8 Wealth Issues: Taxes

The Tax Effect; Taking Taxes Into Account When Saving & Investing

In this month’s 8 Wealth Issues blog, I thought it important to focus on the inter-play between taxes and investing. Many people have been surprised by their tax bill for 2013—and with taxes certainly not decreasing, let’s look at how investment strategies can lead to potential higher “pay as you go” capital gains and interest income taxes.

How many of us save and invest with an eye on tax implications? Not that many of us, according to a recent survey from Russell Investments (the global asset manager overseeing the Russell 2000). In the opening quarter of 2014, Russell polled financial services professionals and asked them how many of their clients had inquired about tax-sensitive investment strategies. Just 35% of the polled financial professionals reported clients wanting information about them, and just 18% said their clients proactively wanted to discuss the matter.1

Good financial professionals aren’t shy about bringing this up, of course. In the Russell survey, 75% of respondents said that they made tax-managed investments available to their clients.1

When is the ideal time to address tax matters? The end of a year can prompt many investors to think about tax issues. Investors’ biggest concerns may include any sudden changes to tax law. Congress often saves such changes for the eleventh hour. Sometimes they present opportunities, other times unwelcome surprises.

The problem is that your time frame can be pretty short once December rolls around. You can’t always pull off that year-end charitable donation, gift of appreciated securities, or extra retirement plan contribution; sometimes your financial situation or sheer logistics get in the way. It is better to think about these things in July or January, or simply year-round.

While thinking about the tax implications of your investments year-round may seem like a chore, it may save you some money. Your financial services professional can help you stay aware of the tax ramifications of certain financial moves.

Think about taxes as you contribute to your retirement accounts. Do you contribute to a qualified retirement plan at work? In doing so, you can lower your taxable income (and your yearly tax liability). Why? Those contributions are made with pre-tax dollars. In 2014, you can contribute up to $17,500 to a 401(k) or 403(b) account or the federal government’s Thrift Savings Plan. If you are 50 or older this year, you can put in up to $23,000 into these accounts. The same is true for most 457 plans. This can reduce your taxable income and lower your tax bill.2,4

Think about where you want to live when you retire. Certain states have high personal income tax rates affecting wealthy households, and others don’t levy state income tax at all. If you are wealthy and want to retire in a state with higher rates, a Roth IRA may start to look pretty good versus a traditional IRA. Withdrawals from a Roth IRA aren’t taxed (assuming the Roth IRA owner follows IRS rules), because contributions to a Roth are made with after-tax dollars. Distributions you take from a traditional IRA in retirement will be taxed.2

What capital gains tax rate will you face on a particular investment? In 2013, the long-term capital gains tax rate became 20% for high earners, up from 15%. On top of that, the Affordable Care Act Surtax of 3.8% effectively took the long-term capital gains tax rate to 23.8% for investors earning more than $200,000.2,3

Greater capital gains taxes can actually be levied in some cases. Take the case of real estate depreciation. If you sell real property that you have depreciated, part of your gain will be taxed at 25%. The long-term capital gains tax rate for collectibles is 28%. Own any qualified small business stock? If you have owned it for over five years, you typically can exclude 50% of any gains from income, but the other 50% will be taxed at 28%. Lastly, if you sell an asset you’ve held for less than a year, the money you realize from that sale will be taxed at the short-term rate (i.e., regular income), which could be as high as 39.6%.2,3

Are you deducting all you can? The mortgage interest deduction is not always noticed by taxpayers. If a home loan exceeds $1.1 million, interest above that amount may not qualify for a deduction. Itemizing can be a pain, but may bring you more tax savings than you anticipate.2

A tax-sensitive investing approach is always specific to the individual. Therefore, any strategy needs to start with an in-depth discussion with your tax or financial professional. With growing concern over government entitlement programs and rising debt, taxes are likely on the rise. It is important to incorporate strategies to help mitigate taxation of your investments into your financial plan.

Citations.

1 - russell.com/us/newsroom/press-releases/2014/russell-survey-advisors-say-tax-aware-investment-strategies-not-top-of-mind.page? [4/29/14]
2 - foxbusiness.com/personal-finance/2014/08/07/investments-and-tax-planning-go-hand-in-hand/ [8/7/14]
3 - bankrate.com/finance/money-guides/capital-gains-tax-rates-1.aspx [3/27/14]
4 - irs.gov/uac/IRS-Announces-2014-Pension-Plan-Limitations;-Taxpayers-May-Contribute-up-to-$17,500-to-their-401%28k%29-plans-in-2014 [11/4/13] 

MarketingPro, Inc.contributed to this blog post.  This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.

