MONEY inversions

WATCH: Stephen Colbert and Jon Stewart Slam “Corporate Deserters” Who Flee U.S. Taxes

The late night duo are the newest celebrities to speak out against corporate inversions.

Last night the Comedy Central dream team of Jon Stewart and Stephen Colbert each took a moment on their respective shows to attack the growing number of American corporations moving their official addresses abroad to escape U.S. taxes.

The specific kind of tax flight the duo is talking about is known as an inversion, and these maneuvers have become all the rage in recent months. As MONEY’s Pat Regnier explains, an inversion is when a U.S. company merges with a (typically smaller) foreign company in tax-friendly country. The U.S. company then claims it is now based in the foreign company’s nation and thus avoids paying U.S. taxes while continuing to enjoy many benefits of essentially remaining an American company.

“It’s like me adopting an African child, and then claiming myself as his dependent,” quipped Colbert.

This practice has been widely condemned as unpatriotic and unfair to American taxpayers who will be stuck footing the bill if the government needs to replace corporate tax dollars with new sources of revenue. The anti-inversion chorus has so far included public figures ranging from President Obama to entrepreneur and Dallas Mavericks owner Mark Cuban, who recently advised his Twitter followers to divest from inversion-happy corporations.

On Wednesday, Stewart and Colbert added their own two cents, with Colbert bringing on Fortune’s Allan Sloan, author of a recent seminal article on inversions, to talk about the problem.

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MONEY Social Security

The 5 Key Things to Know About Social Security and Medicare

No need to panic, but both Social Security and Medicare face long-term financial challenges, this year's trustees report finds. There's still time to make fixes.

If you worry about the future of Social Security and Medicare, this is the week to get answers to your questions. The most authoritative annual reports on the long-term health of both programs were issued on Monday, and while the news was mixed, there are reasons to be encouraged about our two most important retirement programs.

Under the Social Security Act, a board of trustees reports annually to Congress on the status and long-term financial prospects of Social Security and Medicare. The reports are prepared by the professional actuaries who have made careers out of managing the numbers and are signed by three cabinet secretaries, the commissioner of Social Security and two publicly appointed trustees—one Republican, one Democrat.

Here are my five key takeaways from this year’s final word on our social insurance programs.

* Imminent collapse nowhere in sight. Social Security and Medicare face long-term financial problems, but there’s no cause for panic about either program.

Social Security’s retirement program is fully funded for the next 19 years. It has $2.8 trillion in reserves, and that figure will rise to $2.9 trillion in 2019, when the surplus funds will begin depleting rapidly as baby boomer retirements accelerate. Although you’ll often hear that Social Security spends more annually than it receives in taxes, the program actually took in $32 billion more than it spent last year, when interest on bond holdings and taxation of benefits are included.

The retirement trust fund will be depleted in 2034, at which point current revenue would be sufficient to pay only 77% of benefits—unless Congress enacts reforms to put the program back into long-term balance.

Medicare’s financial outlook improved a bit compared with last year’s report because of continued low healthcare inflation. The program’s Hospital Insurance trust fund – which finances Medicare Part A— is projected to run dry in 2030, four years later than last year’s forecast and 13 years later than forecast before passage of the Affordable Care Act (ACA).

In 2030, the hospital fund would have enough resources to cover just 85 percent of its expenditures. (Medicare’s other parts—outpatient and prescription drug services—are funded through beneficiary premiums and general revenue, so they don’t have trust funds at risk of running dry.)

Could healthcare inflation take off again? Certainly. Some analysts—and the White House – chalk up the recent cost-containment success to features of the ACA. But clouds on the horizon include higher utilization of healthcare, new medical technology and a doubling of enrollment by 2030 as boomers age.

* Medicare is delivering good pocketbook news. The monthly premium for Medicare Part B (outpatient services) is forecast to stay put at $104.90 for the third consecutive year in 2015. That means the premium won’t take a larger bite out of Social Security checks, and that retirees likely will be able to keep most— if not all—of the expected 1.5% cost-of-living adjustment (COLA) in benefits projected for next year. (Final numbers on Part B premiums and the Social Security COLA won’t be announced until this fall.)

* Social Security Disability Insurance (SSDI) requires immediate attention. The program faces a severe imbalance, and only has resources to pay full benefits only until 2016; if a fix isn’t implemented soon, benefits would be cut by 20 percent for nine million disabled people.

That can be avoided through a reallocation of a small portion of payroll tax revenues from the retirement to the disability program – just enough to keep SSDI going through 2033 while longer-range fixes to both programs are considered. Reallocations have been made at least six times in the past. Let’s get it done.

