Financial Frontlines®

With money market funds and short-term CDs paying next to nothing, investors are anxiously looking for higher-yield investments. This is a dangerous distraction that has caused many of them to forget why they put their money in these securities in the first place: safety.

A higher rate of return is attractive but higher returns inevitably involve higher risks.  So if your primary objective is safety (that is, getting a dollar back for every dollar you invest) taking on more risk, even with the promise of a higher rate of return, could be a big mistake.

Choosing between higher returns (and greater risk) or safety (and lower returns) has everything to do with your investment objective.  You have to distinguish between investment capital and savings.  Investment capital is money that can be set aside for the long-term while savings consists of money needed to pay near-term financial commitments and emergency funds.  If you know that this money must pay for Johnny’s tuition in six months, then safety is paramount and you need to keep that money in a money fund or a six-month CD.  The same holds true for an emergency fund.  If you unexpectedly need to tap into your emergency fund to fix a leaky roof, you don’t want to come up short because your bond fund has dropped.  This is “safe” money so you just can’t take chances with it.

On the other hand, if this is investment capital then looking for higher returns is probably the right thing to do.  I define investment capital as money that you don’t expect to need for at least five years.  Five years is roughly equivalent to a full market cycle so if you invest at the start of the down portion of the cycle, you want to be reasonably certain that you can stay invested and recover your losses through the up portion of the cycle.  If you can’t expect to stay invested for five years then you should stay in money funds, CDs or short-term bonds.

Choosing between higher returns and safety isn’t always easy but it is helpful to remember what  Will Rogers used to say on the subject: “I am more concerned about the return of my money than the return on my money.”

In 2010 the IRS will remove the income limit on conversions from Nondeductible IRAs and Traditional IRAs to a ROTH IRA. We anticipate the tax law change to create a marked increase in conversion activity in 2010. Undoubtedly, savvy individuals and investment managers will take advantage of this opportunity to insulate themselves and their clients against possible future higher income tax rates. Previous to 2010, households with Modified Adjusted Gross Income (MAGI) exceeding $100k were ineligible to make conversions to ROTH IRAs. This change is welcomed news for those households who have been unable to invest in deductible Traditional IRAs or ROTH IRAs due to income limitations.

The Tax Increase Prevention and Reconciliation Act of 2005, signed into law on May 17, 2006, created the loophole which takes effect in 2010. To demonstrate the potential benefit of this loophole, a previous ineligible household who has not made contributions to an IRA this year could ultimately fund a ROTH IRA with $20k by April 15, 2010. That number increases to $24k for qualified wage earners, married filing jointly, and at least 50 years old. How can this be done? It’s really a simple process. First, establish a Nondeductible IRA and contribute $5k for each spouse for 2009 and again in 2010, then convert the balance into a ROTH IRA in 2010.

Washington’s unabated printing of the U.S. Dollar is setting the stage for future income tax increases. Policy makers have already zeroed in on those earning $250k/year and we anticipate that number to creep lower as spending continues and the deficit surges. The federal debt for Fiscal Year 2009 was $1.4 Trillion. Enacting a conversion strategy now and in future years (until Congress changes the law) enables investors to keep more of their hard earned money as converted ROTHs will provide tax free growth and tax free distributions (as long as distributions are qualified).

Conversions of Traditional IRAs to ROTHs may also be a timely option for those impacted by the current economic downturn. Individuals who have seen a drop in their personal income can benefit from converting their Traditional IRA to a ROTH in 2010 as well. Reduced income levels and low current tax rates equate to a lower tax bill if converted now as opposed to the future when personal incomes recover and tax rates increase. In addition to personal income levels, many retirement accounts have also seen a significant drop in value. Converting now makes sense, as lower current account values translates into lower tax liabilities. The market has rallied nicely this year and as it continues to recover and account balances increase all the gains made over the ensuing years will be tax free when withdrawn as qualified distributions. As if it couldn’t get any better, the IRS is providing an additional benefit in 2010 by extending the timeline for payment of taxes.

Conversions completed in 2010 can be paid over a two year period, reducing the immediate income tax burden for those who convert. This can help offset cash flow concerns for investors in these tough economic times. Understanding the three possible taxation methods is critical and must be reviewed to ensure proper calculation of tax liability. Taxation is based on the type of IRA accounts you own, Nondeductible, Traditional or a combination of both.

1. Investor owns only a Nondeductible IRA: Taxation is based on the gain above contribution. If the investor previous to this year did not own an IRA, he could apply the strategy outlined in paragraph two and incur only a minimal income tax liability, (gain above contribution) while fully funding a ROTH IRA for 2009 and 2010. This is a significant benefit for those who were previously ineligible and made no prior IRA contributions.
2. Individual owns only a Traditional IRA: The entire conversion amount is taxed at their income tax rate.
3. Individual has both a Traditional and Nondeductible IRAs: The balances of each type of account must be aggregated to determine the applicable income tax liability. Example, if an individual has $20k in Traditional IRAs and $10k in Nondeductible IRAs, 2/3 of the conversion amount would be subject to the individual’s income tax rate.

The decision of converting a Nondeductible and/or Traditional IRAs to a ROTH IRA is one that must be analyzed. There are numerous assumptions and planning factors that should be considered to make an informed decision. If one can foresee the future and know that they will be in a higher tax bracket in retirement then the tax free growth and tax free qualified withdrawals are a convincing option for conversion. One should thoroughly research the 2010 conversion tax laws and assess their personal circumstances prior to making a decision and/or seek professional assistance.

