October 1998 Newsletter

Financial Security by Design
925.299.0472 or Fax 925.299.0473
e-mail: lingane@post.harvard.edu

October 1998 Newsletter

Tomorrow is Halloween and the market is spooky. The rapid twenty percent decline in the third quarter and the astonishing October regain of half the lost ground demonstrates why market timing is so very difficult.

Stock Market Performance. The diversified stock mutual fund benchmark was down a little over eleven percent for the quarter ending September 30. The benchmark is up three percent over the twelve months ending September 30 and up 68 percent over the past three years. Volatility (risk) is a little better than the stock market as a whole as measured by the Vanguard Total Stock Market fund. If your stock portfolio exceeded this benchmark, or matched it at lower risk, then the wrong person is writing this letter. Congratulations.

If your stock portfolio has not done as well as the benchmark, I encourage you to understand the reasons why. There may be special circumstances which affect your portfolio or it may be appropriate to examine your investment strategy, specific investments or investment expenses.

Capital Gains. The capital gains rates have been changed, again. Now, any asset held more than one year will be taxed at a 20% federal rate (10% if you are in the lowest federal tax bracket.) The eighteen month holding period has been repealed retroactive to January 1, 1998.

Many mutual funds closed their books for the 1997 fiscal year before the effective date of this legislation and it appeared that they would have to distribute "mid term gains." Fortunately, the omnibus spending bill signed a few weeks ago allowed the funds to make everyone’s life a little less complex.

The tax code allows mutual funds to accumulate unrealized capital gains only until assets are sold. Thus, mutual fund distributions are more reflective of performance a year or two ago than they are of recent performance. I predict, therefore, that many mutual funds will make unusually large distributions this December even though 1998 gains may be modest.

My general rule is to not buy a mutual fund less than three months before the year end distribution so as to avoid with a tax liability shortly after purchase. Investing after the distribution is especially good advice this year because year end distributions are probably going to be bigger than usual.

If you were planning to sell a fund, selling before the distribution is likely to result in less tax because your entire appreciation is taxed as a capital gain.

An important part of year end planning is determining how much of your state estimated tax payment to pay in December. Most people benefit from paying state tax early but think carefully if your state tax payment is large and if you have large capital gains income or incentive stock options. If you are careless, you could get stuck with a nasty Alternate Minimum Tax liability.

Roth IRA. The federal government approved legislation which allows you to reverse a Roth conversion for any reason. They even coined a new word "recharacterization" to describe the annulment process. Governor Wilson vetoed similar California legislation for an unrelated reason in September but the Franchise Tax Board, with admirable creativity, decided that it has the administrative authority to allow recharacterization for California income tax purposes. Details may be found on my web site.

Recharacterization provides a safe haven for someone who is concerned they might exceed the $100,000 conversion ceiling. Recharacterization, followed by a second conversion, also allows someone who converted before the third quarter market decline to reduce his income tax liability.

I spoke on the Roth IRA to the Denver chapter of the American Association of Individual Investors. The San Francisco chapter is sponsoring the presentation on November 18th at the Veterans’ Building in Lafayette at 7 p.m. Give me a call and I’ll arrange for tickets. The Denver group kept me busy with questions for more than two hours. If you can’t make the Lafayette talk, I will send you the presentation or you can print it from my web site after mid November.

Web Site. www.lingane.com/tax is only three months old but it has already had one hundred fifty visitors. My goal is to post educational materials and developments in the tax and financial areas where I practice. This site is an awfully good way for you to evaluate my planning and financial philosophy. Give it a try and please let me know which parts you find useful. Many libraries provide Internet access if you do not have a computer.

Pension Distributions. Those born before July 1, 1927 must take a minimum distribution from IRAs and pension plans by December 31st. If you do not receive the forms from your plan custodian, give them call. If you have questions about how to fill out the forms or to calculate the distribution, give me a call. There is a 50% penalty if you fail to take out the required amount.

(Chris Caul of Pension Reporting Systems in Oakland, CA has pointed out that the date for beginning distributions from employer sponsored pension plans can be delayed until retirement, so long as you don't own 5% of the shares of the company which employs you. The option of delaying distributions until retirement DOES NOT APPLY to traditional IRAs. See IRC 401(a)(9)(C)(ii)(II). Posted 11/7/98.)

If you were born between July 1, 1927 and June 30, 1928, you are allowed to delay the distribution until April 1st of next year. There are two very important decisions to be made before taking this initial distribution: whom to name as your beneficiary and whether to recalculate life expectancies. These decisions determine how quickly your pension is distributed and poor choices can cost your heirs big bucks. Even if you change your beneficiary at a later date, you are generally locked into the initial distribution scheme forever.

The default option is to refigure life expectancies. This is unfortunate since recalculating a spouse’s life expectancy is usually not the best choice. IRS Publication 590, which can be obtained free by calling 1-800-829-FORM, describes the rules and Seymour Goldberg’s "How to Pay Less Tax on Your Retirement Savings" (Macmillan, $20) describes the pitfalls of an ill considered beneficiary scheme. Give me a call if you need further assistance.

Incidentally, converting to Roth can get you out from under a poor distribution scheme.

Power of Attorney. Since we are on the subject of pension beneficiaries, let me encourage you to check the powers that you have granted in your durable power of attorney. Your agent needs to be able to manage your pension investments but the statutory language also gives your agent authority to change pension beneficiaries. It’s a simple matter for your lawyer to add a sentence or two withholding the power to change beneficiaries or to limit the conditions under which beneficiaries can be changed.

Personal. My beans and melons finally ripened and my cucumbers, egg plants and tomatoes are still producing.

I will be training the Tax Counseling for the Elderly volunteers this January. If you would enjoy helping others with their taxes four hours a week, please call (888) 227-7669. The free training is great and there is no obligation to be an AARP member.

I hope that you, your family and friends will be able to enjoy the Thanksgiving and holiday celebrations together.

As always, feel free to call or e-mail me with your tax and planning questions.

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