Perspectives from Above the Noise – Week of August 25, 2014

The minutes of the Fed’s July 29-30 meeting were released on last Wednesday, and they note that “some participants” were comfortable calling for a relatively prompt reduction of policy accommodation. But only hawkish Philadelphia Fed President Charles Plosser officially dissented to the July policy statement maintaining language that accommodation would remain in place for a "considerable time” after the Fed completes its asset purchases in October.  The minutes did not include a discussion of the timing of the first interest-rate increase, although Fed officials have previously forecast it would occur sometime in mid-2015. The minutes also make clear that the majority of committee members, presumably including Janet Yellen, believe more evidence of declining labor market slack is needed before any move to increase rates.

But it was European Central Bank (ECB) President Mario Draghi who stole the show at the Federal Reserve’s annual Jackson Hole conference on Friday to wrap up the week. Draghi emphasized that the ECB has several unconventional monetary tools at the ready to combat a struggling Eurozone economy. By stating that inflation expectations continued to fall, Draghi appeared to move closer to a European asset purchase program.

For the week, the S&P 500 added +1.71%, the Dow Jones Industrial Average gained 2.03%, and the MSCI EAFE (developed international) increased +0.77%.

Here are the 3 stories this week that rose above the noise:

A New Reason to Question the Official Unemployment Rate
A new academic paper suggests that the official unemployment rate reported each month by the Labor Department appears to have become less accurate over the last two decades due in large part to the survey response rate which has dropped from 96 percent in the 1980s to 89 percent today. And, with those less willing to respond likely having a more unfavorable job experience, the extent of economic pain in the country today is likely understated. 

Technology has contributed to the lower response rates with the advent of caller ID and the decline of landlines. Additionally, more people today potentially view the survey as an intrusion into their privacy than in the past. The paper also highlights that individuals respond differently during the early and later stages of their unemployment.

The Shifting Economics of Global Manufacturing
The Boston Consulting Group recently published a research report that analyzed the cost competitiveness of the 25 largest exporting economies. According to their analysis, several countries that have historically provided low-cost manufactured goods—including Russia, Brazil and China—have experienced a decline in global competitiveness over the previous decade. 

On the other hand, the U.S. and Mexico saw their cost competiveness improve more than all of the other 23 largest exporting countries over the last decade. Several factors including wages, exchange rates and rising energy costs are changing the manufacturing landscape. This could ultimately result inmanufacturing becoming more regionalized as low-cost manufacturing nations exist in all regions of the world.
 

Surging U.S. Stocks Echo Dot-Com Rally with Cheaper P/E
With the S&P 500 Index crossing above 2,000 for the first time to new all-time highs, many investors question whether the current markets are reaching extended levels, similar to the dot-com days. One big difference is valuation – today’s S&P 500 today trades at a price earnings (P/E) ratio of 19, or 19 times the annual earnings of the S&P 500, compared with a P/E of 30 back in 2000. 

Another significant difference is breadth. Today’s current bull market has seen widespread gains across sectors, whereas the technology bubble was concentrated in computer shares. However, some investors worry that the recent spate of technology IPOs is a concern that mirrors the dot-com era when companies that were yet to make a profit began offering shares for the first time. Option traders have displayed their concern as seen by the current put/call ratio which is currently near the highest levels since October 2008.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of August 18, 2014

A solid week for stocks ended with some volatility, as reports of renewed tension in the Russia/Ukraine conflict temporarily sent stocks lower and Treasury yields plunged to new 52-week lows. Domestic data continues to provide conflicting signals about economic momentum. Labor data remains relatively encouraging, with Tuesday’s release of the monthly Job Openings and Labor Turnover Survey (JOLTS) from the Bureau of Labor Statistics indicating job openings in June rose to the highest level since February 2001. Fed Chair Janet Yellen has referenced the JOLTS data when discussing indicators she is tracking and the report helps provide context to the monthly nonfarm payrolls figures.

Globally, the Eurozone failed to generate any economic growth in the second quarter. Italy has already slipped back into recession and even the Eurozone’s core economies, such as Germany and France, are showing their own signs of considerable weakness with second-quarter GDP in Germany indicating the economy contracted by 0.2%.

