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Welcome to the August 2011 issue of the Brighton Bulletin
We survived a rather tumultuous month as markets attempted to navigate global politics. As the month ended, it appeared we had some resolution to the hottest topic of the month - the U.S. debt ceiling. The following article encapsulates the pertinent questions and answers regarding the potential resolution.
By Daniel Gross | Contrary Indicator - 8/1/2011
Daniel Gross is economics editor at Yahoo! Finance
At long last, a deal on raising the debt ceiling and cutting spending has been reached. The agreement, which the White House dubbed "a Win for the Economy and Budget Discipline," includes: a $2.1 trillion increase in the debt ceiling and 10-year discretionary spending caps generating nearly $1 trillion in deficit reduction (balanced between defense and non-defense spending) over ten years. What's more, a super Congressional committee will come up with a package of $1.5 trillion more in cuts and/or revenue enhancements that's guaranteed an up-or-down vote by December. And if Congress can't agree to a package, automatic cuts will commence in 2013, split 50/50 between domestic and defense spending (exempting entitlement programs like Social Security and Medicare).
Should it pass, the deal will have far-reaching consequences. The conventional wisdom on the politics of the deal have already hardened: good for the GOP and especially its Tea Party base; bad for President Obama, who gave in to repeated threats; bad for Congressional Democrats, who were marginalized; a slight gain for the U.S., which finally affirmed it would live up to its financial obligations. Much of this conventional wisdom is likely to prove wrong in time. And the impact is likely to be larger in the coming months on the markets, the economy, consumers and taxpayers than on politics.
Is this deal good for investors? It sure seems to be a plus for global stock markets, as Asian stock markets and U.S. stock futures rose after the deal was announced. It's difficult to see why, though. The U.S. stock market isn't a barometer on the U.S. economy any more. The typical member of the S&P 500 already gets about half of its revenues (and almost all its growth) from overseas. It's a truism that equity markets hate uncertainty. And the quick positive reaction is the latest example of the risk-on/risk-off trade. When bad things happen, or when investors think bad things are going to happen, they sell stocks. When anxiety fades, they buy stocks. That's what is happening now.
But when there are crises over government debt, doesn't the real action take place in the bond markets? Yes, it does. And the action in the U.S. bond markets has been odd in recent weeks. As the U.S. careened toward a debt crisis, people and institutions around the world continued to buy U.S. government bonds, pushing interest rates down further. In fact, last Friday, the 10-year bond closed at 2.8 percent. Investors never really believed that the U.S. would not pay its debt. They did believe, correctly, that large budget cuts would slow growth in an economy whose rate of growth is already slowing. And that tends to push interest rates down. So bonds may fall as investors embrace risk again. But over the long term, this deal in and of itself, is likely to act as downward pressure on rates.
Isn't slower growth a potential negative factor for stocks? Exactly. While the deal takes uncertainty over debt payments off the table, it does contribute to other types of uncertainty for stocks in general, and for certain classes of stocks. For example, the deal calls for real cuts in defense spending (with the prospect of much more), which would be negative for the large defense contracting/aerospace complex. And as a general rule, actions that reduce domestic demand (as across the board budget cuts would) are a negative for companies that derive a disproportionate share of their revenues from the U.S.
If this is resolved, can we get back to worrying about the ongoing crisis in Europe? Yes. As the U.S. flailed toward an agreement, Europe has continued to grapple - or fail to grapple - with its own sovereign debt crisis. Spain is paying high interest rates to borrow. There's no path toward a resolution of Greece's severe fiscal problems. And don't look now, but Cyprus, the island nation whose banks are heavily exposed to Greece and that just suffered a huge power plant explosion, could be the next problem spot.
How will this deal affect growth? Poorly. Government spending is demand. If you don't believe it, try asking Wal-Mart or any food retailer what would happen to sales if food stamp payments were to be disrupted. As we've noted many times, government, at all levels, has already been throttling back employment for many months. The private sector is driving growth and will increasingly have to do so on its own. Cuts in discretionary spending, even if they are backloaded and spread over ten years, will mean less money for scholarships, for education, for health care, transportation and infrastructure - all vital parts of the economy.
