Highlights of Tax Provisions of the 2009 Economic Stimulus Bill

February 13, 2009 — Sam H. Fawaz

The following are highlights of the tax provisions included in the House and Senate conference agreement on H.R. 1, the American Recovery and Reinvestment Act of 2009.  Among numerous provisions, the agreement includes a one-year Alternative Minimum Tax (AMT) patch for 2009.  This will once again help middle-income households avoid the impact of the AMT in 2009 without having to wait for a last minute law change at year end.  The House will vote on the final agreement today and the Senate vote will follow this weekend.   If the legislation passes both bodies as expected, the President intends to sign the legislation on Presidents Day, next Monday February 16.  The below summary was compiled and provided by the Financial Planning Association.

AMERICAN RECOVERY AND REINVESTMENT ACT OF 2009
PARTIAL SUMMARY OF TAX PROVISIONS FROM CONFERENCE AGREEMENT
Full 19 page summary available at: http://finance.senate.gov/press/Bpress/2009press/prb021209.pdf

TAX RELIEF FOR INDIVIDUALS AND FAMILIES

Extension of AMT relief for 2009. The bill would provide more than 26 million families with tax relief in 2009 by extending AMT relief for nonrefundable personal credits and increasing the AMT exemption amount by $70,950 for joint filers and $46,700 for individuals. This proposal is estimated to cost $69.759 billion over 10 years.

Exclude Private Activity Bonds from the Alternative Minimum Tax. The alternative minimum tax (AMT) can increase the costs of issuing tax-exempt private activity bonds imposed on State and local governments. Under current law, interest on tax-exempt private activity bonds is generally subject to the AMT. This limits the marketability of these bonds and, therefore, forces State and local governments to issue these bonds at higher interest rates. Last year, Congress excluded one category of private activity bonds (i.e., tax-exempt housing bonds) from the AMT. The bill would exclude the remaining categories of private activity bonds from the AMT if the bond is issued in 2009 or 2010. The bill also allows AMT relief for current refunding of private activity bonds issued after 2003 and refunded during 2009 and 2010. This proposal is estimated to cost $555 million over 10 years.

Sales Tax Deduction for New Vehicle Purchases. The bill provides all taxpayers with a deduction for State and local sales and excise taxes paid on the purchase of new cars, light truck, recreational vehicles, and motorcycles through 2009. This deduction is subject to a phase-out for taxpayers with adjusted gross income in excess of $125,000 ($250,000 in the case of a joint return). This proposal is estimated to cost $1.684 billion over 10 years.

Plug-in Electric Drive Vehicle Credit. The bill modifies and increases a tax credit passed into law at the end of last Congress for each qualified plug-in electric drive vehicle placed in service during the taxable year. The base amount of the credit is $2,500. If the qualified vehicle draws propulsion from a battery with at least 5 kilowatt hours of capacity, the credit is increased by $417, plus another $417 for each kilowatt hour of battery capacity in excess of 5 kilowatt hours up to 16 kilowatt hours. Taxpayers may claim the full amount of the allowable credit up to the end of the first calendar quarter in which the manufacturer records its 200,000th sale of a plug-in electric drive vehicle. The credit is reduced in following calendar quarters. The credit is allowed against the alternative minimum tax (AMT). The bill also restores and updates the electric vehicle credit for plug-in electric vehicles that would not otherwise qualify for the larger plug-in electric drive vehicle credit and provides a tax credit for plug-in electric drive conversion kits. This proposal is estimated to cost $2.002 billion over 10 years.

Parity for Transit Benefits. Current law provides a tax-free fringe benefit employers can provide to employees for transit and parking. Those benefits are set at different dollar amounts. This provision would equalize the tax-free benefit employers can provide for transit and parking. The proposal sets both the parking and transit benefits at $230 a month for 2009,
indexes them equally for 2010, and clarifies that certain transit benefits apply to federal employees. This provision is estimated to cost $192 million over ten years.

Computers as Qualified Education Expenses in 529 Education Plans. Section 529 Education Plans are tax-advantaged savings plans that cover all qualified education expenses, including: tuition, room & board, mandatory fees and books. The bill provides that computers and computer technology qualify as qualified education expenses. This proposal is estimated to cost $6 million over 10 years.

“American Opportunity” Education Tax Credit. The bill would provide financial assistance for individuals seeking a college education. For 2009 and 2010, the bill would provide taxpayers with a new “American Opportunity” tax credit of up to $2,500 of the cost of tuition and related expenses paid during the taxable year. Under this new tax credit, taxpayers will receive a tax credit based on one hundred percent (100%) of the first $2,000 of tuition and related expenses (including books) paid during the taxable year and twenty-five percent (25%) of the next $2,000 of tuition and related expenses paid during the taxable year. Forty percent (40%) of the credit would be refundable. This tax credit will be subject to a phase-out for taxpayers with adjusted gross income in excess of $80,000 ($160,000 for married couples filing jointly). This proposal is estimated to cost $13.907 billion over 10 years.

