Sunday, February 14, 2016

The Federal Reserve and Other Retirement Risks

The Federal Reserve’s growing balance sheet is a major concern for professional investors. However, it should be a growing concern for main stream investors, and it should be a concern for folks looking at retirement in the near future. Why should this be a concern for individuals attempting to accumulate wealth for retirement, and seeking to use their retirement funds to enjoy the golden years? What other concerns should individuals have while planning for retirement?

Background

The Federal Reserve’s balance sheet has grown since the Great Recession of 2008. The Federal Reserve began purchasing US Government Debt instruments via programs such as Operation Twist. When the Fed purchases Government debt (Bonds), it does not purchase them directly; it purchases them via a 3rd party dealer. This purchase, in turn, increases the money supply.  The Fed creates the cash, from a computer entry, and the purchase occurs. Due to the rules of the fractional banking system, the money supply is increased once that purchase check is deposited.

Here is an example a chart here showing the growth of the Federal Reserve’s balance sheet:












Eventually, the Federal Reserve must have an exit strategy to deal with this debt from the growing balance sheet. What is the strategy? Raising interest rates? Selling off the debt? What is it?


Inflation Concerns

Recall, for readers who frequent this blog, the definition of inflation: It is the increase of the monetary stock or base.  The monetary base is increased, as the Fed continues to purchase more US Government Debt.  Inflation impacts individuals that are on fixed incomes, which are typically retirees.  As the monetary base is debased, the ability for retirees to spend dollars on goods and services alters dramatically.  This means that retirees must have the ability to have their investment dollars outpace inflation.

Analysts love to cite the CPI as a measure of inflation; however, this is not an accurate measure of inflation. Looking at various factors, such as commodity prices, is one way of looking at inflation. Food prices should be analyzed as well, with regards to looking at inflation. While food prices, as well as commodity prices have dropped considerably since 2008, they are still higher than they were 10 years ago.

Graph of Food Prices:





Graph of Commodity Prices:







Individual Savings Rate

Currently, the individual savings rate is around 5.5%, as of December 2015. Since the 1950s, the individual savings rate has shown a downward trend. This is an interesting trend.  From an economics perspective, savings is needed to expand the economy and spur economic growth.  If the savings rate is down, this could be a harbinger for things to come.  As a retiree, one must review their stocks accordingly. Should my equities include companies that are seeking to expand? Can they expand if there is a declining savings rate? If this is the trend, how should one manage their portfolio?

A graphical display showing the trend of the individual savings rate:











Taxes 

Currently, the marginal income tax rates are the lowest in decades. With the United States Government debt load reaching its zenith, and the demand of the use of Social security, Medicare, Obamacare, and the like, politicians will seek to raise tax rates.  In fact, some of the leading presidential candidates are proposing to raise taxes on the “rich”. For example, Donald Trump says the following:
“If you look at actually raise, some very wealthy are going to be raised. Some people that are getting unfair deductions are going to be raised. But overall it’s going to be a tremendous incentive to grow the economy and we’re going to take in the same or more money. And I think we’re going to have something that’s going to be spectacular.” (Nolte, 2015)
Presidential Candidate Bernie Sanders is pushing the following:

“Mr. Sanders has proposed a headline top tax rate of 52 percent, applying only to incomes over $10 million. But that’s just the federal income tax. When you combine it with other taxes that apply to income, like existing payroll taxes and new ones Mr. Sanders would impose to pay for Social Security, single-payer health care and family leave, and then add those on top of taxes levied by state governments, it would add up to a combined tax rate of over 73 percent on the highest incomes, more than 20 points higher than today. That’s in the average state — maximum rates in high-tax jurisdictions like California and New York City would be even higher.” (Barro, 2016)

One should consider that all sorts of tax increases could occur; this is to include an increase with Estate Taxes.  No one knows for sure if this will happen, however, there needs to be a plan in place to deal with this tax risk.

Conclusion

Saving retirement in this economic climate will be a challenge. All of these aforementioned items must be considered while designing a plan for retirement. These risks are real concerns, and building an solution to protect and grow your hard earned cash should be the objective. This can be done, as there are solutions to mitigate these risks. If you are at retirement age, these things, and many other items, should concern you. Attempting to mitigate your tax liability, while at retirement, should be one of the top priorities in dealing with your economic plan. Ideally, having a Tax Free retirement should be the objective.



