What I’m Watching This Week – 30 June 2014

The Markets

Domestic equities seemed to shrug off a massive downward revision to first-quarter GDP and mostly ended the week flat. Though the Nasdaq’s gain was slight, it was the sixth positive week out of the last seven. Meanwhile, the benchmark 10-year Treasury yield remained low as demand from bond investors continued to support prices.

Market/Index 2013 Close Prior Week As of 6/27 Weekly Change YTD Change
DJIA 16576.66 16947.08 16851.84 -.56% 1.66%
Nasdaq 4176.59 4368.04 4397.93 .68% 5.30%
S&P 500 1848.36 1962.87 1960.97 -.10% 6.09%
Russell 2000 1163.64 1188.42 1189.49 .09% 2.22%
Global Dow 2484.10 2617.86 2603.77 -.54% 4.82%
Fed. Funds .25% .25% .25% 0 bps 0 bps
10-year Treasuries 3.04% 2.63% 2.54% -9 bps -50 bps

Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

Last Week’s Headlines

  • The U.S. economy contracted at a much faster pace in Q1 than anticipated, falling 2.9% (not the 1% recently estimated). The Bureau of Economic Analysis said its unusually steep downward revision of gross domestic product was caused not only by winter weather but also by exports and health-care spending that were both lower than previously thought.
  • The housing market rebounded strongly in May from its winter slump. According to the Commerce Department, sales of new single-family homes leaped 18.6% in May and were almost 17% better than a year earlier. Also, the National Association of Realtors® said the 4.9% increase in resales of existing homes was the biggest monthly gain in nearly three years. However, the NAR also said existing home sales were 5% lower and the number of unsold homes was 6% higher than in May 2013.
  • Data on April home prices also was mixed. Cities in the S&P/Case-Shiller 20-City Composite Index averaged a 1.1% gain in April, for a gain of almost 11% since last April. Boston saw its biggest monthly gain in the index’s 27-year history, and San Francisco had its sixth straight price increase. However, seven cities reported a decline since March, and S&P said year-over-year price gains had begun to slow.
  • U.S. incomes rose faster than personal consumption in May; according to the Bureau of Economic Analysis, incomes were up 0.4%, while spending rose 0.2%. Even after adjusting for inflation, incomes were up 0.2% for the second straight month. The bad news? That 0.2% increase in personal consumption expenditures–a key inflation gauge for the Fed–resulted in the biggest 12-month gain since October 2012; further increases could mean inflationary pressure that might affect interest rates.
  • The European Union formalized a trade agreement with Ukraine, Georgia, and Moldova–the agreement whose rejection by the former Ukrainian president led to subsequent protests and ultimately Russia’s annexation of Crimea. Shortly thereafter, European leaders told Russia it had until Monday evening to persuade rebels in Ukraine to respect a cease-fire or face further EU economic sanctions.
  • Durable goods orders fell 1% in May after three strong months. However, the Commerce Department said most of the decline was caused by a 31% drop in defense spending on equipment. Other than defense, new orders were up 0.6%.

Eye on the Week Ahead

In a holiday-shortened week, trading volumes are likely to continue to be light. Manufacturing data may suggest whether recent improvements can be sustained. The European Central Bank is scheduled to report on Thursday, but last month’s decision to adopt a negative interest rate likely precludes much immediate change in policy. And as always, the jobs report, issued a day early, will be watched.

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Retirement Income Investing: Beyond Annuities

One of the challenges of investing during retirement is providing for annual income while balancing that need with other considerations, such as liquidity, how long you need your funds to last, your risk tolerance, and anticipated rates of return for various types of
investments. Annuities may be seen as a full or partial solution, since they can offer stable income or guaranteed lifetime payments (subject to the claims-paying ability of the issuer). However, they’re not right for everyone.

A well-thought-out asset allocation in retirement is essential. While income investments alone are unlikely to meet all your needs, it’s important to understand some of the most common non-annuity investments that can provide income as part of your overall investment strategy.

Bonds: retirement’s traditional backbone 

A bond portfolio can help you address investment goals in multiple ways. Buying individual bonds (which are essentially IOUs) at their face values and holding them to maturity can provide a predictable income stream and the assurance that unless a bond issuer defaults, you’ll receive the principal when the bond matures. (Bear in mind that if a bond is callable, it may be redeemed early, and you would have to replace that income.) You also can buy bonds through mutual funds or exchange-traded funds (ETFs). Depending on your circumstances, funds may provide greater diversification at a lower cost than individual bonds. However, a bond fund has no specific maturity date and therefore behaves differently from an individual bond, though like an individual bond, its price typically moves in the opposite direction from interest rates.