For the week, the S&P 500 added +1.22%, the Dow Jones Industrial Average gained 0.66%, and the MSCI EAFE (developed international) increased +1.71%.

Here are the 3 stories this week that rose above the noise:

Consumer Prices in U.S. Rise at Slowest Pace in Five Months

The Consumer Price Index (CPI) edged up 0.1% in July, its slowest pace in five months as widespread declines in energy prices helped offset a larger-than-expected uptick in food prices. Stripping out the volatile food and fuel components, the so-called core measure also climbed 0.1%, less than the 0.2% consensus economist forecast. For the trailing 12 months ending in July, overall and core CPI are up 2% and 1.9%, respectively. Inflation metrics continue to remain below the Federal Reserve’s targets which should allow policy makers to keep interest rates low throughout the remainder of the year.

Today’s report indicates there are about two unemployed people for each job opening, which is down from 3-to-1 ratio one year ago but not quite back to the pre-recession level of 1.8. Although the headline job numbers remain very encouraging, the article mentions many other employment measures that remain below pre-recession levels, suggesting the Fed is unlikely to bring forward expectations for its first interest-rate hike unless these indicators of slack in the labor market rapidly improve.

Home Builder Confidence Surges despite Slower Sales

Home Builder confidence rose to a seven-month high this month according to the National Association of Home Builders. A number of factors, including tighter lending conditions and housing affordability, have kept a lid on the housing recovery for the first half of 2014. However, there is increased optimism that the housing recovery will accelerate in future months because of improvements in the labor market, historically low mortgage rates, and pent-up demand.

U.S. housing starts and building permits rebounded strongly in July, which hopefully leads to strong momentum in housing activity for the remainder of the year.

Yellen Channeling Slick as Surrealistic Economy Shows ’67 Claims

Many indicators of the health of the U.S. labor market have recently shown the most strength since before the recession of 2008. However, economists remain divided on the true underlying health of the job market. A recent Bloomberg article summarizes this broad range of opinions, with initial jobless claims as a percentage of the population at the lowest level since 1967 viewed as a sign of strength by many economists.

Meanwhile, others point to the remaining number of long-term unemployed as an indication of continued slack. This debate has important implications for Fed policy and interest rates. For now, Fed Chair Yellen remains in the camp that believes considerable slack remains in the labor market and the risk of wage inflation sharply rising is minimal.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of August 11, 2014

Geopolitical risks contributed to sharp market declines during the middle of last week after reports that Russia was again amassing troops along the border of Ukraine, and the U.S. was preparing airstrikes against ISIS in northern Iraq. Concerns over Russia’s military activities were exacerbated by an announcement that Russia would ban imported foods from Ukraine, the U.S., and the European Union in retaliation for previously announced sanctions imposed by the west. By Friday, however, reports that Russia was ending its military exercises and looking to de-escalate the conflict in Ukraine sent U.S. equities soaring into the weekend.

Domestic economic data during the week was generally strong, which may have contributed to Friday’s rally once the imminent risk associated with the Russia/Ukraine conflict subsided. Labor market indicators continue to show some momentum, with weekly unemployment claims declining to 289,000 and the four-week average of claims falling to the lowest level since February of 2006.

For the week, the S&P 500 added +0.33%, the Dow Jones Industrial Average gained 0.37%, and the MSCI EAFE (developed international) declined -2.44%.

Here are the 3 stories this week that rose above the noise:

Job Openings in U.S. Increase to Highest Level Since 2001

The monthly Job Openings and Labor Turnover Survey (JOLTS), which is helpful in providing context to the monthly non-farm payrolls report, was released this morning and indicated job openings in June rose to the highest level since 2001. As detailed in this summary of the report from Bloomberg, Fed Chair Janet Yellen has mentioned JOLTS data as indicators she is tracking to determine the overall health of the labor market.

Today’s report indicates there are about two unemployed people for each job opening, which is down from 3-to-1 ratio one year ago but not quite back to the prerecession level of 1.8. Although the headline job numbers remain very encouraging, the article mentions many other employment measures that remain below pre-recession levels, suggesting the Fed is unlikely to bring forward expectations for its first interest-rate hike unless these indicators of slack in the labor market rapidly improve.

