We often evaluate the quality of a conversation by its activity; the pace of the back-and-forth banter can be used as a barometer of how engaged someone is in the discussion. Given our tendency to find comfort in sustained dialogue - thus the phrase "awkward silence" - I was very struck to see the following profound tweet: "Get comfortable with silence. Some of the most important things clients say follows silence."
Most planners think of college planning as accumulation planning – contribute to a 529 plan, invest properly, and start spending in 5, 10, or 15+ years; and if you don’t earn much income nor have a lot of wealth, you can apply for need-based financial aid. In reality, though, it’s never too late and you’re never too wealthy to keep doing good planning for college funding… but the strategies are different!
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It is a popular trend these days in financial planning to talk about all the ways our clients behave irrationally, supported by a growing base of research in "behavioral economics" that demonstrates how our hunter/gatherer brains are ill-equipped to cope with today's complex world. We tend to talk about these behaviors in the negative, but what if we could use some of our irrational tendencies to our benefit, instead?
Financial planning has long witnessed an unfortunate “gap” between practitioners and academia. As the stereotype goes, the practitioner community to too focused on strategies, techniques, and application, while the academic community spends too much of its time on research that is too basic or too abstract. Well, at the Academy of Financial Services meeting held in conjunction with the FPA’s annual convention, that gap appears to be narrowing, quickly.
In this new column I'm calling "On the nighttable..." I will be highlighting some of the books that I'm reading. Right now, I'm just finishing up a book called "Stabilizing an Unstable Economy" by Hyman Minsky. But the interesting thing is not just that it's another book on stabilizing the economy... it's that Minsky wrote it several decades ago, yet it is nonetheless remarkably prescient about the events of the recent years!
After being absent from this blog for nearly a year, I'm happy to report that the Nerd is back! That's right, Nerd's Eye View is coming back to life with a new focus, and a fresh commitment that it will have content!
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August 2010: What We Can Learn From Lifecycle Finance Quiz
Course Review Date:
October 20, 2018
Kitces Topic Areas:
- General Planning
- Human Capital
- Investments
Session Description:
In this issue of The Kitces Report, we look at some of the information that was taught during the 2010 “Life Cycle Investing for Financial Planners” during July 26-28, 2010, in Boston, MA. In doing so, we attempt to understand whether and how some aspects of financial planning might be changed, or improved, by incorporating some of the life cycle finance economics perspectives.
Learning Objectives:
LO #1: Be able to explain what Life Cycle Finance is and why it is important to understand as a financial planner.
LO #2: Discuss what utility and utility function are. Explain why they are important considerations in financial planning, and why humans tend to exhibit a tendency for diminishing marginal utility of consumption.
LO #3: Describe how using TIPS as a baseline strategy for optimizing lifetime consumption is an ideal strategy. Explain why someone might consider using the strategy of annuitization, and discuss how the use of options can help mitigate risk.
LO #4: Illustrate how human capital changes over time. Identify the various factors that impact a client’s human capital. Explain how financial planners can begin integrating human capital into their practices. Define total wealth.
LO #5: Discuss the implications for the financial planning profession. Identify the caveats and concerns that need to be considered under the life cycle framework.
Key Terms::
Life Cycle Finance: The name or label for the body of economic theory, models, and research that explore how individuals should make decisions about savings, investing, and spending over their lifetimes. Over the planning horizon, individuals will make decisions about how to manage their financial wealth, and what to do with their income/earnings as received, in order to fund their spending (consumption) throughout the years.
Human Capital: In LCF, human capital represents the present value of an individual’s future lifetime earnings.
Consumption: In LCF, consumption is the present value of all future spending; I.e. a liability.
Utility: An abstract measure of how much enjoyment or good an individual derives from the decision that they make.
Utility function: This is a mathematical function that ranks choices, typically goods and services, based on an individual’s utility preferences.
Diminishing Marginal Utility: This is a term that describes individual’s tendency to feel less enjoyment the more an item, good, or service is consumed. To explain another way, as income rises higher and higher we derive less and less additional enjoyment from each additional increment of income.
