December 29, 2010 11:00 a.m.
TCW Strategic Income Fund
You might have noticed that yesterday the price of TCW Strategic Income declined substantially and the closing price was below our sell price. I’m recommending that you hold on to the fund if you haven’t sold it yet and consider repurchasing if you sold it. Here’s why.
The decline was due to yesterday being the ex-dividend date for the special distribution the fund declared on Dec. 15. The decline was about equal to the sum of the special distribution and the regular distribution that will be paid Jan. 11.
The fund announced Dec. 15 that there would be a special dividend of $0.283 per share paid Jan. 11 along with a quarterly distribution of $0.0835. The record date for the distributions is Dec. 30. Don’t consider this as a trigger of the sell signal. Hold on to the fund until I issue a sell recommendation in the newsletter.
December 17, 2010 04:45 p.m.
The New Estate Tax and Other Details in the New Tax Law
Last night Congress finally enacted a new estate and gift tax law, among other tax provisions. The law doesn’t resolve all the uncertainty over estate and gift taxes, because it is effective only through the end of 2012. The law also extends the special provision for charitable contributions from IRAs. We’ll review these and a few other provisions of the law.
We start with the estate and gift tax.
The estate tax is reinstated for 2011 and 2012 with the tax-free exemption amount of $5 million per person. The amount is indexed for inflation after 2011. The maximum estate tax rate is 35%. Also reinstated is the generation skipping transfer tax with the same exemption and tax rate. This is the tax that applies to gift made directly to grandchildren.
Here’s a trick to the new estate tax rules. They are effective for the estate of those dying after 2009. You know there is no estate tax in effect for 2010. The new law gives the executors of estates of those who died in 2010 an option. They can choose the 2010 rules or the new rules. Even if the estate tax return already is filed, the executor can review the option and, if he or she thinks it is wise, file an amended return choosing to the 2011 estate tax rules.
Here’s why someone might elect the 2011 rules instead of the 2010 rules.
The estate of someone who died in 2010 would avoid all estate taxes. But heirs are subject to the “carryover basis” on all the assets they inherit. That means they take the same tax basis the decedent had. When they sell the asset, they’ll pay a capital gains tax on all the appreciation that occurred while the decedent owned the property. If the property appreciated a lot, the capital gains tax could be substantial.
But under the 2011 rules, heirs get a stepped up basis for the property. Their tax basis in the property they inherit is its fair market value on the date the decedent died. They can sell it immediately and not owe any capital gains taxes. Or they can hold the property and, when they sell, owe capital gains taxes that occurred only during the period they owned the property.
When the estate was worth $5 million or less, it probably makes sense to choose the 2011 regime. There won’t be any estate tax, and the heirs receive the stepped up basis on all the assets they inherit. So, there won’t be any capital gains taxes either.
Larger estates need to calculate the estate taxes they would owe under the 2011 rules and compare them to the capital gains taxes heirs would owe under the 2010 rules when they eventually sell the assets. Then, in most cases they should opt for the lower of the two taxes.
The IRS eventually will issue rules detailing how to make the election.
The gift tax is unified with the estate tax after 2010. You have a $5 million lifetime gift tax exemption, which is on top of the annual exclusion amount currently at $13,000. Gifts above the lifetime exclusion are taxed at a maximum rate of 35%. Any amount of the lifetime gift tax exclusion you use reduces the amount of the estate tax exclusion available to your estate.
Sharing Lifetime Exemptions
There’s a new wrinkle to the estate tax after 2010.
Previously, the lifetime estate tax exemption was available only to the individual. It had a use-it-or-lose-it feature. Any amount not used by your estate because you didn’t own enough assets was lost. It was important for married couples to split the title to their assets to ensure neither’s lifetime exemption was wasted.
Under the new law, in 2011 and 2012 a surviving spouse generally can use the unused exemption amount of the first spouse to pass away. The surviving spouse can use the unused exemption to shelter either lifetime gifts or the estate. There are rules that apply when the surviving spouse was predeceased by more than one spouse.
This rule means a couple jointly has a $10 million estate tax exclusion, regardless of how ownership of the assets is split.
