Category Archives: September

Small Island, Big Debt — Why Puerto Rico Matters to Muni Investors Puerto Rico’s dire fiscal situation and the potential implications for municipal bond and mutual fund investors.

On August 3, Puerto Rico missed a payment to bondholders for the first time. The default was not a big surprise, given the island’s weak economy and heavy $72 billion debt load.1 A painful recession has persisted for nearly a decade, while Puerto Rico’s debt-to-GDP ratio spiked to more than three times that of any U.S. state or territory.2

Tax-friendly municipal bonds, sold by state and local governments to finance public-works projects, are a key component of the portfolios of many investors who depend on the stable income. Puerto Rico’s bonds also have municipal status, but the U.S. territory’s municipalities don’t currently have a legal right to file for bankruptcy under Chapter 9, as Detroit and some other struggling cities have done in recent years.3

Nonetheless, additional defaults could be in store, and the fallout from Puerto Rico’s dire fiscal situation may continue to affect U.S. municipal bond and mutual fund investors.

Puerto Rico’s Issues

Puerto Rico has issued three different kinds of debt. The first default by the Public Finance Corporation involved appropriation debt, which is considered the riskiest of the three because payments depend on the legislature’s willingness to provide funds. General-obligation (G.O.) bonds have first priority under the commonwealth’s constitution, and revenue bonds are backed by dedicated revenue sources, such as public utilities.4

Officials are working on a proposal to restructure Puerto Rico’s debt, while major creditors are pressuring the government to meet its obligations.5 It might take years for Puerto Rico’s financial mess to be ironed out, and bondholders could suffer some losses in the process.

The Merits of Munis

Puerto Rico’s debt problems are fairly isolated and not expected to weigh heavily on the nation’s broader $3.7 trillion muni market.6 The U.S. economy is more than six years into a slow but steady economic expansion, and the default rate of the S&P Municipal Bond Index, which follows bonds of more than 22,000 issuers, was just 0.17% in 2014.7

Municipal bond interest is generally exempt from federal income tax and is usually exempt from state and local income taxes for investors who live in the state where a bond was issued. However, selling a municipal bond or tax-exempt fund at a profit could trigger capital gain taxes. (The interest on bonds issued outside an investor’s state of residency could be subject to state and local taxes, and some municipal bond interest could be subject to the federal alternative minimum tax.)

Because government entities have the power to raise taxes and fees to pay the interest, municipal bonds are generally considered to be higher-quality assets than taxable bonds such as corporates, so they typically pay less interest. The lower tax-free yields offered by muni bonds and tax-exempt mutual funds are often more valuable to investors in the top tax brackets. For example, a 3% tax-free yield is equivalent to a 4.62% taxable yield for an investor in the 35% federal income tax bracket.

Bond Fund Exposure

Nearly 20% of U.S. bond funds, including about half of municipal bond funds, hold Puerto Rican debt, with exposure varying widely from less than 1% to nearly 50% of fund assets.8–9

How did so much Puerto Rican debt end up in the portfolios of so many U.S. municipal bond funds? Because Puerto Rico is a U.S. territory, its bonds are not subject to any federal or state taxes regardless of where the investor lives, which allows them to be included in muni funds intended to be tax-free for residents of a single state. Some fund managers might also have been reaching for more generous yields, which are typically associated with a higher level of risk.10

For individual investors, owning an assortment of munis in a mutual fund makes it easier to attain credit diversification. However, Puerto Rico serves as a reminder that some muni funds are more diversified than others, and it highlights the importance of looking closely at any bond fund’s underlying investments. (Diversification is a method used to help manage investment risk; it does not guarantee a profit or protect against loss.)

Headline Risk Remains

Municipal bond prices may continue to fluctuate as events in Puerto Rico unfold. But credit jitters could also create opportunities for buy-and-hold investors who are willing to ride out periods of market volatility.

The return and principal value of bonds and mutual fund shares fluctuate with changes in market conditions. When redeemed, they may be worth more or less than their original cost. Bond funds are subject to the same inflation, interest-rate, and credit risks associated with their underlying bonds. As interest rates rise, bond prices typically fall, which can adversely affect a bond fund’s performance.

Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

1) The Wall Street Journal, August 3, 2015
2) Kiplinger.com, July 22, 2015
3) CNNMoney, July 1, 2015
4–5) Bloomberg.com, August 3, 2015
6, 8, 10) The New York Times, July 24, 2015
7) S&P Dow Jones Indices, 2015
9) Investor’s Business Daily, August 13, 2015

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.

Inheriting an IRA If you’ve inherited an IRA or might inherit one in the future, it’s important to understand your options.

Although IRAs are primarily intended to help fund retirement, some people don’t withdraw all IRA assets during their lifetimes. Any remaining assets go to the account owner’s designated beneficiaries and could provide a generous legacy.

If you’ve inherited an IRA or might inherit one in the future, it’s important to understand your options. IRS rules and regulations for inheriting an IRA can be complex, and an uninformed decision could result in unexpected taxes and penalties.

To Stretch or Not to Stretch?