How will this affect consumers? There was great concern that a debt crisis would cause interest rates to spike and ignite inflation. That prospect now seems unlikely. In fact, interest rates remain extraordinarily low. On net, for those with jobs and decent credit scores who want to borrow, the deal is likely to be a plus.
And America's long-suffering taxpayers, who pay the salaries of the politicians who brought us to the brink of default? How do they come out?
That remains to be seen. The big concern among many was that this crisis would result in significant tax increases. All the big discussions -- the Simpson-Bowles Commission, the Gang of Six in the Senate, the potential Grand Bargain between President Obama and House Speaker John Boehner -- included revenue enhancements, the elimination of loopholes, the termination of tax credits. In other words, tax increases on some people. And at time when income tax rates and overall tax receipts as a percentage of GDP are as low as they've been in recent history, the prospect of making a huge dent in the deficit through spending cuts alone seemed politically unviable. And yet, thanks to a combination of Republican intransigence, moderate wishy-washiness, and Democratic lameness, the deal included no revenue enhancements. People worried about higher taxes have dodged a bullet, for now.
So taxes will never go up? Remember, I just said "for now." As always, the devil is in the details. As the White House noted in its fact sheet, tax cuts are always just over the horizon. President Obama couldn't get Republican agreement to raise taxes on the wealthy, but he may not have to. Current law calls for the Bush-era tax cuts on income and investments to expire at the end of 2012. All that has to happen for taxes to rise is for President Obama and Congress *not* to agree on how and whether to extend them. And as this whole artificial crisis has shown, Washington as it is currently configured has a great capacity for not agreeing.
This potential resolution is good but global economic and political leaders must still work hard to return the global economy to higher and more stable long-term growth. There is always more work to be done!
John P. Middleton, CFA, CAIA
Brighton Financial Planning
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Borrowing from Your 401(k)
With the current financial situation, you may be tempted to tap your 401(k). But before you decide to take a plan loan, be sure you understand the financial impact. It's not as simple as you think.
The basics of borrowing
A 401(k) plan will usually let you borrow as much as 50% of your vested account balance, up to $50,000. (Plans aren't required to let you borrow, and may impose various restrictions, so check with your plan administrator.) You pay the loan back, with interest, from your paycheck. Most plan loans carry a favorable interest rate, usually prime plus one or two percentage points. Generally, you have up to five years to repay your loan, or longer if you use the loan to purchase your principal residence.
The opportunity cost
When you take a loan from your 401(k) plan, the funds you borrow are removed from your plan account until you repay the loan. While removed from your account, the money isn't continuing to grow tax deferred within the plan. So the economics of a plan loan depend in part on how much those borrowed funds would have earned if they were still inside the plan, compared to the amount of interest you're paying yourself. This is known as the opportunity cost of a plan loan, because you may miss out on the opportunity for more tax-deferred investment earnings.
Can you continue to contribute to the plan?
If you take a loan, will you be able to afford to pay it back and continue to contribute to the plan at the same time? If not, borrowing may be a very bad idea in the long run, especially if you'll wind up losing any employer matching contributions.
What if your employment terminates?
If you terminate employment, your plan will typically provide that your loan is immediately payable. If you can't repay the loan, the outstanding balance will be treated as a taxable distribution to you (reduced by any after-tax contributions you've made). And if you're not yet 59½, a 10% early distribution penalty may also apply to the taxable portion of your distribution.
However, if you borrow from a Roth 401(k) account and you don't repay the loan, there will be no income tax consequences if your distribution is "qualified" (that is, your account satisfies a five-year holding period requirement, and you're either 59½ or disabled). Even if your distribution isn't qualified, only the earnings you've borrowed from your account, not your own contributions, will be subject to tax and potential penalty.
When should you consider a loan?
Plan loans may make sense in certain cases (for example, to pay off high-interest credit card debt, or to purchase a home). But make sure you compare the cost of borrowing from your plan with other financing options, including loans from banks, credit unions, friends, and family. To do an adequate comparison, you should consider:
- Interest rates with each alternative
- Whether the interest will be tax deductible (for example, interest paid on home equity loans is usually deductible, but interest on plan loans usually isn't)
- The amount of investment earnings you may miss out on by removing funds from your 401(k) plan
Copyright 2006-2011 Broadridge Investor Communication Solutions, Inc. All rights reserved
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Federal Unemployment Tax Act (FUTA) surtax expired June 30, 2011
Business owners received a gift from the federal government recently: the temporary 0.2% Federal Unemployment Tax Act (FUTA) surtax expired June 30, 2011.