• Typically conversions will benefit those who anticipate being in a higher tax bracket in retirement
• IRA Conversions which have not been taxed are includible in your gross income in the year of conversion (Taxes on conversions made in 2010 can be paid over a 2 year period)
• If funds are not available to pay the taxes it is not advisable to use retirement funds to pay the taxes
• You MUST submit IRS Form 8606 for Non-deductible IRA contributions each year a contribution is made
• Converted ROTH can play an effective role in Estate planning for taxes and minimum withdrawals

By Navy Lt. Jennifer Cragg
Special to American Forces Press Service

WASHINGTON, Dec. 11, 2009 – After an initial delay caused by software and manpower issues, the first retroactive payments will be disbursed next week to soldiers who were retained on active duty involuntarily under the so-called “Stop Loss” program.

Army Maj. Roy Whitley, program manager for the Army’s Retroactive Stop Loss Special Pay program, acknowledged problems over the program’s first 50 days and said officials are working to reduce the current backlog for the thousands more who are expected to file their claims over the next year.

“We are going to plow through the backlog as quickly as we can,” said Whitley, who spoke with bloggers and online journalists yesterday during an Army bloggers roundtable.

“We lost time [by] improving the claims end early on,” he said. “For every day we spent working the claims, we knew we were losing a day on development and case management.

“We are building it out [and] improving software. [That is] the reason why you are seeing some delay.”
Parts of the initial Web-based claims program, launched Oct. 21, lacked complete functionality, and many of the claims were processed manually, Whitley said. However, he added, the case-management software is expected to be finalized this week, closing at least 1,000 cases. Those cases will then be forwarded to Defense Finance and Accounting Service for payment.

“The latest enhancement gives us the ability to close the cases,” Whitley said, and will allow Army claims managers to advise claimants on the status of their claims.

He added that he is working on adding more claims managers to his staff of 14. “We saw the volume coming forward,” he said, “and we knew we had to make some changes both on software and personnel.”

As soon as the software changes are tested and finalized, he added, his staff will be better able to ease the backlog.

“We are hoping this will knock down on the anxiety caused by our backlog and e-mails,” Whitley said. “We are really working through those and trying to focus exclusively on claims clearing.”

The deadline to submit Stop Loss pay claims is Oct. 21.

(Navy Lt. Jennifer Cragg serves in the Defense Media Activity’s emerging media directorate.)

I have recently learned of a couple of organizations I think are using the front of helping with VA benefits as a way to meet prospective customers. These groups solicit for your business. They offer to get you money from the VA for long term care cost, assisted living, or survivor benefits. Tread lightly around these offers.

I have no evidence or indication that these organizations have or will cause harm. One has the Better Business Bureau seal on its web site. On the surface, they appear legitimate. So why are my senses peaked?

• Because both organizations have at their base, a financial services firm.
• Because neither of the organizations is an official Veteran Service Organization (VSO). VSOs are chartered by the VA to act as an official VA representative for members on VA matters.
• Because I question the motives behind a financial service firm’s interest in helping military members with issues that get them nothing in return—except the likelihood of finding new customers and getting access to your accounts.
• The process, bureaucracy and time involved in helping members with VA programs is substantial so these organizations (the financial service firms at their root) are doing this out of the goodness of their hearts?
• They are ‘helping’ in an area that is not their core business.
• I can’t get a satisfactory answer about how they make their money.
• It just so happens that helping with some of these VA programs provides access to a military member’s complete financial information.

If you need help learning about VA programs or with a VA application process, I highly recommend you work with an approved VSO. It’s their job to help you at no cost. To find a VSO check here.  You can also check with your state VA department and your state’s network of county veteran service officers.  Find your county office here.

 If someone approaches you to help with a VA application, claim, or appeal, check to see if they are a VSO.  Chances are they won’t be because VSOs don’t solicit for your business, you have to find them.  It’s a too-good-to-believe story if there ever was one.

****************************************************

UPDATE 20 July 2010

Based on the story of one of our MOAA members and this Bloomberg Businessweek Magazine article, the picture on these commercial financial firms parading as Veteran Service Organizations (VSO) is starting to develop.

Once in the front door by stating they can help get you VA’s Aid and Attendance money, they want to reorganize your finances in trusts and annuities claiming it is how they make you eligible for the money.  The Businessweek article and our MOAA member tell the same story.

The VA’s Aid and Attendance program is to help provide extra money to those veterans and their spouses who have long term care needs.  The VA also has a program called Housebound that serves a similar purpose.

Bottom line: If you want to apply for these programs, work with an official Veteran Service Office.  They will do the job for free and won’t be selling you anything or asking to manage your money.  Plus it is their mission to work VA issues and only VA issues.  These financial firms don’t care about your VA claim; they just want access to your money and to sell you something.  See the article above for how to find your VSO.

For those of you bumping up against the “10% decline in the market impact zone” requirement, we have an update. Plus, $323M in additional HAP funds on the way.

We spoke to the Corps of Engineers national project officer for HAP Friday. He told us that impact zone requirement can be disputed if sellers can provide data that indicate your immediate area was impacted more than the Corps of Engineers area studies show. He says every regional office has the discretion to allow other evidence and the national/regional offices accept other information. We know of examples here in Fairfax county VA where some areas of the county were hit much harder than other areas. Marketing surveys provided by real estate firms and appraisals from local/county governments can help. The other Shane who has been posting on this site mentioned a case like this previously where a family overturned the 10% rule using this regional office management flexibility.

Also, there is a bill working through Congress now that will add $323 million to the current HAP budget. This bill stands a high chance of passage from the Congress and the President. This additional money is projected to be enough to cover most HAP claims. Updates will follow.