Consider the issuer

Bonds are available from many types of issuers, including corporations, the U.S. Treasury, local and state governments, governmental agencies, and foreign governments. Each type is taxed differently.

For example, the income from Treasury securities (unlike corporate bonds) is exempt from state and local taxes but not from federal taxes. Bonds issued by state and local governments, commonly called municipal bonds or munis, are just the opposite. Often a staple for retirees in a high tax bracket, munis generally are exempt from federal income tax (though specific issues may be taxable), but may be subject to state or local taxes. Largely because of that tax advantage, a tax-free bond typically yields less than a corporate bond with the same maturity. You’ll need to compare a muni’s tax-equivalent yield to know whether it makes sense on an after-tax basis.

Think about bond maturities

Bond prices can drop when interest rates and/or inflation rise, because their fixed income will buy less over time. Inflation affects prices of long-term bonds–those with maturities of 10 or more years–the most. One way to keep a bond portfolio flexible is to use so-called laddering: buying bonds with various maturities. As each matures, its proceeds can be reinvested. If bond yields are up, you benefit from higher rates; if yields are down, you have the option of choosing a different maturity or investment.

Certificates of deposit/savings accounts

Certificates of deposit (CDs), which offer a fixed interest rate for a specific time period, usually pay higher interest than a regular savings account, and you typically can have interest paid at regularly scheduled intervals. A CD can be rolled over to a new CD or another investment when it matures, though you may not get the same interest rate, and you’ll pay a penalty if you cash it in early. A high-yield savings account also pays interest, and, like a CD, is FDIC-insured up to $250,000.

Stocks offering dividends

Dividend-paying stocks, as well as mutual funds and ETFs that invest in them, also can provide income. Because dividends on common stock are subject to the company’s performance and a decision by its board of directors each quarter, they may not be as
predictable as income from a bond. However, dividends on preferred stock are different;
the rate is fixed and they’re paid before any dividend is available for common stockholders. That fixed payment means that prices of preferred stocks tend to behave somewhat like bonds. Preferred shares usually pay a higher dividend rate than common shares, and though most preferred stockholders do not have voting rights, their claims on the company’s assets will be satisfied before those of common stockholders if the company has financial difficulties. However, a company is often permitted to call in preferred shares at a predetermined future date, and preferred stockholders do not participate in a company’s growth as fully as common shareholders would.

Pass-through securities/REITs
Some investments are designed to act as a conduit for income from underlying assets. For example, mortgage-related securities represent an ownership interest in mortgage loans made by financial institutions. The most basic of these, known as pass-throughs, represent a direct ownership interest in a trust that consists of a pool of mortgages. Examples of pass-throughs include securities issued by the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Federal National Mortgage Association. Certain types of investment trusts–for example, REITs that buy, develop, manage, or sell real estate–don’t owe taxes as long as they pay out at least 90% of their net income to investors. That payout has traditionally made them popular as an
income vehicle and portfolio diversifier (though diversification alone does not guarantee a profit or ensure against a loss). There are many types of REITs, so be sure you understand how the one you choose functions before investing.

Automated inflation fighting

Some investments are designed to fight inflation for you. Treasury Inflation-Protected Securities (TIPS) pay a slightly lower fixed interest rate than regular Treasuries. However, your principal is automatically adjusted twice a year to match changes in the Consumer Price Index (CPI). Those adjusted amounts are used to calculate your interest payments.
That inflation adjustment means that if you hold a TIPS until it matures, your repaid principal will likely be higher than when you bought it (the government guarantees it will not be less). However, you can still lose money if you sell a TIPS before maturity. Inflation
rates change, and other interest rates can affect the value of a TIPS. If inflation is lower than expected, the total return on a TIPS could actually be less than that of a comparable non-indexed Treasury. Also, federal taxes on the interest and increases in your principal
are owed yearly even though additions to principal aren’t paid until a TIPS matures. Inflation-linked CDs function much like TIPS, but you’ll generally owe federal, state, and local taxes each year. Some mutual funds are managed with an eye toward inflation. A mutual fund that invests in inflation-protected securities pays out not only the interest but also any annual inflation adjustments, which are taxable each year as short-term capital gains. Some funds target inflation by mixing TIPS with floating rate loans, commodity-linked notes, real estate-related investments, stocks, and bonds.

