the total compensation of all plan participants. (To go back to the previous example, the total deductible contribution would again be $50,000: ($50,000 x 4) x 25% = $50,000.) Like profit-sharing plans, money purchase pension plans are relatively straightforward and inexpensive to maintain. However, they are less popular than profit-sharing or 401(k) plans because of the annual contribution requirement.

Defined benefit plans

By far the most sophisticated type of retirement plan, a defined benefit program sets out a formula that defines how much each participant will receive annually after retirement if he or she works until retirement age. This is generally stated as a percentage of pay, and can be as much as 100% of final average pay at retirement. An actuary certifies how much will be required each year to fund the projected retirement payments for all employees. The employer then must make the contribution based on the actuarial determination. In 2017, the maximum annual retirement benefit an individual may receive is $215,000 ($210,000 in 2016) or 100% of final average pay at retirement. Unlike defined contribution plans, there is no limit on the contribution. The employer’s total contribution is based on the projected benefits. Therefore, defined benefit plans potentially offer the largest contribution deduction and the highest retirement benefits to business owners.

SIMPLE IRA retirement plans

Actually a sophisticated type of individual retirement account (IRA), the SIMPLE (Savings Incentive Match Plan for Employees) IRA plan allows employees to defer up to $12,500 for 2017 (same limit as 2016) of annual compensation by contributing it to an IRA. In addition, employees age 50 and over may make an extra “catch-up” contribution of $3,000 for 2017 (same limit as 2016). Employers are required to match deferrals, up to 3% of the contributing employee’s wages (or make a fixed contribution of 2% to the accounts of all participating employees whether or not they defer to the SIMPLE plan). SIMPLE plans work much like 401(k) plans, but do not have all the testing requirements. So, they’re cheaper to maintain. There are several drawbacks, however. First, all contributions are immediately vested, meaning any money contributed by the employer immediately belongs to the employee (employer contributions are usually “earned” over a period of years in other retirement plans). Second, the amount of contributions the highly paid employees (usually the owners) can receive is severely limited compared to other plans. Finally, the employer cannot maintain any other retirement plans. SIMPLE plans cannot be utilized by employers with more than 100 employees. Other plans The above sections are not exhaustive, but represent the most popular plans in use today. Current tax laws give retirement plan professionals new and creative ways to write plan formulas and combine different types of plans, in order to maximize contributions and benefits for higher paid employees.

Finding a plan that’s right for you

If you are considering a retirement plan for your business, ask us to help you determine what works best for you and your business needs. The rules regarding employer-sponsored retirement plans are very complex and easy to misinterpret. In addition, even after you’ve decided on a specific type of plan, you will often have a number of options in terms of how the plan is designed and operated. These options can have a significant and direct impact on the number of employees that have to be covered, the amount of contributions that have to be made, and the way those contributions are allocated (for example, the amount that is allocated to you, as an owner).

Jose Cuevas
Vice President
Wisdom Investments
jose@wisdominvestments.com
http://www.wisdominvestments.com

 

Professionally Managed Mutual Funds or Index Funds? What if that’s not the question?

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CONVENTIONAL INVESTING & INDEX INVESTING VS. EVIDENCE BASED INVESTING
Should you utilize actively managed funds (conventional investing) or use index funds (passive strategy)? This has been a debate for quite some time. For decades, conventional investing is all we knew. Indexes on the other hand weren’t supposed to be the investment. Indexes were designed to be the measurement for conventional investing. After the indexes were created, it was discovered that most of the professionally managed funds couldn’t beat the index. What we’ve learned through years of history and study is that only about 15% of the actively managed mutual funds available have beaten the indexes. So, as an investor if you knew you had an 85% chance of making less money than your designated index, what would you choose? Yes, 15% of those mutual funds did beat the index. The problem is you had no idea before hand what mutual fund was going to beat the index and how much risk they were going to take to do that.

From this explanation, you might say “Great. Thanks. I’ll go buy that index fund now”. And, you might be ok if you did that on your own. Chances are you would be better off if you bought the index fund and held onto it than if you had invested conventionally. However index funds have their own set of problems. These are problems you don’t hear advertised due to the massive amount of inflows into index funds right now. Plus, you have billionaire investor extraordinaire Warren Buffet telling you to buy index funds. A downside of utilizing index funds are the Hidden Costs. One of the hidden costs of owning an index fund is something called “Reconstitution day”. An index fund must follow an index or else it’s not an index. If a stock is no longer part of an index, what happens? The stock is moved out of the index. What happens when a stock is performing well and has increased in size? It moves into the index. The problem is this all happens on the same day. Everyone knows it’s coming. So, what happens? The stocks being sold decrease further in value and the stocks added to the index increase in value. By the time this happens, you have lost money on both ends.

There’s a third approach. This third approach was designed by noble prize winners from the University of Chicago and is implemented through Dimensional Fund Advisors. Unfortunately, the average investor can’t walk into Dimensional funds and use this approach. But, we will gladly help you incorporate this strategy! We believe this third approach is a better option. Actually, it’s been proven to be a better investment. Rather than trying to predict what’s going to happen in the market, we embrace the market pricing. We say, “You know, most of those guys on Wall Street are pretty smart and they have way more information than we do”. So deciding that most of the analysts have it right, we move to consider expected return. We know that not all stocks are going to have the same return. The same is true in the real estate market. The value of a Beverly Hills  home is going to grow faster than homes in Cleveland. Even though you know the Beverly Hills home is going to appreciate faster, you might still want that Cleveland home because it’s also going to appreciate. We may not want to own every home in Cleveland, but we know we want some of them. Translate this to stocks and you have an idea of why we think certain stocks should and shouldn’t be in our portfolio. As fund managers at DFA pick these stocks they start to discern, “is the stock too expensive?”, “is it right for the portfolio?”, “can we get the stock cheaper tomorrow”?  Then by eliminating stocks that are too expensive or have appreciated too much, a basket of stocks is created for clients to invest. In addition, it’s been proven over time that value stocks outperform growth stocks with less risk. Knowing this, portfolios are created with a tilt towards Value. A quick note: 82% of Dimensional Funds have beaten their index.

This is just one of the many reasons you should choose to work with our firm. We’d love to introduce you to evidence-based investing. Email me today to learn more about how this approach can help you with your goals.

Best,

Jose Cuevas
Vice President
Wisdom Investments
jose@wisdominvestments.com
847-290-0753