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Quarterly Newsletter
July 2010
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Greetings! Welcome to another addition of our quarterly newsletter. In this edition, we will introduce you to some interesting ideas on international living including links to sites that will help support your future travel plans. We also have a solid tip on a little known retirement plan distribution that could save a small fortune in income taxes. In addition, we have included another take on investing called "The Naked Truth About Capital Markets".I would like to encourage you to give us any feedback on issues you would like to see in this forum and feel free to forward this newsletter along to your family, friends and colleagues. I thank you for your continued patronage to Dowley & Company. |
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International Living
While many Americans are struggling
to find ways to make an elusive retirement affordable, a growing number are
making their limited funds go further by moving themselves to foreign locales in Central and South America, Europe, Australia
and New Zealand. These ex-patriots are finding economic value
and cultural diversity in foreign lands. Considering that luxury life styles are available at a fraction of the
cost of what it takes to live in the US, it is no surprise that many are
pulling up roots to find a life without compromises.
One nice feature of life south of
the equator is that it is summer there while it is winter here in the
northeast. In most Central American
countries, as well as the north shore
of Columbia, being close
to the equator gives you spring/summer conditions year round. Given the massive diversity of geography in
the region should make finding the right micro climate a breeze for any
traveler. Beaches are plentiful.
Mountains are in abundance as are urban settings. Many countries have discovered the virtues of
eco tourism and the value of attracting and catering to an international
clientele.
While many
ex-pats have made these countries their home, still more have opted to make
them temporary refuges during North America's
hostile winters. While some have committed
themselves to purchasing a permanent home, others are avail themselves of
rentals that allow them to explore. While real estate is cheap in many places and growth is fueled by
developing economies, ownership in a foreign country can be tricky and make
your travel experiences a headache if you need to handle maintenance items,
local zoning and financing. Given the seemingly
endless amounts of rental possibilities, one might want to think twice about
taking on the burdens of ownership.
While
online exploration and research of overseas living abounds, nothing beats a
visit in person to "test drive" the experience. Many considerations go into a decision to make such a commitment.
- Find someone you know who has been there and
spent time there (for business or pleasure).
- Is it easy to get around or is your own car a necessity?
- Can you get by not speaking the local
language?
- Are currency transactions easy?
- Can you get internet access to conduct your
financial affairs and keep in touch with friends and family back home?
- Will your cell phone work there?
- Can you get health care affordably and easily
and find prescriptions if you need them?
While the
research may seem a bit daunting, the possibilities are endless and the exploration
can be exciting. Checkout a few websites
below to help you get started.
www.InternationalLiving.com
www.vrbo.com
www.homeexchange.com
There
is one other word of caution. When
traveling to any foreign country, safety is always a concern. While checking the political climate of your
destinations is a must, for many countries, their image has been tarnished by
pop culture and media for political purposes. Lingering stereotypes abound as biased reporting proliferates
misinformation. If you have ever talked
to anyone who has spent time in Cuba
or Columbia, it
will surprise you how different life is compared to popular conceptions.
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Net Unrealized Appreciation
Qualified Retirement Plan participants, who hold employer
stock as a plan investment, can take advantage of special tax rules related to
what is known as Net Unrealized Appreciation (NUA for short). NUA, when it is distributed from a plan, has
special tax considerations that make it an important tax management tool and
can result in significant tax savings for stock holders and their ultimate plan
beneficiaries. Simply stated, NUA is the
increase in value of employer stock while it is held in a qualified retirement
plan. The most common types of plans
that offer employer stock as an investment are 401K, Profit Sharing Plans,
Stock Bonus Plans and Employee Stock Ownership Plans or ESOP's. Net Unrealized Appreciation is determined at
the point when the stock is paid out of the plan as part of a lump sum
distribution. A lump sum distribution is
a payment from a qualified retirement plan of a participants vested balance
within one taxable year. The lump sum
must be paid out because of either the employee's death, attainment of age 59 ½
years of age, separation from service or disability. If the employer stock is part of a non lump
sum payment, then only NUA that is attributable to the participant's non
deductable employee contributions is excludable from gross income.
NUA is calculated by taking the original cost basis of
the employer stock and subtracting the amount from the current value. The remainder is the NUA. The cost basis is the amount equal to the
value of the employer stock at the time it was acquired by the participant
through the purchase within the plan or when it was contributed to the plan by
the employer. The current value of this
stock is the amount the stockholder would receive if the stock were sold. When the employer stock is distributed the
individual pays ordinary income taxes on the cost basis alone. The NUA is eligible for special tax treatment
under IRS code sections 402 (e) (4) (A & B). According to these tax rules, NUA that is attributable
to the employer stock that is paid out from a qualified retirement plan as part
of a lump sum distribution may be excluded from gross income when
distributed. However it does not escape
taxation completely. When the
distributed stock is eventually sold outside of the plan, NUA is taxed at the
long term capital gains tax rates which in most cases will be lower than the
individual's income tax rate. Currently
long term care capital gains rate are capped at 15% while the range of personal
income tax rates can be as high as 35%.
For individuals who hold sizeable qualified plan assets including
employer stock, NUA can provide a substantial tax benefit if they fall in the
upper tax brackets.