Habit formation: In LCF, this is when we notice consumers reaching and preferring to sustain a certain standard of living, or maintain certain spending habits.
Loss aversion: We experience more negative feelings about a loss than positive feelings about an equivalent gain. Losing $10 hurts more than gaining $10 feels good.
Risk-free rate: The theoretical rate of return of an investment with zero risk. Treasury bills, assuming the U.S. government remains a secure borrower, are an example of a financial product with a risk-free-rate.
Annuitization: The process of converting an annuity investment into a series of periodic income payments.
Level of Complexity:
- CFP / IWI (formerly IMCA): Intermediate
- NASBA: Basic
Specialized Knowledge:
- CFP: General Principles of Financial Planning / Investment Planning / Retirement Planning
- NASBA: Specialized Knowledge (Personal Financial Planning)
Recommended CE Hours:
- 1.5 CFP / IWI (formerly IMCA) hours
- 1.5 NASBA hours
- 1.5 IWI General Financial Planning hours
Availability:
All self-study courses will be available at least through December 31, 2024.
Live courses are only available for the scheduled date.
All of our courses are reviewed on a yearly basis and renewed or discontinued every December.
For additional information about our programs, click here.
As George Santayana said, "Those who cannot remember the past are condemned to repeat it," but fortunately we don't need to remember the past ourselves, at least when it comes to financial planning. E. Denby Brandon, Jr., and H. Oliver Welch, have done it for us in their new book "The History of Financial Planning: The Transformation of Financial Services."
October 2009: Understanding Marginal And Effective Tax Rates Quiz
Course Review Date:
October 30, 2018
Kitces Topic Areas:
- General Planning
- Taxes
Session Description:
Many financial planners do not necessarily have a firm grasp on what tax rates are really associated with certain levels of income, and often underestimate marginal tax rates and overestimate effective tax rates. In this month’s issue of The Kitces Report, we review some of the foundations of tax principles, looking primarily through a lens towards their impact on marginal and effective tax rates. We also look at what kinds of tax rates really occur at varying levels of income.
Learning Objectives:
LO #1: Be able to explain how to identify what your tax rate really is. Discuss how income tax brackets are used, and how you arrive at taxable income.
LO #2: Illustrate an understanding of marginal tax rates. Describe how you arrive at the marginal tax rate, and why there is more to them than meets the eye.
LO #3: Describe how dividends and capital gains are taxed, specifically qualified dividends and long-term capital gains. Discuss how they are applied under the tax bracket tables themselves.
LO #4: Explain how the Alternative Minimum Tax (AMT) system works. In doing so, identify the various tax rates, the exemption amounts, and discuss how capital gains and qualified dividends are treated. Show an understanding of where it is applied on the tax return.
LO #5: Estimate the marginal and effective tax rates for your clients.
Key Terms:
Marginal Tax Rate: Is the tax rate that will apply – at the margin – to the next $XX of income that the client earns, and/or the tax rate will be saved with the next $YYY of deductions.
Tax Bracket: This refers to the tax rate tiers that apply under the tax code at increasing levels of income.
Progressive Tax System: This is the style of tax system where those with higher income pay a higher percentage share of taxes.
Gross Income: Defined in IRC Section 61, Gross income is all income from whatever source derived [except as otherwise provided by the tax code]
Adjusted Gross Income: This is the income left over after eligible income types and sources have been excluded, and the negative economic adjustments have been made to account for income that wasn’t really received/earned/made.
Above the Line Deduction: These deductions are taken deducted or excluded when determining AGI
Below the Line Deduction: These are the deductions taken from AGI, after it has been determined in order to calculate one’s final taxable income
Alternative Minimum Tax (AMT): This is a supplemental income tax imposed by the federal government which is required in addition to income tax for some individuals, trusts, estates, or corporations
Capital Gains: These are the profits from the sale of property or an investment
Level of Complexity:
- CFP / IWI (formerly IMCA): Advanced
- NASBA: Basic
Specialized Knowledge:
- CFP: General Principles of Financial Planning / Investment Planning / Retirement Planning
- NASBA: Specialized Knowledge (Personal Financial Planning)
Recommended CE Hours:
- 1.5 CFP / IWI (formerly IMCA) hours
- 1.5 NASBA hours
- 1.5 IWI General Financial Planning hours
- 1.5 IWI Taxes & Regulations hours
Availability:
All self-study courses will be available at least through December 31, 2024.
