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The Advocate Group’s Perspective on Stock Splits

In theory….there should be no bump in value based on a 2:1 stock split. Intrinsically valued, splits are a non-event.

  • In practice….there can be a behavioral effect, and therefore a resultant market bump when a company’s stock splits as it broaches or approaches a psychological price sensitivity level such as $100/sh.
  • There may however, be a “signaling” effect that is implied when a split is done to the extent investors think the Board of Directors voted for the split with the belief future price per share will be higher.
    • This is hard to prove empirically but by virtue of selective sample, splits which increase outstanding shares are done by companies that have appreciated in value.
    • Many of these companies go on to appreciate substantially in value
    • The market generally “remembers the increase in value”
  • Some believe a wider audience of investors (a broadening of the market) are purported to have greater levels of interest in investing in a lower priced stock than in a higher priced stock which “may” bid the price up in the market (this is perhaps a less sophisticated way of saying what we already said in the first two bullet points.
  • While The Advocate Group regards a stock split to be favorable news, our enthusiasm is tempered.
  • That said, because of the “Leverage Effect” of stock options, any potential benefit which might arise in the market will be “leveraged up” and nicely reflected in option exercise spreads.
    • Clearly, restricted stock and held shares will participate in any potential market uptick due to a split, however; stock options are where the positive impact of a split will be most positively experienced (by employees).

  • Please Note: We believe the most significant impact on future option exercise spreads will come from continued quarterly posting of operational excellence.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

— 12 May 2010 White Papers

The Top 7 Reasons to Consider a Roth IRA Conversion

By Echo Huang, CFP®, CPA
Partner, The Advocate Group, Inc.

The Roth IRA is even hotter this year, as many individuals, who were unable to fund a Roth IRA due to income restrictions, are planning for 2010 when some of the funding restrictions will be lifted. While the income cap on regular contributions will remain in effect, the restrictions on Roth conversion of assets from eligible retirement accounts are repealed as of January 1, 2010. Currently many individuals cannot contribute to Roth IRAs because they make too much income – joint Modified Adjusted Gross Income (MAGI) over $176,000. They cannot convert any amount from their IRAs to Roth IRAs if joint MAGI are over $100,000. Now it is the right time for many people to plan for Roth IRA conversion starting in year 2010 because the $100,000 income limitation on Roth conversion will be repealed.

ARE YOU READY TO ROTH?

Now is the perfect time for you to consider Roth IRA conversion. If you are like many investors who have all the retirement savings in conventional tax-deferred accounts such as Traditional IRAs and 401(k) plans, you may be less diversified than you realize. Conventional savings vehicles like Traditional IRAs and 401(k) plans are great plans since they allow you to delay paying taxes on your contributions and investment returns. These conventional arrangements do not, however, shield you from future taxes. Roth IRAs do shield you from future taxes.

Now let’s look at the top 7 reasons to consider Roth:

1. Tax-Free Growth – Unlike the growth within a Traditional IRA which is taxed at your ordinary income tax rates at the time of withdrawal, the growth you accumulate within a Roth IRA is generally tax exempt at the time of withdrawal, provided that your distribution is a “Qualified” distribution.

2. Protection From Future Tax Hikes – With Roth IRA savings, you pay taxes on your contribution (or conversion) “up front” in the year you contribute or convert, in order to avoid paying income taxes in the future when you take qualified distributions. By “locking in” today’s tax rates at the time of contribution (or conversion), Roth IRA savings help you shield retirement savings from potential future increases in personal income tax rates. Because of our country’s projected huge deficit in many programs such as social security and Medicare, higher income tax rates in the future is likely. The current low tax rates are due to expire after 2010, and unless Congress acts, stretching out the conversion could also increase total tax bills. If the income tax rates are higher in 2011 and 2012, then it would make sense to pay income taxes on conversion income in year 2010 instead of allocating 50% of conversion income in tax year 2011 and 50% of conversion income in tax year 2012 as is the current default election under the new law.

3. Tax Diversification – Since we do not know the future income tax rates, it would be important to have all types of accounts: tax-deferred accounts such as IRAs and 401(k)s, tax-free accounts such as Roth IRAs, and taxable accounts that you pay income taxes or capital gain taxes every year. When you have all types of accounts that are taxed differently, you have more flexibility to decide how, when and from which account to take distributions in the future when you retire depending on which will give you the most tax advantage. Tax diversification is why I believe almost everyone should allocate a portion of retirement savings to a Roth IRA.

4. Withdrawal Flexibility – Unlike Traditional IRA savings which become subject to mandatory annual distributions once you reach age 70 ½, withdrawals from a Roth IRA are completely discretionary throughout your lifetime. If you don’t want/need to withdraw assets from your Roth IRA, you don’t have to withdraw anything – regardless of your age.