*Aging Americans aren’t gobbling up the economic pie. Social Security outlays equalled 4.9% of gross domestic product last year and will rise to 6.2% in 2035, when the last baby boomer is retired. Medicare accounted for 3.5% of GDP in 2013; it will be 3.7% of GDP in 2020 and 6.9% in 2088.

* Kicking the can is costly. There’s still time for reasonable fixes for Social Security and Medicare, but the fixes get tougher as we get closer to exhausting the programs’ trust funds. Social Security will need new revenue. Public opinion polls show solid support for gradually eliminating the cap on income subject to payroll taxes (currently $117,000) and gradually raising payroll tax rates on employers and workers, to 7.2% from 6.2%. There’s also strong public support for bolstering benefits for low-income households and beefing up COLAs.

Medicare spending can be reduced without resorting to drastic reforms such as vouchers or higher eligibility ages. Billions could be saved by letting the federal government negotiate discounts on prescription drugs, and stepping up fraud prevention efforts. And an investigative series published earlier this summer by the Center for Public Integrity uncovered needed reforms of the Medicare Advantage program, pointing to “tens of billions of dollars in overcharges and other suspect billings.”

Your move, Congress.

Related stories:

How to Fix Social Security—and What It Will Mean for Your Taxes

Why Taxing the Rich Is the Wrong Way to Fix Social Security

3 Smart Fixes for Social Security and Medicare

 

MONEY Savings

5 Ways to Keep a Crisis From Crushing You

Falling anvil with inadequate parachute
A majority of Americans are unprepared for a financial emergency. Michael Crichton + Leigh MacMill; Prop Styling by Jason MacIsaac

What would you do if you suffered an emergency that's bigger than your safety net? These strategies can cushion the blow.

You’ve no doubt diligently socked away a chunk of cash for a rainy day. But chances are it isn’t enough to keep you from worrying about being swept under by a passing financial storm. In a MONEY survey of 1,000 Americans conducted earlier this year, 60% of respondents said they didn’t feel they had enough emergency savings.

They’re probably right to be ­concerned: A new survey by Bankrate.com found that the majority of Americans making $75,000-plus have less than six months of emergency savings on hand. Meanwhile, experts typically recommend having at least that much and often as much as 12 months’ worth—lofty goals even for those who are otherwise well-off.

While you’re in the process of bulking up your kitty, lessen your anxiety by figuring out how you’d quickly lay your hands on cash if the roof fell in, literally and figuratively. “The goal is to reduce long-term damage to your finances,” says Scottsdale financial planner Brian Frederick. Putting the bills on a credit card can be a reasonable option for those able to pay off their debt in a jiffy, but carrying a balance for longer gets pricey when you’re talking about a 15% interest rate. Instead, keep these five better options in the back of your mind:

1. Crack a CD

In hopes of discouraging customers from fleeing when rates rise, banks have been hiking penalties for tapping a CD before its maturity date—six months’ interest is now common on a one-year certificate, and six to 12 months’ is typical on a five-year. Even so, “the interest is so small these days that a six-month penalty is almost meaningless,” says Oradell, N.J., financial planner Eric Mancini. On a $100,000, five-year CD at 2%, you’d give up just $100.

2. Sell Some Securities

Ditching money-losing stocks is clearly a better move than borrowing, says Frederick, given that you can use losses to offset up to $3,000 of capital gains for this year and carry any overage into future years. Everything in your portfolio on the up and up? While you’ll pay a 15% capital gains tax on the profits from any security you’ve held for more than a year, it might make sense to pare back on winners if your allocation has gotten out of whack.

3. Take Out a 401(k) Loan

Most plans allow you to borrow half your vested amount, up to $50,000, with generous terms: no setup fees and a 4% to 5% interest rate, paid to yourself. Moreover, as long as you keep making contributions, you probably won’t sacrifice much growth. A five-year, $20,000 loan against a $250,000 401(k) would reduce your balance by just $9,000 after 20 years, assuming you continued to save $500 a month during the loan term. But should loan payments require you to pull back on contributions, your nest egg will take a hit (see the graphic). Another risk: If you leave your job for any reason before repaying, you must cough up the entire balance within 60 days, or else you’ll owe income taxes and a 10% penalty on the funds. “You can end up feeling stuck in your job,” says Edina, Minn., ­financial planner Kathleen Longo.

the 20k loan

4. Tap the House

Whether or not you have a home-equity line of credit already, you’ll benefit from today’s low rates. The average on a new line is about 5%, but if your credit is nearly perfect, you can get closer to 3%, with no setup fee, Bank­rate.com reports. Plus, interest payments are usually tax-deductible. The caveats: It may take a few weeks to open a new line. Also, HELOCs are var­iable rate, so your payments may rise if the Fed hikes interest rates. Finally, some banks charge a fee if you close the line early; look for one that doesn’t.