Refundable First-time Home Buyer Credit. Last year, Congress provided taxpayers with a refundable tax credit that was equivalent to an interest-free loan equal to 10 percent of the purchase of a home (up to $7,500) by first-time home buyers. The provision applies to homes purchased on or after April 9, 2008 and before July 1, 2009. Taxpayers receiving this tax credit are currently required to repay any amount received under this provision back to the government over 15 years in equal installments, or, if earlier, when the home is sold. The credit phases out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 in the case of a joint return). The bill eliminates the repayment obligation for taxpayers that purchase homes after January 1, 2009, increases the maximum value of the credit to $8,000, and removes the prohibition on financing by mortgage revenue bonds, and extends the availability of the credit for homes purchased before December 1, 2009. The provision would retain the credit recapture if the house is sold within three years of purchase. This proposal is estimated to cost $6.638 billion over 10 years.

TAX INCENTIVES FOR BUSINESSES

Small Business Capital Gains. Under current law, Section 1202 provides a fifty percent (50%) exclusion for the gain from the sale of certain small business stock held for more than five years. The amount of gain eligible for the exclusion is limited to the greater of 10 times the taxpayer’s basis in the stock, or $10 million gain from stock in that small business corporation. This provision is limited to individual investments and not the investments of a corporation. The non-excluded portion of section 1202 gain is taxed at the lesser of ordinary income rates or 28 percent, instead of the lower capital gains rates for individuals. The provision allows a seventy-five percent (75%) exclusion for individuals on the gain from the sale of certain small business stock held for more than five years. This change is for stock
issued after the date of enactment and before January 1, 2011. This provision is estimated to cost $829 million over 10 years.

Temporary Reduction of S Corporation Built-In Gains Holding Period from 10 Years to 7 Years. Under current law, if a taxable corporation converts into an S corporation, the conversion is not a taxable event. However, following such a conversion, an S corporation must hold its assets for ten years in order to avoid a tax on any built-in gains that existed at the time of the conversion. The bill would temporarily reduce this holding period from ten years to seven years for sales occurring in 2009 and 2010. This proposal is estimated to cost $415 million over 10 years.

Extension of Enhanced Small Business Expensing. In order to help small businesses quickly recover the cost of certain capital expenses, small business taxpayers may elect to write-off the cost of these expenses in the year of acquisition in lieu of recovering these costs over time through depreciation. Until the end of 2010, small business taxpayers are allowed to write-off up to $125,000 (indexed for inflation) of capital expenditures subject to a phase-out once capital expenditures exceed $500,000 (indexed for inflation). Last year, Congress temporarily increased the amount that small businesses could write-off for capital expenditures incurred in 2008 to $250,000 and increased the phase-out threshold for 2008 to $800,000. The bill would extend these temporary increases for capital expenditures incurred in 2009. This proposal is estimated to cost $41 million over 10 years.

5-Year Carryback of Net Operating Losses for Small Businesses. Under current law, net operating losses (“NOLs”) may be carried back to the two taxable years before the year that the loss arises (the “NOL carryback period”) and carried forward to each of the succeeding twenty taxable years after the year that the loss arises. For 2008, the bill would extend the maximum NOL carryback period from two years to five years for small businesses with gross receipts of $15 million or less. This proposal is estimated to cost $947 million over 10 years.

Extension of Bonus Depreciation. Businesses are allowed to recover the cost of capital expenditures over time according to a depreciation schedule. Last year, Congress temporarily allowed businesses to recover the costs of capital expenditures made in 2008 faster than the ordinary depreciation schedule would allow by permitting these businesses to immediately write-off fifty percent of the cost of depreciable property (e.g., equipment, tractors, wind turbines, solar panels, and computers) acquired in 2008 for use in the United States. The bill would extend this temporary benefit for capital expenditures incurred in 2009. This proposal is estimated to cost $5.074 billion over 10 years.

Delayed Recognition of Certain Cancellation of Debt Income. Under current law, a taxpayer generally has income where the taxpayer cancels or repurchases its debt for an amount less than its adjusted issue price. The amount of cancellation of debt income (“CODI”) is the excess of the old debt’s adjusted issue price over the repurchase price. Certain businesses will be allowed to recognize CODI over 10 years (defer tax on CODI for the first four or five years and recognize this income ratably over the following five taxable years) for specified types of business debt repurchased by the business after December 31, 2008 and before January 1, 2011. This proposal is estimated to cost $1.622 billion over 10 years.

Incentives to Hire Unemployed Veterans and Disconnected Youth. Under current law, businesses are allowed to claim a work opportunity tax credit equal to 40 percent of the first $6,000 of wages paid to employees of one of nine targeted groups. The bill would create two new targeted groups of prospective employees: (1) unemployed veterans; and (2) disconnected youth. An individual would qualify as an unemployed veteran if they were discharged or released from active duty from the Armed Forces during the five-year period prior to hiring and received unemployment compensation for more than four weeks during the year before being hired. An individual qualifies as a disconnected youth if they are between the ages of 16 and 25 and have not been regularly employed or attended school in the past 6 months. This proposal is estimated to cost $231 million over 10 years.