Live courses are only available for the scheduled date.
All of our courses are reviewed on a yearly basis and renewed or discontinued every December.
For additional information about our programs, click here.
May 2009: To Roth Or Not To Roth Quiz
Course Review Date:
October 25, 2018
Kitces Topic Areas:
- Retirement Planning
- Taxes
Session Description:
In this month’s newsletter, we explore the necessary analytical framework to understand when and in what situations it may be more effective to contribute to a Roth IRA versus a traditional IRA and vice versa. By developing a series of rules and evaluating certain known exceptions to those rules, and by exposing certain myths along the way, planners can more clearly evaluate when a Roth IRA contribution (or conversion) may or may not be effective for a particular client situation, to maximize long-term wealth accumulation.
Learning Objectives:
LO #1: Explain the basic tax rules of a Traditional IRA, a Roth IRA, and of Roth IRA conversions. Be able to explain to a client the situations in which they can withdrawal from a Traditional IRA penalty and tax-free. Calculate the amount a client can contribute to their IRAs, and explain why contribution totals are taken together.
LO #2: Be able to compare and contrast a Roth IRA versus a Traditional IRA. Illustrate when it might make sense for a client to utilize a Roth Conversion strategy. Describe the “tax equivalency principle”.
LO #3: Explain the exceptions to the Roth conversion/tax equivalency principle rules.
LO #4: Discuss how your client can apply the rules and exceptions as mentioned in this newsletter. Explain why forecasting future tax rates is important.
LO #5: Identify the strategies your clients can use to implement the rules around the decision to contribute to a Roth IRA versus a Traditional IRA, and whether or not to convert to a Roth IRA from a Traditional IRA.
Key Terms:
Individual Retirement Account (IRA): This is a tax-deferred retirement plan, meaning the individual does not pay taxes when the money goes in, but when the money comes out it is taxed as regular income.
Roth IRA: A compliment to the IRA, the Roth IRA is an after-tax savings vehicle. Taxes are paid when the money goes into the Roth IRA, but earnings on the account and withdrawals from the account after age 59.5 are tax-free.
Roth Conversion: This is a process where by a traditional IRA is converted into a Roth IRA. In order to do this you then pay the taxes on the money earned as well as on contributions originally deducted on your taxes.
Roth IRA Re-conversion: The goal of a re-conversion is to minimize tax burden. This process re-characterizes a Roth IRA-converted, back to the traditional, and then back again to the Roth.
Required Minimum Distribution (RMD): This is the minimum amount that must be withdrawn from an account: IRA, SEP IRA, SIMPLE IRA, ect. once you have reached age 70.5. However, this does not apply to Roth IRAs, which only required distributions once the owner has passed.
Estate tax: This is a tax on the net value of a deceased person’s estate.
Income in Respect of Decedent (IRD) Deduction: IRD deductions apply to beneficiaries. After the decedent has passed, but paid federal estate taxes on IRD assets, then the beneficiary can apply for a deduction on the estate taxes.
Tax liability: This is the tax debt, or amount, owed to the IRS.
Adjusted Gross Income (AGI): This is the measure of income calculated from your gross income and used to determine how much of one’s income is taxable.
Level of Complexity:
- CFP / IWI (formerly IMCA): Advanced
- NASBA: Basic
Specialized Knowledge:
- CFP: General Principles of Financial Planning / Investment Planning / Retirement Planning
- NASBA: Specialized Knowledge (Personal Financial Planning)
Recommended CE Hours:
- 1.5 CFP / IWI (formerly IMCA) hours
- 1.5 NASBA hours
Availability:
All self-study courses will be available at least through December 31, 2024.
Live courses are only available for the scheduled date.
All of our courses are reviewed on a yearly basis and renewed or discontinued every December.
For additional information about our programs, click here.
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