Distribution funds

Some mutual funds are designed to provide an income stream from year to year. Available as part of a series, each fund designates a percentage of your assets to be distributed each year as scheduled payments, usually monthly or quarterly. Some funds are designed to last over a specific time period and plan to distribute all your assets by the end of that time; others focus on capital preservation, make payments only from earnings, and have no end date. You may withdraw money at any time from a distribution fund; however, that may reduce future returns. Also, payments may vary, and there is no guarantee a fund will achieve the desired return.

Many choices

New ways to help you translate savings into income are constantly being created. These are only a few of the many possibilities, and there’s more to understand about each.

IRS Guidance Limits Employer Pre-Tax Subsidies

The IRS has put the kibosh on any potential attempts by large employers to skirt the requirements of the Affordable Care Act (ACA) by paying employees before-tax subsidies to buy individual health insurance through private (commercial) carriers or through a Health insurance Exchange Marketplace. According to a recently published IRS Q&A, such employer payment plans are considered group health plans, and do not conform to the ACA, potentially subjecting the employer to an excise tax of $100 per employee, per day ($36,500 per employee, per year). Essentially, the IRS says employers can’t offer tax-free money to employees for the purpose of buying individual health insurance coverage.

Shared responsibility

Effective 2015, the ACA imposes a shared responsibility mandate on large employers with 100 or more full-time equivalent employees (2016 for employers with 50 or more full-time equivalent employees) to provide qualifying and affordable health insurance to employees or face a penalty. For information on the shared responsibility mandate, see IRS Questions and Answers on Employer Shared Responsibility Provisions Under the Affordable Care Act.

However, some employers might attempt to comply with the ACA mandate by paying employees a before-tax subsidy that they can use to buy their own health insurance from a private insurer or through a Health Insurance Exchange Marketplace. The IRS has determined that these employer payment plans are akin to group health plans. Among other things, the ACA requires that group health plans must provide certain benefits such as preventive screenings without co-pays or other charges. In addition, group health plans cannot impose annual limits on the dollar amount of benefits for any individual. The IRS says these employer pre-tax payment arrangements do not meet the requirements of group health plans under the ACA.

Some ACA provisions unaffected

The IRS essentially prohibits employers from paying tax-free funds to employees to buy individual policies of health insurance. It does not appear to affect other provisions of the ACA, however. For instance, employers can pay taxable funds to workers that they can use to buy their own health insurance. Large employers can elect not to offer any group coverage to employees and pay a penalty of either $2,000 or $3,000 per employee, depending on the circumstances. Or, employers can contract with a private exchange; employers can provide tax-free money to employees, which they can use to shop for coverage on the private exchange, which may provide several health-care plan alternatives. Also, it’s important to note that the employer shared responsibility mandate applies only to large employers; employers with fewer than 50 full-time equivalent workers are not required to offer health insurance coverage to employees. In any case, it’s a good idea for employers to consult with a health care benefits professional to discuss options available under the ACA.

Foreign Account Tax Compliance Act (FATCA): The Basics

The Foreign Account Tax Compliance Act generally requires: (1) U.S. persons to report information on their foreign financial accounts to the IRS, (2) foreign financial institutions (FFIs) to report information on their U.S. clients to the IRS, and (3) withholding on payments to FFIs that fail to comply with FATCA. As final implementation on this 2010 legislation begins, withholding on U.S. source income subject to FATCA generally takes effect July 1, 2014.

Individuals

If you are a U.S. citizen or a U.S. resident alien who is required to file a federal income tax return, you must generally file a Form 8938 with your federal income tax return if you have an interest in foreign financial assets and the total value of those assets exceeds certain thresholds.

File Form 8938
If Your Foreign Assets Exceed the Appropriate Threshold You Live in the United States You Live outside the United States
Married Taxpayer Filing Jointly Other Taxpayers Married Taxpayer Filing Jointly Other Taxpayers
On the last day of the year, or $100,000 $50,000 $400,000 $200,000
At any time during the year $150,000 $75,000 $600,000 $300,000

Foreign financial assets generally include foreign financial accounts and foreign non-account assets held for investment (as opposed to held for use in a trade or business), such as foreign stock and securities, foreign financial instruments, contracts with non-U.S. persons, and interests in foreign entities.

Foreign financial assets do not include financial accounts maintained by a U.S. payer (including a domestic branch of a foreign bank or insurance company, and a foreign branch or subsidiary of a U.S. financial institution–e.g., U.S. mutual fund accounts, IRAs, 401(k)s, qualified U.S. retirement plans, and brokerage accounts maintained by U.S. financial institutions). There are other exceptions as well.

