.McQuade.Brennan.LLP.

Earlier this month the Employee Benefit and Research Institute (EBRI) released a detailed study on why deferring retirement just won’t work.

The study found that Baby Boomers and Gen Xers who delay their retirement past the age of 65, still wouldn’t have adequate income to cover basic retirement expenses and uninsured health care costs.

According to a recent article in U.S. News & World Report, the lowest-earning 25 percent of Americans would have to work until 84 so that 90 percent of them would have even a 50-50 chance of having enough money to afford basic living expenses and out-of-pocket medical care.

Not surprisingly, the study revealed a major factor that makes a difference in a person’s ability to meet their basic expenses and uninsured health care costs in retirement is whether they are still participating in a defined-contribution retirement plan (such as a 401(k)) after the age of 65. The increase will depend on several factors in a household, such as retirement age and preretirement income level, but participation in a retirement plan makes at least a 10-percentage point difference.

The analysis of the study is based on data from EBRI’s Retirement Security Projection Model, which is divided into four income groups. The groups are determined by adding a person’s lifetime income during their working years, adjusting the amounts for inflation, then determining a year of average income stated in 2011 dollars. According to EBRI, the dividing lines for the four groups are zero to $11,700, $11,701 to $31,200, $32,201 to $72,000, and $72,001 and higher.

For those in the lowest preretirement income quartile, only 29.6 percent of these households would have sufficient resources to avoid running short of money in retirement 50 percent of the time. For those in the second group, less than a quarter (23.5 percent) of households would have a 70 percent probability of adequate income if they retired at 65. For those households in the next to highest income group, almost half (49.1 percent) would have a 70 percent probability of adequate income if they retired at 65, while 75.9 percent of households in the last and highest group are likely to have enough money to retire at the same age.

The full report appears in the June 2011 EBRI Issue Brief, “The Impact of Deferring Retirement Age on Retirement Income Adequacy,” online at www.ebri.org.

They say Virginia is for lovers, but more realistically, it’s for residents of Washington, DC and Maryland trying to dodge their state’s estate tax.

Though the federal estate tax exemption is currently set at $5 million, tax policies in Maryland and DC target residents who have estates valued at $500,000 or higher.

Virginia repealed its estate tax five years ago, which has prompted many financial advisors in the DC metro area to tell their clients to move across the state line.

And there’s good reason: back in 2008 when Maryland legislators created a “millionaire” tax bracket (I wrote about it in more detail here) raising the top income tax rate to 6.25 percent from 5.5 percent on taxable income over $1 million, legislators were hoping the increase would fill in the state’s expanding deficit. Just the opposite occurred – the State Comptroller’s office revealed they received 1,000 less tax returns from that qualifying tax bracket. Where did those upper income families go? They chose to leave the state.

Though the 6.5 tax rate expired at the beginning of the year, those with income greater than $500,000 are still taxed at 5.5 percent. And millionaires aren’t off the hook yet – in March legislators discussed making the 6.5 tax rate permanent. It’s part of $827 million package in potential state tax increases.

It’s not only the estate tax that gets the wealthy moving. The District has the third highest state or local corporate tax rate in the country. It’s not news that higher tax rates often result in higher unemployment rates and lower tax revenue. For companies looking to set up shop in the District, it’s a deal breaker.

Virginia from an economic performance perspective is knocking the socks off Maryland and DC – it’s more business friendly, and more jobs have been created. The legislative policies pursued by Maryland and DC are job killers and the estate tax is just another nail in the coffin.

As 2010 is coming to close, there is still time to maximize your federal tax savings for the year by using the following techniques.

• MAKE CHARITABLE CONTRIBUTIONS

Year-end charitable giving is always a smart way to reduce current year taxes. Be certain to retain receipts and any other documentation regarding your charitable contributions.

Gifts of appreciated stocks to a qualified charity generate a deduction in the amount of the fair market value of the stock, regardless of the basis you hold in that asset.  This creates a double benefit:  you avoid the capital gains tax while receiving a full deduction.