ASSISTANCE FOR FAMILIES & UNEMPLOYED WORKERS

“Making Work Pay” Tax Credit. The bill would cut taxes for more than 95% of working families in the United States. For 2009 and 2010, the bill would provide a refundable tax credit of up to $400 for working individuals and $800 for working families. This tax credit would be calculated at a rate of 6.2% of earned income, and would phase out for taxpayers with adjusted gross income in excess of $75,000 ($150,000 for married couples filing jointly). Taxpayers can receive this benefit through a reduction in the amount of income tax that is withheld from their paychecks, or through claiming the credit on their tax returns. This proposal is estimated to cost $116.199 billion over 10 years.

Economic Recovery Payment to Recipients of Social Security, SSI, Railroad Retirement and Veterans Disability Compensation Benefits. The bill would provide a one-time payment of $250 to retirees, disabled individuals and SSI recipients receiving benefits from the Social Security Administration, Railroad Retirement beneficiaries, and disabled veterans receiving benefits from the U.S. Department of Veterans Affairs. The one-time payment is a reduction to any allowable Making Work Pay credit. This proposal is estimated to cost $14.225 billion over 10 years.

Refundable Credit for Certain Federal and State Pensioners. The bill would provide a one-time refundable tax credit of $250 in 2009 to certain government retirees who are not eligible for Social Security benefits. This one-time credit is a reduction to any allowable Making Work Pay credit. This proposal is estimated to cost $218 million over 10 years.

Increase in Earned Income Tax Credit. The bill would temporarily increase the earned income tax credit for working families with three or more children. Under current law, working families with two or more children currently qualify for an earned income tax credit equal to forty percent (40%) of the family’s first $12,570 of earned income. This credit is subject to a phase-out for working families with adjusted gross income in excess of $16,420 ($19,540 for married couples filing jointly). The bill would increase the earned income tax credit to forty-five percent (45%) of the family’s first $12,570 of earned income for families with three or more children and would increase the beginning point of the phase-out range for all married couples filing a joint return (regardless of the number of children) by $1,880. This proposal is estimated to cost $4.663 billion over 10 years.

Increase Eligibility for the Refundable Portion of Child Credit. The bill would increase the eligibility for the refundable child tax credit in 2009 and 2010. For 2008, the child tax credit is refundable to the extent of 15 percent of the taxpayer’s earned income in excess of $8,500. The bill would reduce this floor for 2009 and 2010 to $3,000. This proposal is estimated to cost $14.830 billion over 10 years.

Tax Credits for Energy-Efficient Improvements to Existing Homes. The bill would extend the tax credits for improvements to energy-efficient existing homes through 2010. Under current law, individuals are allowed a tax credit equal to ten percent (10%) of the amount paid or incurred by the taxpayer for qualified energy efficiency improvements installed during the taxable year. This tax credit is capped at $50 for any advanced main air circulating fan, $150 for any qualified natural gas, propane, oil furnace or hot water boiler, and $300 for any item of energy-efficient building property. For 2009 and 2010, the bill would increase the amount of the tax credit to thirty percent (30%) of the amount paid or incurred by the taxpayer for qualified energy efficiency improvements during the taxable year. The bill would also eliminate the property-by-property dollar caps on this tax credit and provide an aggregate $1,500 cap on all property qualifying for the credit. The bill would update the energy-efficiency standards of the property qualifying for the credit. This proposal is estimated to cost $2.034 billion over 10 years.

Temporary suspension of taxation of unemployment benefits. Under current law, all federal unemployment benefits are subject to taxation. The average unemployment benefit is approximately $300 per month. The proposal temporarily suspends federal income tax on the first $2,400 of unemployment benefits per recipient. Any unemployment benefits over $2,400 will be subject to federal income tax. This proposal is in effect for taxable year 2009. This proposal is estimated to cost $4.740 billion over 10 years.

Increase in Unemployment Compensation Benefits. The bill increases unemployment weekly benefits by an additional $25 through 2009. This provision is estimated to cost $8.8 billion.

Extension of Emergency Unemployment Compensation. Through December 31, 2009, the bill continues the Emergency Unemployment Compensation program, which provides up to 33 weeks of extended unemployment benefits to workers exhausting their regular benefits. This provision is estimated to cost $26.96 billion.

Premium Subsidies for COBRA Continuation Coverage for Unemployed Workers. Recession-related job loss threatens health coverage for many families. To help people maintain coverage, the bill provides a 65% subsidy for COBRA continuation premiums for up to 9 months for workers who have been involuntarily terminated, and for their families. This subsidy also applies to health care continuation coverage if required by states for small employers. With COBRA premiums averaging more than $1000 a month, this assistance is vitally important. To qualify for premium assistance, a worker must be involuntarily terminated between September 1, 2008 and December 31, 2009. The subsidy would terminate upon offer of any new employer-sponsored health care coverage or Medicare eligibility. Workers who were involuntarily terminated between September 1, 2008 and enactment, but failed to initially elect COBRA because it was unaffordable, would be given an additional 60 days to elect COBRA and receive the subsidy. To ensure that this assistance is targeted at workers who are most in need, participants must attest that their same year income will not exceed $125,000 for individuals and $250,000 for families. The Joint Committee on Taxation estimates that this provision would help 7 million people maintain their health insurance by providing a vital bridge for workers who have been forced out of their jobs in this recession. This provision is estimated to cost $24.7 billion.

