Brighton Perspective

New 401(k) Plan Disclosure Rules

2012-02-09T10:01:47-05:00

As 401(k) plans have become more popular, plan participants have become increasingly responsible for making their own retirement savings decisions. The Department of Labor (DOL) has become concerned that participants in self-directed 401(k) plans (those that allow participants to direct the investment of their own accounts) might not have access to, or might not be considering, information critical to making informed decisions about the management of their accounts--particularly information on investment choices, fees, and expenses.

As a result, in October 2010, the DOL issued new regulations that require self-directed 401(k) plans to provide detailed information to participants about the plan and its investments, on a regular and periodic basis, so that participants can make informed investment decisions. Some information must be provided on an annual basis, and some information must be provided quarterly. For most plans, the initial annual disclosure must be furnished no later than August 30, 2012. The first quarterly statement must be furnished no later than November 14, 2012 (for July through September).

If you're currently participating in a 401(k) plan, chances are you're already receiving similar information as a result of an earlier set of DOL regulations. However, employer compliance with the older regulations was voluntary, whereas the new disclosure rules are mandatory for all self-directed 401(k) plans. Even participants in plans that previously complied with the earlier disclosure rules will see some changes when the new regulations take effect. For one, you'll receive more detailed information about investment fees and expenses. Another change is that plan investment information must be provided in a chart, so that you'll be better able to compare investment alternatives. And plans will no longer be required to automatically provide a prospectus, although one must be provided if you request it.

These new disclosure rules apply to 401(k) plans and other plans that allow participants to direct their own investments, but they do not apply to IRAs, SEPs, or SIMPLE IRA plans. They also do not apply to plans that are not covered by the Employee Retirement Income Security Act of 1974 (ERISA), including governmental plans, owner-only plans, certain 403(b) plans, and certain church plans.

Morningstar Q&A on 529s

2012-01-30T10:25:17-05:00

Interesting, and very useful, material

529s and Crummey Trusts

by | 01-27-2012

1. My client has about an $8,000,000 estate and wants to fund education for his two very small daughters. He and I discussed a gifting trust because excess funds can be used for other purposes later in the children's lives. The financial advisor who referred the client to me prefers 529 accounts for this purpose. The client is looking to eventually leave a fair amount to his daughters and wants divorce protection, etc., for the rest of their lives. Should I just advise him to do the 529 accounts for educational gifts and gift to a trust for other purposes? To get something set up by year end, would it be possible to simply advise the client to establish a 529 account for each of his children and then later transfer the account to a Crummey trust?
Your year-end solution--to establish a 529 account for the beneficiary and then, after there is time to draft and sign a Crummey Trust for the beneficiary, to change the account owner from the client to the Crummey Trust--is clever, but it would have had some risk. (For a description of Crummey Trusts, see my September 2009 column .)

The designated beneficiary of the 529 account would remain the same; only the account owner would change. Internal Revenue Code section 529 does not impose gift tax on a change of account owner and the Advance Notice of Proposed Rulemaking does not contain any such proposal. Nonetheless, some 529 plans may prohibit changes of account owners except under limited circumstances or may report a change of account owner as a nonqualified distribution, leaving it to the taxpayer to explain to the IRS why the transaction should not be taxable. Therefore, it is advisable to consult the plan manager on its policies before changing the account owner.

The Advance Notice, however, proposes that in determining the amount of earnings subject to income tax and penalty on a nonqualified distribution, only contributions made by the account owner should be treated as capital contributions or basis. If this rule went into effect, any contributions made by the client prior to changing the account owner to the trust would be ignored, thus causing them to be subject to income tax and the penalty tax if a nonqualified distribution were later made. This proposed rule would not impact qualified distributions.

Further, the Advance Notice proposes that trusts not be allowed to be account owners. If this rule went into effect, it would be prospective only, and it is unclear how 529 accounts that already had trusts as account owners would be treated.

