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June 2012

June 2012

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Published by Rachael Samuels

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Categories:Business/Law, Finance
Published by: Rachael Samuels on Jun 01, 2012
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Collaborative FinancialSolutions, LLC
CA Insurance License #0B33145Janet Barr, MS, ChFC, CLULPL Registered Principal206 E. Victoria StSanta Barbara, CA 93101805-965-0101
June 2012
Market-Moving Indicators for MonitoringEuropeRetirement Rules of ThumbOf Taxes Past, Present, and FutureWhat happens to my retirement benefitsif my employer goes out of business?
Market-Moving Indicators for Monitoring Europe
See disclaimer on final page
If you've struggled to make sense of theongoing European debt debacle, you're notalone. It's difficult even to keep track of all thepieces of this financial Rube Goldberg puzzle,let alone understand how they can influenceone another.Though new aspects of the situation seem tocrop up every month, here are some of themost common factors that either reflect or affectsentiment about what's happening in Europe.Knowing about them might help you understandwhy markets react to a seemingly obscureheadline. After all, one of the few things thatalmost everyone seems to agree on is that thesituation isn't likely to be solved overnight.
Take an interest in interest rates
Interest rates on sovereign debt are perhapsthe most closely watched indicator. Whendemand for a country's bonds is low becauseinvestors are concerned about the possibilitythat they might not be repaid in full and on time,that country must offer a higher interest rate inorder to borrow money to finance its day-to-dayoperations.Interest rates become particularly worrisomewhen they reach or exceed 7%. That's the levelthat prompted Greece, Ireland, and Portugal toseek bailouts from their European peers, andit's widely seen as unsustainable. When acountry must pay that much simply to serviceits debt, investors become concerned that highborrowing costs will make a country's financialsituation even worse.
Watch credit ratings
Troubled European countries are struggling todeal with a devilish Catch-22. In many cases,unsustainable debt burdens have led tostringent austerity measures; however, suchmeasures also can hamper economic growth,which reduces tax revenue and can potentiallyincrease deficits. Higher deficits can lead to alower credit rating that in turn can mean higherborrowing costs, bringing on the problemsdiscussed above and potentially launching anew downward economic cycle. Thus, adowngrade to a country's credit rating tends toraise concerns.However, investor reaction also can beunpredictable. For example, Standard & Poor'sJanuary downgrade of nine sovereign nationsand the European Financial Stability Fund waslargely met with a shrug by investors. There'sbeen so much pessimism about Europe for solong that in some cases, markets may alreadyhave priced in much of the bad news.
Monitor credit default swap costs
A credit default swap (CDS) is a form ofinsurance against the possibility that a bondissuer might default or fail to make a paymenton its obligations. Bondholders buy a CDS froma financial institution or insurance company thatpromises to reimburse the bondholder for anylosses sustained in the event of a default. Thecost of that insurance is seen as a proxy for theperceived risk involved in investing in aparticular country's bonds. The higher the costof a CDS on, say, Italian sovereign debt, thegreater the anxiety about whether the bondissuer will default and the CDS issuer will haveto pay.
Follow the money
To prevent credit markets from seizing up, theEuropean Central Bank late last year providedalmost €500 billion in three-year loans toEuropean banks, making it easier for them torefinance their debt. The level of borrowing atthe ECB is seen as one indicator of how banksare being affected by their holdings ofsovereign debt. The greater the need to borrowfrom the ECB, the greater the banks' perceivedlevel of vulnerability.
Bailouts: Nein nein nein?
U.S. voters aren't the only ones who aresensitive about bailouts; so are Germans. AsEurope's most powerful economy and the onewith the best credit rating, Germany is thetentpole upon which European financial stabilityhangs. However, by the end of 2011, theGerman economy had begun to slow. Anyindications that economic pressure couldthreaten Germany's ability and willingness toremain strong in its support of the eurozone canspook anxious investors.
Page 1 of 4
Retirement Rules of Thumb
Because retirement rules of thumb areguidelines designed for the average situation,they'll tend to be "wrong" for a particular retireeas often as they're "right." However, rules ofthumb are usually based on a sound financialprinciple, and can provide a good starting pointfor assessing your retirement needs. Here arefour common retirement rules of thumb.
