Author Archives: Edi

California continues to move forward with payroll Long-Term Care insurance

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Long-Term Care insurance (LTCi) funded through a payroll tax is currently under serious consideration by California. We do not yet have details, but this may be similar to what Washington State instituted several years ago.

To prepare you for this possibility we will be adding a LTC insurance conversation to our fall meetings for anyone employed in California (we will look to see if other states are also considering a similar measure).

The passage of AB 567 (2019) established the Long-Term Care Insurance Task Force (Task Force) of the California Department of Insurance. This task force is developing a statewide insurance LTC services program. The Task Force has already recommended several options to the Governor and the Legislature (2022). The options in the Feasibility Report will undergo financial analysis and their findings will be included in an Actuarial Report, which, if approved by the Task Force, will be submitted to the Legislature no later than January 1, 2024. (if you want more details let us know and we’ll send you information from California Insurance Commissioner Ricardo Lara).

What does this program mean for any employee (or business owner)? A mandated LTC insurance program would be an ongoing cost to cover an insurance pool that may or may not provide a significant level of support or portability. If this follows a similar program implemented in Washington State, we recommend that most of our California employed clients consider obtaining a minimal LTC insurance policy prior to year-end (for now we don’t yet know what options California will provide to opt out so no action is needed).

How soon could the Program be implemented? The Task Force will make its final recommendations to the Legislature in the Actuarial Report, which will be submitted by January 1, 2024. At that point, legislation would be required to establish and implement a statewide program which can be dated in the future or more likely as of the day it is accepted.

How is the Program opt-out designed? We only have minimal information, but for now individuals who own eligible private insurance as of a certain date on or before the program effective date would be permitted to opt out of the program. Any new policies sold after this deadline would be ineligible for program opt out but could qualify for reduced program contributions. To be eligible to opt out, or receive reduced program contributions, the policy would have to meet certain standards (not yet outlined but expected this fall) and would be subject to periodic recertification.

How would the program be funded? A progressive payroll tax, perhaps split between employees and employers, with an income-based tax for self-employed individuals is the most commonly recommended design so far.

We will keep monitoring the progress of the Long-Term Care Task force and also work with clients to determine if a private LTC insurance policy is appropriate. This is only relevant to anyone who will continue to earn income in California.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

AI and Data Analytics – new SEC rules in 2024

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At end of July, the SEC approved a plan that they say will root out conflicts of interest that can arise when financial firms use Artificial Intelligence (AI) to serve clients. They are also improving rules requiring companies to disclose serious cybersecurity incidents within four business days of any significant breach.

I would be more impressed if these were required for all technology firms that handle customer data analytics (not only financial firms).

The SEC asserts that the new regulations will ensure that ‘predictive data analytics is used to optimize services that better serve clients’ and not for the benefit of the financial firm. Banks and brokerage firms are typically using AI for fraud detection and market surveillance, but recently the shift has been made to have AI and analytics as part of trading recommendation, asset management, and lending. This is a huge development with serious implications for consumers. The goal of the new regulation is to ensure that biases are not ingrained in the technology algorithm, particularly since many vendors and consumers accept technology output, as fact, without human verification.

In this vein, The Federal Trade Commission (FTC) has opened an investigation into Microsoft Corp – OpenAI Inc (the creator of ChatGPT) to examine what risks the chatbot poses for consumers . . . these programs are written by humans and can extend biases and discrimination.

The ideal ‘responsible innovation’ in technology is appealing but so is responsible capitalism or governance and we are currently not doing well in any of these areas.

AI has the potential to draw on reams of data to target individual investors and nudge them to alter their behavior on trading, investing, borrowing, or even opening financial accounts for them. Many of the new tools can be transformative in our time, and I would love to use them. Even so, we should be leery about the concentration of this technology and powerful data in the hands of only a few firms which can pose a huge risk for future stability in financial markets.

It is important that we not provide our private data to technology or analytics software that is not yet fully tested and regulated from unregulated companies. We need to continue to demand that regulations be developed to ensure the safety of our data and particularly add controls for how for-profit firms can use our data. I am particularly concerned when I see errors in financial software output that are accepted as correct because they are software generated.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Charitable Deductions

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There are many ways to give to charitable causes without risk of IRS wrath. We agree that there is a lot of value in making contributions to charities partly with dollars that would be paid in income taxes, but each person has to recognize that you must simultaneously give away non-tax money. For example, a gift of $1M can in some cases reduce your taxes by about $400K (or 40% of the donated dollars) BUT you must accept that the other $600k will be funded from your savings (non-tax dollars).