Works Cited

Barro, J. (2016, Febuary 9). Bernie Sanders' Plan Would Test an Economic Hypothesis. New York Times.
Nolte, J. (2015, September 28). Trump Pushes Single Payer Healthcare, Tax Increases on the Wealthy. Breitbart.



Saturday, February 13, 2016

The Single Biggest Benefit in the Federal Tax Code?

Ed Slot, the famous Tax Advisor, opines on the benefits of using the single biggest benefit in the Federal Income Tax code. This benefit is:

"And as a tax advisor, I can tell you that the single biggest benefit in the federal tax code is the income tax exemption for life insurance." ~Ed Slott

Most people focus on the income tax free death benefit that life insurance provide. However, there are many other benefits that Life insurance can provide, while one is alive.

Tax Benefit

Life Insurance can provide a means to build wealth tax deferred. Similar to a 401k or an IRA, a permanent life insurance contract grows the cash value tax deferred. However, the IRS does not provide restrictions on when these funds can be withdrawn. Also, at retirement, the funds can be accessed income tax free.

Life Insurance Costs are really paid by...Uncle Sam? 

As the cash value grows, the true amount that is being insured by the insurance company is the net difference between the total cash value and the face amount. As previously stated, the cash value is growing tax free, thus the insurance costs are being covered by the IRS. This is a win-win for those utilizing this wealth building strategy.

Control

With Life insurance, the owner of the policy has more control. Compare this to a typical retirement account(e.g 401 k, IRA, and the like), there are more restrictions and penalties with regards to accessing the monies in these account. With life insurance, one can withdraw monies, in many cases, without penalties, at any time. This assumes, of course, the monies are available. The over all point still holds: The owner has more control over his hard earned cash.

Leverage

Life Insurance, with the use of leverage, allows one of the best vehicles to build wealth over the long haul. One dollar in a life insurance policy can do multiple things: It can work as a cash accumulator, it has a death benefit pay out, it can pay out long term care benefits, it can grow tax free, the death benefit is passed down tax free, and on and on. All with simply the same dollars placed into the policy. Whereas with an IRA or 401k type account, it does not have multiple uses with that same dollar.

Conclusion

Having a solid life insurance program is a vital cornerstone in anyone's wealth building program. With these benefits, and many more, a solid life insurance policy can turbo charge one's wealth. It is typically overlooked, but it should be taken more seriously when placing together a financial plan.

Friday, February 12, 2016

More on Negative Interest Rates

It seems the Central Bank in the Euro Zone is continuing to embrace the notion of negative interest rates. The notion of the natural rate of interest is based in the individual's time preference of their utility ranking. In English, this simply means that all of us rank things that we are going to consume from lowest to highest. Of course, since we are limited to only 24 hours in a day, many of those preferences must be done in the future. That is the foundation of interest: The net between things consumed in the future, as compared to those things consumed in the present.

This notion is the foundation of many theories in finance and business.  The notion of interest helps price out long term loans, debt, and large long term capital projects, just for starters. Business owners need to have the ability to price things, in the present, in the terms of future prices. They can adjust these present prices in the terms of the future based on a calculation using the interest rate.

You maybe asking yourself, "How does the notion of negative interest rates fit into this definition?" Answer: It does not. It is against nature. Yet, these central bankers will continue to push for "negative" interest rates simply to stimulate the economy. Think of it this way: The lower the central bank pushes a form of price control by using negative interest rates, this will encourage more consumption, in the present. Long term capital projects will not happen, shorter term projects will take place. Savings and hoarding become extinct. Without proper savings, the economy can not expand and grow organically. This will lead to many asset bubbles, market swings, and crashes.

Of course, this impacts the Euro, as it will debase the Euro. All of this makes the Dollar, and commodities, look sweeter for folks who have the euro.

Read more of the ECB's exploration in Negative Interest Rates here: 

Thursday, February 11, 2016

Two Good Tax Free Retirement Options

You are planning for retirement, but you are concerned about paying taxes to THEIRS(The IRS). You realize that your financial plan may accumulate a large sum of cash, and you need all that cash to last during your Golden Years. What options are there?

