In my last post I discussed Understanding Death and Taxes – Your Taxable Account . I also mentioned there was a big difference between investments inherited in a taxable account vs. an IRA or 401K account.
Currently if you bequeath investments held in a traditional IRA or 401K account your heirs will have to pay tax on the account(s). Currently the holdings are drawn down over a lengthy period of time and taxes areas this occurred, hence the term “Stretch IRA”.
If Congress kills the Stretch provision, your heirs would have to draw down the investments over 5 years and probably get hit by very large tax bills (drawdown plus their normal income). The Whitehouse tried to eliminate the Stretch in 2013 and again this year. Sooner or later this may get eliminated.
What might you do to anticipate leaving your heirs with a huge tax burden?
- Consider withdrawing money from your IRA to live on instead of the conventional wisdom of withdrawing from a taxable account. Maybe calculate out the amount that will still say keep you in the 25% tax bracket.
- Consider converting some of the IRA to a ROTH IRA (which is never taxed). Yes you again will pay taxes on the conversion but your heirs will pay less.
- Consider purchasing life insurance so that your heirs can use the proceeds to pay tax bills.
The current “death tax” threshold is $5.43 million; many people therefore feel they don’t need to worry about a death tax. Of course there is no such thing as a “death tax”, it is actually called the Federal Estate Tax. Not to be confused with complex State Estate Taxes.
Here is what you need to know.
When you die and leave stock in a taxable account to someone the “cost basis” value of that investment is reset to the current market value upon your death. This can be a huge advantage for your loved ones. For example, if you bought 500 Apple (APPL) at $100/share years ago and then it split 7:1 and is now trading at $127. Your “cost basis” is $50,000, the current value is $444,500. If you sold it you would be paying a huge capital gains tax on the $394,500 gain. However if you die and leave the stock (not cash) to say family members, the “cost basis” becomes $444.500. Therefore, If the person(s) inheriting the stock immediately sold it there would be NO TAX. This is called a “step-up in cost basis”. You can use this information in your overall estate planning.
Beware of the “stretch IRA” law change! Notice I mentioned taxable account, it is completely different in a retirement account, either IRA or 401K. I’ll explain this in my next blog posting.
In my last posting “The Easiest Way to Lose Money in the Market – Selling” I discussed how the average investor unfortunately sells when stock prices are dropping and panic sets in.
There are however some simple rules that you can use to determine when is a good time to sell an investment, including stocks, bonds, funds or ETF’s. These rules aren’t for day traders; they are for long term investors.
- Rebalancing. Investors need a plan that includes diversification. The larger the portfolio the more diversification makes sense. Let’s say that you determine Healthcare should be 10% of your portfolio. At the end of a quarter you review your holdings and see that your Healthcare has gone up so much that it is now 15%. This is just too high and you decided to sell some of your holdings in this sector and “rebalance”.
- The Story Changes. You always need a specific reason to buy or sell a stock. I started buying Airline stocks in early 2014 when I saw that oil prices were dropping and each of my airline stocks had a unique story. American Airlines was bought by US Airways, Delta bought a refinery in Philadelphia, JetBlue announced a restructuring. At the same time I started selling my Utilities in late 2014 to lock in my gains as it became clear that the Federal Reserve would start raising rates in 2015 and Utilities would not be a good place to be for the next 12 months.
- Look at the Technical’s. Technical’s refer to stock charts. It is really important that you know how to read and understand stock charts. If you are a long term investor you might want to look at the 12 month “daily” chart. On this chart you can plot the following comparisons:
- 50 day EMA (exponential moving average), this is 2 trading months
- 200 day EMA, this is roughly 10 trading months
- SPY, the industry standard ETF normally referred to as “the market”
Here is an example of a strong selling indicator, a “death cross”. One of my past holdings was AEP, American Electric Power, one of the largest and best run utilities in the country. In the last few days AEP’s stock price ( had a “death cross”, a clear broken trend. The 50 day EMA (black Line) crossed below the 200 EMA (green line). In addition, AEP (blue line) was already trending below the overall market SPY (purple line). Sell, sell, sell!
4. Play with House Money. When you make a lot of money in a speculative stock, sell some on an “up day” to take some profits. This is especially true in a tax sheltered account like an IRA or 401K plan. Jim Crammer always preaches this.
5. Moves by the Federal Reserve. Never fight the Federal Reserve, as the saying goes, it will bite you in the backside. The upcoming rate hike by the Fed has been telegraphed now for almost a year. This means that most interest rate sensitive stocks or bonds will get hammered. Sell your bonds now, they are already dropping in price and you will lose much more in principal that the very small dividends they pay.