Federal Reserve Tapering Part II: Emerging-Market Local Debt Performance

A recent WisdomTree blog supports the bullish case (faster economic growth, improving fundamental balances and increases in investor sentiment) for investing in emerging-market local debt. Since tapering began in December 2013, currencies have been a modest detractor from overall returns for the asset class, however WisdomTree does not believe that this currency underperformance will continue in perpetuity.

Many of the countries that were the largest underperformers leading up to the implementation of tapering have reverted to be among the strongest outperformers this year as higher income and the fall in yields from their peaks has helped many of these countries recoup losses experienced in 2013. Further, they state “while volatility is undeniably higher for emerging-market fixed income, 5-year U.S. Treasury yields of 1.75% provide limited options for attractive returns if rates rise by even a modest amount.”

Fed Survey: Mortgage Standards Ease for First Time since Housing Bust

A July Federal Reserve survey showed that lenders continued to ease standards on loans to businesses amid a “broad-based pickup” in loan demand. Nearly one in four banks in the U.S. said they had eased mortgage-lending standards for borrowers with strong credit during the second quarter, the largest such movement by lenders since the housing bust hit nearly eight years ago.

Demand for prime mortgages rebounded to its highest level in a year, according to the Fed survey, offering a hopeful sign for housing markets that have stumbled during the first half of the year. Despite the uptick in the number of banks that signaled easier standards on mortgage lending, most banks said standards remain tighter than normal.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

Perspectives from Above the Noise – Week of August 4, 2014

Last week was busy for domestic economic data and an eventful week for global markets, with equities experiencing their sharpest decline in several months. The initial estimate of second-quarter GDP released Wednesday showed the U.S. economy grew at a 4% annual rate, sharply ahead of consensus expectations for 3% growth. First-quarter GDP growth was also revised up to a -2.1% rate from the prior estimate of -2.9%, resulting in 1% average annualized growth in the first half of the year.

Wednesday’s policy statement from the Fed provided no new details regarding its tightening schedule and little mention of inflationary pressures other than noting that low inflation is becoming less of a concern having “moved somewhat close to the Committee’s long-run objective.”

After the S&P 500 fell 2% on Thursday (its 3rd largest drop of 2014), and turned U.S. equities negative for the month of July, a potential crisis in Portugal's banking system helped push European stocks into the red for 2014. Stronger U.S. and European Union sanctions against Russia this week added additional uncertainty to European equities.

For the week, the S&P 500 fell -2.69%, the Dow Jones Industrial Average dropped -2.69%, and the MSCI EAFE (developed international) declined -2.13%.

Here are the 3 stories this week that rose above the noise:

Millennials Are Dragging Down Home Ownership

Last quarter, home ownership fell to its lowest level in 19 years and it may fall even lower because of the millennial generation’s low rate of household formation. Soaring student loan debt, weak employment prospects, and rising home prices are among the several factors that have kept the millennial generation’s home ownership rate low relative to prior generations.

The combination of these factors is having a strong ripple effect on both the housing market and the economy. Homeownership should eventually improve for millennials, but at a later age compared to previous generations.

Eurozone Nears Deflation

A recent article from The Guardian details the latest inflation data from the Eurozone. The flash estimate of inflation for the 12 months ended in July showed just a 0.4 percent rise, an almost five-year low. The persistently low and falling inflation figures are renewing concerns that Europe is close to slipping into Japanese-style deflation, and some countries such as Spain are already reporting falling prices.

The deflation fears are prompting speculation that the European Central Bank (ECB) will soon announce its own version of quantitative easing, but in the author’s view this is unlikely in 2014. The data from Europe and the ECB’s response will be important factors for global markets over the remainder of 2014.

Correction Coming for the Shanghai Stock Rally?

Since the middle of June, China’s Shanghai's Composite Index has risen by 9.7 percent (close to an eight-month high) compared with the S&P 500 which has traded flat. However, despite the recent rally many analysts are skeptical that this outperformance will continue. Much of the concern centers on slowing GDP as well as questions around the efficacy of government reform initiatives.

One recent economic data point, the services purchasing manager's index (PMI), fell to 50 in July, its slowest pace in nearly nine years. However, bearish sentiment is not universal, as Erwin Sanft, the head of China & Hong Kong equity research at Standard Chartered, expects the Shanghai Composite will outperform global markets for the rest of the year, mainly due to a pickup in money supply.

Articles chosen and summarized by the First Allied Asset Management, Inc. investment management team.

International investing involves additional risk, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets. Investing in companies involved in one specified sector may be more risky and volatile than an investment with greater diversification.