Essential InSights

Core Topics for the Everyday Investor

Account Types: Traditional IRA

Account Types: Traditional IRA

A “Catch All” Retirement Plan

Annual Contribution Max: $6,000 or $7,000 if over 50 years old. 

Why we like Traditional IRA’s:

  • Available to anyone
  • Wide variety of investment choices
  • Total control over the amount of control you want
  • Ability to get Fiduciary level investment advice
  • Easy to set up and contribute
  • Tax-deferred growth
  • Can make deductible
  • Nondeductible contributions (these types of contributions are typically used for roth conversions or stashing more money away in tax deferred investments without the tax benefit now)

Why we don’t like Traditional IRA’s:

  • Low contribution limits
  • Limited creditor protection
  • No access to loans
  • Income restrictions
  • Can’t take out without penalty until 59 ½ unless you have a qualifying event 

The InSight-full® financial plan will almost certainly have one of these as a core component for tax mitigation. An IRA is an Individual Retirement Arrangement and most investors will have at least one of these. A traditional IRAs is a tax-deferred savings plan that is mostly a “catch all” for any plan that savers have had in the past because it preserves the qualified status {not a Qualified account like a 401(k)} of those dollars.  The IRA is rarely the best option for maximizing current contributions. Anyone, regardless of age, can contribute to a traditional IRA provided that you have earned income. An IRA may be your only option if you don’t have access to an employer plan or you’re not self-employed.

Traditional IRAs look a lot like a 401(k)’s, including the way it handles taxation and income. The contributions you make can reduce your taxable income (if you fall under the income limits for IRAs) for that year, and the money grows tax-deferred until you begin withdrawing on it. 

Let’s highlight the differences you’ll see from a 401(k).  First, the contribution limits are much lower: $6,000 in 2020, or $7,000 if you’re 50 or older. Second, you will have broad choices between many different financial-services companies, and each of those companies may include a much wider range of investment options and strategies including stocks, bonds, ETFs as well as mutual funds insurance or even non-marketed securities.

In some cases, we will use both an IRA and a 401(k) in the same year, but be careful: your IRA contributions may not be tax-deductible unless your income is below a threshold amount requiring some additional work to be done safely.

essential insights

Other Related Topics:

Definitions: Fixed Income

Fixed Income (or debt) represents your ownership over the repayment of a debt. Usually considered bonds, they are contracts promising the repayment of loaned money. Other forms of debt arrangements include Mortgage-Backed Securities, liens, loans, and CDs. Fixed income is called that because the return is decided on the outset – so the return is fixed from the initial offering. Because the upside is fixed from the start, the change in their pricing is less dramatic. Thus, fixed income pricing becomes less about the asset itself, and more about the prevailing rates for other options (read “current interest rate environment”). Debt is usually priced based on three variables, 1) How likely you are going to get your debt repaid, who owes the borrowed money, and what is the way they will pay it back? (Taxation, revenue, etc.) 2) how long until you are repaid your initial investment, this is called duration and indicates how long the money is at risk for. 3) the rate that the debtor is paying on the borrowed sum, usually expressed percentage as a coupon or yield. There are subcategories based on who the entity requesting the money fall into: Muni’s  – a Districts or Municipalities Debt. Usually issued to fund special projects, schools, or city and municipal improvements. In addition to the yield, these are priced for risk based on cities’ credit history, the source they plan to repay the loan (taxation or toll-based), and any available insurance they put on the bonds. Treasuries – the sovereign debt of a country. This is debt usually supported by the taxing authority of a country and its ability to create (fiat) the money they need. This is priced based on the credit rating of the country, the outlook of its currency, and the yield. Corporate – debt issued by companies and priced based on their creditworthiness. These are divided into investment grade and non-investment grade (called affectionately “high yield”) and then subdivided further. Certified Deposits (CD’s) – debt issued by banks. These are usually issued in small increments and for a short duration. The returns are insured by the FDIC (federal government) Mortgages (MBS) – These are backed by the creditworthiness of the borrower, and usually the risk is mitigated by grouping a pool of mortgages into tranches based on their collective credit rating. Collateralized Debt Obligations (CLOs) – Similar to the mortgages, this is a collection of debts that secure equipment or are backed by specialty financial arrangements.  Often backed by the repossession of accounts receivable or equipment.  

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Definitions: Equity

The term Equity represents any ownership rights over an asset’s cash flow generation potential. As an asset class, there is no guarantee of a return on your investment, it is the most speculative of assets classes and is the only asset class that can have its intrinsic value brought to zero. But because it is ownership without end, and a right to the value in perpetuity, it is also the source of the greatest returns. The math looks like this: The most common sources of Equity are stocks, your home, and other real estate assets. But equities can also include ownership in a business through your own formation, or as the result of a private placement and they also include art, royalty agreements, or leasing agreements.  Other terms for Equity are shareholder value, book value, or stake.

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Definitions: Asset Allocation

Asset Allocation is how we discuss the percent of assets in one of the four main asset classes. It is the balance of risk and reward and is the most reliable leading indicator of the intermediate and long term trajectory of a portfolio. The Asset Allocation is the first place we can adjust to a client individual’s goals, risk tolerance, and investment horizon. Asset allocation is often displayed as a pie chart and discussed in terms of the ratio. For example, the “60/40” is a shorthand reference to a portfolio that is 60% allocated to equities, and 40% to debt. These are used by many firms to place clients into a suitable collection of investments. The four assets classes we define in Asset Allocation are Equity, Fixed Income, Cash, and Precious metals.

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