The other provision unique to my readers is the extension of the provision for charitable distributions from IRAs. The provision expired at the end of 2009. The law reinstates it for 2010 and 2011.
Here are a few details of the provision. It applies only to IRA owners age 70½ and older. The distribution must be made directly from the IRA to the charity. When that is done, the distribution is not treated as gross income to the IRA owner. The owner also does not receive a charitable contribution deduction for the distribution. The charitable distribution does count toward the required minimum distribution for the year. This special treatment is limited to $100,000 annually per IRA owner.
A special provision in the extension allows the taxpayer to elect to have a qualified distribution that is made in January 2011 to be treated as if it were made on Dec. 31, 2010. This is important, because it allows ensures the distribution satisfies the 2010 required minimum distribution, and it also enables the owner to take full advantage of the $100,000 limit in both 2010 and 2011.
There are other provisions in the law, of course. The 2010 tax rates are extended to 2011 and 2012 (after adjustments for inflation). The 15% maximum tax rate for long-term capital gains and qualified corporate dividends also is extended for both years.
These are the key provisions in the law for my readers. We’ll provide more details in the next Retirement Watch. In the meantime, there’s no longer an excuse for procrastinating about estate planning. Make a note to contact an estate planner and put your plan in order.
December 6, 2010 05:30 p.m.
Puzzles in the Economy and Markets
I apologize for some data errors in the December 2010 issue of Retirement Watch. The allocations in the recommended portfolios are incorrect. Also the buy above and sell below prices of Harbor High Yield are inverted. A corrected PDF of the data is posted to the web site.
The economic data are confusing investors. Here are some points that might help you interpret recent data and the data that come out in the future.
The investment markets react to surprises in data. Stocks surged the last couple of months largely because the data were unexpectedly positive. There was negative data through the summer, and investors were talking about a double dip recession. The data reversed and were better than expected, so most markets had strong surges. Where the markets go in coming months will be influenced largely by how the data come in relative to what investors were expecting.
Most investors try to decide if we’ll have a strong economic recovery or a new recession. The data point to a different scenario. Economic growth will be at or below the long-term average (2.5% annually). That is good enough to maintain the current employment numbers but not good enough to allow for improvement in the number of jobs, hours worked, or income.
This is an improvement from a few months ago, when the data were indicating growth was 2% or less.
Growth could slow in coming months for several reasons. The production boost due to inventory rebuilding after the recession has about run its course, and businesses don’t seem inclined to ramp up production in expectation of better sales. Stimulus spending continues to fade. Business investment looks like its also beginning to fade. Households are not reducing saving or increasing borrowing, so it’s hard to see how retail sales can continue the growth of recent months.
This is the ideal environment for investments focused on “safe yields.” The high yield bonds we added this month should do well (and are doing better than the investment grade bonds we sold). The portfolios of DoubleLine Total Return Bond and TCW Strategic Income also should continue to perform well. Enterprise Product Partners declined last week because it announced it will sell some equity to pay down debt. It’s nothing to worry about. Hussman Strategic Growth generally moves opposite of the stock market indexes because of its hedging. Hussman announced this week that he’s taking a little bit different approach to allow the fund to better capture some of the short-term moves we’ve seen in this trendless, volatile market environment.
Here are a few other items that are worth your time.
A few month back I linked to an article in Vanity Fair that investigated the Greece debt crisis and indicated a monastery was a major trigger to the crisis. The monks and others have responded, and the article is another good read.
An article in The New York Times attracted a lot of attention. A former investment banker (a bond salesman) turned investment consultant learned he was terminally ill. He decided to co-author a book for individual investors distilling his advice on how they should handle their capital. His simple principles are similar to what we use to guide our readers in our recommendations in Retirement Watch. For example: Don’t go it alone (use an outside advisor and Retirement Watch), diversify, and rebalance.
We disagree with a couple of points. The diversified portfolio as described in the article isn’t fully diversified. We recommend a broader portfolio, such as our “hedge fund” mutual fund portfolio, that includes real estate securities, tactical asset allocation funds, some foreign bonds, and more. We also disagree that index funds always are the best way to invest. We’ve shown that there are a few active managers worth their fees and also that tactical asset allocation funds deliver value when you pick the right funds as we have. It’s an article worth your time.