The percentage of stock in a portfolioshould equal 100 minus your age
Financial professionals often advise that ifyou're saving for retirement, the younger youare, the more money you should put in stocks.Though past performance is no guarantee offuture results, over the long term, stocks havehistorically provided higher returns and capitalappreciation than other commonly heldsecurities. As you age, you have less time torecover from downturns in the stock market.Therefore, many professionals suggest that asyou approach and enter retirement, you shouldbegin converting more of your volatilegrowth-oriented investments to fixed-incomesecurities such as bonds.A simple rule of thumb is to subtract your agefrom 100. The difference represents thepercentage of stocks you should keep in yourportfolio. For example, if you followed this ruleat age 40, 60% (100 minus 40) of your portfoliowould consist of stock. However, this estimateis not a substitute for a comprehensiveinvestment plan, and many experts suggestmodifying the result after considering otherfactors, such as your risk tolerance, financialgoals, the fact that bond yields are at historiclows, and the fact that individuals are now livinglonger and may have fewer safety nets to relyon than in the past.
A "safe" withdrawal rate is 4%
Your retirement income plan depends not onlyupon your asset allocation and investmentchoices, but also on how quickly you drawdown your personal savings. Basically, youwant to withdraw at least enough to provide thecurrent income you need, but not so much thatyou run out too quickly, leaving nothing for laterretirement years. The percentage you withdrawannually from your savings and investments iscalled your withdrawal rate. The maximumpercentage that you can withdraw each yearand still reasonably expect not to deplete yoursavings is referred to as your "sustainablewithdrawal rate."A common rule of thumb is that withdrawal of adollar amount each year equal to 4% of yoursavings at retirement (adjusted for inflation) willbe a sustainable withdrawal rate. However, thisrule of thumb has critics, and there are otherstrategies and models that are used tocalculate sustainable withdrawal rates. Forexample, some experts suggest withdrawing alesser or higher fixed percentage each year;some promote a rate based on your investmentperformance each year; and some recommenda withdrawal rate based on age. Factors toconsider include the value of your savings, theamount of income you anticipate needing, yourlife expectancy, the rate of return you anticipatefrom your investments, inflation, taxes, andwhether you're planning for one or two retiredlives.
You need 70% of your preretirementincome during retirement
You've probably heard this many times before,and the number may have been 60%, 80%,90%, or even 100%, depending on who you'retalking to. But using a rule of thumb like thisone, while easy, really isn't very helpfulbecause it doesn't take into consideration yourunique circumstances, expectations, and goals.Instead of basing an estimate of your annualincome needs on a percentage of your currentincome, focus instead on your actual expensestoday and think about whether they'll stay thesame, increase, decrease, or even disappearby the time you retire. While some expensesmay disappear, like a mortgage or costs fortransportation to and from work, new expensesmay arise, like yard care services, snowremoval, or home maintenance--things that youmight currently take care of yourself but maynot want to (or be able to) do in the future.Additionally, if travel or hobby activities aregoing to be part of your retirement, be sure tofactor these costs into your retirementexpenses. This approach can help youdetermine a more realistic forecast of howmuch income you'll need during retirement.
Save 10% of your pay for retirement
While this seems like a perfectly reasonablerule of thumb, again, it's not for everyone. Forexample, if you've started saving for retirementin your later years, 10% may not provide youwith a large enough nest egg for a comfortableretirement, simply because you have feweryears to save.However, a related rule of thumb, that youshould direct your savings first into a 401(k)plan or other plan that provides employermatching contributions, is almost universallytrue. Employer matching contributions areessentially "free money," even though you'll paytaxes when you ultimately withdraw them fromthe plan.
Rules of thumb are usually based on a sound financial principle, and can provide a good starting point for assessing your retirement needs.
Page 2 of 4, see disclaimer on final page
Of Taxes Past, Present, and Future
With the 2011 tax filing season behind us,much attention is being paid to the expiring"Bush tax cuts"--the reduced federal income taxrates, and benefits, that will expire at the end of2012 unless additional legislation is passed. Infact, though, several important federal incometax provisions already expired at the end of2011. Here's a quick rundown of where thingsstand today.
What's already expired?