With respect to your more general question of whether to use 529 accounts or Crummey Trusts for annual exclusion gifts to minors, I would limit gifts to 529 accounts only to the amount that the client is fairly certain will be used for higher education, taking into account that the client (or a grandparent) may wish to directly pay tuition under 2503(e) as a tax-free gift to reduce his or her estate for estate tax purposes. The remainder of the annual exclusion gifts could go into Crummey Trusts.

Gifts to Crummey Trusts qualify for the gift tax annual exclusion, but the trusts do not need to distribute to the beneficiary at any particular age. Thus the assets could remain in trust for the beneficiary's entire life, subject to the Trustee's power to make discretionary distributions to the beneficiary. In most states this would protect the trust assets from being distributed to the other spouse in a divorce, although a divorce court might take into account the trust assets in dividing marital property (in a state in which the court has discretion in dividing marital property) and in setting maintenance or child support payments.

The degree of protection from creditors of the beneficiary will depend upon the applicable state law. In some states the trust assets will be protected from the beneficiary's creditors, especially if the trust contains a "spendthrift provision." Other states may not protect the trust assets from the beneficiary's creditors on the theory that a Crummey Trust is akin to a self-settled trust because the beneficiary had a right to withdraw the trust assets when contributed. Traditionally, trusts created by a settlor for the settlor's own benefit (a "self-settled trust") are not protected from the settlor's creditors.

2. Parent, as account owner, sets up a 529 account for child beneficiary. Grandparent makes gift to the 529 account. Could the IRS argue that this is really a gift to the parent given the parent-owner's right to withdraw the 529 account assets for himself (subject to the penalty and tax on the income)?
I think it's tough for the IRS to make that argument because Code section 529 says the contribution is a completed gift to the beneficiary. Nor can the IRS argue that a subsequent distribution from the 529 account to the parent is a gift because of Code section 529(c)(5)(A). In the January 2008 Advance Notice of Proposed Rulemaking, the IRS indicated that it was considering a different approach. (See my February 2008 column .) Under the Advance Notice approach, if the child withdrew the money, the IRS would count as basis only any contributions the child (the account owner) made to the account and would ignore the grandparents' contributions. Thus the grandparents' contributions would be subject to income tax if distributed to the child. The income tax would be a rough proxy for the gift tax the IRS could not impose. However, the IRS's approach would penalize legitimate uses of 529 accounts, as has been pointed out in Comments on the Advance Notice.

3. Can a trustee of an irrevocable trust use trust funds to establish a 529 account for one of the beneficiaries?
If the trust contains typical Trustee powers, the short answer is that it should be able to invest in a 529 account. Most 529 plans permit trusts to be account owners. As noted above, however, the 2008 Advance Notice proposes to limit account owners to individuals, but any such change would be prospective. For a more detailed examination of the trust law issues, including the prudent investor rule, see my January 2009 column .

4. I'd like to help with college expenses for a family friend (18-year-old high school student going away to college this fall), with the idea of letting him access $10,000 per year (or $5,000 two times a year) for four years. It would be an interest-free loan for 20 years or so. I'd like to put up the $40,000 now and let him take out the money each year for college expenses as needed. What do you suggest? The basic point is that I want him to know the money is there without having to ask me each year, but I'd like to have it available to him as needed, but just to pay tuition. Seems like some sort of trust might be overkill. Perhaps it could be something as simple as a checking account he could be a signatory on, but I'd see each time a check is drawn to make sure it is payable to the university.
The checking account titled in your name with the student as a signatory would work so long as you trust the student not to pull all of the money out. Each withdrawal would be treated as a gift to the student, unless it is a bona fide loan. Alternatively, you may be able to establish a 529 account with you as the account owner, but grant the student a power of attorney to direct account distributions. (See my April 2011 column on powers of attorney over 529 accounts.) Again, you would be trusting the student not to pull all of the money out.