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There’s That Dirty Word Again

February 5, 2009 — Sam H. Fawaz

Two of the most hated words in the English dictionary are “diet” and “budget”.  Whether you call it a diet, counting calories or eating smart, you know deep down what that means.  When you think about it, the first three letters of diet spell “die”, so how could it be a good thing?

Similarly, whether you call it a budget, fiscal responsibility or a spending plan, deep down you know it means that you have to cut back on spending.  Fortunately, you don’t have to go hungry just because you are on a spending plan.  And just like weight loss, developing a spending plan can yield significant financial and non-financial benefits:

  • Being in control of one’s finances reduces stress. Stress can make people eat more and spend more.
  • Having a spending plan in place means you’ll have already prioritized the key activities, expenditures and projects you’ll need to make for the year and the money you’ll need to afford them.
  • Spending less time worrying about money means you’ll have more time to think about the people in your life.
  • Fewer money issues means lesser strains placed on your relationship with your significant other.

Here are some ideas you may want to incorporate into that process:

Don’t be afraid to ask for help: Do you know where you need to be? A financial planner can ask the right questions and develop a customized plan to help you figure out your starting point and where you’ll finish based on your age, earnings potential and the new habits you’ll develop.

Start tracking every dollar  you spend: Whether you do it with a pen and a notebook or a computer program (like Quicken or Microsoft Excel), make a concerted effort to track your everyday spending.  Physicians say that overweight people should track every morsel of food they eat; with money, it’s a similar thing.  Knowing where every dollar goes gives a quick picture where certain dollars can be saved or invested.  Some say that you should track each and every penny, but that’s not always necessary unless you want to.  What is mandatory is that you write it all down somewhere.  Doing it in your head doesn’t work.

Prioritize… When it comes to spending, there are needs and wants.  Try this exercise: You can do this on a big 2009 desk calendar (or an electronic calendar that allows space for lots of notes to yourself).  Mark down at the appropriate dates and times of the year items for which you need to spend and those for which you want to spend.

What are needs?  In part, food (not carryout or restaurant meals), the monthly mortgage, tuition, auto or rent payments; monthly utilities; home, auto, life or disability insurance; retirement savings; property taxes and credit card payments (for past purchases).

What are wants? Wants are non-essential items like vacations, non-essential home improvement projects, restaurant meals (you can cook at home, cant you?) or treats like clothing splurges, jewelry or electronics.  Compare these total expenditures to your total income.  What will this crowded calendar tell you?  That by attacking debt, making certain sacrifices and spending and saving smarter, you can eventually “un-crowd” that calendar and take control of your financial life.

…then zero in each month: There has to be a living, breathing side to budgeting that accommodates change.  Do this: Near the end of each month, make a list of the specific “needs” and “wants” you’ll face next month and figure out how much money you’ll have for wants after needs are addressed.  For example, if your car needs a necessary repair, that’s certainly going to boost the “needs” side of the page.  If you find, due to a one-time event (paying off a particular credit card, for example), that you have more to spend in the “wants” column, then it’s time to decide whether it’s time for a treat or to throw more into savings, investments or attacking any other debt.  Every treat that you put off gives you much satisfaction of getting closer to your financial goals, but, just like a diet, you don’t want to deprive yourself and get so frustrated that you go on a spending binge.

Identify and plan for long-term goals: You must think about the things that you really want to do with your life and what those things will cost.  Putting goals in writing gives them a formality and a starting point for the planning you must do.  If these goals require saving, make sure that you put those savings dates on the financial calendar you made.

Build failure and recovery into the plan: How many diets have evaporated with the words, “I blew it?”  The fact is, with food or money, everyone goes off course at times.  The important thing is to have a plan for corrective action.  If you’re about to make an impulse purchase, implement a three-day spending rule.  That means you should give yourself three days to check your budget and think through the purchase before you make it.  If you can minimize the damage and get back on course, your progress will continue.

My experience with those who adopt a spending plan is that they feel a certain sense of freedom that mirrors the feeling of fitting into a pair of jeans that haven’t fit in years.  Anytime you take control of important life decisions makes you feel empowered and ready to tackle new challenges.  Good luck with it!

Note: This post is based in part on an article produced by the Financial Planning Association of which I am a member.

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The Perils of Loaning to or Borrowing Money from Family or Friends

January 24, 2009 — Sam H. Fawaz

Are you thinking about loaning to or borrowing money from a friend or family member?  Perhaps you’re considering co-signing a loan for someone.  Maybe you should reconsider and make a gift instead.

While sometimes you don’t have much of a choice, loaning to or borrowing money from family or friends is fraught with problems.  The transaction immediately changes the dynamic of the relationship because you are no longer just friends or family members; you are now entwined in a business transaction.  This is a business transaction that probably doesn’t observe many, if any, of the formalities of business loans, lest those formalities taint the relationship.  You’ll make excuses like “She’s my friend” or “He’s family, we don’t need formal documents, I trust him.”  Oh but you do.  You really do.