The average American spends more time researching what’s on TV tonight or their favorite team’s upcoming schedule than their investments. Some do what I call “buy and forget”, others listen to friends and own the latest fad stocks, and finally there is the group that trust someone else to make decisions like financial advisors.
The biggest reason people lose money in their investments isn’t due to a recession, the Federal Reserve or a “bear market”. The reason they lose is really simple, they sell low! It is impossible to “time” the market, all the experts and talking heads on CNBC have no idea whether the market will go up or down in the short term. Short term being a day, a month or a quarter. In the longer run, stocks always go up, you just need to be patient and do a little homework. The problem isn’t as much buying high, it’s selling low based on your panic.
Take a look at the attached chart, it shows the market over the last 12 months (SPY is the S&P 500 ETF, commonly referred to as “the market”). The blue line is the SPY, the red line shows the 50 days moving average of the stock’s price.
It is easy to see that people who sold their stocks or funds in a panic, lost money. You can use any stock choice you want, the analysis is the same. You are your worst enemy, you sell or switch funds when the market goes down. I really pity the people who sold their stocks in 2008-2009 at the low points when the stock market was demolished. They then sat on cash, CD’s or bonds and missed one of the greatest rebounds in stocks in our lifetime. Along with your homework, time is the most important factor in your ability to make large returns on your investments.
Want some proof? Warren Buffet is currently worth about $73 billion is 84 years old. He made $70 billion of that after he turned 60 years old. Your wealth will grow exponentially if you just follow some simple rules and don’t panic! Warren buys and sells based on fundamentals and investing in value. He buys low and sells (or holds) when the price is high.
In my next blog post I’ll give you some ideas when to buy and when to sell your investments.
Given the current economy this may be an important topic in your business. I saw an interesting story written by Amy Gallo in the Harvard Business Review that indicated conventional wisdom of not hiring “over qualified” candidates may not hold true in all cases. The assumption of course is that an over qualified candidate will be underutilized, become bored and leave.
Point #1: What is over qualified anyway, the person’s skills exceed the requirements? Education is not experience and may not include the required skills. Previous experience may not be a good indicator since the required skills for the new job might be different. Meeting the candidate personally and addressing the reason the candidate is interviewing for a job that one might think he/she is “over qualified” for. In the early 80’s, I left a senior sales management job at a big national company to join a very small software company, I was viewed as very over qualified. Why, I wanted to get into the software industry when it was still young. It turned out to be a win/win for both parties. Look past the resume.
Point #2: Hire for more than the current job. Many businesses are growing and the hiring manager should be looking for someone that can move up in the organization, beyond just the current requirement. There can be no guarantees and the manager should communicate this to the candidate. Growing businesses always need people to promote, hire them now, before you need them and see what happens. Your biggest problem is that managers won’t hire people they view as being better or more skilled than they are.
Point #3: Don’t under pay. It doesn’t do any good to under pay a new employee just because of a down economy. What will your expectations be when the economy turns? People know what a fair salary is and your goal is to keep employees and pay them for performance. If your salary range is quite a ways from the normal pay for the level candidate you’d like to hire address the issue heads-on with the candidate. Again, there may be common ground that will allow you to bring on this “over qualified’ person.
The bottom line is that hiring and training new employees is very expensive. As they say in sports, “pick the best athlete” in the draft, then worry how to fit them in.
As I wrote in a previous blog posting, “This Stock has been flat for 3 years – You’ll just love it!” preferred stocks can generate a very nice yield and still have a margin of safety.
Most investors don’t understand preferred stocks. Preferred stocks are positioned between common stocks and bonds. Most commonly preferred shares carry no voting rights but have a higher claim to earnings than common share and are usually less volatile than common. When the S&P 500 fell 37% in 2008, for example, the iShares preferred fund fell only 24%. Preferred shares are next in line to bond holders in the capital chain of any company. Investors can easily choose from preferred stock ETF’s or individual stocks. Investors should also understand that most high-yield stocks are affected by rising interest rates, similar to bonds.
Here are some examples of preferred investments you should consider:
- iShares U.S. Preferred Stock ETF (PFF) 5.11% yield
- Ladenburg Thalmann Financial Services (LTS-PA) 9.75% yield
- Barclays Bank (BCS-PD) 7.7% yield
By allocating a portion of your portfolio to some of these ultra-high-yielding investments you’ll be able to improve your cash flow while waiting for the next Facebook or Apple investment to come along. In future posts we’ll discuss the pros and cons of these investments and some helpful tips.