March 12, 2012Vol 5, Issue 3 
DFW Financial Planning

Jean Keener, CFPIt's a little early, but I'm going to go ahead and wish you a Happy Spring!  I hope you're enjoying our unseasonably warm weather and early start to the season.


Investment markets have continued their strong beginning to the year.  Year to date, large U.S. company stocks (S&P 500 Index) are now up more than 9%.  International markets are mostly holding onto their gains from the first months of the year with developed markets company stocks (MSCI EAFE index) still up nearly 10%, and emerging markets stocks (MSCI EM index) up nearly 16%.  On the bond side, both the U.S. and global aggregate bond market indices are up about 2/3 of a percent for the year. 


In this month's newsletter, we have information on what to do when you inherit an IRA, how to pay down debt without hurting your credit, and more.   I'm especially enthusiastic about my next workshop at the Keller library because it's a new topic suggested by a recent attendee -- how to make the most of your employer retirement plan.  Please see below for more specifics and plan to join us if it's of interest to you.  As always, feel free to e-mail me at [email protected] with requests for newsletter topics you'd like to see covered or to discuss concerns or questions on anything in the financial world.  Thanks, and live well!

In This Issue
Inheriting an IRA: What you Need to Know
Paying down debt: how to avoid hurting your credit score
Stock Market Valuation Debate
Election Year Tax Terminology
Free Keller Workshop: Making the Most of Your 401k
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Inheriting an IRA: What You Need to Know

Inheriting an IRAThe rules governing inherited IRAs can be complicated. Here are the major issues to consider.

Transferring inherited IRA assets


If you inherit a traditional or Roth IRA from someone who isn't your spouse, your options are fairly limited. You can't roll the proceeds over to your own IRA, treat the IRA as your own, or make any additional contributions to the IRA. What you can do is transfer the assets to a different IRA provider, as long as the registration of the account continues to reflect that the IRA is an inherited IRA, and not your own.


If you inherit an IRA from your spouse, however, you have additional options. You can roll over all or part of the IRA proceeds to your own IRA (or to a qualified plan). If you roll the proceeds over to your own IRA (an existing one, or one you establish just for this purpose) the rules that apply to IRA owners, not beneficiaries, will apply from that point on. If you're the sole beneficiary, you can also generally treat the inherited IRA as your own by simply retitling the IRA in your name.


But you aren't required to assume ownership of an IRA you inherit from your spouse. You can, instead, continue to maintain the inherited IRA as a beneficiary. You might want to do this if, for example, you inherit a traditional IRA and you'll need to use the funds before you turn 59� (distributions from inherited IRAs aren't subject to the 10% early distribution penalty but distributions from IRAs you own are subject to the penalty, unless an exception applies).


A spouse beneficiary can also convert all or part of an inherited traditional IRA to a Roth IRA (you'll generally have to pay income tax on the amount converted). This option is not available to nonspouse beneficiaries.


Required minimum distributions


Nonspouse beneficiary: Federal law requires that you begin taking distributions (called required minimum distributions, or RMDs) from an inherited IRA (traditional or Roth) after the IRA owner dies.


Spouse beneficiary: If you roll the inherited IRA over to your own IRA, or treat it as your own, then the RMD rules apply to you the same way they apply to any IRA owner--you'll generally need to begin taking RMDs from a traditional IRA after you turn 70�; no lifetime RMDs are required at all from a Roth IRA. If you don't roll the IRA assets over or treat the IRA as your own, then the same rules described above for nonspouse beneficiaries generally apply to you, except that you can defer receiving distributions until your spouse would have turned 70�.


Note:   In both cases, if the IRA owner died after turning 70� and didn't take a required distribution for the year of death, you'll need to make sure to take that distribution by December 31 of the year of death in order to avoid a 50% penalty.


Taxation of inherited Roth IRAs


Qualified distributions to a beneficiary from an inherited Roth IRA are free from federal income taxes. To be qualified, the distribution must be made after a five-year holding period. The five-year period begins on January 1 of the year the deceased IRA owner first established any Roth IRA, and ends after five full calendar years. If you take a distribution from an inherited Roth IRA before this five-year period ends, any earnings you receive will be nonqualified, and will be subject to federal income taxes (earnings generally come out last).


For example, you inherit a Roth IRA from your father on January 1, 2013. Your father established this IRA in June 2012. Your father also established a separate Roth IRA, which you did not inherit, in December 2008. Distributions you receive from the Roth IRA will be qualified, and tax free, because the five-year holding period (January 1, 2008, to December 31, 2012) has been satisfied.


If you're a spouse beneficiary, and you roll the inherited Roth IRA over to your own Roth IRA or treat the inherited IRA as your own, then you'll be eligible to take tax-free distributions only after you reach age 59�, become disabled, or have qualifying first-time homebuyer expenses. You'll also need to satisfy the five-year holding period, but a special rule applies. The five-year period for all of your Roth IRAs--including the inherited IRA--will be deemed to have started on January 1 of the year either you or your spouse first established any Roth IRA.