An individual who inherits an IRA can take all or part of the funds as a lump-sum distribution or stretch withdrawals over his or her life expectancy (under current law) by taking required minimum distributions (RMDs). If the original account owner was under 70½ at the time of death, the beneficiary can delay distributions until December 31 of the fifth year after the original owner’s death, but all the assets must be distributed by that time.

The lump-sum approach may be appropriate for small accounts, but you should think twice before liquidating a large account. Distributions from a traditional IRA are subject to ordinary income tax, so taking a large distribution could push you into a higher tax bracket and reduce the potential value of the inheritance. Roth IRA distributions might not be taxable (as long as the original owner met the Roth five-year holding requirement), but liquidating the account would lose the benefit of potential tax-free growth.

Taking RMDs

The rules on RMDs depend on the beneficiary’s relationship to the original owner. RMDs are generally based on the life expectancy of the beneficiary.

A nonspouse beneficiary who doesn’t cash out should properly retitle the account as an inherited IRA — such as “Joe Smith (deceased) for the benefit of Mary Smith (beneficiary).” Inherited IRAs are not subject to early-withdrawal penalties, but they are subject to annual RMDs, which must begin no later than December 31 of the year after the original owner’s death (regardless of the beneficiary’s age). However, if the original owner died after age 70½ and failed to take an RMD in the year of death, the beneficiary must take at least the amount of the RMD by December 31 of that year.

A surviving spouse who is the sole beneficiary has more options. The survivor can treat the assets as his or her own by rolling them over to an existing or a new IRA. RMDs would not have to start until age 70½ (distributions prior to age 59½ may be subject to a 10% early-withdrawal penalty). If the account remains an inherited IRA with the surviving spouse as sole beneficiary, minimum distributions are based on the beneficiary’s or the late spouse’s life expectancy (whichever is longer). If the late spouse died before reaching age 70½, distributions can be delayed until the year he or she would have turned 70½, but RMDs would be based on the surviving spouse’s life expectancy.

Another option that may be available to both spousal and nonspouse beneficiaries is to disclaim the IRA and allow it to pass directly to the account’s contingent beneficiaries. RMDs typically would be lower if based on the life expectancy of a younger beneficiary, which may result in a greater opportunity for the assets to pursue growth.

RMD rules become more complex when multiple beneficiaries are designated or when the IRA is left to the estate or a trust. Be sure to consult with a tax or estate professional before taking any specific action.

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.

Investing in Your Values More investors are considering their values, social as well as environmental, when making investment decisions.

It’s probably safe to say that people choose an investment with the assumption that it will add financial value to a portfolio. However, more investors are considering other values when making investment decisions — the way a company does business, the way it treats employees, and the social and environmental impact of its products and services.

This type of value-based investing is called by various names, including socially responsible investing; sustainable and responsible investing; and sustainable, responsible, and impact investing. Typically, the acronym SRI is used to represent all these terms, and the principles are similar regardless of terminology. Investing based on your social beliefs does not necessarily reduce the potential for financial gain. In fact, SRI stocks tend to perform similarly to the broader stock market (see chart).

Interest in sustainable and responsible investing has grown steadily since it was first tracked in 1995, but growth has accelerated over the last two years. U.S. assets invested according to SRI principles increased by 76% from 2012 to 2014, rising from $3.74 trillion to $6.57 trillion — equivalent to about one out of six professionally managed U.S. investment dollars.1 Globally, the increase was 61%, rising from $13.3 trillion to $21.4 trillion.2

Strategies and Advocacy

SRI strategies typically incorporate environmental, social, and corporate governance (ESG) factors to analyze and construct investment portfolios. This is often done by professional investment managers for large institutional investors, but individual investors might consider these factors when developing their own portfolios. Along with screening individual stocks, investors can choose from more than 450 ESG mutual funds.3

ESG factors include such issues as employee relations, environmental practices, product safety and utility, and respect for human rights. For example, an SRI approach might include companies that produce “green” products or are proactive in community and employee relations; it might screen out companies that produce tobacco or alcohol products, engage in questionable employment practices, or invest in countries with poor human rights records. A more targeted ESG approach, often called community investing, channels dollars to benefit individuals or organizations that have been underserved by mainstream financial institutions.

In addition to considering ESG factors when choosing investments, shareholders are increasingly using voting power and other influence to encourage corporate management to follow practices that might improve the company’s ESG efforts. This may reflect shareholders’ personal values as well as the belief that greater ESG engagement could improve business results and increase share value.

Consider the Risks

Although the number of companies and funds that consider ESG factors continues to grow, focusing on SRI strategies limits the total universe of available investments and could make it more challenging to diversify and maintain your desired asset allocation. Diversification and asset allocation do not guarantee a profit or protect against loss, but they may help manage risk.

Like all investments, SRI stocks and funds entail risk and could lose money, and they may underperform similar investments not constrained by social policies. There is no guarantee that an SRI-focused investment will achieve its objectives, and different companies may use different definitions of ESG factors and SRI strategies. You should take the time to learn about a potential SRI stock or fund before making a commitment to purchase it.

Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

1, 3) The Forum for Sustainable and Responsible Investment, 2014
2) Global Sustainable Investment Alliance, 2015

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.

Do You Need Disability Insurance? In 2013, 59% of new disability claims were for people 50 and older and it often takes more time for them to recover.

It might surprise you to know that the odds of long-term disability actually decline with age. For example, a 40-year-old has a 43% chance of experiencing at least one disability lasting 90 days or more before reaching age 65. For a 50-year-old, the odds drop to 36% — still a higher risk than most people might expect.1

Of course, the average 50-year-old is not healthier or less accident-prone than the average 40-year-old. The difference reflects the fact that the 40-year-old has a longer period of risk before reaching age 65.

In fact, disabilities tend to occur later in life. In 2013 (most recent data available), 59% of new long-term disability claims were for people 50 and older.2 And when older people become disabled, it often takes more time for them to recover, or they might not return to work at all. A 55-year-old who experiences a 90-day disability has a 60% chance of it lasting for at least five years.3

Individual vs. Group Coverage

If you’re concerned about the potential effect of losing your income due to sickness or injury, you might consider an individual disability income insurance policy. Though your employer may offer long-term disability coverage, group plans typically don’t replace as large a percentage of income as an individual plan could, and disability benefits from employer-paid plans are taxable to the employee if the employer paid the premiums. Of course, if you change jobs, you might lose your subsidized employer-based coverage.

An individual disability income policy could help replace a percentage of your income, up to the policy limits, if you’re unable to work as a result of an illness or injury. Benefits may be paid for a specified number of years or until you reach retirement age. Some policies pay benefits if you cannot work in your current occupation; others might pay only if you cannot work in any type of job. If you pay the premiums yourself, disability benefits are usually free of income tax.

A loss of income not only could put immediate pressure on you and your family, but might also alter your options for retirement. An appropriate individual disability income policy may help you weather a difficult time and stay on track to pursue your long-term financial goals.

1, 3) 2015 Field Guide, National Underwriter
2) Council for Disability Awareness, 2014

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.

Financing Options for Small Businesses Some common types of financing that a small biz may need in order to upgrade its operations or finance expansion.

While bank lending to large businesses (loans over $1 million) rose to record levels in 2014 — loans outstanding were more than 24% higher than before the recession — small-business loans (under $1 million) in 2014 were still 17% below pre-recession highs.1

Even though the credit market is becoming friendlier, small firms are still having difficulty tapping into today’s low interest rates. Here are the pros and cons of some common types of financing that small businesses may need in order to upgrade their operations or finance expansion.

Bank loans. Many financial institutions restrict lending to the most creditworthy businesses, and even qualified owners may need to contact many banks before finding one willing to offer financing. New or fast-growing small businesses — even healthy ones with good prospects — are often rejected. Banks often require significant collateral and documentation of stable profits. Because of lower property values in some places, owners may not be able to rely on real estate equity to help secure business loans, cash-out mortgage refinances, or equity lines.

SBA loans. The U.S. Small Business Administration guaranteed more than $19 billion in loans made by private banks in fiscal year 2014.2 The program often makes it easier to obtain financing and may offer more competitive terms and longer repayment periods. However, SBA loans also require “worthwhile” collateral, and it can take several months for qualified applicants to complete the process and receive the funds.

Alternative sources. Specialty lenders may extend short-term loans that are backed by business assets such as securities, equipment, inventory, and accounts receivable. These loans are usually more expensive but can sometimes be used to access capital quickly.3

Credit cards. About 36% of small businesses used credit cards to meet their capital needs in 2014.4 Business accounts often charge higher interest rates and offer fewer financial protections than personal accounts. Using a business credit card responsibly, however, is one way that a new business could help establish the positive credit history it might need to obtain business loans in the future.

If you are thinking about borrowing funds to strengthen or grow your business, be sure to do plenty of research and weigh your options carefully.

1) Federal Reserve Bank of Cleveland, 2015
2) U.S. Small Business Administration, 2014
3) Inc., May 2014
4) National Small Business Association, 2014

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.

Women May Need More Life Insurance While women make up more than half of the U.S. labor force, about 43% of women don’t have life insurance.

Did you know that 100 years ago, women were not even able to buy life insurance? Now women make up more than half (57%) of the U.S. labor force. Yet in spite of their important contributions to the nation and their families’ financial well-being, about 43% of women still don’t have life insurance.

In fact, the average insured woman has $129,800 of individual life insurance, which isn’t enough coverage to maintain her family’s current lifestyle. One rule of thumb calls for having life insurance that equals seven to 10 times annual salary, but each situation is different.

For women with a spouse, children, or even parents who depend on them, life insurance funds could help replace their incomes and provide essential financial support for survivors. The proceeds of a policy could also help pay for costly child care, future college costs, and other household needs that are often met by stay-at-home moms.

The cost and availability of life insurance depend on factors such as age, health, and the type and amount of insurance purchased. Policies commonly have mortality and administrative charges beyond the cost of premiums.

Sources: Insurance Information Institute, 2015; U.S. Bureau of Labor Statistics, 2015
The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright 2015 Emerald Connect, LLC.