5. Borrow from a Stranger

Those who don’t have adequate home equity can still beat rates on credit cards and personal bank loans by nabbing a loan from a peer-lending site like LendingClub or Prosper. Rates on those sites can be less than 7%, plus an origination fee of 1% to 3%. Peer loans are a good option for those with sterling credit histories, says Steve Nicastro, investing editor at NerdWallet. Check what rate you’d get using the sites’ tools. Look good for you? After you fill out an online form, the sites will take a few days to verify your info, then send your loan out to prospective lenders. Most loans are funded within a week.

More on building a stronger safety net:

MONEY Sports

WATCH: Lionel Messi’s Messy Tax Situation

Global soccer star Lionel Messi and his father are facing charges of tax fraud in Spain.

MONEY Ask the Expert

Why It Pays to Spend Down Your College Savings Plan Quickly

140605_AskExpert_illo
Robert A. Di Ieso, Jr.

Q. I have enough in my daughter’s 529 to pay her full tuition for freshman year. Should I? — Andrea B., Location withheld

A. Yes, it’s best to use the savings sooner rather than later, says Raymond Loewe, an adviser with United Planners Financial Services. Given that your time horizon is short and the stock market has had a good run, it’s best to realize those tax-free gains now. Plus, spending down the 529 early could improve your odds for financial aid in future years, albeit slightly. Every $100 used can be worth $6 in aid, says Loewe. One caveat: The IRS won’t let you snag an education tax credit and take the 529 tax break for the same expenses. So to get the full $2,500 American Opportunity credit, for example, you’ll want to pay at least $4,000 with other money, says Joe Hurley of Savingforcollege.com.

More on college savings:

MONEY The Economy

WATCH: How Some U.S. Companies Are Dodging Taxes

Major American corporations are reincorporating overseas to avoid paying higher U.S. taxes.

MONEY

Mark Cuban to Investors: Get Out Of U.S. Companies That Run Overseas

Mark Cuban
Hey, you! Get back here! Mpu Dinani—Getty Images

Companies are merging with foreign competitors to get tax breaks. Here's what the notorious Mavs owner thinks of that.

Dallas Mavericks owner and investor Mark Cuban has taken to Twitter this morning with some big thoughts about the U.S. companies changing to foreign addresses to get tax breaks.

Such corporate relocations, known as inversions, have become a hot-button issue in recent days after several major corporations pulled the tax maneuver and President Obama began calling for Congress to block this virtual corporate exodus.

Cuban starts with what sounds like your basic economic patriotism argument:

 

And then things get more interesting.

 

By PE, Cuban means price-earnings ratio, the standard way investors value a stock. He means that if companies take the tax break, investors ultimately benefit because it raises earnings. (We recently discussed who really benefits here. Short answer: That’s true mostly for wealthy investors like Cuban.) And he says he’s wiling to live with lower earnings. But what does “risk doesn’t leave the system” mean?

This:

 

Of course, he adds, if you sell to punish a company for cutting its taxes, make sure it doesn’t mean you pay a bunch of taxes.

 

Activism has its limits, amirite?

MONEY

This Hedge Fund’s $6.8 Billion Tax Break Is Going to Enrage You

If it looks like a loophole... Jupiterimages—Getty Images

Short-term trades are usually taxed like regular income. But not if you are a hedge fund with a helpful banker.

If you invest or do any stock trading outside of a 401(k) or IRA account, you know that how long you hold your stocks can make a big difference at tax time.

If you buy and then hold an investment for at least a year, your profits will be taxed at the long-term capital gains rate — 15% for people in most tax brackets and 20% for those in the very top one. Fast in-and-out trades, on the other hand, face a much bigger tax bite because they are taxed as ordinary income. What’s more, you can be hit with those higher rates even if you aren’t a day trader: For example, if you own an aggressively managed mutual fund that does a lot of trading, you may get capital gains distributions you have to pay tax on.

Now it appears that some high-powered hedge funds found a clever way around those higher rates, basically by turning short-term trading gains—often really short-term, as in minutes—into long-term ones. According to a report issued this week by a the Senate subcommittee on investigations, that move might have netted one fund managed by Renaissance Technologies a tax saving of $6.8 billion over several years. That billion with a B.