The tools used to make charitable contributions can be simple direct donations to a charity or to many using Donor Advised Funds (DAF), or a specific group using a charitable trust or use of Family Private Foundations. The type of contributions can be cash, stock, shares in a company, or any asset. What is important is that the charitable deduction follow IRS proven process to the letter. This will prevent negative consequences of having to pay taxes and tax penalties years later.

This month, we have a case (Braen, et. al v. Commissioner of Internal Revenue, TC) that disallowed a $5.22 million charitable income tax deduction claimed by the Braen family in connection with a sale of a property in NY made through S Corp shares. The rejection appears to be based on not adhering to standard timing/practices and on property valuation misstatements. Unless they appeal, the family will have no deduction and must pay substantial penalties to the IRS.

What does this mean for you? There is nothing risky about using known and established ways to reduce your tax liability and particularly advantageous if you can also use it to fulfill your philanthropic plan, but this must be implemented using proven processes. Let us know if you are ready to create your philanthropic financial plan.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

What we heard at the July Fed meeting

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The latest Federal Reserve meeting (July 26th) increased the interest rate another 25 basis points to 5.375%. We have another three upcoming meetings (September 20th, November 1st, and December 13th) left in 2023.

The current focus is now on fall corporate financial reports and the impact of existing debt payments on corporate profits to see if additional interest rate hikes are needed. GDP numbers out by July 27th showed an economy that is growing and consumers who are still spending (particularly in services rather than material goods) indicating that we are not in a recession. The CORE inflation measure (which strips out food and energy) used by the Federal Reserve in their evaluation actually dropped from 4.6 to 4.1% from May to June.

The new increase resulted in mortgage rates that though high (around 7%), compared to recent extremely low mortgage rates, are not historically the highest. It may be surprising to see that in areas with low housing supply (most people don’t want to sell a house with a mortgage below 3%) we are expecting house prices to actually increase 5%-10%. In areas with excess supply the story is different, and prices are dropping in the short-term. Similarly, the increased mortgage rates and abundant supply appear to be negatively impacting the commercial property market.

What does all this mean? Though your home and real estate may be impacted by this rate increase, we are not seeing a similar impact on your portfolio. If you feel strongly that commercial real estate will recover significantly this would be a time to invest in commercial REITs. Though we see promise in undervalued commercial real estate, we have more confidence that residential (not commercial) will outperform in the long-term despite additional potential interest rate increases.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

US credit downgrade by Fitch

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As you have no doubt heard, Fitch downgraded US credit to double A plus from triple A. Many reasons have been given for their decision though I think only one is at the core of the downgrade — “the increasing failure of politicians to tackle pressing reforms” and demonstrate a stable process for making long-term country-wide financial decisions. I can’t argue with that . . . the debt ceiling crisis demonstrated that our politicians are disinterested in an orderly financial decision process.

A bit of history to provide perspective on these credit rating companies:
Fitch Ratings Inc., Moody’s, and Standard & Poor’s are the “Big Three” credit rating agencies nationally recognized to evaluate financial products/companies by the Securities and Exchange Commission (SEC) since 1975.

In 2011, the S&P Global Rating was the first to drop US credit to double A. The market mostly ignored this downgrade since this is the same credit rating company that continued to sustain a AAA rating for Lehmann Brothers even as LB filed for bankruptcy. Making matters worse, when the dust settled, this credit agency was found to have benefited from providing high credit ratings to packaged subprime mortgages (i.e., those with no-job, no income) that were then sold to unwary investors.

Moody’s is the remaining credit agency that still believes that the US will pay off its bills and deserves the AAA rating.

Though the remaining countries with triple A credit ratings from all three agencies have stable financial process around debt management many of them have high national debt levels. The countries are Germany, Denmark, Netherlands, Sweden, Norway, Luxemburg, Singapore, and Australia.

What does this downgrade mean? For now, not too much since the US dollar remains the go-to currency and US Treasuries are still considered the risk-free asset to have, particularly during a crisis. Unfortunately, this downgrade does mean that the debt service payments will increase and erode faith in the US dollar.

To resolve this issue, the US needs to deal with long-term fiscal issues in an organized and responsible manner.

What does this mean for your portfolio? Not much in the short-term. It does though remind us to maintain a globally allocated portfolio.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

What to expect from the next Fed meeting

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The Federal Reserve System’s US Federal Open Market Committee (FOMC) meets 8 times each year to decide on the short-term interest rate – the next meeting is July 26th. We’ve seen market volatility prior to and following each of these rate increases. The table below shows the last ten increases out of the last twelve meetings. Most pundits expect a small rate increase either in July or/and September and we expect market volatility.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Property Insurance Changes

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Insurance companies are pulling out of property insurance in locations that are showing signs of high claims/costs. In some areas of California, there is rising concern among property owners regarding homeowner’s or rental property insurance now that two of the largest property insurance companies (State Farm and Allstate) announced that they are going to stop selling new policies and are canceling existing policies in disaster-prone areas.