The 529 account would be treated differently than the checking account for gift tax purposes. With the 529 account, the gift would be made when the money went into the account, unless the contribution was a bona fide loan. Thus you may wish to limit your annual contributions to the 529 account to the $13,000 gift tax annual exclusion (or $26,000 if you are married and your spouse makes the split-gift election). Funding the 529 account on an annual basis, however, would reduce the risk of funds being withdrawn for purposes other than tuition by limiting the amount in the account.

If you intend these distributions to be loans, you should have the student sign a promissory note describing the repayment terms. The note might state that you intend to fund up to $40,000 of tuition. If the note does not charge appropriate interest, the foregone interest will be treated as taxable income to you and a gift from you to the student. You may wish to consider charging the minimum amount of interest required to avoid income and gift tax consequences. See Internal Revenue Code section 7872. For example, for a 20-year term note entered into in January 2012, the minimum interest rate would be 2.63%.

To comply with certain Treasury regulations, we state that (i) this article is written to support the promotion and marketing of the transactions or matters addressed herein, (ii) this article is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (iii) each taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor."

Morningstar 2012 Economic Outlook

2011-12-29T10:06:49-05:00

Outlook for the Economy

by | 12-27-2011

After smoothing out bumpy GDP results, the economy is probably growing at about 2%.
Potential sources of an upside surprise include increased U.S. oil production, a sharper rebound in auto production and aircraft production (Boeing), and a stronger housing market.
Though corporations continue to remain cautious, consumers have continued to spend.

The U.S. economy grew in 2011, but at a slower rate than I had hoped when the year began. I had predicted that the economy might grow as fast as 3.0% to 4.0% when the year started, and it now looks as if the economy will turn in a more modest 2% or so growth rate on a fourth-quarter-to-fourth-quarter basis.

Even more surprising than the overall growth rate was the pattern of that growth rate throughout the year. Growth plunged to 0.4% in the first quarter and accelerated throughout the year with the fourth quarter now likely to produce annualized growth well in excess of 3%.

A combination of poor weather, a shocking jump in oil and gas prices due to political unrest in the Middle East, and supply-chain disruptions related to the Japanese tsunami all contributed to the pitiful level of economic growth in the first half. As those factors reversed themselves in the second half, economic growth spiked. When the first half and second half are combined, I think the overall 2% growth rate is more representative of the state of the U.S. economy than the first half doldrums or the second half spurt.

Although the overall GDP for 2011 was below my forecasts, given all the first-half shocks, followed by more severe sovereign debt issues in the second half, I am not that disappointed with the U.S. economic performance. I may have started the year too bullish, but I didn't cave into the chorus of economists who were overly focused on manufacturing data and calling for another recession late this summer. Instead I remained focused on the U.S. consumer, which continued to power ahead throughout 2011.

More Upsides Than Downsides (Though the Downside Is Scary)
My overall forecast for 2012 is for slightly higher growth than the consensus, but not by a lot. However, I think the odds of an upside surprise are substantially higher than a downside surprise. Potential sources of an upside surprise include increased U.S. oil production, a sharper rebound in auto production and aircraft production ( Boeing BA), and a stronger housing market.

Recent news seems to support each of these potentials. U.S. oil production is now growing again after years of decline, led by increased production in North Dakota and Texas and facilitated by higher prices and new technologies.

U.S. auto production is on the mend as consumers can't put off the purchase of a new automobile indefinitely. Further fueling U.S. auto production is news out of Honda HMC that the company will produce substantially more cars in the U.S. in the years ahead, many of those for export from U.S. plants.

Boeing finally appears on the cusp of a major production jump, especially for its 787 Dreamliner. However, Boeing has been optimistic in the past only to hit snag after snag, so no one really believes them. But with real deliveries under way now and commercial flights a reality, I think the investment community is underestimating the ability of Boeing to boost the U.S. manufacturing economy in a major way.

