When is it appropriate to buy an annuity? Joe and Big Al run a retirement annuity spitball analysis. Plus, when might it make sense to take Social Security early, and what are the rules for collecting survivor Social Security benefits? Finally, how does net investment income tax (NIIT or the Medicare surtax) on long term capital gains impact a house sale? Is it possible to do a 1031 exchange from rental real estate in Utah for investment property in California?
- (00:47) When is it Appropriate to Buy an Annuity? (Gene, San Diego)
- (02:49) Social Security and Annuity Retirement Spitball Analysis (Joan)
- (13:00) Take Social Security Early If You Save the Benefits? Are You Sure? (John)
- (19:06) My Husband Died at 60. I’m 54. Can I Collect Survivor Social Security Benefits? (Laura, Dyess, Arkansas)
- (21:16) How Does Net Investment Income Tax on Long Term Capital Gains Impact Our House Sale? (Christopher, NV)
- (27:00) 1031 Exchange Utah Rental Real Estate for California Investment Property? (David, Carlsbad)
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Today on Your Money, Your Wealth® podcast 374, Joe and Big Al run a retirement annuity spitball analysis. When is it appropriate to buy an annuity? YMYW regulars, you get three guesses on Joe’s answer, and the first two don’t count! Plus, when might it make sense to take Social Security early, and what are the rules for collecting survivor Social Security benefits? Finally, how does net investment income tax, AKA NIIT or the Medicare surtax on long term capital gains impact a house sale? Is it possible to do a 1031 exchange from rental real estate in Utah for investment property in California? I’m producer Andi Last, and here are the hosts of Your Money, Your Wealth®, Joe Anderson, CFP® and Big Al Clopine, CPA.
When is it Appropriate to Buy an Annuity? (Gene, San Diego)
Joe: Gene writes in from San Diego. He goes, “When is it appropriate to buy an annuity?” Never.
Andi: I knew you were going to say that.
Joe: Next question, please. I don’t know, Gene.
Al: Well, if you were going to buy an annuity-
Joe: I mean, you would want to buy an immediate annuity that you’re exchanging cash for income that will last the rest of your life.
Al: Payment stream, right? Most annuities are a little different.
Joe: Yes. I don’t know. What do you think, Al?
Al: I think if you really can’t handle at all the ups and downs of the market and you need a cash flow, it’s like buying a pension plan. But I think you’re right. I think you want to buy an annuity that’s simple, that you understand, that you get immediate payments. Do it when you’re ready to have a payment stream.
Joe: Otherwise, if you don’t understand it, if it sounds too good to be true, it probably is. So just kind of be careful on that end. But annuity is insurance, so you’re buying income is what you’re doing. So if you have longevity in your family and you’re worried about running out of money and you want some sort of floor of guaranteed income from that insurer, then that’s when it’s appropriate. But there are tradeoffs. You’re going to receive a guaranteed fixed income stream, but it’s going to potentially be a lot lower than what you could generate. Or once you die, it’s gone.
Al: And I think that’s the downside. For safety, you give up a lot of return. I’ll say it this way, Gene. We have people that come into our office all the time with annuities, and I would say the majority of the time they’re sorry they bought them.
Joe: Well, they don’t understand what the hell they bought.
Al: And then when they find out, it’s like, oh.
Joe: It’s just like, well, do you need the income from this? They’re like, no, I’m good. I got a pension and I got Social Security. I think I’m all right. I want it for growth. And I’m like, why did you buy this? This is income.
Social Security and Annuity Retirement Spitball Analysis (Joan)
Joe: We got Joan writes in. She goes, “Hi, I just watched your Social Security retirement strategy show online. I don’t think my email was sent through your portal.” It probably was Joan. We just ignored it. It happens, Al.
Al: It does.
Joe: I get questions all the time and I’m like, I’m not going to answer that.
Al: Well. So Joan thinks her situation is unique. Don’t they all?
Joe: All right, let’s see how unique it is. “I’m currently living separately with my son from my spouse- friendly separation, albeit.’ Well, that’s good.
Al: That’s better than not.
Joe: It’s like, all right, I’m going to live with little Johnny. See you later. “But I don’t see any reconciliation- “them getting back together.
Al: Yeah, reconciliation, at this time.