Cash Out and Hide Yo Cash Under the mattress 

This is a viable option for the Chicken Little crowd, or the crowd that works in organized crime. If this is you, seek another economic consultant to obtain guidance. Also, THEIRS will attempt to collect....aggressively. 

Roth IRA

This is a good option. The Roth IRA allows one place money in the account post tax. The money grows inside the account Tax free, as the returns compound tax free as well. Later, at retirement, the user can pull the money out tax free! That is correct! No need to pay Uncle Sam additional taxes. Of course, there are some limitations. For example, there are income limitations. If you earn too much money, on an annual basis, the Roth IRA may not be an option for you. Secondly, there is an annual contribution limit. There is an annual cap on contributions into a Roth IRA. Contact me directly to find out if you qualify for a Roth IRA. 

Why is this option tax free at retirement? It is tax free at retirement because of this: During the working years, the client has paid taxes on the contributions into the Roth IRA. When retirement occurs, the client can withdraw the monies tax free. This is a function of the IRS tax code. 

Life Insurance

Yes, you read this correctly: Life Insurance. More specifically, Permanent Life insurance. My personal favorites: Fixed Universal Life, Index Universal Life and Participating Whole Life insurance. All of these contracts can be structured to mimic a Roth IRA. Since the Roth has an income restriction for participation in the program, the Life Insurance option is an excellent option for higher income earners. However, lower income earners can utilize this option as well. Also, with life insurance, the annual contribution "limit" is based upon the size of the policy, or the face amount.

With these three aforementioned life insurance options, the cash value growth, in most cases, have a built in guarantee of a prevention of downside risk. Translation: The Insurance company guarantees a baseline payment regardless of the downside action of the market. This varies from company to company. At retirement, the client can pull the funds out TAX FREE! With this option, it still comes with the death benefit, which can be passed down to the beneficiaries TAX FREE, and bypass probate. 

With some companies, these policies can have riders that will allow for Long Term Care benefits. This is a fantastic option, as many retirees must deal with health challenges as they age. Check with me to see if you can obtain this sort of option in your personal economic plan. 

Conclusion

Seeking a tax free retirement plan is a prudent option in today's economic climate. With the current Presidential campaign heating up, all the candidates are seeking ways to raise taxes and grab more of your hard earned cash dollars. These two methods are nice ways of keeping those pesky hands of the politicians off your retirement dollars. 

Tuesday, February 9, 2016

Questions Regarding Inflation

Many folks have concerns about inflation and deflation. Addressed below are questions submitted by the vox populi regarding this topic. Before addressing the questions, the definition of inflation and deflation must be addressed.


Definition of Inflation

Inflation is the increase of the monetary base. If the central bank decides to increase the money supply, this is inflation.

Who is negatively impacted greatly by inflation?

When inflation occurs, it increases the monetary base. Once the monetary base has increased, it makes the next monetary base unit less "valuable", on the margin. The net result is that the currency because weaker, it it loses its ability to store value for consumers. Individuals who are are on a fixed income, such as retirees, savers, and the like are impacted greatly by inflation. Individuals who are creditors are impacted by inflation as well. Why is this the case? When someone creates a debt, it is based on today's dollars, but the interest rate helps adjust the total amount paid to future dollars. If inflation occurs, the interest rate on the debt is fixed, it does not adjust to the increase in the money supply. So, those future dollars maybe less valuable if there is inflation, and the interest rate on the debt does not account for this.

How Savers are impacted by Inflation

The act of savings is deferred consumption for the future. For example, one may save up to purchase a house in the future, utilizing the savings as a down payment. The saver is placing faith that the monetary base, in most cases the currency, holds the value during the time the person is saving up to purchase the item. When inflation occurs, the value is eroded,

How to protect yourself from Inflation

There are various strategies to mitigate against the risk of inflation. Some advisers suggest purchasing Gold, Silver or other commodities to hedge against inflation. Many also invest into equities, as this can be a way to deal with inflation. Others may look into Real Estate investing, as this is a popular method to deal with an increasing currency supply. While all of these methods, and many others, are appealing, they have their own risks. The main takeaway is to make sure one is educated on how to invest into these various investment classes.