By what magic does a trade of a minutes become a long-term, buy-and-hold investment eligible for lower taxes? Well, it appears you just had to find a bank that will wrap your trading into something called a ” basket option.”

Here’s how it worked: Instead of buying and selling the stocks directly, hedge funds would go to a bank—the Senate report singled out Barclays and Deutsche Bank—and buy an options contract linked to the value of a basket of securities. Think of the basket of securities as being like a stock fund; and just like a stock fund you might have in your 401(k), the composition of that basket is constantly changing. In the Renaissance case, the basket changed based on computer algorithms looking for tiny inefficiencies in asset prices, which meant constant buying and selling.

At some future date, the hedge fund could exercise the option and get back the amount it paid for the option plus or minus any returns on investments in the basket. And here’s where the tax break happened: If the hedge fund waited at least year to exercise the option, all those quick in-an-out trades inside the basket got wrapped up in one big long-term trade.

The really clever (or, some might say, devious) part is that the basket of securities was all along actually still managed by the hedge fund. Technically, the banks hired Renaissance managers to run the basket backing the options that they sold to Renaissance. Did you catch that?

In Senate testimony this week, execs from the banks and Renaissance offered their side. They say that while it’s true there were tax advantages to this set-up, it wasn’t only a tax shelter. For example, in addition to changing the tax treatment, using an options contract also gave Renaissance a lot of leverage, since they only put in part of the money to buy the basket. That amplified their wins as well as losses. (The Senate’s not too happy about that part, either, though. Since 2008, big investors using borrowed money looks more like a bug than a feature.) It also limited Renaissance’s exposure to catastrophic losses, since they couldn’t lose more than they paid for the option, giving the banks some skin in the game on the portfolios. In tax law, something that works like a tax shelter can still be okay if it has another economic purpose.

The Internal Revenue Service, though, indicated in 2010 that moves like this don’t pass the smell test.

Howard Gleckman of the Tax Policy Center explains here why it is that the IRS might not yet have clamped down on this particular maneuver. Short answer: It’s tough for the IRS to go after big hedge funds and their investors. They are outgunned. Gleckman wonders if we have a “two-tiered” tax system, one for the rich and another for the rest of us.

At the subcommittee hearing, there were really two arguments in play. One was whether the tax law technically allows quick trades to be turned into long-term investments in this way.

The other was whether it should. That doesn’t seem like a hard question.

MONEY IRAs

This Simple Move Can Boost Your Savings by Thousands of Dollars

Stack of Money
iStock

Last-minute IRA savers and those who keep their money in cash are paying a procrastination penalty.

Individual Retirement Account contributions are getting larger—an encouraging sign of a recovering economy and improved habits among retirement savers.

But there is an “I” in IRA for a reason: investors are in charge of managing their accounts. And recent research by Vanguard finds that many of us are leaving returns on the table due to an all-too-human fault: procrastination in the timing of our contributions.

IRA savers can make contributions anytime from Jan. 1 of a tax year up until the tax-filing deadline the following April. But Vanguard’s analysis found that more than double the amount of contributions is made at the deadline than at the first opportunity—and that last-minute contributions dwarf the amounts contributed throughout the year. Fidelity Investments reports similar data—for the 2013 tax year, 70% of total IRA contributions came in during tax season.

Some IRA investors no doubt wait until the tax deadline in order to determine the most tax-efficient level of contribution; others may have cash-flow reasons, says Colleen Jaconetti, a senior investment analyst in the Vanguard Investment Strategy Group. “Some people don’t have the cash available during the year to make contributions, or they wait until they get their year-end bonus to fund their accounts.”

Nonetheless, procrastination has its costs. Vanguard calculates that investors who wait until the last minute lose out on a full year’s worth of tax-advantaged compounded growth—and that gets expensive over a lifetime of saving. Assuming an investor contributes the maximum $5,500 annually for 30 years ($6,500 for those over age 50), and earns 4% after inflation, procrastinators will wind up with account balances $15,500 lower than someone who contributes as early as possible in a tax year.

But for many last-minute savers, even more money is left on the table. Among savers who made last-minute contributions for the 2013 tax year just ahead of the tax-filing deadline, 21% of the contributions went into money market funds, likely because they were not prepared to make investing decisions. When Vanguard looked at those hasty money market contributions for the 2012 tax year, two-thirds of those funds were still sitting in money market funds four months later.