• CONVERT TO A ROTH IRA

For 2010,  you can convert a traditional IRA to a Roth, regardless of your income (prior to 2010, such a conversion was allowed only in a year in which your modified adjusted gross income (MAGI) didn’t exceed $100,000).  The IRS offers a one-time opportunity to spread the resulting taxable income evenly over 2011 and 2012, and thereby defer the related taxes.  You must act now – this opportunity is for 2010 only and disappears at the end of the year.

• SELL YOUR STOCK “LOSERS” TO OFFSET CAPITAL GAINS

Consider getting rid of your portfolio losers.  These losses can be a valuable tax planning tool by wiping out your realized capital gains for the year, plus another $3,000 in regular income ($1,500 if you are married filing separately).   If your net capital loss is more than the $3,000 limit, you can carry the loss forward to later years.

• PAY STATE INCOME TAXES AND DEDUCTIBLE EXPENSES BEFORE YEAR-END

Paying your state income tax estimate before December 31^st will generate a federal deduction for 2010.

• MAKE YOUR ANNUAL REQUIRED DISTRIBUTION FROM IRA’s AND 401(k)’s

If you are 70 years of age or older, you must take minimum distributions from your IRA and 401(k) accounts by the end of the year or face stiff penalties.  Failure to make the required minimum distribution results in a penalty of 50% of the amount required to be distributed.  You may delay your required distribution until April 1, 2011 if you turned 70 this year.  Keep in mind that all withdrawals are taxed at ordinary income rates.

• MAKE YEAR-END GIFTS

If you planning on making a gift to a family member(s) or a friend(s), take advantage of the annual exclusion from federal estate and gift tax in 2010. You may give up to $13,000 ($26,000 if you a filing a joint return)  per person to any number of recipients. In addition to not being taxed, the gift is not added back to the taxable estate at death.

• SPEND YOUR FLEXIBLE SPENDING ACCOUNTS

If you have a flexible spending plan (tax-free earnings put aside to cover medical and dental expenses through an employer), you need to spend the remaining money in your account before year-end or you’ll lose it.  Get new medical supplies, fill prescriptions early, get new glasses or contacts, and make doctor and dentist appointments that you have deferred earlier in the year.   You should also evaluate your medical needs for 2011 to ensure you maximize your benefit for next year’s FSA.

• GO GREEN FOR TAX SAVINGS

You can reduce your taxes dollar for dollar with the home-energy tax credit.    If you add insulation, energy efficient replacement windows, super-efficient hot water heaters, furnaces or boilers you qualify for a tax credit equal to 30% of the cost up to $1,500.  This tax credit is more valuable than a deduction, which merely reduces the amount income subject to tax.

• MAXIMIZE YOUR SECTION 179 DEDUCTION

If you own a business and bought property in 2010 you may elect to expense those items, instead of depreciating them over a certain life, to help reduce taxable income from your business for the year. The maximum deduction for 2010 is $500,000. The total cost of property that may be expensed during the year cannot exceed taxable income of the business for the year. Any amount that has been elected to be expensed but has been disallowed due to the taxable income limitation will be carried forward to 2011.

• MAXIMIZE YOUR PENSION CONTRIBUTION FOR 2010

Self-employed individuals can contribute 20 percent of net self-employment income, after the self-employment tax deduction is accounted for, to their defined contribution or SEP plan, however, contributions cannot exceed $49,000. Other participants of defined contribution plans may contribute 100 percent of compensation up to a maximum of $49,000 for 2010.

SEP plans must be set up by the due date of the return (including extensions) and contributions must also be received by that date for the contribution to be counted for 2010. Defined contribution plans must be set up by December 31, 2010 and contributions must be received by the due date of the return (including extensions) for the contribution to be counted for 2010.

Fed Chair Bernanke launched QE 2 Wednesday afternoon, and it’s as imposing as the real thing. The Federal Reserve announced it will buy up to $600 billion of U.S. government bonds over the next eight months.

QE 2 (Quantitative easing) is a euphemism for the (second) monetization of government debt this year, and is the electronic equivalent of printing money. The Fed’s goal is to create an environment where interest rates are so low that investments in fixed income (or cash) are so unattractive that it will result in a rising stock market by stimulating demand through a “wealth effect”. Some economists believe the Fed is exchanging one bubble (the bond market) for another, the stock market.

For investors, they have their marching orders. The Fed’s have provided the most compelling environment for equity investments in many years.

