United Bank & Trust Blog

To raise, or not to raise the US debt ceiling, that is the question.

It is also the dilemma that has led to the current showdown between Congress and President Obama, which must be resolved by August 2nd, or the US risks defaulting on its debt for the first time in our nation’s history. Since inception, our country has never missed a payment on its debt. And, in order to maintain our top-rated status and AAA credit rating, we must never allow ourselves to do so.

This is no political rant and you will hear no rhetoric from the extreme ‘left’ or ‘right’ in the following paragraphs. Rather, this post was authored by an investment manager who is concerned about the ramifications and potential catastrophic consequences that could occur if our leaders in Washington fail to raise the debt ceiling by August 2nd.

What I think some fail to realize in Washington – and around the country – is that there are billions of investment dollars in pension funds, money markets, mutual funds, and other entities and vehicles that are mandated by policy to be maintained in AAA-rated securities such as US Treasury bills, notes and bonds. If we continue to play this game of chicken down to the 11th or 12th hour, fail to raise the debt ceiling, and lose our AAA status, we risk a potential sell off in US Treasuries that would make the most recent financial crisis look minor in comparison.

Some argue that we should allow the debt to default – even temporarily – to restore discipline and fiscal responsibility to our nation, but I would counter that the price to teach that ‘lesson’ is much too high. We are currently playing a dangerous game of roulette with our nation’s credibility and standing in the world. The potential damage to our reputation is something the world would not soon forget.

What is the debt ceiling?

Back in 1917, the US Congress first passed a law setting the national debt limit initially at $11.5 billion. Of course, since they have raised that ceiling many, many times, today it sits at $14.294 trillion. It is a cap on the public debt and debt owed to trust funds like Social Security and Medicare. At a minimum, the ceiling serves as a periodic reminder of our fiscal situation and the fact that at some point we must address our longer term structural issues to change our economic path. By August 2nd, though, our government must either raise the debt ceiling or stop spending more than it takes in. If the ceiling is not increased, we risk not being able to pay our bills and defaulting on our debt payments. The gyrations caused by such an event would certainly be felt in financial markets around the world.

We actually reached the ceiling back in mid-May, but thanks to some rearranging of payments and financial maneuvering, US Treasury Secretary Tim Geithner was able to postpone a potential default until August 2nd.

Today we see the era of massive stimulus winding down with the Federal Reserve’s program of QE2 ending in June. Fiscal austerity seems to be the path that we are now embarking down. While we need to instill discipline to our nation’s fiscal house, I do question the timing of any severe spending cuts given the fragility of the current economic recovery. In the short term, however, we must raise the debt ceiling. To get it passed, we will likely see some kind of intermediate to longer-term framework created to cut spending and address the structural issues of the budget deficit and national debt overall. If an outline to address our longer-term structural issues is developed and the debt ceiling is raised, those would be very positive developments.

How will this end?

When one looks beneath all of the rhetoric, I believe most people recognize the magnitude of the decision that must be made in the coming weeks. I have faith (and hope) that our leaders will eventually come up with a compromise and get the debt cap raised.

Upon thorough examination, it appears that the two most likely potential options are:
1. Congress will raise the debt ceiling sufficiently to get us through the 2012 election cycle
-OR-
2. Congress will pass a temporary measure to get us just into next year – in which case we would see the showdown replay around this time next year

Though the political posturing and rhetoric will no doubt heat up in the next few weeks, I expect that the ceiling will be raised in the end, because the consequences of not doing so are simply too dire.

In my last blog post, I discussed the importance of reviewing your 401(K) or IRA beneficiary designation form. Hopefully, you have taken time over the past couple of weeks to review the provisions I mentioned. Ensuring you have named a primary as well as a contingent beneficiary are key provisions which require further discussion to ensure the parties named are consistent with your estate planning needs. Here is some helpful information for you to consider.

Choosing a Beneficiary:

Make sure your IRA has a primary and contingent beneficiary named. A primary beneficiary is your first choice- the person you want to receive your IRA at the time of your death. In the event your first pick does not survive you, a contingent beneficiary should be made.

If you fail to name a beneficiary of your IRA, it will become payable to your estate. Which means the funds will need to be withdrawn from the IRA within five years. Depending on the size of your IRA, the tax liability can be steep. Estate income tax rates hit the highest tax rate of 39.6% at just over $11,000 in income. Not naming a beneficiary can be a costly mistake.

If you are married, a good first choice for your primary beneficiary is your spouse. If your spouse receives your IRA, he or she can complete a qualified rollover, which means that the IRA will be treated as if your spouse owns it. As a contingent beneficiary, you may want to consider naming your children or a charity. By naming a charity, the entirety of your IRA will pass free of tax. If you name a child, be sure to talk with him/her about the advantages of a stretch IRA, which include:

• It allows for long term tax deferral of the IRA

• The beneficiary has more control when the IRA funds will be taxed

Naming Your Trust as Beneficiary:

You may be asking why, “can’t I just name my trust?” Before naming your trust as a primary or contingent beneficiary of your IRA, it is paramount you check with your estate planning attorney to determine if your trust qualifies as a designated beneficiary. To qualify as a designated beneficiary trust, it must meet four criteria:

• Be valid under state law.

• Be irrevocable at the death of the grantor.

• Name natural individuals as beneficiaries—estates, charities and corporations generally do not qualify.

• The trustee must certify to the retirement plan or IRA administrator the names and ages of the trust’s beneficiaries no later than October 31 of the year following the owner’s death.

If your trust does not qualify as a designated beneficiary, naming your trust as a beneficiary of your IRA can have the same devastating impact on your IRA as not having a beneficiary named. If your trust does not qualify, all the income taxes may be accelerated and due within five years. This means that your $100,000 IRA could have a tax liability of $39,000.

Working with your attorney and accountant, United can help develop your IRA distribution strategy by utilizing our United Legacy IRA. This is an IRA that allows you to develop a sound distribution strategy to insure your beneficiary can maximize the value of your IRA. It also serves as an alternative to naming your living trust as a beneficiary of your IRA. And you can rest assured that your hard work and discipline will benefit the people you love most.

You worked hard- put as much as possible aside for retirement. During your working years you shifted your 401(K) or other retirement savings into overdrive; and you’re able to retire on the very day you had planned. Congratulations! Your efforts have paid off, and you can plan your days doing whatever you want. Hold up! Your work is not done yet.

Your retirement fund did not grow because of wishful thinking or good intentions. Nor will the transition of your wealth magically transfer to your beneficiaries. You achieved your pre-retirement nest egg by having a plan and sticking to it. So, you must be thinking, “what’s next?” (more…)