5. Legacy Leverage – Depending on your income needs during retirement and your unique estate planning objectives, Roth IRA savings can potentially enable you to leave a greater financial legacy for your heirs on a tax-leveraged basis. This is especially beneficial for the taxpayer whose estate exceeds the estate exemption ($3.5 million now for federal); paying some income taxes now to convert some IRA savings to Roth savings can reduce gross estate to potentially reduce future estate taxes in addition to leaving your heirs tax-free Roth accounts.

6. Peace of Mind – For many tax payers, one of the most valuable advantage of Roth IRA savings is the peace of mind that comes from knowing that all or a portion of their retirement nest egg is sheltered from future increases in federal and state income tax rates.

7. Extended Funding – Unlike Traditional IRAs which may not be funded with annual contributions once you reach age 70 ½, Roth IRAs may be funded beyond age 70 ½ so long as you (or your spouse) continue to receive earned income from working and meet the income limitation for making Roth contributions. Therefore, semi-retired individuals can continue to contribute to Roth IRA.

Who Should Consider a Roth IRA Conversion in Year 2010?

The first question I would ask my clients is “Do you think that you are more likely to pay a higher percent in income taxes related to your income in the future than in year 2010?” If the answer is quite sure, then I would ask more questions to determine how much of the IRA balance should be converted and over what period of time. If you are not sure about being in a higher tax rate in the future, then I still believe investors should look at some analysis of their investment objective, estate plan, current income, marginal tax rate and their projected future income.

These types of individuals may be ideal candidates for Roth IRA Conversion:

1. Retirees who do not need money from IRAs to live on. Retirees who do not need the money from IRAs to live on must still take the required minimum distributions (RMD) from their IRAs to avoid a 50% penalty. These individuals have non-IRA assets to support their lifestyles. Having the IRA accounts grow tax-deferred may not be the best solution for wealth transfer to next generations because IRAs are loaded with taxes (income taxes and possible estate taxes). We can help them carve out a piece of their IRAs for transferring to children or grandchildren and use some money outside of IRAs to pay income taxes in year 2010. If they choose to convert this portion to Roth in 2010, they can use other assets to pay some income taxes now to have more money in tax free Roth IRA account for beneficiaries to inherit. In addition, for the individual who has a credit shelter trust in their will to shelter the estate exemption amount, IRAs are not the ideal assets to go to credit shelter trust because of RMD requirements and thus a depleting asset. Paying some income taxes now reduces the size of your future taxable estate and the Roth IRA becomes a great asset to go to the credit shelter trust for your beneficiaries.

2. Individuals who want to supplement a savings plan for college education that is more than five years from now. Many people use 529 plans to save for higher education expenses, but may be concerned about overfunding them because distributions from 529 plans for other than qualified higher education expenses will be subject to a 10% penalty and ordinary state and federal income taxes. For example, the child needs about $250,000 to pay for private college education 5 years from now and the 529 plan is projected to fund $200,000. One solution is to increase funding to the 529 plan to reduce shortfall. Another better solution is to convert some IRA money ($50,000) to Roth IRA in year 2010 and wait for at least five years to take out the $50,000 penalty free and income tax free to pay for college expenses. There are two major benefits of converting IRA to Roth IRA than just increasing funding to the 529 plan: flexibility to use the $50,000 five years after conversion on any expenses tax free, not just qualified higher education expenses; more investment choices than typical 529 plans. If the $50,000 grows to $80,000 in five years, after taking out the $50,000, the earnings of $30,000 can stay in the Roth IRA to let the magic of compounding work longer. For many baby boomers, having the flexibility is the key to balance their retirement income needs and college expenses. If the child does not need the $50,000, then the owner of the Roth IRA account can use it for retirement. (NOTE: This example is hypothetical and is not representative of any specific situation. Your results may vary.)

3. Young individuals who have more than 20 years before retirement. Tax-Free compound growth inside a Roth IRA is more powerful when you have many years before you need to withdraw money. For younger individuals, converting money to a Roth IRA is an easier decision.

4. Individuals who are charitably inclined can combine Roth IRA conversion with a major donation to charities or a donor-advised fund in year 2010 to reduce income taxes. Both actions will help reduce estate taxes and leave more money to beneficiaries.

Caution:

If the IRS had never retroactively changed tax policy, Roth IRA conversion would be an easy decision for many people; however, we have seen historic moments such as the passage of Tax Reform Act of 1986 where the IRS did not grandfather a change in tax policy. People who made investment decisions on what they thought was sound tax law prior to 1986 were horrified in 1986 that the new law negatively impacted their investment outcome. To be completely comfortable on execution of a Roth IRA conversion, we believe you must have confidence that the IRS will never retroactively change their policy on taxation of Roth IRAs.

In summary, for many people, conversion to Roth IRA in 2010 is the right decision. It does not have to be all or nothing. Working with your trusted advisor can help you look at the pros and cons clearly and plan better for your financial future.

— 24 November 2009 White Papers


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