All aboard!

On July 1^st, I commented on Apollo Group’s 34% increase in earnings (The Next Big Short: Part 3 – The Apollo Group Announces Third Quarter Earnings).  I also noted that Apollo Group was the largest recipient of federal student aid (to the tune of $1.8 billion in 2008), so the earnings report was no surprise.  What prompted my commentary were the analyst reports from Barrington and FBR.  Even a cursory review of the legislative activity last summer, particularly that of the Senate Committee on Health, Education, Labor and Pensions, should have  alerted the analysts at both firms that the game was about to drastically change for the for-profit higher education industry.  I noted the industry will soon be facing new standards that many schools will fail to comply with.  I also suggested that Barrington and FBR review their target prices for Apollo ($65 for Barrington and $49 for FBR), which were bizarre even back in July.

Today, FBR downgraded Apollo to “underperform”, and gave a target price of $40.  Thanks.  As of this writing, I have no information for Barrington.  However, investors should not expect an upgrade.

Check out the price action of the following publicly traded for-profit/internet schools over the past five months:

On September 8, 2010, Obama proposed a 100 percent bonus depreciation tax incentive for 2011 and asked Congress to make the research-and-development (R&D) tax credit permanent.

Obama proposes to increase the current 50% bonus depreciation deduction to 100%, retroactive to September 8, 2010. This deduction applies to purchases of equipment such as vehicles, solar panels, and computers.

The Administration hopes to encourage business investment and support the business community by making the R&D tax credit permanent and increasing bonus depreciation.

Don’t buy any equipment just yet. We’ll inform you once Congress has voted.

The discussion of for-profit universities continues in a recent New York Times editorial: Who Profits? Who Learns?. 

It reiterates many abuses by these schools including high student debt-to-income ratios, low graduation rates, and reliance on federal student aid for the bulk of their revenue. We’ve discussed these concerns in more detail previously (The Next Big Short – the For-Profit Colleges).  This editorial outlines proposed rules that seek to protect students and limit federal funding to for-profit schools.  Provisions include oversight of the student recruiting process and licensure of for-profit universities.  See our previous post for a detailed review of the proposed rules. 

This environment presents an excellent investment opportunity – short Appollo, DeVry and Capella.

Check out the price action of the following publicly traded for-profit/internet schools over the past months:

Coming down the pipeline and ignored by Congress, is a waterfall of potential tax increases, the likes of which we haven’t seen for a decade. The massive amounts of legislation this year coupled with sunset provisions create a perfect storm for taxpayers.

The recent healthcare legislation was also a tax bill. From a new tax surcharge on tanning salons, all the way to altering the way millions of Americans purchase medications. If you have grown used to using your flexible spending account (FSA), health savings account (HSA), or a similar vehicle for non-prescription medications – other than insulin, these medications will now have to be purchased with after-tax dollars.

The healthcare legislation also limits the dollars that can be placed in an FSA to $2,400, drastically limiting the tax advantages. This limitation will have a particularly severe impact on disabled individuals and parents of disabled children who have used pre-tax dollars to pay for expensive treatments, medical devices, and related education.

After January 1, 2011, it will be much more expensive to die; the “Death Tax” returns, taxing up to 55% on an estate of $1 million, a threshold that will be surprisingly easy to reach.

The tax ratio in effect since the early 2000s will be rolled back: the lowest bracket will go from 10% to 15% and the highest from 35% to 39.6%. This will be in addition to narrower tax brackets for taxpayers filing jointly, a significantly lower child tax credit, lower adoption credit, lower dependent care tax credit, and a lower standard deduction.

Retirees will pay both higher capital gains tax, going from 15% to 20%, and higher taxes on dividend income, going from 15% to 39.6%. Charitable contributions from IRAs will be discontinued, and rules governing student loan interest deductions are changing, for the worse.

There’s more.  If you currently receive health insurance, your W-2 will show a big gain next year, but not in a good way. You will magically have more gross income, monies that you never saw, that went to purchase health insurance will now be taxable income; this has the potential to push taxpayers into higher brackets even though they never saw any additional net earnings.