Finally, the housing market seems to be ambling its way out of the valley of death, too. Housing starts, housing permits, and builder sentiment have all been improving over the past several months. Inventories are approaching normal levels, and affordability is at a record high even as rents continue to go up in most markets. I'm not calling for a boom, mind you. But I think for once, housing is going to be a positive for the economy in 2012. I would be shocked if housing starts in 2012 aren't meaningfully ahead of those in 2011.

Corporations Are Scared Even as Consumers Accelerate Spending
Another potential positive is businesses' cautionary stance and low inventories even in the face of decent customer demand. It looks like U.S. corporate managers are far more scared about Europe and the economy in general than the U.S. consumer is. Recent reports out of Oracle ORCL and Accenture ACN seem to suggest at least some precautionary spending cuts by corporations in the software arena. Managers also seem to be paring inventories to the bone, as inventories were a massive detractor to GDP growth in the third quarter, in anticipation of slowing consumer demand. Instead, it appears that U.S. consumers are accelerating spending as they seem to be "thrifted out" and can no longer delay certain purchases, especially autos. I believe this asymmetric world will resolve itself with the need for greater production both in the U.S. and in other world economies that export to the U.S. sometime in 2012.

So, If U.S. Growth Were to Accelerate, Could Corporations Handle It?
Even as most economists worry about Europe, deleveraging, and slow economic growth, I am more worried that if the economy does begin to rebound in a bigger way, corporations may not easily meet the new demand. Closed plants, reduced labor forces, and rock-bottom inventories just don't leave much room for upside growth, if it were to occur. The Japanese auto industry has been rocked not once, but twice in one year by major supply-chain issues (the tsunami in Japan and the floods in Thailand six months later). Even the personal computer industry (and consequentially the semiconductor industry) has been shaken by the Thailand issue. The dangers of razor-thin inventories and sole-source, single-region agreements have been laid bare over the past year. Though I don't expect to see change overnight, I've got to believe that a major rethinking of supply-chain issues is going to occur over the next several years.

Europe Remains at the Top of the Worry List
Risks remain, however. Certainly the European sovereign debt crisis remains front and center in investors' minds. The issue isn't so much that a softening in European growth prospects and austerity could kill worldwide economic growth. Instead, the concern is related to the crisis's potential to wreck havoc on the worldwide financial system.

U.S. exports to Europe represent just 3% of U.S. GDP, and a lot of that is for basic necessities that can't be bought elsewhere. However, with a web of lending in which European banks lend to sovereign governments, and those governments lend the money back to the undercapitalized banks, the failure of any one link could bring down a healthy chunk of the European banking system. The problem is, no one can see inside the relatively opaque balance sheets of European banks, so it is difficult for me or anyone else to provide a lot of reassurance to investors on this front. This type of opacity and cross-lending dependency turned a potentially minor recession in the U.S. into a near catastrophe for the world economy in 2008.

China Slowing Is an Issue for Some, but Potentially Good News for the U.S.
China certainly remains an issue, too, as growth there slows modestly and the construction industry pulls back from its break-neck pace. Slowing there is bad news for Europe, Australia, and perhaps Brazil, which are major exporters to China. It is also bad news for a lot of high-profile capital goods manufacturers in the U.S. But overall, China is an even smaller part of U.S. GDP than Europe. Furthermore, slowing growth in China could mean significantly lower commodity prices, especially in the U.S.--which would be good news for low-end U.S. consumers, who were particularly crippled by rising commodity prices in 2011.

Regulation Continues to Affect a Lot of Industries
Regulation is another risk for investors to consider. I approach this issue with some trepidation, as remarks on regulation in my last quarterly review drew more negative comments than any other single article I have written during my years at Morningstar. For now, I will stay out of the business of judging whether regulation in general was/is too light/tight, and instead say it is "impactful."

A quick perusal of our stock analysts' sector outlooks shows a regulatory/government factor in almost every one. The utility team notes new emissions protocols moving forward, the health-care team describes cuts in payments to nursing homes and potential cuts to physician payments under Medicare, and even our industrials team mentions the potential consequences of a long-term decline in the defense budget. That's on top of the Dodd-Frank legislation and pipeline meddling that I mentioned in my last outlook.

