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Investing Blog Roundup: Is Your Investment Plan Reasonable?

One of the messages I’ve tried to deliver over and over on this blog is that there’s no perfect portfolio, but there are countless perfectly fine portfolios.

Jim Dahle recently shared a similar message, with some guidance on how to tell if your portfolio is in fact perfectly fine.

“I often tell people to choose a reasonable asset allocation (written investing plan) and stick with it. In this regard, the investor matters far more than the investments. Of course, that requires that the investing plan first be REASONABLE. Those of us who have been doing this for a long time can tell at a glance whether a plan is reasonable or not.”

Other Recommended Reading

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Inflation-Adjusted Annuities No Longer Available: Now What?

A reader writes in, asking:

“I’ve read on Bogleheads that the last insurance company stopped selling annuities with a CPI adjustment, meaning that there’s no nowhere to buy an annuity that has inflation protection. What are the implications for somebody nearing retirement?”

It’s true: sometime in the second half of 2019 (I’m unsure of the exact date), Principal stopped offering inflation-adjusted lifetime annuities, so they’re now unavailable commercially at all, as the other insurance companies that had been offering them stopped a few years ago.

So what impact does this have on retirement planning?

The first thing that comes to mind is that delaying Social Security is now the only option at all to buy an inflation-adjusted lifetime annuity. But I’m not sure how much this actually changes any decision-making, because it was already the case that delaying Social Security was the most desirable option available for somebody looking for safe lifetime income (with the possible exception of the lower earner in a married couple).

If I personally were in that critical stage of “just about to retire or recently retired” my overall plan for funding retirement spending would have looked something like this, back when inflation-adjusted annuities were available:

  1. Higher earning spouse delays Social Security to age 70,
  2. Lower earning spouse delays Social Security until the point at which our safe income satisfies what we consider to be our “necessary” spending,
  3. Buy an inflation-adjusted lifetime annuity if we needed more safe income than what we would get from Social Security if both of us were already planning to file at age 70,
  4. Use primarily stocks for any remaining assets, since such assets would be intended for discretionary spending (i.e., non-necessities).

But, step #3 is no longer an option.

The primary options to consider as alternatives would be Treasury Inflation Protected Securities (TIPS), a nominal annuity (i.e., one with no cost of living adjustment), or some combination of the two.

This is probably a good time to point out that annuities with a fixed annual cost of living adjustment (e.g., 2% per year) are still available. But as we’ve discussed previously, that doesn’t really protect you from inflation. (And in fact they perform worse in inflationary scenarios than annuities without any COLA at all.)

Creating a TIPS ladder would work well in that it creates a predictable, inflation-protected source of spending. But it has the downside of leaving you exposed to longevity risk (e.g., you build a 30-year TIPS ladder but end up living beyond 30 years).

A nominal annuity eliminates longevity risk, but it leaves you with inflation risk.

As for me personally, I have to admit that if I were recently retired, or just about to retire, I’d have a hard time devoting a particularly large chunk of my retirement savings to a nominal lifetime annuity. But it’s worth pointing out that some researchers have found that nominal annuities tended to be a better deal than inflation-adjusted ones anyway (see Wade Pfau’s An Efficient Frontier for Retirement Income, or David Blanchett’s article in Advisor Perspectives last year, for example).

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Investing Blog Roundup: Fama French Value Premium Update

Eugene Fama and Kenneth French recently released a new paper looking at the value premium (i.e., the additional returns earned by stocks with high book-to-market ratios — “value” stocks — relative to the overall stock market).

The point of the paper was to determine whether the expected value premium declined or disappeared after the publication of their initial papers on the topic in 1992 and 1993.

That is, the value premium has been quite a bit lower since the publication of their papers. But there’s a question of whether that was because:

  1. The expected premium has declined/disappeared, or
  2. The expected premium is still there, but the random nature of the stock market happened to result in a lower premium (in much the same way that stocks have an expected risk premium relative to bonds, but over any particular period they may not actually earn more).

Their conclusion:

“The high volatility of monthly value premiums clouds inferences about whether the declines in average premiums reflect changes in expected premiums. Comparing the first and second half-period averages, we don’t come close to rejecting the hypothesis that out-of-sample expected premiums are the same as in-sample expected premiums. But the imprecision of the estimates implies that we also can’t reject a wide range of lower values for second half expected premiums.”

In other words, “we don’t really know.” The value premium is sufficiently volatile that we can’t say conclusively whether the expected value premium has declined or not.

Other Recommended Reading

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What Counts as Compensation (Earnings) for IRA Contributions?