If a plan participant dies after receiving a distribution
of employer stock, the NUA is considered income in respect of a decedent. The plan participant's beneficiaries will be
responsible for capital gains tax on the NUA portion when the stock is
eventually sold. The beneficiaries will
not be taxed on the increase of the value of the stock from the point of
distribution until the date of death. In
essence they receive a step up in basis of the stock of any gains during this
period (subject to a current limit of $1.3M per estate). Any gain in the stock's value following the
original owner's death will be taxable to the beneficiaries.
It is important to note that the capital gains treatment
of NUA is lost if any of the following were to occur: if the stock is sold and
the proceeds are paid out from the plan in cash, or if proceeds are paid from
the retirement plan in a non lump sum distribution. In this case only the NUA
attributable to non deductable employer contributions receive special tax
treatment. If proceeds are rolled into
an IRA then all capital gains treatment is lost.
Using this technique can save a lot of money for
retirement plan participants who have. If you think this situation applies to
someone you know you may want to have them contact us before finalizing any
distribution decisions about their retirement plans.
If you have any questions regarding Net Unrealized Appreciation, please do not hesitate to contact us 781-631-4100 or email cdowley@dowleyandco.com
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The Naked Truth About Capital Markets
Here is the naked truth: capital
markets are designed to reallocate money from dumb people to smart
people. If that weren't true, smart people wouldn't play. Smart people
don't play unless they have a probability of winning. For example, smart
people don't tend to play the lottery. (If you have ever wondered why
the PowerBall winner is always a nitwit and flat broke again in three years,
now you know.) This might be the real reason that the rich continue to
get richer. I have a high degree of conviction that if one took all of
the money in the world and split it equally among all of its inhabitants, ten
years later the people who have the money now would be likely to have the money
again, simply because they understand what it takes to be successful in
capital markets. Although I wrote the first sentence of this article for
shock value, the naked truth is actually quite comforting.
Now, when I use the word
"smart," in the context of capital markets, I'm not talking about IQ
at all. You don't have to be a university professor or have an extensive
financial background to be smart. In fact, it's even possible those
things could work against you. Rather, being smart about the capital markets
requires a very specific skill set consisting of three things.
1) Knowledge. Smart means
understanding which return factors are likely to outperform over time. If you plow
through all of the investment literature as we have, you will see that it
largely boils down to two return factors: relative strength and value. Both are
robust and work in numerous formulations. Although we use a proprietary
relative strength factor, there's no one formulation that is magic. Success is
mainly a matter of consistently exposing the portfolio to the return factor.
Pick one--or both--because they complement one another extremely well. If you
have just this small nugget of knowledge, you are miles ahead of the game.
2) Discipline. Smart means
understanding that execution is more important than knowledge. It's not
enough to have the knowledge of which return factors will likely work over
time. You need to have a systematic method of exposing the portfolio to your
chosen return factor in a disciplined fashion. You cannot waver or let your
emotions get in the way--and believe me, your fear will try to run you into the
ditch during every correction. Maintain your emotional balance. You must remain
resolute up to and including the end-of-the-world scenario. Maybe the world
will end and I will be wrong about all of this. Probably not. If you
consistently expose your investment capital to a good return factor in a
disciplined way, you are light years ahead of your competition.
3) Patience. Smart means
understanding that great patience is required. Most investors, I suppose,
would like to get rich quick. That's unlikely to happen. In a karmic kind of
way, the universe actually makes you earn your money by going through trials
and tribulations. The E-ticket ride you get in capital markets is never easy,
and often not pleasant. Both relative strength and value go in and out of favor
as return factors, sometimes slipping into eclipse for years at a time. Great
investors are enveloped with a kind of Zen- like calmness. They are neither
their profits nor their losses. You can't take giddy mental ownership of your
equity high-water mark or despair at your draw down during a correction. Stay
centered and let compounding work its magic. The journey of a thousand miles
really does begin with a single step, but don't forget that it also takes a
long, long time to walk a thousand miles!
Investors with a small kernel of
knowledge and oodles of discipline and patience are likely to see money flow
their way over time--that's how capital markets are designed to work. As you
can see, "smart" relates much more to temperament than IQ.
I would go so far as to say the temperament piece is probably the most
important. While most investors engage in dumb behaviors like jumping from
questionable method to method, adding money when they feel good about their
results, pulling money out when they are temporarily panicked, measuring
results over a short period of time, hiring and firing managers like a
revolving door, and generally running about like a chicken with its head cut
off, smart investors pursue reliable return factors with discipline and
immense patience. If you take the perspective that the market is
designed to take your money when you do something dumb, investors would be
well-advised to think about their behavior carefully before every portfolio
change.
Author: Michael Moody, Dorsey Wright Money
Management; originally published by Dorsey, Wright & Associates, May
2010 and reprinted here with permission. www.dorseywrightmm.com
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About Us
Dowley & Company is an independent Financial Advisory Firm started
in 1997 motivated by the idea of making full service financial planning
available to individuals and families.
We pride ourselves in helping independent minded clients break
through limitations and get to a place of greater affluence they might
not achieve on their own.
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