It's especially important to speak with a financial professional if ...

  • You're sharing the inherited IRA with other beneficiaries. This can impact when and how you must begin receiving RMDs from the IRA.
  • You don't want or need the IRA funds. You may be able to disclaim the IRA and have it pass to another beneficiary. This must be done in accordance with strict IRA rules.
  • Any estate taxes were paid that are attributable to the inherited IRA. You may be entitled to an income tax deduction equal to the estate taxes paid.
Avoid Hurting Your Credit Score When Paying Down Debt

Smart Debt ReductionMost lenders use an automated credit scoring system to help determine your creditworthiness. The higher your credit score, the more creditworthy you appear.


One of the factors built into credit scoring systems is your credit card balance-to-limit ratio (the amount of debt you owe compared to your total credit limit for all cards). Lenders like to see ratios indicating you're indebted for balances approximating no more than 30% of your total limit. Generally, if your balance-to-limit ratio is higher than that, then reducing your debt will improve your credit score. But how you reduce your debt can make a difference.


You may have heard that you should consolidate several credit card balances on one card with a low interest rate, then close the paid (usually higher-rate) accounts. Doing so, the claim goes, not only minimizes the risk that you'll "dig the hole" of indebtedness even deeper, it also reduces your exposure to identity theft through the fraudulent use of inactive open lines of credit.

But if you do this, you could: 

  • Lower your total credit limit available without lowering your total debt, thus raising your balance-to-limit ratio--and potentially lowering your credit score in the process
  • Make your credit history appear shorter by canceling accounts you have had open longest--and a shorter credit history also may lower your credit score


While it makes sense to transfer balances subject to high interest rates to accounts with lower rates (and then concentrate on paying down what you owe), consider waiting to close the paid accounts. Keeping them open may actually improve your credit score by lowering your balance-to-limit ratio (since you'll have the same amount of debt, but a higher total credit limit) while maintaining the longevity of your credit history.

Stock Market Valuation Debate

market valuatio debateThere's an important--if somewhat geeky--debate going on in investment circles about the true valuation of the stock market--specifically the S&P 500 index of large companies, and similar indices followed by the Wilshire and Russell organizations. The heart of the debate is surprisingly simple: are today's investors paying more than the historical average price for a dollar of corporate earnings, or less?


Why is this important? Because whenever you're paying higher than average prices, it's possible that your expected future return will be below average. If less, then you have a better hope of getting above-average returns. There are, of course, no guarantees, but in general professional investors prefer bargains to overpaying for a share of stock.


Why is there a debate at all? Don't we know the current market prices, and the earnings on those companies? The problem is that the current price/earnings ratio that you hear quoted can be calculated in a variety of ways. One is to take the aggregate price of the stocks in the S&P 500 index and divide them by last year's overall earnings. As an alternative, you could use today's stock prices and the earnings that analysts are projecting for the next 12 months. Or you could use "operating" earnings, which take out unusual writedowns. Finally, since corporate earnings tend to jump around, you could perform the same calculation using the average earnings of the past ten years, which gives you what the industry calls the PE10 ratio.


In a recent industry presentation, Dr. Jeremy Siegel, author of "Stocks for the Long Run," calculated the S&P 500 PE at 12.3, based on 2011 earnings per share of $97. The PE is a bit lower if you use forecasted earnings of $105. Siegel says that the S&P 500's PE ratio has averaged around 15 for the past 50 years. Therefore, you could argue that the index is selling at roughly a 20% discount. Then he blurred the picture a bit by noting that in years when interest rates are low, the average PE has been closer to 19. That would suggest that stocks are closer to 50% undervalued.


However, if you use the PE10 ratio, you get a different picture, and this is the heart of the debate. Siegel calculated the PE10 at 21.2--which would suggest that stocks are 30% overvalued.


What's right? Siegel told the professional audience that the PE10 might not be an accurate valuation measure when one or more of the ten earnings years it averages together is unusual in some way. Perhaps the most unusual year in recent memory is 2008, when earnings on the S&P index fell 80% from the previous year. Siegel says that when you look closely at the data, three companies were primarily responsible for the overall earnings drop: Bank of America, Citibank and AIG, the epicenter of the financial crisis and subsequent bailout, wrote off a total of $450 billion. If you make a few simple adjustments, and account for the effect of companies buying back their own shares, Siegel reports a doubly-adjusted PE10 of 15.


Which suggests that the market today is fairly valued.


This is enough to make anyone's head spin, but it also helps you maintain a bit of skepticism whenever you see a talking head on TV telling you, with calm assurance, that the stock market is over- or undervalued. At the end of his presentation, Siegel pointed out that many stocks that pay dividends are paying out more, per year, than 10-year Treasury bonds. This may be the only valuation measure that matters: an astute investor can designate a part of the portfolio to collect dividends that beat government bonds, and if stock prices go up you get a bonus. 

