2022 AFBA Financial Planning Guide

changes in the cost of living. On the other hand, the value of a REIT investment can be influenced by the fluctuating value of real estate property. In addition, since REITs do not pay taxes, the dividend distributions to shareholders are generally taxed at ordinary rates rather than the qualified dividend tax rate which is normally lower. 10–11. OTHER TANGIBLES. These investments have the potential of providing a capital return but generally do not offer the opportunity for an income return. Included in this category are precious metals (e.g., gold and silver), art work, and other collectibles such as antiques. The most popular metals for investment purposes are gold, silver, and platinum. Conventional wisdom holds that these items provide a hedge against inflation and can serve as an economic haven in

The potential disadvantages of real estate include lack of liquidity, the requirement for a relatively large initial investment, and the risk of reduced values during a period of economic depression. Real Estate Investment Trusts (REITs) provide an alternative method to invest in real estate. They may be suitable for investors with limited capital or for those who do not want to be involved in the daily management of a real estate investment. REITs are corporations that own and manage a portfolio of real estate property and/or mortgages. They sell shares of ownership and operate on a “pass though” basis which means that they distribute their income to the company shareholders. They are different from normal corporations who pay taxes and distribute stock dividends which are then taxed at shareholder level. With REITs, the company’s income is distributed to the shareholders and taxes are paid once at the stockholder level. From the purchase standpoint there are two types of REITs — publicly traded and private. There are approximately 225 publicly traded REIT companies who are registered with the SEC. The shares of these companies are traded on the various public exchanges including NASDAQ and the New York Stock Exchange. Private REITs are not registered with the SEC. They sell their shares directly to individuals and other entities like trusts. There are approximately 900 private REIT companies. From the standpoint of investment holdings there are basically three types of REITs — Equity, Mortgage, and Hybrid. Equity REITs own and operate income producing property such as apartments, office buildings, and retail shopping centers. They produce income through property rents and can provide a capital gain if the property is sold at a profit. Mortgage REITs either purchase existing mortgages, buy mortgage backed securities, or provide mortgages for new construction. Their objective is to earn an income return on the interest associated with mortgage payments. Hybrid REITs are companies which combine the characteristics of both equity and mortgage REITs by directly buying and managing property investments and acquiring the outstanding mortgages on selected property. As with any investment, REITs have certain advantages and disadvantages. Stable dividend returns and portfolio diversification are two major advantages of REITs. Also, REITs that rely on rental income may be somewhat resistant to inflation because property rental charges tend to adjust for

times of political or economic chaos. 10–12. RETIREMENT ACCOUNTS

401(k) and 403(b) plans are qualified tax-advantaged retirement plans offered by employers to their employees. 401(k) retirement plans are generally offered by private or for-profit employers while 403(b) are offered by non- profits and government. Employees contribute a portion of their paycheck either before or after-tax, depending on the options offered in the plan. With a traditional 401(k) the contributions are made pre-tax and earnings are not taxed until distribution. While Roth 401(k) contributions are made with after tax income but withdrawals are not taxed. Many employers will match a certain percentage of the employee’s contribution. Tax laws limit the amount that can be contributed to a 401(k) each year. In 2022 the maximum contribution is $20,500 for those under age 50 and $27,000 for those 50 and older. Generally withdrawals before age 59½ are subject to regular income tax plus a 10% penalty. Required minimum distributions (RMDs) must begin by age 72 (70½ if you turned 70½ prior to January 2020). 457 plans are similar to 401(k)s but are offered by state and local public employers and some nonprofit employers. Independent contractors can also participate in these plans. The contribution limits are the same as for 401(k)s. However, 457 plans feature a double limit catch-up provision that 401(k) plans do not have. This provision allows those within three years of the plan’s “normal retirement age,” to save double the annual limit for three years as long as they have not maxed out their contributions in the past. In 2022, this provision would allow an employee to contribute up to $41,000 to a plan. Another plan difference is the lack of


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