I’ve received a few questions recently about what types of income count as “compensation” for IRA contribution purposes.

The definition of compensation is important because your IRA contributions for a given tax year are limited to the amount of your “compensation that is includible in your gross income” for the year. (If you are married, you and your spouse’s combined IRA contributions are limited to your combined such compensation.)

There are two key points here:

  1. The income in question must be something that is included in your gross income (e.g., foreign earned income that is excluded would not count), and
  2. It has to be income that counts as compensation.

So what counts as compensation?

Treasury Regulation 1.219-1(c) provides the following definition:

For purposes of this section, the term compensation means wages, salaries, professional fees, or other amounts derived from or received for personal service actually rendered (including, but not limited to, commissions paid salesmen, compensation for services on the basis of a percentage of profits, commissions on insurance premiums, tips, and bonuses) and includes earned income, as defined in section 401 (c) (2), but does not include amounts derived from or received as earnings or profits from property (including, but not limited to, interest and dividends) or amounts not includible in gross income.

In plain language, that means that the following count as compensation:

  • Wages/salary,
  • Commissions,
  • Net earnings from self-employment,
  • Scholarship or fellowship income if the income is reported in Box 1 of Form W-2 (i.e., reported as wages),
  • Taxable alimony and separate maintenance (i.e., for divorces that became finalized prior to 2019), and
  • Nontaxable combat pay.

And compensation does not include:

  • Interest or dividend income,
  • Other earnings or profits derived from property (e.g., rental income),
  • Social Security benefits,
  • Pension or annuity income,
  • Deferred compensation,
  • Income from a partnership for which you don’t provide services that are a material income-producing factor, and
  • Any income (other than combat pay) that isn’t included in your gross income.

Compensation Reduced by Pre-Tax 401(k) Contributions

One noteworthy point here is that, when it comes to wages, it’s the amount that shows up in Box 1 of your Form W-2 that matters. And this amount in question is reduced by any pre-tax (“traditional”) 401(k) contributions that you make at work. Point being, if your earnings are low enough, pre-tax 401(k) contributions at work could reduce the amount you’re allowed to contribute to an IRA for the year. Roth 401(k) contributions do not, however, reduce the amount in Box 1. So Roth 401(k) contributions would not reduce the amount you can contribute to an IRA.

Investing Blog Roundup: Is Vanguard’s “At Cost” Model Even Good Enough?

Vanguard’s claim to fame is that it runs everything “at cost” because of its ownership structure (i.e., no external shareholders demanding a profit). And the benefit to Vanguard clients has been tremendous over the years.

In a recent article for Financial Planning, Allan Roth pointed out that Schwab is now basically able to run their entire asset management business below cost — offering what many would see as superior service, while charging fees as low or lower than Vanguard’s.

The key point is that Schwab simply has a different business model (most especially, a key other revenue source), so they are able to use their asset management business as a loss leader, whereas Vanguard must break even on theirs.

Other Recommended Reading

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Can I Change the Beneficiary of My 529 Plan/Account?

A reader writes in, asking:

“Can I create a 529 account, contribute to it with my daughter named as the beneficiary, and then change the beneficiary to another family member if we end up wanting to help fund somebody else’s education?”

The short answer is: it depends on who exactly the family member is, but probably yes.

Naturally, Code section 529 is where we’d find information about 529 plans.

There, we find that there are no income tax consequences to changing the beneficiary of a 529 account, provided that you change the beneficiary to somebody who is a “member of the family” of the existing beneficiary. Members of the family include:

  • A child or a descendant of a child (i.e., a grandchild);
  • A brother, sister, stepbrother, or stepsister;
  • The father or mother, or an ancestor of either (i.e, grandparent);
  • A stepfather or stepmother;
  • A niece or nephew;
  • An aunt or uncle;
  • A son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law;
  • An individual who, for the taxable year of the beneficiary, has the same principal place of abode as the beneficiary and is a member of the beneficiary’s household;
  • The spouse of any of the above people;
  • The spouse of the existing beneficiary; or
  • A first cousin of the existing beneficiary.

Reminder: When going through this list, remember that these relationships are with regard to the existing beneficiary — not with regard to you or to any other person(s) contributing to the account.

If you change the beneficiary to somebody who is not in one of the above categories, the distribution will be taxable as income and will be subject to a 10% penalty.

Finally, section 529 also notes that the gift tax and generation-skipping transfer tax shall apply unless the new beneficiary is:

  1. In the same generation as (or a higher generation than) the existing beneficiary, and
  2. A member of the family of the existing beneficiary (as described above).

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