Joe: Thank you, sir. Thank you, sir. “I’m 65. He’s 61. Ultimately, I would be collecting Social Security first regardless. I’m seeking unemployment, was let go due to Covid in June 2020, collected EDD for 18 months, and have a job that I think will pan out after the background check is complete.” Okay. She’s got a little background check-
Al: Really really close.
Joe: She’s so close. See what happens with that background check though.
Al: You never know.
Joe: Joan. “The salary will be approximately $46,000 a year, which will allow me to defer me taking Medicare, even though I will apply now, but currently under hubby’s insurance.” Wait a minute. So she’s still calling him hubby?
Andi: It’s a friendly separation.
Joe: Friendly, but do you think, I mean- ?
Al: Well, they’re probably still married. They’re separated.
Joe: Yeah, but it’s kind of like a term of endearment, isn’t it?
Al: Generally. It’s a friendly separation.
Joe: Does your wife call you hubby?
Joe: Oh, hey, hubby. Hey, Big Al.
Al: No, she doesn’t call me hubby.
Joe: Hubby. Okay. All right. Where am I?
Al: Not sure.
Andi: She’s on hubby’s insurance.
Joe: I think Joan still has a lot of feelings, to be honest with you.
Al: You were at hubby’s insurance.
Joe: Yes. I think it’s going to be hard for her to let go. “-defer taking Social Security early. Her aim is to wait until she’s age 70 while still trying to save in the 401(k). After 5 years employment, I believe I can receive a pension. Don’t mind working to 75. I currently have $475,000 in an IRA, in an annuity, which I am told to take at 70 or 72 because it also grows 8% per year.” Oh, boy.
Al: That’s another topic.
Joe: “$150,000 in stocks, $350,000 in cash from the sale of my home last year. I anticipate earning approximately $2800 a month at age 70 from Social Security. I also believe that my full Social Security will be higher than half of my husband’s. I don’t see filing suspending Social Security benefits on my husband who isn’t claiming yet, as an option. Am I understanding this correctly? Also, I don’t see the real estate market changing very much anytime soon. The $350,000 in cash isn’t earning very much, but I’m conservative- but I must conserve this for my future home purchase. I’m anxious about placing this in the stock market. Are you in agreement regarding this? Thank you so much for your opinion.” Okay, Joan. Getting over her hubby comment.
Al: So you’re thinking they might reconcile?
Joe: I don’t know.
Al: It’s possible.
Joe: I think it’s possible. But she says it’s not an option, so we’ll go with that. So she’s got some assets. So call it- she’s got a $1,000,000. And she’s going to get $3000 a month at age 70 from Social Security. She doesn’t mind working to 75. So what is she spending, is what we’re missing.
Al: Yeah, that would be a good thing.
Joe: She’s got a salary of $46,000 a year. So let’s say she wants just to replace the $50,000 a year. With the $1,000,000 and the Social Security, you’re right in line. You’re just going to replace your paycheck. You’re sitting in a good spot.
Al: And so without knowing anything more, Joan, I think that the concept of working till age 70, as long as you can do that, it’s a great idea. Because your Social Security is higher, you have more years to save. More years of compounding growth and less years of pulling out of your portfolio. So for people that are willing and able to work to 70 or longer, fantastic. A lot of people in their 60s decide, you know what? I really don’t want to do this anymore.
Joe: Is that your feelings, Alan?
Al: Can I leave now, Joe? Where’s the door?
Joe: Where’s the exit?
Al: It’s like, how many podcasts have we done? How many more do I have to do?
Joe: I don’t know. Yes, Joan, Alan is right on. Because if you just like delay retirement one or two years, I mean, the money on the back end could last another 3 to 5.
Al: Yes. It’s a big deal.
Joe: Keep the money out of the stock market if you want to buy another house. So if you’re going to rent a little bit, maybe put that money in CDs, do not buy another annuity. That annuity, by the way, is not growing at 8%.
Al: That’s what they tell you. That was the illustration, right?