Sure, while payments are being made on a timely basis and everyone is playing by the rules, everything’s just cool.  But once a payment is late, or not made at all, both parties begin to feel uncomfortable in each other’s presence.  Should you say something, ask about the money, or should you just wait a few more days?  Sure, he was just too busy, and probably forgot.  The lender starts making excuses for the borrower so she doesn’t have to confront him.  Then the borrower loses his job, has a catastrophic loss, or otherwise falls ill.  Days turn into weeks, and weeks into months, and maybe into years, but no payment surfaces.  The lender musters up the courage to mention something about it at one point, and the borrower offers excuses for not paying, and promises to pay soon.  You both feel bad about having to discuss it.  The promised day comes and goes without a word or a payment.  The borrower starts to avoid the lender.  Resentment starts to fester.  A confrontation eventually ensues; it’s not good.  The relationship is forever tainted, both parties are resentful.  The borrower is resentful because he can’t believe that the lender doesn’t trust him long enough to pay her back.  The lender is resentful because she trusted him to keep his word, pay on time, and avoid any confrontations.

The above scenario plays out quite a bit, I’m sure.  People want to believe that their friends and loved ones don’t need written documents to pay back money they owe.  They want to believe that life isn’t messy, that the borrower will be healthy and fully able to pay them back with no hassles and no delays.  But that’s not realistic.  Lives change, people change, they move, they lose jobs, they change relationships, and, when they get into trouble, justify why they should not have to pay the money back.  “He doesn’t need it”, “I did her so many favors”, “I’ve fallen on hard times, so I’m sure that she understands” are a sampling of the justifications people use.  In many cases, they don’t take the time to talk to the lender to try and work it out.  Instead, they avoid the subject, hide, and hope the problem will just go away.

In most cases, it simply makes more sense to just give a gift to the friend or family member and not expect repayment.  Whether we’re talking about $20 or $20,000, you really have to ask yourself what would happen if you loaned the person the money and they did not pay it back.  Depending on the amount, you can probably count on the fact the the relationship is forever tainted, if not over.  So when that friend or family member asks to “borrow” some money, depending on your financial ability and the amount requested, you might just want to give it to them and tell them that you don’t expect repayment.  If they do repay it, then great.  If they don’t, then you weren’t expecting repayment so the above scenario does not play out.  For smaller amounts, this just makes sense.

If you’re the borrower, then also think twice about asking a friend or family member for money.  If a bank or other 3rd party lender won’t loan you the money, there’s a good reason for it: they probably believe that you’re just not going to be able to pay it back, and therefore you’re not worth the risk.  Going to a friend or family member for the money just puts them on the spot, and sends the message that although you weren’t a good enough credit risk for a legitimate lender, that they should trust you to pay them back.  That’s not fair to your friend or family member.

Similarly, if someone, or anyone, asks you to co-sign a loan, don’t do it. Ever.  Odds are very high that you will end up paying off the debt.  Again, the bank is saying that the borrower’s credit is not good enough to get the loan, and therefore they don’t believe that the borrower would be able to pay it back.  So having a qualified borrower co-sign it just means that the co-signer is equally liable for the loan, and the lender can go after her for the full amount when the primary borrower does not pay.  Sometimes the co-signer doesn’t find out that the borrower has defaulted, especially if it’s a long term loan and the co-signer has moved or changed phone numbers and cannot reach the co-signer.  By then, the co-signer’s credit record is tarnished and collection agents are searching for her.

If you must loan friends or family a rather large sum of money, then you have to protect your family and yourself.  Once you are married or have kids, you have a primary responsibility to look out for their best interests and ensure that they can recover the money if something should happen to you.  If the borrower balks at using paperwork, then you already have your answer and have just saved yourself a bit of money and headaches down the road.  So here’s what you need to know to do it right:

  1. Make sure that you draw up the proper loan paperwork.  Get legal help to draft the documents, especially if collateral or real estate is involved.  Any office supply store can provide a simple loan form, or search for one on the web.  For a small fee, go to Virgin Money to set up the whole thing.
  2. Charge a reasonable rate of interest.  This is an IRS requirement for loans between related parties, or they will impute additional taxable interest income to the lender, and the borrower will likely end up with more non-deductible interest expense.  Go to the IRS web site for more information about applicable federal rates and loans between related parties.
  3. Spell out as many of the terms of payment (time, place, form) and remedies for default in the loan documents.
  4. Follow up and communicate on non-payment early and often.  It’s better to stay on top of it and let the borrower know that you still expect payment.  Seek legal advice about collection rights and responsibilities if necessary.

When it comes to loaning and borrowing money between friends or family, learn to just say no if you value the relationship.  Perhaps you can help the would-be borrower by pointing them to other peer-to-peer lending sources such as Virgin Money, Prosper, or Zopa. (1)   If you end up with a deadbeat borrower, then you’ve probably lost a friend or close relationship in addition to your money.  Alas, this is the price of mixing friends and money.

(1) I have not performed any due diligence on the the listed peer-to-peer lending sites and cannot vouch for their services.  TheMoneyGeek does not endorse them nor receives any compensation for mentioning them.