The surtax was part of the 6.2% unemployment tax rate that employers pay to the IRS on the first $7,000 of wages paid annually to each employee. The 6.2% gross rate represented a permanent tax rate of 6% and a temporary surtax of 0.2%.
Note: There is a 5.4% credit available for employers who pay their state unemployment taxes in a timely manner. This change yielded a net tax rate of 0.8% before the expiration of the 0.2% surtax, and now yields a net rate of 0.6%.
The 0.2% surtax was passed in 1976, and has been extended eight times. The surtax was most recently extended through 2010 and the first six months of 2011 by the Worker, Homeownership, and Business Assistance Act of 2009. In his budget, President Obama proposed making the surtax permanent. Congress, however, has allowed the provision to lapse, and it is not clear whether the surtax will be reinstated, retroactively or otherwise. Retroactive action could place employers in a difficult situation when calculating future required unemployment tax deposits (employers with an annual unemployment tax obligation exceeding $500 must deposit their taxes quarterly). The IRS has informally indicated that it will waive penalties on employers that calculate the tax at a 6% rate if Congress does retroactively reinstate the surtax.
The expiration of the surtax is expected to reduce federal unemployment taxes by $1.4 billion per year, or about $14 per employee per year. | |
Copyright 2006-2011 Broadridge Investor Communication Solutions, Inc. All rights reserved |
Early Retirement Considerations
What is it?
As you near retirement age, you may be offered early retirement by your employer who may refer to the offer as a golden handshake or a golden parachute. The offer usually consists of severance payments and post-retirement medical coverage combined with already existing retirement benefits. While many early retirement offers appear attractive, it is important for you to review an offer carefully to ensure that it is indeed offering a golden opportunity.
Early retirement, IRAs, and retirement plans
If you accept an early retirement offer, make sure that you're aware of all possible implications. If you're going to be using the money from your IRA or retirement plan to fund your retirement, remember that in addition to income taxes, there may be penalties if you withdraw the funds prematurely. Or, there may be a limit on what you can withdraw without penalties.
Traditional defined benefit pension plans may be adversely impacted by retiring early. One reason is that the accrual of benefits under such a plan is generally the greatest during the final few years before retirement, which in most cases are the highest earning years. As a result, early retirement can result in considerably lower monthly retirement benefits from such a plan. On the other hand, employers sometimes sweeten early retirement packages, increasing your pension benefit beyond what you've earned by adding years to your age, length of service, or both, or by subsidizing your early retirement benefit or your qualified joint and survivor annuity option. These types of pension sweeteners are key features to look for in your employer's offer--especially if a reduced pension won't give you enough income.
Also, taxable distributions from employer-sponsored retirement plans are generally subject to the 10 percent premature distribution tax if made before age 59½. However, there are a number of exceptions to this rule. One important exception is for distributions made from 401(k)s and other qualified plans as a result of separation from service in the year you reach age 55 or later (age 50 for qualified public safety employees participating in governmental defined benefit plans). Another important exception from the 10 percent premature distribution tax is for substantially equal periodic payments (sometimes called SEPPs). Substantially equal periodic payments are amounts you receive from your IRA or qualified retirement plan not less frequently than annually for your life (or life expectancy) or the joint lives (or joint life expectancy) of you and your beneficiary. There is no minimum age requirement for this exception, but distributions from qualified retirement plans are eligible for the exception only after you separate from service.
Finally, if you're retiring early and plan on using your IRAs or retirement plans as a source of income, you should understand that you run the risk of depleting--or at least considerably reducing--such accounts. The reason is obvious: You have more years of retirement to fund than if you had waited to retire. Depending on how early you actually retire, you may find that you're going through those retirement accounts more quickly than you had originally intended. This could pose a problem both for your later retirement years when you need income the most, and for your plans to leave your beneficiaries with an inheritance. However, the possibility of depleting your retirement accounts may not be a major concern if you have no beneficiaries or if you have other income sources (such as job earnings or other investment assets) that will carry you through a lengthy retirement. But, you should at least be aware of the risk.