A series of temporary legislative "patches" overthe last several years has prevented a dramaticincrease in the number of individuals subject tothe alternative minimum tax (AMT)--essentiallya parallel federal income tax system with itsown rates and rules. The last such patchexpired at the end of 2011. Unless newlegislation is passed, your odds of being caughtin the AMT net greatly increase in 2012,because AMT exemption amounts will besignificantly lower, and you won't be able tooffset the AMT with most nonrefundablepersonal tax credits.Other provisions that have already expired:
Bonus depreciation and IRC Section 179 expense limits-- 
If you're a small businessowner or self-employed individual, you wereallowed a first-year depreciation deduction of100% of the cost of qualifying propertyacquired and placed in service during 2011;this "bonus" depreciation drops to 50% forproperty acquired and placed in serviceduring 2012, and disappears altogether in2013. For 2011, the maximum amount thatyou could expense under IRC Section 179was $500,000; in 2012, the maximum is$139,000; and in 2013, the maximum will be$25,000.
State and local sales tax-- 
If you itemize yourdeductions, 2011 was the last tax year forwhich you could elect to deduct state andlocal general sales tax in lieu of state andlocal income tax.
Education deductions-- 
The above-the-linededuction (maximum $4,000 deduction) forqualified higher education expenses, and theabove-the-line deduction for up to $250 ofout-of-pocket classroom expenses paid byeducation professionals both expired at theend of 2011.
What's expiring at the end of 2012?
After December 31, 2012, we're scheduled togo from six federal tax brackets (10%, 15%,25%, 28%, 33%, and 35%) to five (15%, 28%,31%, 36%, and 39.6%). The rates that apply tolong-term capital gains and dividends willchange as well. Currently, long-term capitalgains are generally taxed at a maximum rate of15%. And, if you're in the 10% or 15% marginalincome tax bracket, a special 0% rate generallyapplies. Starting in 2013, however, themaximum rate on long-term capital gains willgenerally increase to 20%, with a 10% rateapplying to those in the lowest (15%) taxbracket (though slightly lower rates might applyto qualifying property held for five or moreyears). And while the current lower long-termcapital gain rates now apply to qualifyingdividends, starting in 2013, dividends will betaxed at ordinary income tax rates.Other provisions expiring at the end of the year:
2% payroll tax reduction-- 
The recentlyextended 2% reduction in the Social Securityportion of the Federal InsuranceContributions Act (FICA) payroll tax expires atthe end of 2012.
Itemized deductions and personal exemptions-- 
Beginning in 2013, itemizeddeductions and personal and dependencyexemptions will once again be phased out forindividuals with high adjusted gross incomes(AGIs).
Tax credits and deductions-- 
The earnedincome tax credit, the child tax credit, and theAmerican Opportunity (Hope) tax credit revertto old, lower limits and (less generous) rulesof application. Also gone in 2013 is the abilityto deduct interest on student loans after thefirst 60 months of repayment.
New Medicare taxes in 2013
New Medicare taxes created by the health-carereform legislation passed in 2010 take effect in just a few short months. Beginning in 2013, thehospital insurance (HI) portion of the payrolltax--commonly referred to as the Medicareportion--increases by 0.9% for high-wageindividuals. Also beginning in 2013, a new 3.8%Medicare contribution tax is imposed on theunearned income of high-income individuals.Who is affected? The 0.9% payroll tax increaseaffects those with wages exceeding $200,000($250,000 for married couples filing a jointfederal income tax return, and $125,000 formarried individuals filing separately). The 3.8%contribution tax on unearned income generallyapplies to the net investment income ofindividuals with modified adjusted gross incomethat exceeds $200,000 ($250,000 for marriedcouples filing a joint federal income tax return,and $125,000 for married individuals filingseparately).
Qualified charitable distributions 
A popular provision allowing individuals age 70½ or older to make qualified charitable distributions of up to $100,000 from an IRA directly to a qualified charity expired at the end of 2011. These charitable distributions were excluded from income, and counted towards satisfying any required minimum distributions that you would have had to take from your IRA for the year.
Return of the "marriage penalty"? 
Tax changes that were originally made to address a perceived "marriage penalty" expire at the end of 2012. If you're married and file a joint return with your spouse, you'll see the effect in the form of a reduced 2013 standard deduction amount, as well as in lower 2013 tax bracket thresholds in the tax rate tables (i.e., couples move into higher rate brackets at lower levels of income).
Page 3 of 4, see disclaimer on final page

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