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Highlights of NAPFA 2009 Investments Conference Day 3

January 23, 2009 — Sam H. Fawaz

St. Petersburg Florida – The last day of the NAPFA 2009 Investments Conference finally brought warmer temperatures to go along with the beautiful Florida sunshine we’ve been seeing; of course, it showed up just in time to for us to head home.  The day kicked off with a presentation by Moshe A. Milevsky, Ph.D, Associate Professor of Finance at York University entitled “Are You a Stock or a Bond?” The quirky title notwithstanding (it’s his book title), this presentation proved to be today’s highlight and perhaps the highlight of the conference.

Moshe has a dynamic presentation style that makes you want to sit up and pay attention.  As he flashed numerous press clippings of more employers dropping defined benefit plans (estimated to be one large company freezing its benefits every 10-14 days), he explained how we are all becoming responsible for creating our own personal pension plan.  With longevity risk increasing every day (over 2 million people in the U.S. are over 90 years old), companies are turning corporate liabilities into personal liabilities under the guise of increasing shareholder value.

Moshe went on to explain that, for most of our lives, the most important asset on our personal balance sheet is often never listed or estimated–that is, our human capital or earning capacity.  When we are young, our human capital far exceeds our financial capital.  As we age, our financial capital begins to exceed our human capital until we retire and rely exclusively on our financial capital.  In asking “are you a stock or a bond”, Moshe encourages us to try to estimate the value of our remaining human capital and attempt to classify it as a stock or a bond, and factor it into our asset allocation.  Depending on the nature of your work, you may classify yourself as a bond (e.g., a tenured professor) or as a stock (e.g., an investment banker in this economic environment).  He goes on to explain that we often ignore this asset in our portfolios to our detriment, even though we may classify defined benefit pensions as fixed income instruments.   In addition, workers often over-invest in sectors or industries they know well (e.g., investment bankers investing in financial stocks), when they should really diversify to sectors they don’t know much about (e.g., technology.)

Next up were Paula Hogan CFP®, CFA and Scott Witt, FSA, MAAA to co-present “Income Protection – Immediate Fixed Annuities vs. Variable Annuities with Living Benefits”.  The two had worked up an extensive comparative case study using a 60 year-old male investing in a 15-year period certain immediate annuity (with inflation protection) versus a variable annuity with guaranteed living benefits of 5%.  The retiree invested 20% of his portfolio in the annuity.  As you might expect, the conclusion was that the benefits of the 15-year period certain annuity were greater than the variable annuity even though the variable annuity had the potential to generate far greater income for the retiree.  Paula explained that “most people care about maintaining their standard of living more than the wealth that they accumulate.”

Scott MacKillop of Frontier Asset Management got the next to last presentation slot and discussed “Outsourcing Investment Management”.  As you can imagine, he discussed the many advantages of outsourcing and the CEG Worldwide studies which concluded that advisors who use turn-key asset management programs (TAMPs) generally have more revenue, better margins and better results.  Scott cautioned advisors to look to see who funds these types of studies and make sure that they’re not funded by companies that have a vested interest in promoting investment management outsourcing.  He also observed that many TAMPs are pretty much available for sale even before they start business, citing the example of Genworth Financial purchasing two large outsourcers recently.  So obviously you want to ensure that the provider you may be considering is not just setting up shop to sell itself in short order.

The conference ended on a high note with a panel discussion entitled “Comparing Investment Management Procedures” including Cheryl Holland of the Abacus Planning Group, Janet Briaud of Briaud Financial Advisors, Frank Moore of Vintage financial services, LLC and moderator Palmer Jones of Palmer Jones & Associates, Inc.  Palmer peppered the panel with various questions about how they run their investment management practices including the type of research resources they used, the software employed, their investment philosophy, and their asset allocation approach amongst others.  I was surprised to hear that Janet had pared down all her clients’ allocation to equities to around 25% in 1999 in anticipation of a long bear market.   I was equally surprised that she had done that with all of her clients, young and old.  Her thinking was that a downturn was coming and of course, it did happen, and she admitted that perhaps she was a bit early.  At this point, Janet has sold off all Treasuries given that she believes that the downside is far greater than the upside.

Some of the reading resources the panel used in their practices included The Economist Magazine, Financial Times Newspaper, John Mauldin’s Frontline Thoughts, Woody Brock’s Economy Newsletter and Dan Ferris’ Extreme Value Newsletter.  All of the panelists indicated that they read for about two to four hours per day to keep up with changes in the industry. “What may be more important is what you don’t read” added Janet.  Most of the panelists acknowledged using Morningstar Principia or Workstation for fund research.  Palmer indicated that he used the Investors FastTrack system, but did not elaborate.

The interesting question came at the end when Palmer asked the panelists about their worst and best decisions made in their firms.  Cheryl said that the worst decision she probably made was to add certain asset classes too early, or perhaps before she had performed adequate due diligence on them.  Her best decision was to hire a Chief Investment Officer and purchasing iRebal.  Frank said that his worst decision was probably to not pay enough attention to the cash situation, that is, letting his clients manage their own cash needs in certain ways.  Janet indicated that purchasing a closed-end tax-free bond fund at the wrong time was probably her worst decisions.  All agreed that they everyone in this business makes mistakes; the key is to make more good decisions than bad ones.

I would rate the Conference as a great success and want to thank the Committee and the NAPFA staff for putting so much time and effort into putting it on.  While I had hoped for a bit more nuts and bolts “how-to” sessions, I was pleased with the conference.  I hope that they decide to put it on again next year, and maybe, just maybe, it will be a bit warmer.

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Highlights of NAPFA 2009 Investments Conference Day 2

January 22, 2009 — Sam H. Fawaz

St. Petersburg Florida – Day two of the NAPFA Investments Conference brought a parade of presenters, some better than others.  Here are highlights from the sessions that I attended:

The first session I attended, “Sharing Investment Research Resources” was put on by conference chair Carolyn McClanahan and member Nancy Bryant.  It seems that they, along with three other NAPFA members, have been sharing mutual fund research responsibilities and picks.  Each member has a particular sector of mutual funds to research and report on via a monthly one-hour conference call.  One member maintains the list of preferred funds and they all weigh in on the choices.  No one member is bound to use all the funds, and anyone can keep any fund that is dropped from the list.  The benefits in time and effort saved is obvious.  The purpose of the presentation was to encourage the formation of more groups of five around the country.  Watch for further details to come from NAPFA in the near future.  A conference call is planned along with the maintenance of a list of interested members.

Next I enjoyed a lively presentation by Doug Poutasse of the National Council of Real Estate Investment Fiduciaries entitled “Direct vs. Indirect Investments in Real Estate”.  Doug mostly discussed commercial real estate and the many ways to invest in them: directly, via REIT’s, via open-end funds, and via closed-end funds.  Closed-end funds, as you might imagine, are the least liquid of all types of real estate investments and keep your money invested for as long as they need it–there is no set timetable for return of your funds.  Open-end funds allow you to get your money at certain intervals, though they are less liquid than direct investments in real estate.  That was a surprise to me since I would have thought that direct investments were the least liquid of all.  But liquidity does not necessarily equate to profitability–you can get out anytime, but at what price?

After a break, Rudy Aguilera of Helios LLC presented a fast paced “Insulating Your Clients from Volatility.”  Rudy discussed how using options can protect the downside risk of many portfolios at a very low cost.  With several examples, he showed how porting just a fraction of the investment can improve the return while reducing the volatility of the overall investment.  I can’t profess to have understood everything he explained, but several of the examples made sense.  He also showed an example of how he could legally convert a long term capital loss into a short term capital loss using the wash sale rules to your advantage.

Our (rubber chicken) lunch presentation by Michael Sharmer of Skeptic Magazine did not disappoint and was the highlight of the day.  Michael gave a lively presentation about human behavior and how we tend to follow the crowd and how easily our brains can be primed to give the desired results.  He demonstrated his points with numerous multi-media examples showing, for instance, how our extreme focus on one thing can lead us to literally miss the gorilla in the room.  In one example, we were asked to count the number of rebounds made by a pair in a video wearing white shirts.  While that occurred, a man in a gorilla suit appeared and danced across the screen for several seconds, but most of us didn’t even realize it because we were focused on counting rebounds.  At a minimum, it makes a convincing case why texting while driving is a bad idea.

“Building Your Own Alternatives Fund” was a panel discussion presented by Giles Almond of Matrix Wealth Advisors, Sheila Chesney of Chesney & Company, Brian Farmer of Hirschler Fleischer, and  Jonathan Self of Compliance LLC.  The panel discussed the advantages of and the due diligence that goes into building your own pool of (say private equity) funds ultimately managed by a registered investment advisor.  Since most clients don’t qualify for private placement of equities due to high minimums, this can be a way for firms to offer these alternatives to your clients.  The work involved was by no means short or easy.

Continuing the alternative investments theme, Sheila Chesney continued with her presentation entitled “A Roadmap for Investing in Alternative Assets” and described how her firm went about developing their own alternative investment fund.  “The affluent are not looking for just another mutual fund shop” Sheila explained.  The key here is to perform extensive due diligence, diversify amongst alternate investments, and educate clients about the risks involved.  “And just because it’s new and different doesn’t mean that it’s necessarily riskier.”  Sheila stressed that setting up one is in no way a turn-key solution.

The day wrapped up with a nice reception at the St. Petersburg Museum for Fine Arts.

Please come back tomorrow for highlights of the third and final day of the conference.  For live updates, please follow my Twitter feed.

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Highlights of NAPFA 2009 Investments Conference Day 1

January 20, 2009 — Sam H. Fawaz

On a blustery cool day in St. Petersburg Florida, as the nation got ready to inaugurate a new president, a couple hundred members of The National Association of Personal Financial Advisors (NAPFA) gathered for their first ever conference dedicated exclusively to investments.  Chaired by Carolyn McClanahan, the 2009 Investments Conference is also one of the first conferences that was mostly coordinated by NAPFA staff with the help of the committee.  All indications are that they’ve put together a winning lineup (see agenda).

Held at the historic Renaissance Vinoy, two three-hour pre-conferences kicked things off: one was a bond investing workshop and another entitled “The Business of Managing Money”.  I attended the bond investing workshop presented by David Summers CFA,  Managing Director of YieldQuest Securities.  The material flew by so fast that it probably would have taken two days to cover the material adequately.

Despite being a CPA, I never realized that municipalities actually issue fully taxable municipal bonds (that is, not just subject to the alternative minimum tax.)  David suggested that this is an excellent time to be investing in investment grade municipal bonds, though his (very expensive) Bloomberg terminal gave him more data on muni’s than we could ever get our hands on.  He also cautioned us to watch out for certain exchange traded funds (ETFs), specifically some commodity and currency funds, that might not be issued by registered investment companies, and may surprise investors with a partnership Schedule K-1 rather than a 1099.  As always, read the prospectus prior to investing to avoid surprises.

On such a historic day in our country, it would have been a shame to miss the inauguration of President Obama.  There was no need to miss it since the committee factored this in and set up lunch in a room with a large screen for everyone to watch.  I don’t have to tell anyone who watched it how special and moving President Obama’s speech was.  I felt so proud to be an American on this very emotional day for our nation.

Next up, with a tough act to follow, was Zanny Minton-Beddoes, Economics Editor for The Economist Magazine speaking on the economy after the credit crunch.  Even in her heavy British accent, Zanny’s message could not disguise the somber truth about the grim economic outlook for 2009 in the United States and around the world.  While far from Great Depression conditions, many statistics point that industrial production is way down, unemployment is way up, and global trade will contract for the first time since 1982.

As always, choosing between breakouts is always tough when you have two great topics: “Investment Opportunities in Microfinance”, and the one I attended, “Navigating the ETF Landscape” presented by John Hyland, who is Principal and Business Development Officer with Barclays Global Investors iShares division. While presenting mostly basics and some advanced concepts about ETFs, the key take away for me was the implicit costs of investing in ETFs.  Most people know about the commissions and expense ratio, which are explicit costs, but many do not realize that there are trading spreads, rebalancing costs, and tracking error costs.  Check the ETF provider’s web site or talk to your ETF provider about these costs and make sure that you are looking at total costs when comparing ETFs.

“Investing Today-Navigating Through the Headlines & Positioning Your Portfolio for a Slowdown” presented by Alison A. Deans, Chief Investment Officer of Neuberger Investment Management, was the day’s closing general session.  The title of the session was a bit misleading, since she really didn’t discuss much in the way of portfolio structuring, but instead discussed the state of the economy and how Neuberger managers viewed the environment.  She indicated that corporate bond yields were attractive, and, in response to a question, indicated that if they invested in fixed instruments issued by beneficiaries of the Troubled Asset Relief Program (i.e., financial institutions), it would be for maturities of no more than 18-24 months.

While not rivaling an inaugural ball, the day was capped off with a very nice reception with the exhibitors.

Tomorrow’s agenda is a full one with a much anticipated lunchtime presentation by Dr. Michael Shermer, who is the Founding Publisher of Skeptic magazine.  For highlights of Day 2, come back tomorrow.  For live highlights, follow my Twitter feed at http://twitter.com/themoneygeek.  Thanks for reading!

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Does the World Really Need Another Blog?

January 18, 2009 — Sam H. Fawaz

With millions of blogs out there, of course the answer has to be no.  So why am I doing this anyway? Because I am a writer and want to share my experience, insights and tips with the rest of the world.  In becoming a financial planner, my objective was mainly to help people reach their dreams and enjoy financial peace of mind.  Of course, that’s the mission of my financial planning and registered investment advisory firm YDream Financial Services, Inc. (YDream when you can plan?)  Our web site, which I’ll admit is in serious need of revamping, is at http://www.ydfs.com.

Please bear with me for now as I learn the about the various features of this blogging platform and how to make the site more inviting and navigation easier.  For now, this gets me up and running quickly and it will have to do.

I’m a financial guru of sorts and a self-proclaimed technogeek.  Hence, the name I elected for myself is TheMoneyGeek. The purpose of this blog is to share my thoughts with you in hopes that I can help you make those all important decisions to help you reach your dreams.  I’ll also write about tech trends and products that will make your life easier, save you money or are just plain fun.

As a fee-only financial planner with the Certified Financial Planner® designation and CPA, I’ll share my 28 years of tax, financial planning, investment and retirement planning expertise.  To understand what fee-only really means and why you want a fee-only planner working for you, please visit http://www.napfa.org, the membership organization that I’m proud to be a member of.  I’m also a member of the American Institute of Certified Public Accountants (http://www.aicpa.org) and the Financial Planning Association (http://www.fpanet.org)

My purpose is to inform and instruct, and, as financial expert Dave Ramsey says, I have the heart of a teacher.  I promise this won’t be just another sales site, though I hope that you’ll consider us when you’re ready for professional help from an unbiased and unconflicted planner.  My name is Sam Fawaz and I thank you for taking the time to stop by and hope you’ll find the content compelling enough to come back and that you’ll tell your friends about us.  You can e-mail me at shf at ydfs dot com.

Please follow me on Twitter at http://twitter.com/themoneygeek.

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