Election Year Tax Talk: Deciphering the Terminology

Election Year Tax TermsThis year's election chatter is sure to include a healthy dose of tax talk. Here are definitions and a bit of background on 5 of the most commonly discussed terms. 


The "Bush tax cuts" 


A number of major tax changes were enacted in 2001 and 2003, including lower federal income tax rates, special maximum rates for long-term capital gains and qualifying dividends, and increased standard deduction amounts. While most of the provisions were extended by legislation passed in late 2010, these tax provisions are still commonly referred to as the "Bush tax cuts" or the "Bush-era tax cuts." With these provisions set to expire again at year-end, much of the tax debate will center around whether to extend the provisions again--particularly whether to extend the provisions for all taxpayers, or only to those who make less than a certain amount (e.g., individuals with incomes under $200,000, married couples with incomes under $250,000). 


Alternative minimum tax (AMT) 


The AMT is essentially a separate federal income tax system with its own rates and rules. If you're subject to the AMT, you have to calculate your taxes twice--once under the regular tax system and again under the AMT system. Bush tax cuts expanding AMT exemption amounts were extended only through the end of 2011. This increases the pressure to address AMT this year--failure to extend AMT relief would result in an estimated 30 million or more individuals being affected by the AMT in 2012. (Source: U.S. Congressional Research Service. The Alternative Minimum Tax for Individuals (RL30149; August 23, 2011), by Steven Maguire.) 


The "Buffett rule" 


On August 14, 2011, the New York Times published an opinion piece written by Warren Buffett, chairman and CEO of Berkshire Hathaway (Warren E. Buffett, "Stop Coddling the Super-Rich," New York Times, August 14, 2011). In the piece, Buffett essentially argued that he and his "mega-rich friends" weren't paying their fair share, noting that the rate at which he paid taxes (total tax as a percentage of taxable income) was lower than the other 20 people in his office. As Buffett points out, this is partially attributable to the fact that the ultra-wealthy typically receive a high proportion of their income from long-term capital gains and qualified dividends, which are currently taxed at rates that are generally lower than the rates that apply to wages and other ordinary income. President Obama has articulated the "Buffett rule" as the tenet that people making more than $1 million annually should not pay a smaller share of their income in taxes than middle-class families pay. (Source:


Value added tax (VAT)


A value added tax (VAT) is a consumption tax, like a sales tax. What distinguishes the VAT from a straight national sales tax is the fact that the VAT is assessed and collected at every point in the chain of production, on the "value added" at that step in the chain. Although a VAT can be implemented in different ways, here's one general approach: With a 10% VAT in effect, a supplier who sells $100 of materials to a manufacturer would pay $10 in VAT; the manufacturer who, in turn, sells a finished product to a retailer for $150 pays $5 in VAT ($150 sale price - $100 cost of materials, multiplied by the VAT rate); the retailer sells the product for $200, and pays an additional $5 in VAT ($200 sale price - $150 cost, multiplied by the VAT rate). Total VAT paid on the product is $20, or 10% of the final sale price. 


Flat tax


Simple in concept, a flat tax would apply a single tax rate to individual income, or individual wages only (i.e., excluding investment income). A separate single rate might apply to businesses. Depending on the specific proposal, a base exemption may be allowed to exclude low-income families from the tax, and certain deductions may be allowed in determining the amount subject to tax.

Upcoming Personal Finance Workshops
Keller Public Library Free Financial Education Seminars

This month's workshop is a new topic in the personal finance series -- it will cover how to get the most out of your employer retirement plan.  We'll look at how to select the best funds based on the information provided, getting the most of employer matching, how to diversify, and how to coordinate your 401k plan with your other investments.



The next workshop is Tuesday, March 20 at 6:30 pm.  Registration is encouraged for planning purposes to [email protected]



Workshops are usually on the 3rd Tuesday of the month at 6:30 pm.  Please mark your calendars and tell your friends about ones that interest you.     

  • April: Couples and Money: Harmonize your Finances and your Relationship - jointly presented with Marriage and Family Therapist, Maryellen Dabal
  • May: Structuring your Retirement Income (designed for those in retirement or within 5 years)
  • June: Social Security Planning for baby boomers


The Keller Public Library is located at 640 Johnson Road.


I hope you found this newsletter informative.  KFP offers a free, no-obligation initial consultation to start the financial planning process for new clients.  To learn more or schedule a time, call 817-993-0401 or e-mail [email protected].
Jean Keener, CFP, CRPC, CFDS
Keener Financial Planning

Keener Financial Planning provides as-needed financial planning and investment services on an hourly and flat-fee basis.

All newsletter content except where otherwise credited Copyright �2012, Keener Financial Planning, LLC.