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The Advisory Firm Newsletter:  February 2013

THIS MONTH IN PERSONAL FINANCE: The tax man is coming.......

 

This month we will continue with our discussion on tax facts (since April 15th is right around the corner) by recapping some key personal tax numbers, summarizing Roth / IRA contributions, and wrap it up with a discussion on interest rate risks in bond allocations.

Preliminary Key Financial Data for 2013:

Fresh off the press I have the official tax facts for 2013, If you downloaded the preliminary version last month please update with this latest copy. If you want a laminated copy to keep around the office, just email me with your address and I'll send out.

financial facts

Recap of key numbers for 2012:

(Hopefully this will keep you from bugging your accountant, you can still contribute up to April 15th)

  • Non-deductible IRA contribution limits: $5000 with over age 50 catchup $1000. Anyone can contribute as there is no-deduction on taxes.
  • Deductible IRA contribution: same limits as above, but for 2012 if you have access to 401k and your income is above $92k joint / $58k individual your ability to contribute phases out.
  • Roth IRA contribution: same limits as above, as long as your adjusted gross income is below $173k joint or $110k individual you are okay, above that it phases out completely at $183k or $125k respectively.
  • Roth Conversion: there is always a lot of talk about converting a "traditional" IRA to a Roth. The income caps have been removed so anyone can do it. Just remember that you will need cash on the sidelines to pay income taxes when you convert the traditional IRA. To the tax man it looks just like ordinary income. KEY POINT: I mentioned this recently, be careful if you do the Non-deductible contribution and immediately convert to the Roth, there are traps that I outlined in December's newsletter.
  • The $5000 contribution limit is an aggregate number, meaning this is the total amount you can put in all IRA's (across a Roth, Traditional). No double dipping.

What's new for 2013:

All this is in the Financial Guide linked above, but for those that need a quick summary:

  • Non-deductible IRA contribution limits: $5500 with over age 50 catchup $1000. Anyone can contribute as there is no-deduction on taxes.
  • Deductible IRA contribution: same limits as above, but for 2013 if you have access to 401k and your income is above $95k joint / $59k individual your ability to contribute phases out.
  • Roth IRA contribution: same limits as above, as long as your adjusted gross income is below $178k joint or $112k individual you are okay, above that it phases out completely at $188k or $127k respectively.
  • 401k contribution limit for 2013: $17,500 over age 50 catchup is an additional $5500.
  • For those putting away the big money the overall Defined Contribution limit (employee contribution, employer contribution, profitshare, etc) is $51,000.

More interesting facts for 2013:

  • If you are in the 39.6% tax bracket, your dividends and capital gains from investments will be taxed at 20%. For everyone else, your dividend and cap gains will be taxed at 15%.
  • If you retire and claim social security benefits early (before your Full Retirement Age) you are eligible to earn up to $15,120 in 2013 before your SS benefits get penalized. For ages 62 to 64 the penalty is $1 for every $2 you earn over the limit. For age 65 (and turning 66 in 2013) you can earn up to $40k before getting penalized.
  • NOTE: SSA will not penalize you for a partial year of work before you claim benefits. It's only once your social security benefits start and you continue to earn an income that the above will affect you.

_____________________________________________________

 

 

What's up with the talk of a Bond Bubble?:

Maybe it is just me, but I seem to see a lot of news stories about the so-called "Bond Bubble". In an effort to educate readers I'll breakdown what this is referring to along with a brief discussion of interest rate risk (also known as duration), then let you make up your on mind as to the potential risks:

First of all, the Bond Bubble has nothing to do with the actor Daniel Craig or the movie franchise. We are talking fixed income investments that you probably hold in your investment accounts. Those fixed income investments may be in the form of individual bonds or more likely in Bond Mutual Funds.

Most investors have a portfolio that has some type of allocation model (60/40 or 80/20, etc). The 60 would mean 60% Stock funds and 40 would mean 40% bond funds. Simple enough, right? This is traditional Asset Allocation modelling, whether you have designed yourself or with the help of a financial advisor.

Since the top of the tech bubble in early 2000, bonds have steadily increased in price (principal value) as interest rates have fallen. The 10 year treasury note was paying 6.5% annual interest in 2000. Now it is paying just under 2%. To give you a visual, think of a see-saw when you were a kid. As one end goes down the other comes up. That is exactly what has happened with Bonds, as interest rates have dropped over the past 13 years the price of the bonds have risen. So your total return over the past decade has been fairly nice on what we assume to be the conservative part of your investment portfolio.

Could danger be lurking?

It's been a heck of a run in bonds, but we are at a point where you could actually achieve a negative short/intermediate term return if rates rise. How is this possible? We are all familiar with the Federal Reserve's Quantitative Easing program, where they have gone into the market and purchased treasuries in order to keep rates artificially low to stimulate the housing recovery. The issue as we saw last week when the Fed Reserve meeting notes were released is that they are now debating how to exit this program. If they do, then interest rates will more than likely begin to rise. As rates rise bond prices will drop.

If you are a long term holder then you will probably be okay, your bonds may give back some principal value but over time the higher rates will compensate you with dividends. If on the other hand you are closer to retirement and don't want to see your account value drop then you need to figure out how much interest rate risk your fixed income allocation has. This value is called Duration and can be thought of as the % your bonds would drop with a 1% rise in interest rates.

Estimated Duration of key fixed income components (courtesy of S&P, Bloomberg and Barclays):

5 year treasuries duration = 4.88

10 year teasury duration = 9.02

Barclays US Aggregate Bond duration = 5.20

ML High Yield index duration = 4.23

 

Is there a solution?

Unfortunately we are at a junction where everything has risk, but reviewing your "conservative" bond allocation might be a good idea. One strategy would be to diversify your fixed income holding geographically and take a look at foreign and/or emerging market bonds. Another would be to look at alternatives to traditional bonds, such as floating rate loan funds or funds backed my mortgage debt. And a final option would be to find the lowest duration (shortest term) fixed income fund you can, if you think rates will move significantly this year. *Please remember that all of these have risks and may not be right for everyone.

Summary:

Simply make sure you are not lulled into a false sense of security if you are a conservative investor. Bonds have been a great hold and we all still use them in portfolios. Just go in with your eyes open as to the risks lurking. Maybe the Fed is successful in keeping rates low indefinitely, or maybe they begin to rise this year. No one knows, but at least you will have a plan of attack whatever happens.

 

 

I hope you enjoyed this months newsletter. If you have any questions about planning or investing feel free to drop me an email:

James A. Daniel, CFP

 

Disclaimer: this information is for general purposes and should not be considered tax advice. Talk with your accountant and/or advisor before implementing!

© 2011 The Advisory Firm. All Rights Reserved.


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The Advisory Firm, LLC provides fee-only financial planning services for clients throughout metro Atlanta and North Georgia including the communities
of Alpharetta, Canton, Cumming, Dawsonville, Duluth, Dunwoody, Marietta, Midtown, Roswell, and Woodstock.

This newsletter if for informational purposes only. The information contained within should not be considered as financial advice nor soliciation
for financial services. Consult with your financial professional if you have any questions. The Advisory Firm, LLC is a fee-only financial planning company and registered investment advisor.