Joe: No, it’s not even that. It’s an income benefit rider of 8% on the money. You’re not going to receive 8% return. So they run this $374,000 and they’re going to be like, okay, well, you’re going to take this benefit at age 70 or 72 because you’re getting an 8% growth rate on it, and then you’re going to be able to pull 5% out of the overall contract. And everyone’s like, wow, this is so great. But it’s going to take Joan to live until like 105 to get any return on the money. Because it’s all principled back to her first. And if she’s going to work until 75 or she turns that thing on at age 72. So just to get a rate of return, she’s probably got- it’s going to be over 85 years old- over life expectancy in most cases.
Al: I think when I’ve seen you do the illustration, it’s about 20 years just to get your money back, right? And if you die at that point, you-
Joe: You made zero return. The insurance company held your money for 20 years and just dribbled it back to you. So it’s a longevity play. But the bad thing is – and she doesn’t understand the product. That’s why I hate this crap so much is because she thinks she’s getting an 8% rate of return. She is not getting an 8% rate of return. Interest rates right now are at all-time lows. And all of a sudden the insurance company just can appear to pay you at 8%? But Joan doesn’t know any better. She’s like, all right, well, this nice insurance person talked to me. And I’m conservative and I want to retire and I got divorced. But I really love my husband and I wish he’d take me back.
Andi: This is a $475,000 IRA in an annuity. So what can she do about that?
Joe: I’m not giving advice. I don’t know. She’s got enough cash. The problem with that is that she has done a really good job of saving money. She’s conservative and she’s listening to financial podcasts and she’s trying to get her ducks in a row. And I think she’ll be fine. If she wants to turn the income on, by all means. You’re conservative, you have a guaranteed income. But the issue that I have is that she doesn’t necessarily understand the product. If she goes, I’m turning income on because I want a guaranteed income stream with my Social Security so I have a certain income floor that I will never outlive and I don’t ever have to worry about this again. Then I’d be like, okay, she understands the strategy that she’s going into. But she states that, oh, I’m getting an 8% rate of return.
Al: Yeah, that’s what it says, which is incorrect. It’s 8% of a factor of an amount that you’re going to later get 5% from.
Joe: Or 4% or 6%, who know?
Al: Whatever the contract is. Yeah.
Joe: So thank you, Joan, very much for the email. Best of luck. Great job.
Check out the podcast show notes at YourMoneyYourWealth.com to learn more about annuities, download free financial resources, read the episode transcript, and to Ask Joe and Big Al On Air any money questions you’ve got brewing. If you’re wondering how much money you need in retirement, how your retirement account balance stacks up, or whether your invested assets are properly allocated, just download our Portfolio Tracker guide. Click the link in the description of today’s episode in your favorite podcast app to go to the show notes. Don’t forget to click share and spread the word about YMYW.
Take Social Security Early If You Save the Benefits? Are You Sure? (John)
Joe: Answering your money questions, go to YourMoneyYourWealth.com, click on Ask Joe and Al. Type in your question and we’ll answer it no matter how great or bad they are. That’s our motto.
Al: We try to do them all, don’t we?
Joe: Oh, we’ll do them all. No matter if you proofread them or not.
Andi: Don’t, because then Joe has to try and figure out his way through it.
Joe: And by the way, we don’t rehearse this. This is-
Joe: There is no preparation for this show.
Al: I think our listeners know that.
Joe: I think it adds value of knowing that we know this stuff off the cuff. Just shows how smart you are, Al. And how great of a reader I am on the third-grade level.
Al: It does.
Joe: Okay. Let’s go to John. He goes, “Hello YMYW team. I recently came across your podcast and been listening to some back episodes. I have some questions.” Oh boy. An investigation. “I hope you can answer this on a podcast episode. You mentioned it may be better to claim Social Security early instead of waiting to age 70, if you saved the Social Security benefits. Every financial advisor I’ve heard shouts from the rooftop, unless the Grim Reaper is pounding on the front door, delay Social Security to 70, end of discussion. Can you explain the math behind your assessment?” Yes, we can. “Does it apply to claiming at 67 only, or does it extend all the way down to 62?” It applies to 62. “What if you have another loss decade in stocks, which seems more likely than not? Does your assessment take into account that the earnings on the Social Security payments you have saved will be taxed as capital gains, instead of being taxed at regular income as most Social Security payments are, or is that even more icing on the cake to take Social Security early? I drive a 2009 Honda CRV with 48,000 miles on it.” This guy does not drive.