“They’re doing a great thing by contributing, and some people do go back to get those dollars invested,” Jaconetti says. “But with money market funds yielding little to nothing, these temporary decisions are turning into ill-advised longer-term investment choices.”

The Vanguard research comes against a backdrop of general improvement in IRA contributions. Fidelity reported on Wednesday that average contributions for tax year 2013 reached $4,150, a 5.7% increase from tax year 2012 and an all-time high. The average balance at Fidelity was up nearly 10% year-over-year to $89,100, a gain that was fueled mainly by strong market returns.

Fidelity says older IRA savers racked up the largest percentage increases in savings last year: investors aged 50 to 59 increased their contributions by 9.8%, for example—numbers that likely reflect savers trying to catch up on nest egg contributions as retirement approaches. But young savers showed strong increases in savings rates, too: 7.7% for savers aged 30-39, and 7.3% for those aged 40-49.

Users of Roth IRAs made larger contributions than owners of traditional IRAs, Fidelity found. Average Roth contributions were higher than for traditional IRAs across most age groups, with the exception of those made by investors older than 60.

But IRA investors of all stripes apparently could stand a bit of tuning up on their contribution habits. Jaconetti suggests that some of the automation that increasingly drives 401(k) plans also can help IRA investors. She suggests that IRA savers set up regular automatic monthly contributions, and establish a default investment that gets at least some level of equity exposure from the start, such as a balanced fund or target date fund.

“It’s understandable that people are deadline-oriented,” Jaconetti says. “But with these behaviors, they could be leaving returns on the table.”

Related:

 

MONEY 401(k)s

How to Fix the 401(k) and Income Inequality in One Fell Swoop

A top economic adviser wants to cut the tax break for 401(k) savings for high earners and launch a new government plan with a generous match and low fees.

Two hot-button economic issues appear to be colliding: the failed 401(k) plan and growing income inequality. Both have been garnering headlines, and now a noted expert is tying them together through proposed reform.

Gene B. Sperling, a former White House economic adviser in both the Clinton and Obama administrations, wants to cut the tax advantage of 401(k) contributions to top earners. He also wants to create a government-funded universal 401(k) plan that would incorporate all the best parts of these plans—low fees, safety, a generous match, and automatic enrollment.

Presumably, a government-backed 401(k) plan also would offer an option like deferred annuities, which the industry has been resisting, and an easy way to convert some or all of your 401(k) balance to guaranteed lifetime income upon retirement. Both those provisions have had strong backing from the White House.

In a New York Times op-ed, Sperling blamed an “upside-down tax incentive system” for contributing to income inequality in America, adding “it makes higher-income Americans triple winners and people earning less money triple losers” as they save for retirement.

Currently top earners pay a federal tax rate of 39.6%, which makes their tax deduction for 401(k) contributions more valuable than the deduction for contributions of those in lower tax brackets. Top earners also have more tax-advantaged savings opportunities, and they benefit more from employer matches. The upshot, Sperling asserts, is that the top 5% of earners get more tax relief for saving than the bottom 80%. He proposes a flat 28% tax credit for saving, regardless of income.

His universal 401(k) plan also would skew toward lower income households with a dollar-for-dollar match up to $4,000 a year below certain income thresholds. Higher income households would be capped at 60 cents on the dollar—still about double the average match today.

Sperling isn’t the first to champion a universal 401(k) or fret publicly about income inequality. President Clinton floated universal accounts in 1999. Versions of this government-funded plan exist in parts of Europe, and Teresa Ghilarducci, a professor of economics at the New School and author of When I’m Sixty-Four, has been arguing for years for private sector workers to be able to enroll in cost-efficient and professionally managed state-operated retirement programs.

So far the idea hasn’t gotten much traction. The debate in Washington has centered on Social Security and tax reform. Maybe this op-ed from a beltway insider is a sign that 401(k) reform—and income inequality—will heat up as an issue in the coming election cycle.

If so, paying for it all will surely be part of the debate. But not to worry, writes Sperling. Among other possibilities, we could cut the federal estate tax exemption. Currently a married couple can leave $10.7 million to heirs tax-free. Cutting the exemption to $7 million would free up billions to bolster the retirement accounts of lower earners and shore up some of what’s wrong with 401(k) plans today—and take a further whack at income inequality in the process.

Related:

Half of Workers Are on Track to Retire Well—Here’s How to Join Them

Why Your 401(k) Won’t Offer This Promising Retirement Income Option

This Nobel Economist Nails What’s Really Wrong with Your 401(k)

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