Severance payments
Severance payments are usually based on your salary and the number of years you have worked for the company. Severance payments can be distributed in either a lump sum or over the course of a number of years. A severance payment can provide you with a stream of income during your transition from one job to another. However, if you take another job soon after receiving the severance payment, it can put you into a higher tax bracket for the year.
Example(s): Ben has 30 years of service with the local utility company, and grosses $675 per week before taxes. When Ben reaches age 57, his employer offers him an early retirement package. The package includes a severance payment based on two weeks' salary for each year that Ben has worked for the company ($1,350 x 30 = $40,500).
Post-retirement medical coverage
Because of the high cost of medical care, you might find it hard to turn down an early retirement package that includes post-retirement medical coverage. These packages usually provide medical coverage until you reach age 65 and become eligible to receive Medicare.
Such post-retirement medical coverage is an important component to look for in an early retirement package. Without it, you will be forced to look into alternative sources of health insurance, such as the Consolidated Omnibus Budget Reconciliation Act (COBRA) or private health insurance to carry you through to the Medicare eligibility age. Unfortunately, COBRA provides only temporary benefits (up to a maximum of 18 or, in some cases, 36 months). And private health insurance premiums can be quite expensive, depending on such factors as your age and present health status. So, think carefully before accepting a package that doesn't include post-retirement medical coverage, especially if you have several years or more until you reach Medicare eligibility age.
However, don't make the mistake of assuming that all your health insurance needs will be met when you turn 65 and become covered under Medicare. The coverage provided by Medicare has gaps and often needs to be supplemented with a private individual policy and/or your own funds ("self-insure"). An early retirement package that provides medical coverage (full or reduced) well past the age of 65 (as some do) can be much more attractive than a package with coverage that ends at 65. You can sometimes negotiate for this extended medical coverage in an effort to sweeten the pot for yourself. Employers who feel strongly about having their offer accepted may very well agree to these terms.
Bridging
Another type of early retirement offer is the Social Security "bridge payment." Here, the employer provides you with temporary benefits to bridge the gap between early retirement and the beginning of your scheduled Social Security benefits. The temporary benefits are usually equivalent to the amount you will receive from Social Security at age 62.
Example(s): Ben, age 57, works for a local utility company. The company offers Ben an early retirement package that includes five years of temporary benefits. These temporary benefits are equivalent to the amount that Ben will receive from Social Security at age 62. The benefits serve as a "bridge" between the period of Ben's early retirement at age 57 and the period when he becomes eligible for early Social Security benefits at age 62.
Social Security benefits
In general
If you accept an early retirement offer, you should also consider applying for early Social Security retirement benefits. The Social Security Administration gives anyone who is eligible to receive Social Security benefits at the normal retirement age the option to receive his or her benefits beginning at age 62.
Tip: If you accept an early retirement offer from your employer, you are not required to receive early Social Security retirement benefits.
Copyright 2006-2011 Broadridge Investor Communication Solutions, Inc. All rights reserved | |
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Why does the U.S. Debt Ceiling matter?
Please check out the link below for a video on the U.S. Debt Ceiling
THE U.S. DEBT CEILING
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Disclosures
The views expressed herein represent the opinion(s) of Brighton Financial Professionals as of the date of this posting, and may change at any time without prior notification. |
The links to other websites provides a path to other entities' websites that are not affiliate with BFP. BFP is not responsible for the content or information practices by websites linked to Brighton. Often we provide links to other sites solely as pointers to information or topics that may be of interest to users of our website. Such links do not imply BFP's endorsement of any information or material on any other site and BFP disclaims all liability with regard to your access to and use of such linked websites.
Brighton Financial Planning utilizes information from third party sources. Brighton Financial Planning is not responsible for verifying the accuracy of any information sourced by such third-party information providers.
Any mention of products or securities does not constitute a recommendation, investment, legal or tax advice, as BFP is not holding itself out as providing such advice.
Any mention of securities does not represent an offer or a solicitation of an offer to buy or sell such securities, particularly in those jurisdictions where such solicitation or offer is prohibited by law.
As with all investments, there are inherent risks to investing that may not be able to be mitigate through responsible investing. You should consult with a qualified investment adviser prior to investing. |
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