Andi: Makes sense.
Al: He lives right next to his work maybe.
Joe: 2009. That’s many years. He’s got 48,000 miles on it.
Al: I got a 2013 that’s about to hit 100,000.
Joe: How many miles is that a year? It’s like 400 miles a year. “When I take it in for service, I usually get, you only got that many miles on it? I give them that old shady used car salesman line, it belonged to a little old lady who only drove it to the grocery store. But it’s true. It belonged to my mom who drove so little, I had to take the car out for exercise every week to keep the battery charged up and to get engine fluids warmed up and flowing.”
Al: There we go.
Joe: “My favorite beverage is Sam Adams Boston Lager, but I seldom drink it anymore since I am carb challenged. I’ve recently settled on Michelob Ultra.
Al: Another one.
Joe: This is the second Mich Ultra guy, “To paraphrase a famous line from a BP political debate, dating back a couple of decades, I know Sam Adams and Mich Ultra. You’re no Sam Adams. Mich Ultra is 2.6 grams of carbs. I think Sam Adams is 11- ish. Maybe more. Consider that constraint and that Mich Ultra is more beer-like than water-like, I guess it really is quite an achievement. So hats off to Mich Ultra brewmaster.” Okay.
Andi: I think that email was more about beer than it was about Social Security.
Joe: I think so too. Okay. Do you want to do the math there, Big Al?
Al: I’ve done it before. So I would say it this way, when I’ve run analysis to look at 70 versus 62, the breakeven turns out to be somewhere around 79 or 80. And that’s just in real dollars. No taxation, no increase for Social Security for cost of living. That’s just straight dollars.
Joe: If you have a $2000 a month benefit or $24,000 a year, you add $24,000 from age 67 to 79, or you take your lower benefit from 62. You add up all those benefits. Basically the breakeven is roughly around 79 years of age or 80.
Al: Exactly. And as you said, that’s because if you take it at 62, you’ve got 8 more years of collecting payments. But if you wait until 70, you start later, but you have a much higher payment. So that’s the breakeven, if you want to think about breakeven. Then when I kind of overlay that with a 6% rate of return, again, no taxes, no cost of living- we’re just trying to keep this simple- it adds about 10 years in the breakeven. It comes out to 89 or 90, the breakeven. Which tells me that if you take it at 62, you are disciplined, you believe the market over a long period of time is gonna earn 6% and you have a much later breakeven, so that’s more like 89 or 90, I would say most people spend what they get. So it doesn’t really work for most people, but if you’re disciplined, that can be a decent strategy. But if we do have another loss decade, then it didn’t work very well, did it?
Joe: It’s all about the assumptions that you’re making.
Al: The market assumptions, which nobody knows.
Joe: It could be negative. And then you would be far less better off by investing. So it’s 100% of the assumptions that you’re making. And so if you assume that you- so John, while you’re drinking your Mich Ultra, get a spreadsheet and then figure out what your benefit is at 62, what your benefit is at full retirement age, what your benefit is at age 70, add up that annually. And then you’ll find out what the real number is, and you’ll find your breakeven. And then you run assumptions and say, okay, well, how about if I get 3% or how about if I get 4%, how about I get 8%? And then you can even get more complex and say, all right, well, let’s just say that there’s a capital gains tax drag on my overall return each and every year. So there’s different things that you could do. However it’s- if you don’t need the money- if you need to spend the money, then it’s a total- I mean, we believe that Social Security is income. It’s not an investment. For those of you that think Social Security is an investment, that’s why we tell you to take it early and invest it if you think it’s an investment. However, we will shout to the rooftops as well, that it probably makes more sense to delay, because it’s a guaranteed income stream that you can’t outlive, that will help you later in life. Because you’re basically taking a fixed income early and investing it. If you need the income, that’s not the right strategy.
Al: Yeah. For what it’s worth, I’m waiting to age 70 myself.
Joe: Oh, look at Big Al giving out his family financial planning secrets.
Al: Family secrets.
My Husband Died at 60. I’m 54. Can I Collect Survivor Social Security Benefits? (Laura, Dyess, Arkansas)
Joe: Laura writes in from Arkansas. “My husband died two months ago. We were married since 1991. I’m 54. What is the best benefit for me to sign up for? He had just signed up on his Social Security. He’s 60. He passed before he received his -“
Al: His back pay. I guess Social Security benefits?
