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The History Channel has been airing a fine documentary entitled "The Crash," which describes the 1929 bloodbath on Wall Street. In one segment, an eighty-year-old stockbroker tells of a man who entered the brokerage office in 1968 to sell shares of RCA. "Why are you selling and when did you buy them?" the stockbroker asked. "I am selling because they have finally reached the price I paid for them, and I bought them in early 1929," the man responded. During the Roaring
'20s, Radio Corporation of America shares went from $2 to over
$500. Then they plunged and took 40 years to recover. On its way
up, RCA was the Microsoft of its day as it commercialized the
invention of radio. On its way down, it resembled many of today's
Internet stocks, whose investors bought into the hype of unlimited
potential. Another lesson is the psychological makeup of this RCA investor. He couldn't bear to take a loss and waited forty years to get his purchase price back. I can imagine the discussion with his wife (if she was still alive) when he walked into the house and announced that they hadn't lost money after all on his brilliant purchase of RCA. What do we do with a stock or mutual fund that is in the tank? The conflicting forces are to hold on or to sell. Setting aside commissions and tax considerations, there is a theory that says that any day we continue to hold a stock is a day we have effectively elected to buy it. Studies show that people are always more likely to sell a stock when they have a gain than when they have experienced a loss. We probably act the same way when we are selecting, or moving money around in, our mutual funds. The fundamental problem is ego. If we have a loser, we don't have to admit to the loss until it actually happens. If a stock is down in value, it is only a loss on paper (an "unrealized loss" in accounting terms). When we actually sell the stock or the fund, we have a "realized loss," which we can do something with -- like apply as a tax deduction. If you hate facing up to your losses, you have a lot of company. A wide universe of investors has proven to be reluctant to sell losses compared to gains. A Journal of Finance study shows that in any given year, investors will sell 14.8% of their gains but only 9.8% of their losses. In theory, anyone
selling stocks that trigger gains should sell a corresponding
amount of stocks that trigger losses. However, something called
the "disposition effect" operates subconsciously and
disrupts rational thinking. This effect is so powerful that there
are actually several different terms that researchers use to describe
our deep-rooted tendency to hold losers too long and sell winners
too soon. If you are agonizing over what to do with a stock that has plummeted, remember that if it goes down and demonstrates reasons for staying down, you are better off selling and investing elsewhere. This brings us back again to the need for diversification (i.e. a mutual fund), which can shelter you against the wide value swings that can be characteristic of individual stocks. For example, an investor who has 75% of her 401(k) in her employer's stock should diversify those assets to other investments. Next, try to establish "mechanical" investment techniques that remove the need to be thinking about when to buy and when to sell. Re-balancing a portfolio at regular intervals and dollar-cost averaging of contributions can remove the uncertainty and the timing ctp://www.buyandhold.com/bh/en/retirement/qa/index.html">Help Topics |
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Who Needs Seinfeld, When We Have the Tax Code?
By Stephen J. Butler
Archives
The laws pertaining to distributions from retirement plans are so complicated as to be just laughable. For example, an employee who was born before 1936 and who participated in their employer's retirement plan before 1974 can receive any company stock in the plan at a flat 20% tax rate. The amount of stock eligible for this treatment is based upon the number of years of participation in the plan prior to 1974. Employees born before 1936 can also elect to take their entire distribution and be taxed as if the money was received in equal installments over ten years --- a huge tax savings over what some poor soul born in 1937 or later would have to pay. At this point, we should be asking, "Who thinks of these things?" What's magic about 1936 or 1974? Whatever happened to "tax simplification?"
Meanwhile, a careful application of new retirement account legislation effective in 2002 offers some surprising opportunities that did not exist previously.
Before going any further, I will point out that a necessary resource for anyone over fifty is the new 4th edition of "IRAs, 401(k)s & Other Retirement Plans Taking Your Money Out." This book by Twila Slesnick and John Suttle is required reading for anyone within fifteen years of accessing their retirement accounts. It is especially important if you think you might be inheriting money from one of these accounts.
Picking through these new rulings yields some startling findings. For example, there is now the opportunity to make grandchildren the beneficiaries of a retirement account, which will then be taxed at children's low tax brackets as the funds trickle out to them over time. Before, anyone dying after age 70 and * would have had their account paid out based on minimum annual required distributions with calculations based upon the life span of the owner of the account.
Congress has always felt that retirement plans should never be available as a means of passing wealth from one generation to the next. However, the application of these new distribution rules combined with massive estate tax reductions essentially perpetuates wealth accumulation in tax-deferred accounts. By comparison, with previous estate tax tables and income tax exposure, a typical retirement account was easily subject to an 80% combined tax at the death of the second spouse when otherwise postponed tax liabilities came due. If we question such a high combined tax we need to realize that tax planning always assumes that the decision impacts the last few dollars of the estate. If we spend or gift estate assets, we are removing the last few dollars that would have been taxed at the highest marginal rates. It's the same "last dollar" mechanism that generates such a high tax savings on money we deposit
into these plans.
As a general rule, money distributed from a retirement plan prior to age 59 and * will be taxed as regular income at the highest marginal rate PLUS about a 12% combined federal and state penalty here in California. However, taking money out of a plan prior to age 59 and * is always of interest to many people sooner or later, and it can be accomplished free of penalties by several different methods. If you leave a job, for instance, and you will be over age 55 by the end of the year, you can take distributions from your employer's plan on a penalty-free basis. You don't have to retire permanently, and, in fact, you can even come back to work for the same employer. The age 55 option, however, is not available with IRA accounts, s