One bit of good news is that Boeing resolved the labor issue with its South Carolina plant and Dreamliner production in the last three months. However, the fight and the Labor Relations Board intervention probably had the desired effect of giving any manufacturer pause about shifting manufacturing to right-to-work states. Again, I am not saying any of this is good or bad for the long term, only that investors really need to keep a close eye on government actions.

A Savvy Consumer May Limit Profit Growth
I suspect corporate margins could begin to shrink as consumers start to gain the upper hand. Consumers are fighting every price increase tooth and nail, with the possible exception of the very high end of the market. The most recent example comes in the banking industry, where a pushback by consumers forced several major banks to cancel proposed increases in debit card fees.

Another example of consumer price sensitivity is the market for gasoline, which saw declining volumes for three quarters in a row as prices rose. Then volumes increased modestly in the third quarter when prices fell. Auto and apparel sales have also been exceptionally sensitive to price increases and decreases.

Europe Will Hurt Big Firms More Than U.S. GDP
Although U.S. GDP growth may escape the worst of the effect of a slowing Europe, U.S. multinationals may not. Many of these firms derive 20%-40% of their revenues from Europe. Since many of those goods are produced in Europe or in other non-U.S. markets, they are not counted in the U.S. GDP calculations, and they don't directly add to U.S. employment. Therefore, a weak Europe could significantly affect U.S. companies even if it doesn't make a dent in the U.S. GDP growth rate. This is the exact opposite of what we have seen over the past several years as revenue growth and earnings at S&P 500 companies have far outstripped U.S. GDP growth rates.

Does Uniform Conservatism Mean Better Times Ahead?
On balance you will find that almost all the sector analyses in this special report are cautious and guarded in their outlook, with our analysts focusing their best investment ideas on conservative, well-managed firms that feature wide economic moats. That approach makes a lot of sense in light of the big European question mark that is balanced against a desire to have some exposure to equity markets (given the paltry rates available in the bond and money markets today). However, I will add that once everyone has become uniformly cautious, it is just about the time that equity markets can provide an upside surprise. I might add that the U.S. economy is probably better positioned than most of the rest of the world economies, showing accelerating growth even as Europe falls into a recession and as growth in Asian economies slows to a more modest pace.

Financial Analysts Dim on 2012, Survey Shows - WSJ.com

2011-12-15T12:37:59-05:00

Many chartered financial analysts are throwing cold water on the idea of a prosperous new year, predicting Europe's sovereign-debt crisis will worsen and stocks to be a less-than-stellar investment.

via online.wsj.com

It is difficult to see the catalyst, in the near term, for better financial market performance at least until the "market" makes it's call regarding the US Presidential election. Markets tend to discount forward expectations so that decision could be made months in advance of the November 2012 election.

On the other side, viewed from a contrarian perspective, such negative sentiment can be seen as sign of potentially stronger markets going forward. Given the negative sentiment, an "unexpected" surprise would be more likely to be a positive surprise and thus beneficial for markets.

How you perceive and use the article's info depends on your inclination (contrarian?) and risk tolerance.

Expand Your Options for Charitable Giving

2011-12-07T11:34:22-05:00

EDITOR'S NOTE: This article was originally published in the December 2011 issue of Kiplinger's Retirement Report. To subscribe, click here.

via www.kiplinger.com

Good information for your year-end tax planning but also for potential estate planning as well.

Managing Volatility

2011-12-01T08:37:10-05:00

Despite being up over 7% for the last 5 trading days of November, the S&P 500 Index ended the month down (0.22%) and the MSCI World Index ended the month down (2.69%). These results are a clear indication of the volatility we’ve witnessed in equity markets over the last several months. When markets are volatile, sticking to a long-term investing strategy can be a challenge. To keep the ups and downs in perspective, it might help to look at past market cycles to see how recent market action compares.

