How Could Changes to 401K Contribution Limits Affect You?

The discussion about possible changes to annual 401k contributions continues. Republicans say that reducing tax-deductible contributions today will increase tax revenue. Democrats say that raising contribution limits will help people save more for tomorrow. Let me share some issues of genuine concern regarding both approaches.

Most of the families we serve either earned too much money to qualify for a Roth contribution (there is no income limit for a Roth 401k contribution), or retired shortly after the Roth was introduced in 1998. In short, the majority of their retirement savings are held in tax-deferred investments. People concerned about losing tax-deferred investment opportunities have not seen what happens to retirees when Required Minimum Distributions (RMB) begin at age 70.5.

Deferring taxes feels good in the moment.  But the pain of paying taxes when mandatory withdrawals begin has left more than one of our families in tears. That unfortunate situation is especially sad when one spouse passes away. One widower asked me, “Joe, why should an 82-year-old man be forced to withdraw $94,000 and pay taxes on it at a high tax rate?” He asks a good question. As always, you either pay the IRS today or you pay them later.

The other side of the aisle wants to increase tax-deferred contribution limits. They reason that higher limits will encourage people to save more for retirement. But realize that most young families are not fully taking advantage of today’s maximum contribution limits. Increasing the amount of taxes that unsuspecting future retirees can defer today is not helpful for several reasons.

We favor neither option because we don’t like regulations that force investment behaviors. Working in this industry for 30 years, I’ve seen that families who can contribute the maximum amount to their 401k continue to do so, regardless of tax deductions. These folks will complain about a lost deduction because they are natural savers. The families who don’t save for retirement are already paying taxes on their income so the change in contribution limits won’t change anything.

Raising limits on tax-deferred contributions will allow people who don’t plan well for future tax rates to put themselves in greater jeopardy today. This approach is like tax cocaine. It may feel great at the moment, but the morning is coming! Who doesn’t want to pay less in taxes today?

Financial journalists will share the viewpoints of those who benefit from tax deferrals. Such entities include insurance providers and mutual fund companies. These businesses have skin in the game if tax-deferred contributions are increased or lowered. Let’s focus on where we are today. Let’s make the best decisions possible.  When things inevitably change, we will help families create the best strategy based on their unique situation.

Perhaps the only thing I can do as a fiduciary that is more important than getting you on the right track today, is assuring you that I will be here tomorrow when things need to change.

Tax advice provided by CPA’s affiliated with Financial Enhancement Group, LLC.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

Consider This… Radio Show 11/4/2017

Here is this week’s radio show, hosted by Joe Clark, CFP with Sherri Contos.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

Time, Value and Long-Term Investment Performance

Being a great investor and managing your retirement are two different things. Ray Dalio, founder of the largest hedge fund in the world, Bridgewater Associates, said “To be a truly great investor you have to bet against the consensus and then be right.”  

While Dalio’s insight is not revolutionary, there is a secret to investing. Investors can only buy what others are selling. As one person pays a certain price for a share of stock, another individual is willing to sell at virtually the same price.  What makes the buyer think he or she knows more than the seller?

At the Financial Enhancement Group, we manage approximately $320 million for families in 31 states. Data does not dictate the stocks we buy and sell. Instead, we buy and sell stocks based on each family’s needs. In sporting terms, our objective is to get on base. We do not intend to always hit a home run by selecting a stock that quickly triples in value. Our buying and selling decisions are not based entirely on opinions about a stock’s valuation. Instead, decisions are based on an investor’s current need and how an investment fits into the investor’s strategy. Valuation still matters, but it is not the only factor influencing investment decisions.

A long-term investment strategy requires sticking to a disciplined process. Investors cannot allow themselves to become distracted by shiny new offerings. Nor can investors afford to be dazzled by trends. Our in-house Chartered Financial Analyst (CFA®) charterholder, Adam Harter, recently reviewed some interesting research on returns and future valuations.

The research from GMO, Worldscope, Compustat and MSCI, examined stock returns from 1970 through December 2016. The research then compared each stock’s performance to its performance over the past seven years. The resulting insights are important and meaningful for disciplined investors. However, the research findings are less important for people trying to score “home runs” with individual stocks.

The individual companies that make up an index change more often than most people think. More than one-third of the companies in the S&P 500 today were not part of the index in 2000. As an unmanaged index, the S&P 500 was never designed to guide investment decisions.

A stock’s past return is broken into four parts: dividends, margin, multiples paid by investors and real growth. “Dividends” are the profits returned to shareholders. “Margin” is the profitability increase resulting from inventory management, technology improvements and capacity utilization. “Multiples” represent the amount investors are willing to pay for that profit. (For instance, consider a stock’s price-to-earnings ratio moving from 13 to 18.) “Real growth” represents actual growth of the stock after backing out inflationary impacts.

Real growth for the S&P 500 between 1970 and 2016 was 6.3% annually. The dividend was the largest contributor at 3.4%. Real growth (after inflation) was 2.3%. Margin and multiple were virtually nonexistent. Over the last seven years, we have averaged growth of 13.6% with dividends being the least significant. Analysts, including Harter, question if that pace can continue.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

Consider This… Radio Show 10/28/2017

Here is this week’s radio show, hosted by Joe Clark, CFP with Sherri Contos.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.

Consider This… Radio Show 10/21/2017

Here is this week’s radio show, hosted by Joe Clark, CFP with Sherri Contos.

Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer.