Is Your Financial Advisor Doing His/Her Job? Year-End Action Items

Is your financial advisor doing his/her job? If not it could cost you thousands of dollars in taxes and penalties. Year-end is a good time to test your advisor’s dedication to your financial success. Prior to the end of the year there are three things that should be addressed: capital gains, required distributions, and Roth IRA conversions. If your advisor hasn’t reached out to you to address these issues it may be time to hire another advisor. Let’s talk about each action item.

Avoiding Capital Gains Taxes

First, you need to take a look at the investments in your non-retirement accounts to see if you have any capital gains that will add to your 2011 tax-burden. For example, let’s assume you bought a stock for $10,000 in 2009 and sold it in 2011 for $20,000; a gain of $10,000. You will have to pay a capital gains tax of $1,500 (15%) on your $10,000 profit. Even worse, if you owned the investment for less than one year the income will be counted as ordinary income, which can be taxed as high as 35% (creating a tax bill of $3,500!). However, you can avoid the tax by finding another stock/bond/mutual fund in your portfolio trading at a $10,000 loss. By selling the stock and incurring the loss it will cancel out the gain for tax purposes. In this example the strategy will save you $1,500 in taxes (or $3,500 if the profit is counted as short-term capital gains!). If you like the stock or fund you sold you can simply buy it back 31 days later. By reviewing your taxable account(s) your advisor can check your capital gains and look for ways to offset those gains. If this isn’t happening your advisor is not doing his/her job.

Avoid a 50% Penalty

Second, if you are over 70 ½ you are required to withdraw some money from your IRA. If you don’t take the required distribution you’ll have to pay a 50% penalty. For example, if you are a 72 year old with a $500,000 IRA you are required to withdraw $19,531 and pay income taxes on the distribution. If the distribution is not taken the penalty is 50% of the amount you were expected to withdraw. In the case of our example the penalty would equal $9,465! If you are over 70 ½ make sure you take your distribution. Again, if your advisor isn’t doing his/her job and overlooks required distributions it could cost you.

Convert to a Roth IRA

Finally, if you are in a low tax bracket in 2011, which may occur if you lost your job or recently retired, you should consider converting some of your traditional IRA money to a Roth IRA. Be aware that there are pros and a cons when you convert. The “pros” of converting is that once the money is in a Roth it will grow tax-free throughout retirement, and annual minimum distributions are not required. The “con” is that you will have to pay income taxes on the money you convert. However, if you are in a low tax bracket your tax bill will be small.

It may makes sense to convert to a Roth and pay the taxes now if you are in a lower tax bracket so you can avoid paying the taxes later when you may be in a higher tax bracket. This strategy could save you a lot of money over time. For those in a lower income tax bracket, you could very well benefit from a Roth conversion.

Now that we are closing in on the end of the year you can see how much income you’ve earned and determine at what rate you’ll be taxed. Your advisor should be aware of your annual income to help you determine whether a Roth conversion might be a good option. If your advisor isn’t aware of your annual income amount, you may want to look for an advisor who is a little more on top of things.

The Bottom Line

At Net Worth Advisory Group, we review all of our client’s accounts to see if there are capital gains issues, monitor distributions for our clients who are over age 70 ½, and make sure we are familiar with our clients income so we can help them decide if a Roth conversion makes sense. This is routine for us in November each year.

If your advisor is not talking to you about these cost saving strategies I’d recommend you contact them, have a frank discussion about why he/she hasn’t contacted you to discuss these three strategies, and consider hiring an advisor who won’t let things fall through the cracks.

Why Your 401(k) May Change Significantly

Next year, 401(k) plan participants will see the true cost of their retirement accounts for the first time – and many will not be pleased. In April 2012, long-awaited Department of Labor rules designed to improve fee transparency in 401(k) plans will go into effect. Consequently, many employers are changing their 401(k) plan provider in an attempt to lower investment fees and provide stronger investment options.

There is an old myth that 401(k) plans are “free.” In fact, in a 2011 survey conducted by AARP, 71% of plan participants thought they paid no 401(k) fees. For this reason, expect to hear a collective gasp when investors open their quarterly 401(k) statements in April.

In reality, the fees charged by poorly-managed 401(k) plans can be quite extensive – record keeping, fiduciary services, direct or indirect compensation for service providers (not to mention the cost of the actual investments) just to name a few. Sharebuilder, a nationwide manager of 401(k) plans, estimates that total annual costs for the average 401(k) plan is approximately 2.25%. Further, many registered investment advisors estimate that some 401(k) plans, especially those of smaller firms, could be as high as 3.5% to 4.8% per year.

This certainly doesn’t suggest that 401(k) plans are poor retirement vehicles. The tax-deferral, automatic contributions, and employer-matching benefits are paramount and should be utilized by nearly everyone with access to a plan. Fortunately, the benefit of the new disclosure laws coming into effect in April is that it forces employers to take more responsibility in ensuring their 401(k) plans offer high-quality investments at a reasonable cost.

Although these new laws have not yet taken effect, they are already beginning to serve their purpose. In preparation for complying with disclosure requirements, many employers are already doing additional due diligence and have discovered that their employees have been paying unjustified and unreasonable fees. Consequently, many employers are already making modifications to their 401k plans, or even changing their 401(k) provider.

Look forward to April 2012. Minimizing investment fees is just as important as obtaining a satisfactory rate of return. Be sure to speak to a fee-only financial planner when you receive your first quarter statement to determine whether your 401(k) plan’s fees are appropriate and to identify responsible actions to be taken.

Ameriprise Workers Find a 401(k) Plan Unsatisfactory – Their Own!

Late last month, a group of workers at Ameriprise Financial Inc. filed a lawsuit in federal court against their employer, accusing the company of stuffing its 401(k) plan with expensive, underperforming mutual funds that came from the company’s own investment management arm. According to the suit, the company placed 401(k) contributions in proprietary funds that charged plan participants $20 million in excess costs.

The workers allege that Ameriprise and its committees, as the plan’s overseers, violated their fiduciary duty to the retirement plan. Investments in the 401(k) plan included mutual funds from Ameriprise subsidiary RiverSource Investments LLC, which is now known as Columbia Management Investment Advisers LLC. (Ameriprise seems to be developing a history of changing the name of their funds frequently to avoid having mutual funds with negative reputations. For example, Ameriprise funds recently utilized the RiverSource name for only five years).

According to the suit, “Defendants chose more expensive funds with inferior performance histories in order to generate revenue for Ameriprise. An investigation would have revealed to a reasonably prudent fiduciary that the RiverSource investment managers investing in RiverSource mutual funds were imprudent.”

The lawsuit highlights several concerns many fee-only financial planners have about their industry. First, as the majority of financial advisors work on a commission basis, there is always concern that advisors will direct their client’s assets into investments that pay the largest commission, not the investments that are necessarily the best option for the client. According to Ron Lieber of the New York Times, since the vast majority of Ameriprise’s revenue comes from investments in the company’s in-house insurance, annuities, and mutual funds, the firm’s success depends on advisors steering client investments into those products.

Second, there is always the concern (and in many cases, plenty of documentation) that proprietary investment options are excessively expensive and provide performance that is under par. In this case, the RiverSource target date funds used by the 401(k) plan cost investors .84% - .94% each year in fees, while a Vanguard alternative charges .10% -.18% in annual fees. Further, workers claim that the RiverSource funds lagged their benchmarks and received poor performance ratings from Morningstar Inc.

The lawsuit provides further support for the contention that fee-only financial planners are in a unique position to focus on what is best for clients. As fee-only advisors never receive commissions from the products they recommend, their job as fiduciaries is to concentrate on recommending the investments with the best performance records and lowest fees at all times. If you haven’t spoken with a fee-only financial planner to confirm you have cost-efficient, high-performance investments in your portfolio, call our office to schedule a complimentary consultation.