Corrections of 10% or more and bear markets of at least 20% are a regular occurrence. Since 1929, there have been 18 previous 20%-plus bear markets (not including 2011 market action). Losses on the S&P 500 in those markets ranged from almost 21% in 1948-1949 to 83% during 1930-1932; the average loss for all 18 bears was 37%.* However, since 1929, the average bull market has tended to last almost twice as long as the average bear, and has produced average gains of about 79%.* Individual bull market gains have ranged from 21.4% at the end of 2001 to the nearly 302% increase registered during the 1990s.* The worst annual loss--47%--occurred in 1931, but the all-time best annual return--a capital appreciation gain of just under 47%--happened just two years later in 1933.**

This year has seen extreme volatility, with weeks and even days when swings of several hundred points in both directions on the Dow seemed to become commonplace. In the first week of August alone, 2 of the Dow's 11 best days in history alternated with 2 of its 11 worst daily point losses ever.***

While by no means normal, the highs and lows are hardly unprecedented. Even though the 634-point drop on August 8 felt historic, it didn't begin to match the real record-holders. The single biggest daily decline occurred in September 2008, when the Dow fell 778 points. The biggest percentage drop was October 1987's "Black Monday," when the Dow fell almost 23%; that makes the Dow's 5.5% loss on August 8 of this year seem relatively tame by comparison. And August 8 was followed by the Dow's 10th best day ever, with a gain of 430 points. While that upward movement may seem exceptional, the Dow's best day ever came during the dark days of October 2008, when a 936-point move up on October 13 represented a gain of more than 11% in a single day.***

The last decade has been a challenging one for stocks. Between 2001 and 2010, the S&P 500 had an average annual total return of just 1.4%, while the equivalent figure for Treasury bonds was 6.6%.**** For much of that time, interest rates were falling, helping bonds to outperform stocks. However, interest rates are now at record lows, and rising rates could change the relative performance of stocks and bonds.

Many experts predict that the global economic recovery will continue to create an uncertain investing environment in coming years, with both strong rallies and strong downdrafts. Take steps to manage your portfolio volatility as best as possible to maintain it within your risk tolerance.

Past performance is no guarantee of future results. Market indices listed are unmanaged and are not available for direct investment. All investing involves risk, including the risk of loss of principal, and there can be no guarantee that any investment strategy will be successful. The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The Standard & Poor's 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy.

DATA SOURCES: *Bull and bear market time frames, gains/losses: all calculations based on data from the Stock Trader's Almanac 2011 for the Standard & Poor's 500.

**1931 and 1933 annual stock returns: based on Ibbotson SBBI data for capital appreciation of S&P 500.

***Based on data from the Stock Trader's Almanac 2011 .

**** 10-year rolling stock returns: based on Ibbotson SBBI data for annual total returns between 2001 and 2010 of S&P 500 and an index of U.S. Treasury bonds with an approximate 20-year maturity.

The Big Dig: Fed Data Shows Households Attack Mountain of Debt | Daniel Gross - Yahoo! Finance

2011-11-29T14:38:57-05:00

The long slog continues. The feature of the post-crisis economy has been a two-speed recovery. As a group, companies have done extremely well. Corporate profits and cash holdings are at record highs. The stock market has bounced back smartly since the lows of March 2009. But consumers haven't done quite as well.

via finance.yahoo.com

GDP grew 2% according to the latest estimate. 80% of the growth came from consumers and 25% came from net exports. Government spending contributed nothing and business spending detracted 5%.

Consumers cutting debt is a rational and appropriate reaction to the excesses of the 2002-2008 real estate bubble. Keep in mind, however, that if consumers make up roughly 70% of GDP and they're cutting debt, growth will likely remain low until consumers are confident their personal debt is under control. With the latest GDP estimate coming in at 2% vs forecasts of 2.5%, it does not appear that is the case yet.