By Ray Ferrara
NEW YORK (AdviceIQ) -- The world of finance has traps for the unwary. Even in a bull market, they can harm you, so it pays to be on the lookout. The three that are most insidious: more complex rules on IRA rollovers, tax scams and too-high margin debt.
A run-down of these problems, for the cautious:
IRA rollovers. In a major surprise, the U.S. Tax Court recently changed 20 years of individual retirement account procedures. Two ways exist to move money from one IRA to the other. First, you can do a direct transfer where the money shifts from one custodian to another without passing through the IRA owner's hands. This type of transfer can be done as often as the IRA owner desires.
It's the second method that the court-mandated change affects. In this type of transfer, the IRA owner withdraws the money from the account. As long as the owner rolls over the money within 60 days, there is no tax, nor penalty. But the IRA owner could only do this once per 12 months (calendar months, not calendar year) for each IRA according to Internal Revenue Service publication 590. In other words, if you had six IRAs, you could withdraw from each of them once every 12 months and roll over within 60 days.
Now, according to the new Tax Court case, you must aggregate the IRAs, and if you move one of the six, you cannot move any of the six for another 12 months. Of course, you could still do a direct transfer without any problem.
Meanwhile, the official regs haven't caught up with the court ruling. Because the IRS' own publication says you can do what the Tax Court says you can't, the agency is going to change publication 590 and not penalize anyone else in the interim. In short, you are always better off to transfer an IRA from one custodian to another.
Tax scammers. Hopefully, by now you have filed your taxes. But if you haven't, we trust you have applied for an extension, which still requires you to pay all of the taxes you think you owe. Otherwise, there might be interest and perhaps even penalties due.
While waiting until the last minute is a common practice for many Americans, filing early has the potential benefit of keeping out the tax scammers who want to steal your identity and file for a refund in your name. Feel fortunate if it hasn't happened to you or someone you know -- it's a huge hassle.
In 2012, the IRS paid out $5.2 billion in tax refunds to scammers and last year this situation improved to only $3.6 billion. That is still a lot of money. While the IRS says it reviewed 12 million suspicious tax returns, it still has a long way to go. If you find yourself having been the victim of identity theft on a tax fraud scheme, please be sure to visit with your tax adviser ASAP.
Margin debt. We have never been fans of long-term use of leverage for our clients' portfolios, a practice known as borrowing on margin. Taking out a loan against your holdings' value, usually to buy more stock, increases risk. If the market moves down a lot, you may end up with a margin call, which requires you to add more cash to the account or liquidate an investment to raise cash.
If a lot of investors are in this same situation, the market could spiral downward. The more stock they must sell, the more the market goes down. This has happened several times over the past 15 years as investors lose their fear during a bull market. In March 2000, the market reached near a peak and the margin balance was $278.5 billion, a record for the time.
We all know what happened over the next two and a half years. Then in July 2007, the margin levels reached another record at $381.4 billion and the market peaked a few months later in October before falling into the Great Recession.
Margin balances as of this January stood at $451.3 billion. Are we suggesting the same thing will happen again? It doesn't have to happen that way.
Although the dollar amount is higher, in relation to the overall economy, it is a smaller percentage than last time. Also, some investors are starting to wise up by reducing the margin balances while the market is up and interest rates are low. Finally, market valuations are not as high today as they were in 2000 or 2007, and the U.S. economy continues to grow.
-- By Ray Ferrara, CFP, CSA, president and chief executive of ProVise Management Group in Clearwater, Fla.
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