Joe: “ – or anything. What should I do?”
Al: Okay. That’s a good question and very easy answer. There’s nothing you can do yet, Laura, because the earliest you could collect survivor benefits is age 60. And if you collect it at age 60, you’re not going to receive the full survivor benefits. So I don’t know if that’s the right answer or not. We’d have to know a lot more about your situation.
Joe: I’m sorry for your loss, but –
Al: But there’s nothing currently you can do.
Joe: Unless they have a minor child.
Al: Well, yeah, that’s true. Good point.
Joe: So there could be a family benefit. But I’m thinking is that he was 60, he passed. Is there some back pay or there could be a death benefit of a couple of $200?
Al: It’s like $385 or something like that and you have to apply for it. It’s a lot of work to get $300.
Joe: But yeah, survivor benefits do not come into play until age 60, unless you have minor children.
A couple weeks ago Big Al offered to run a Social Security Analyzer for YMYW listeners to help you determine the best claiming strategy for your situation, and a LOT of you took him up on that. If you didn’t take advantage, I’ve got a little secret for you. When you schedule a free financial assessment with Pure Financial Advisors, they can run the Social Security Analyzer when they assess your overall financial plan. Click the link in the description of today’s episode in your favorite podcast app, then click the big green “Get an Assessment” button there on the show notes page. Download the Social Security Handbook from the podcast show notes too – it’s a handy reference when determining your Social Security claiming strategy.
How Does Net Investment Income Tax on Long Term Capital Gains Impact Our House Sale? (Christopher, NV)
Joe: Christopher writes in from Nevada. He goes, “Hey, Joe and Big Al, I love the show. My wife and I live in Nevada. We make about $150,000 a year and thinking about selling our house and spending the next two years exploring the country via furnished short-term corporate rentals to find where we want to live next.”
Al: Try before you buy. I like it.
Joe: Try before you buy. Is that a little commercial? “We drive a 2018 Jeep Grand Cherokee. Although I’m not a big drinker, when I choose to participate- “ When I choose to participate.
Al: I’m not thirsty very often, but when I am-
Joe: He’s the most interesting man in the world. Or maybe non-interesting man in the world. “ – my drink of choice is a little whiskey neat. I have the best friend in the world, who is a dachshund- “
Joe: Thank you. “ -Labrador mix who loves long walks in the Nevada Sun.” Very cool. “We have only lived in our house for about 16 months. We will owe long term capital gains tax after the sale of our house. At least that is how I interpret the rule. After depreciation, seller and buyers’ commissions, paying off our loan and improvements, we’ll net about $264,000. We bought right after the election and got a really good deal. I’m confused about when and how the Medicare surtax on capital gains applies. In our case, does it not apply since we typically have modified adjusted gross income below $250,000? I’d appreciate learning a little more about the surtax to try and comprehend how much we will owe in taxes for the year 2022. Thanks so much.” And second email “Because I completely forgot, I wanted to say Hi to Andi as well. The only person who keeps this show running and on track.”
Andi: Thanks, Christopher.
Al: Yes. And agreed. We know that.
Joe: Yes. Keeps us on track.
Al: I think the first thing I would say, Christopher, is let me make sure we’re clear on how a capital gain is computed because it has very little to do with the cash you receive from escrow. So here’s how it’s computed. You look at your sales price and you deduct all your closing costs. And that’s called your net sales price. So that’s one figure. And then the second figure is what you bought the home for, plus any improvements. And if it was a rental, you got to deduct depreciation. I don’t think it was. But so your net sales proceeds minus your tax basis, your purchase costs plus improvements, the difference between those two is your gain. It has nothing to do with how much cash you receive. Let’s just say an example where you didn’t have a loan. And so in that case, you got a lot of money back, but it’s not all taxable. So look at it that way first, to get the right capital gain amount.
Joe: Right. Because if that’s his primary residence, which I believe it is-
Al: That’s what I’m thinking. But they’re only there 16 months. So they may not get the exclusion. You’re supposed to be there two years. But here’s another angle on that one. And that is if you are moving because of unforeseen circumstances, you can get a prorated exclusion. So look into that. Like if your wife is pregnant with twins, that would count.