If you fail to file a required Form 8938, you may be subject to an initial penalty of up to $10,000. Other penalties may also apply. If you have any questions about this requirement, talk to a tax professional.

Foreign financial institutions

In order to avoid withholding on payments made to them, an FFI can register with the IRS and agree to report to the IRS certain information about its U.S. accounts. Registration can be done on the IRS website or using Form 8957. As part of the agreement, the FFI may be required to withhold 30% on certain payments to foreign payees if the payees do not comply with FATCA.

U.S. financial institutions

Starting July 1, 2014, U.S. financial institutions and other U.S. withholding agents must withhold 30% on certain U.S. source payments made to FFIs that do not document their FATCA status. (Payments on certain grandfathered debt obligations outstanding on July 1, 2014, may be exempt from withholding.) They must also report to the IRS information about certain non-financial foreign entities with substantial U.S. owners. Failure to comply may result in liability for the tax that should have been withheld and penalties.

Governments

The United States has collaborated with other countries to develop intergovernmental agreements (IGAs) implementing FATCA. Under such an agreement, the reporting and other compliance burdens on the financial institutions in the jurisdiction may be simplified.

Supreme Court Rules on Inherited IRAs and Bankruptcy

Background

Since the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005, individual retirement accounts (IRAs) have been protected under federal law if you declare bankruptcy. The exemption was originally capped at $1 million, but has since grown to $1,245,475 (as of April 1, 2013) due to cost-of-living increases. (The million-dollar cap does not apply to amounts rolled over from a qualified employer plan like a 401(k)–these amounts are fully protected under federal law.)

Over the years, federal court decisions have been divided over whether or not inherited IRAs are protected under the Act. To resolve this conflict, the United States Supreme Court agreed to hear the case of Clark v. Rameker.

The Supreme Court’s decision

On June 12, the Court decided the Clark case, holding that inherited IRAs are not protected “retirement funds” under federal law. The Court reached this conclusion by noting that the holder of an inherited IRA cannot invest new money in the account, can withdraw the entire balance at any time and use the funds for any reason without penalty, and must take required distributions from the account no matter how far the holder is from retirement.

So what does this mean to you? If you declare bankruptcy and hold an inherited IRA, you will not receive any protection for those assets under federal law. Whether they receive any protection from creditors at all (inside or outside of bankruptcy) will instead depend on the laws of your particular state.

Note that if you inherit an IRA from your deceased spouse, and you are the sole beneficiary, you are generally entitled to treat that IRA as your own (for example, by making an affirmative election or contributing to the account). If you do so, the IRA should not be considered an inherited IRA for bankruptcy purposes. But since the Clark case dealt with an IRA inherited by the IRA owner’s daughter, and not a spouse, this was not specifically addressed by the Court.

Also, you should keep this ruling in mind as you name beneficiaries for your own IRAs, particularly if you intend to name someone other than your spouse as beneficiary. If creditor protection for your heirs is important to you, one option is to consider naming a spendthrift trust as your IRA beneficiary. These trusts limit your trust beneficiary’s ability to control the trust funds, and provide protection from your beneficiary’s creditors under the laws of most states. However, be sure to consult a qualified professional, as establishing a trust as your IRA beneficiary can have significant legal and tax implications.

What I’m Watching This Week – 23 June 2014

The Markets

Reassurance from the Fed seemed to outweigh the situation in Iraq last week as investors showed greater comfort with taking on more risk. The week’s biggest gains were in the small caps of the Russell 2000, which once again returned to positive territory for the year, while the Nasdaq closed the week at a level it hasn’t seen since April 2000. Meanwhile, the Dow and S&P 500 set new record highs yet again–the 11th so far this year for the Dow, the 22nd for the S&P 500.

 

Market/Index 2013 Close Prior Week As of 6/20 Weekly Change YTD Change
DJIA 16576.66 16775.68 16947.08 1.02% 2.23%
Nasdaq 4176.59 4310.65 4368.04 1.33% 4.58%
S&P 500 1848.36 1936.15 1962.87 1.38% 6.20%
Russell 2000 1163.64 1162.68 1188.42 2.21% 2.13%
Global Dow 2484.10 2587.94 2617.86 1.16% 5.38%
Fed. Funds .25% .25% .25% 0 bps 0 bps
10-year Treasuries 3.04% 2.60% 2.63% 3 bps -41 bps

Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

Last Week’s Headlines

  • The Fed’s long/short strategy: The Federal Reserve’s monetary policy committee predicted that further improvement in the economy and the job market would allow it to raise interest rates slightly faster than previously anticipated. It now sees its current near-zero target rate hitting 1.2% by the end of 2015 and 2.4% in 2016. That’s slightly higher than previous forecasts. However, it also suggested subsequent increases might take rates to only 3.75%–slightly lower than its earlier long-term forecast of 4%. And as expected, Fed bond purchases were once again cut by $10 billion, leaving the monthly total at $35 billion.
  • Despite the projected economic rebound, 2014’s winter-weakened first quarter led the Fed to cut its U.S. growth forecast for the year from the nearly 3% predicted in March to 2.1%-2.3%. The Fed also said the growth rate could bump up above 3% in 2015 but would settle back to a little over 2% in the longer term. Both forecasts are roughly in line with figures from the International Monetary Fund.
  • U.S. manufacturing showed strength in May. Industrial production increased for the third month out of the last four and was up 4.3% from a year ago. The Federal Reserve said May’s 0.6% gain was led by a 1.5% increase in automotive output, and that 79.1% of the nation’s manufacturing capacity was being used. Also, the Fed’s Empire State manufacturing index remained at a multiyear high for the second consecutive month, and the Philly Fed index rose from 15.4 to 17.8–its highest reading since September and the fourth straight positive month.
  • Consumer prices rose in May at the fastest pace in more than a year. The Bureau of Labor Statistics said the 0.4% increase was broad-based, but was driven largely by higher prices for housing, food, electricity, airfares, and gas (food prices jumped more than in any month in almost three years, and groceries were up 0.7% for the month). The increases put the overall consumer inflation rate for the last year at 2.1%. Fed Chair Janet Yellen said that though recent upticks have left inflation a bit on the high side, it’s basically in line with the Fed’s 2% target.
  • Housing starts slumped 6.5% in May, according to the Commerce Department, but were still 9.4% higher than in May 2013. Building permits–an indicator of future activity–also fell, and the 6.4% decline left them nearly 2% lower than a year ago.

 Eye on the Week Ahead

New and existing home sales will suggest whether the summer housing market is picking up, while consumer spending also will be of interest. Depending on the situation in Iraq, oil prices could start to become a bigger factor in investor thinking.

What I’m Watching This Week – 16 June 2014

The Markets

Equities took a break across the board from their recent upward surge. After fresh all-time record closes early in the week, both the S&P 500 and the Dow Industrials saw profit-taking that also returned the small caps of the Russell 2000 to negative territory for the year. Renewed conflict in Iraq contributed to equities’ swoon, raising concerns about global oil supplies and pushing oil to roughly $107 a barrel.

Market/Index 2013 Close Prior Week As of 6/13 Weekly Change YTD Change
DJIA 16576.66 16924.28 16775.68 -.88% 1.20%
Nasdaq 4176.59 4321.40 4310.65 -.25% 3.21%
S&P 500 1848.36 1949.44 1936.15 -.68% 4.75%
Russell 2000 1163.64 1165.21 1162.68 -.22% -.08%
Global Dow 2484.10 2599.33 2587.94 -.44% 4.18%
Fed. Funds .25% .25% .25% 0 bps 0 bps
10-year Treasuries 3.04% 2.60% 2.60% 0 bps -44 bps

Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

Last Week’s Headlines

  • U.S. retail sales rose 0.3% in May and were 4.3% higher than a year earlier. The Department of Commerce said the biggest increases were seen at auto and auto parts dealers, building/garden supplies stores, and miscellaneous store retailers such as florists, office suppliers, and used-merchandise stores.
  • Wholesale prices fell 0.2% in May, leaving the wholesale inflation rate for the last 12 months at 2%. According to the Bureau of Labor Statistics, that’s down slightly from the previous month, but substantially higher than the 1% of last May. The decline in prices at the final stage of wholesale distribution was evenly split between goods and services. Inflation is one of the measures being watched by the Federal Reserve as it unwinds its bond-buying efforts.
  • The World Bank cut its estimate of 2014 global economic growth to 2.8% rather than the 3.2% it predicted in January. The Global Economic Prospects report said developing countries have been especially hurt by bad weather in the United States, a slowing housing market in China, political conflicts, and slow progress on structural economic reform; the report sees emerging-market growth at 4.8% this year rather than 5.3%. However, 2015 is expected to be better, with a 3.4% global growth rate and 5.4% growth in the developing economies.

Eye on the Week Ahead

The Fed is expected to once again reduce its monthly bond purchases, and options expiration at the end of the week could mean volatility as traders on the wrong side of equities’ recent surge attempt to manage those positions. U.S. manufacturing data and the state of the oil market also could influence the mood of the markets.