To be fair, insurance companies are facing severe and growing challenges from the unpredictability, frequency, and severity of Climate Change. In addition, in many areas, they are also contending with the very high cost of construction.

What should you do if you suspect an insurance policy cancelation?

  1. Read your mail since insurance carriers are required to follow rules that benefit the consumer before they can cancel a policy. They may provide tools or alternatives, but they usually have a deadline.
  2. Make preventative repairs/upgrades and document them for your insurer.
  3. At the next opportunity consider increasing your deductible since you don’t want to make any small claims.

What should you do if your coverage is denied or dropped?

  1. Read carefully and follow instructions in their correspondence.
  2. You should first look for Admitted Carriers (e.g. State Farm, Allstate, AAA, USAA, Farmers) to obtain new coverage because they are regulated by the Department of Insurance (DOI) which controls costs and enforces regulations.
  3. If there is no Admitted Carrier willing to cover your property, then look for Non-Admitted Carriers. These are less regulated, more costly but can provide essential property insurance. https://www.insurance.ca.gov/01-consumers/120-company/07-lasli/
  4. If neither of these options are available for your property in California, you can pursue a policy under the California FAIR Plan which offers basic fire protection without liability or theft coverage. It will cost more than the traditional policy. In addition, you should consider a supplementary policy to cover what is excluded in the FAIR plan. Let us know if you are in other states so we can let you know of an equivalent resource.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Inherited IRA Beneficiary Rule – A brief overview

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An inherited IRA from a loved one used to be a gift to beneficiaries that was easy to implement with little tax impact and a lifetime of reward. In the last four years, the rules have changed dramatically and now inheriting an IRA can result in a surprisingly large tax liability. It now requires detailed understanding of the rules to ensure the correct ones are applied without additional tax liability.

Below are the rules and the process that we follow with inherited IRAs. We first separate beneficiaries into three large categories: (1) eligible designated beneficiary, or (2) a non-eligible designated beneficiary or (3) a non-designated beneficiary.

Once we know the type of beneficiary we can drill down and verify by using decedent details (below is a chart for non-spousal beneficiaries).

Why is this important? Because the amount of tax liability is at much higher rates if the withdrawals are forced in 5 rather than in 10 years or over your lifetime. In addition, the custodian needs to be encouraged and educated on the nuances of the applicable rules to your situation so that they don’t choose to use the default 5-year worst case scenario. Sometimes we’ve needed to use legal advice to ensure that the correct beneficiary distribution is implemented by the custodian particularly when the beneficiary is a trust.

The take home message is to make sure beneficiaries are clearly delineated in the IRA account form and that inherited IRA transfers follow the correct inherited IRA beneficiary rules.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

Volatility (Bear & Bull Markets) and Market Behavior

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Since this year’s market is expected to continue to be volatile, I want to remind you that in times of market volatility, going to safer alternatives is tempting but can be costly. Safer alternatives should only be used for money that you want to use in the short-term and not as a response to potential market downturn fears.

We would all like to miss market drops (Bear market) but avoiding short-term declines by exiting the market often results in missing large market increases (Bull market). In fact, if you missed the market’s 10 best days over the past 30 years, your returns would have been cut in half. And missing the best 30 days would have reduced your returns by an astonishing 83%.

S&P 500 Index Average Annual Total Returns: 1993–2022*

*Past performance does not guarantee future results. [Data Source: Morningstar 2/23].

The bottom line – “Good Days Happen in Bad Markets” and exiting to safer allocations due to fear usually results in significant losses.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com

More Details on California Tax Filing Extension

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The State of California has clarified that the extensions will apply not just to IRS filing but also state filing for those counties detailed in the last newsletter. The extension lasts until Oct 16th. It includes tax-advantaged contributions and estimated tax payment for the fourth quarter of 2022, and those in 2023. If you haven’t already made your 2022 contributions, please verify with your tax preparer. Keep in mind that the extension is only available to residents from areas designated as disaster zones by FEMA (Federal Emergency Management Agency). In California it appears to be all counties except Lassen, Modoc, and Shasta. If needed, the extension can be useful and provides those impacted more flexibility, but we still recommend that you make every effort to complete your 2022 tax preparation as soon as possible.

Edi Alvarez, CFP®
BS, BEd, MS

www.aikapa.com