Joe: He’s asking about Medicare surtax.
Al: I’m just giving an example of an unforeseen circumstance.
Joe: Got it.
Al: Anyway, so it probably doesn’t qualify, but you should look into that. So anyway, that’s how you compute the gain. And as far as the Medicare surtax, or more appropriately called the net investment income tax, that does kick in when your adjusted gross income is over $250,000. I think you said that your income is normally below that. So let’s just say well, you say you make $150,000 a year.
So let’s just say that $150,000 and then the first $100,000 of gain gets you to the $250,000. So there’s no net investment income tax on that part. But everything above that, the capital gain would have that 3.8% surtax, if you will. And so you’re going to have to pay it. So probably not on the entire gain, but on some of the gains.
Joe: So I think maybe Christopher received $264,000 from the sale of the house. Or he’s doing the math and he’s kind of figuring out this/that, let’s just assume $264,000 is the gain, which I don’t think it is in Nevada, but maybe it’s $1,000,000 house. So if you bought $1,000,000 house and kept it for 16 months, it probably could appreciate by $300,000.
Al: Yes. Housing has been incredible, as you know. Almost everywhere in the last year and a half.
Joe: So if that is truly his gain and he makes $150,000- And then so the $250,000 per se, he saw that and he’s like now I’m going to owe all this surtax on top of that. Well, if you make $150,000, the first $100,000, as Alan just said, you don’t pay the surtax. And then anything above once you hit that $250,000 mark is when the surtax comes in.
Al: So in this example, if that really is your gain. So $164,000, you’ve got to pay that extra 3.8% tax.
Joe: But I think Christopher has some good news. I’m guessing that that’s not his all gain. I’d like to know, Christopher, when you have a little whiskey, neat. Take a little sipper of that and shoot us another email.
1031 Exchange Utah Rental Real Estate for California Investment Property? (David, Carlsbad)
Joe: David, from Carlsbad, he writes in and he goes, “We have a vacation property in Utah. Circumstances are forcing us to sell the property. Can the property be converted to qualify for 1031 exchange into a California investment property?”
Al: That’s a great question. So a 1031 exchange, by the way- So this is when you have a rental property or income producing property, you can sell it and you have to follow the timelines, but then you could buy another replacement property that’s at least as expensive as the one you sold and you can defer that gain into the next property. And you’ll still pay that tax when you sell that next property, plus whatever additional gain you have from that property. But that’s what a 1031 exchange is. It’s a great tool. But it’s a good question because a vacation rental is a mixed-use rental. In other words, you’re getting personal use generally as well as the vacation rental. And so Interestingly enough, in 2008, the IRS did a revenue procedure 2008-16 that actually came up with a safe harbor on when you could do this. And here’s the test you have to satisfy to be able to do a vacation rental on a 1031 exchange. Number one, is you must have owned the property for at least 24 months immediately before the exchange. That’s a little bit different than the normal rules. And number two, within each 12 month period, within that 24 months immediately preceding, in other words, the two years before you sell it, you must have rented out the property at market rates for at least 14 days. That’s number one. And number two is your personal use of the property cannot have exceeded the greater of 14 days or 10% of the days the property was actually rented. So you got to satisfy those two things. And if you buy another vacation rental you have to satisfy that again for the next two years. So you can do it. You just have to make sure you follow the rules.
Joe: What is the likelihood of that? Anyone passes that test?
Al: Well, it’s possible. If you don’t really use it much.
Joe: You never go to Utah- so David never had to visit the state of Utah, basically is what you’re saying. You go there for two weeks out of the year.
Al: So if you rent it for like 250 days you can spend 25 days in it. You could. It’s possible. It’s possible. It’s not necessarily easy. So it doesn’t really work if you use the property a lot yourself for personal use, but it can work. I thought you were going to ask what’s the likelihood of the IRS would ever challenge that.
Joe: They would challenge it all the time. We are strictly by the book here, Al.
Al: And that’s how I answered it. The answer to that question is they don’t really look at that very carefully, but what I told you is the law.
Joe: The honor system.
Whiskey, tequila, beer, Celsius and PT Cruisers in the Derails at the end of the episode, so stick around.
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