Businesses will also be hit with tax increases with significant changes in what can and cannot be deducted. Business tax brackets are set for a similar shift as individual taxpayers. Small, job creating, businesses that are used to expensing equipment purchases up to $250,000 will see the decimal in a different place as the ceiling decreases to a mere $25,000. One of the most notable business tax credits that is being eliminated is the research tax credit, although it has repeatedly been extended, its political future is unsure at best. There are a plethora of other changes, and their implementation and enforcement specifics are still up in the air. 

Finally, Congress has repeatedly raised the Alternative Minimum Tax dollar threshold, which is not tied to inflation, and is likely to do so in the future.  As of today, many middle class taxpayers are subject to this “backup tax” in 2011. 

Hopefully, Congress will scrutinize many of these tax increases.  Though they were designed to pay for current legislation, the political will to maintain them is questionable. The tax code is tedious, but it is changing quickly, and will continue to do so. We’ll keep you posted.

The Apollo Group, which is the parent of the for-profit internet college the University of Phoenix, announced third quarter earnings this morning.  Earnings per share increased 34% on a year-to-year comparison.  No surprise here, considering its student body is the largest beneficiary of federal student aid (to the tune of 1.8 billion last year).

However, the company also told analysts that it expects enrollment growth to decelerate, noting the regulatory/legislative environment.  They also noted that the incentive compensation paid to its recruiters (brokers) is being restricted, because of regulatory pressure.  And here’s the big one…the Apollo Group disclosed that many of its programs would fail to comply with the Department of Education’s proposed gainful employment rules. The gainful employment proposal would cut federal aid to schools whose graduates would spend more than 8% of their starting salary on loan payments.  If enacted, Apollo Group’s operating costs could significantly rise and enrollment could be reduced.

The horse is out of the barn, and well down the road.  So naturally the analyst’s are doing their best moonwalk impressions.  Barrington reduced its 12 month target for Apollo Group from $75 to $65, and FBR lowered their target price from $63 to $49.

Hey guys, Apollo Group is trading at $42 and change this morning, and Senator Harkin, Chairman of the Senate Committee on Health, Education, Labor and Pensions, is on the warpath. The for-profit higher education industry will soon be facing new and stringent standards that many schools will fail to comply with.  Do your clients a favor. Take another look at your numbers.  They’re too high.     

President Obama has called for the U.S. to lead the world in having the highest percentage of college graduates by 2020. In a similar manner, President Clinton stated a key goal of his administration was to increase home ownership to millions of Americans. Both of these initiatives have a common revenue source…Uncle Sam. The now bankrupt Fannie Mae and Freddie Mac eagerly accepted President Clinton’s challenge and helped fuel the housing boom of the last decade. Financing to buy a home was made available to almost everyone, irrespective of their ability to actually repay the loan.

The internet colleges are the latest industry group whose primary source of income is funded or guaranteed by the federal government. And for many of these schools, their revenue is almost exclusively from federal grants and loans. More students, more money. All employ recruiters who essentially serve the same role as the mortgage broker for the home builders. Does anyone believe the feds are capable of monitoring the internet school recruiters (brokers) better than they did the mortgage industry?

The dropout rate and the student loan default rate of internet students makes the subprime defaults look modest by comparison. Well, the good news is Congress may be wising up. Memories of Barney Frank on You Tube defending Fannie and Freddie despite their deteriorating balance sheets may be keeping some legislatures up at night. The White House is backing off its lofty goals of a college degree in every pot, and recently announced it is pressing for increased oversight of recruiters (brokers). Congress announced it will hold hearings on how the for-profit schools use federal aid. All of this is very bad news for the internet schools, and their investors.

Check out the price action of the following publicly traded for-profit/internet schools over the past month:

                                                                                                June 1                   June 29

The University of Phoenix (Apollo Group)          51                              43

DeVry University                                                            57                              53

Kaplan (The Washington Post)                                  451                          412

Capella University                                                          84                              79

Morgan Stanley’s Steven Eisman, who was described in Michael Lewis’ “The Big Short”, for warning investors early on about the subprime mortgage market, has said the following: “Until recently I thought there would never again be an opportunity to be involved with an industry as socially destructive and morally bankrupt as the subprime mortgage industry. I was wrong. The for-profit education industry has proven equal to the task.”

Ouch.