How Parsec Monitors Investment Securities

Parsec invests in a variety of securities for its clients.  These may include mutual funds, exchange traded funds or ETFs, and individual stocks, among others.  All of these investments can and do experience significant price pullbacks from time to time.  While Parsec’s Investment Policy Committee (IPC) focuses on investments it can hold for the long-term and performs significant research before adding any new positions, price declines still happen.  In this email we’ll discuss how the IPC monitors investment securities and we’ll share with you our process for when a stock or fund doesn’t perform as expected.

Investment security returns are driven by a number of factors.  For individual stocks, earnings growth, competitive environment, and exogenous events can significantly affect price performance.  For mutual funds and ETFs, the general capital market environment as well as portfolio management departures or changes at the parent company can influence both fund flows and price changes.  At Parsec, in addition to reviewing all covered securities at regularly-scheduled meetings, the Investment Policy Committee continually monitors client investments for these types of factors in between our ongoing investment reviews.

We do this by reading sell-side research reports, company government filings, and the news.  Likewise, the financial software we use alerts us to any new developments on our covered securities and helps us manage the large volume of news flow in order to focus on the most important stories of the day.  When a significant event does happen that negatively affects a security, we research the development by listening to a company’s conference call, reading industry reports, and conducting our own due diligence.  We review our thesis on the fund or stock and determine if and how the latest events could affect the security’s long-term prospects going forward.  In order to gauge an investment’s upside potential we adjust our growth assumptions to reflect the new information and evaluate the security’s risk/reward profile in light of its new price level.

Oftentimes when a major story surfaces there is minimal information on which to make a decision.  At the same time, the market has a tendency to overreact to news events.  For these reasons, Parsec’s Investment Policy Committee may intentionally wait before taking action when a stock or fund experiences a significant negative development.  Although it may appear that we are not responding to the event in question, we are in fact working diligently behind the scenes to gather as much data as possible while reviewing our thesis and assumptions.  This can be a frustrating time for clients who would, understandably, prefer us to take immediate action.  However, we have found that taking a wait-and-see approach allows us to collect more information and answer important questions before making an uninformed or premature decision.

Waiting for the dust to settle while collecting additional information also allows us to better understand how a development could affect a stock or fund’s long-term prospects.  If we determine that a company or fund can recover from an adverse event and the security has fallen significantly in price, it’s often an attractive buying opportunity.

However, on other occasions it may be clear that it’s time to sell a position.  This can happen when an investigation surrounding a security is new but affects multiple divisions or aspects of the underlying company’s or fund’s operations.  Another example may include an environmental disaster or a significant product recall that could take years to resolve.  In these instances the best action may involve taking a modest loss now in order to avoid a much larger loss in the months or years to follow.

While our bias towards higher-quality stocks and funds may mean we’re more likely to hold a security or even add to positions following a negative news event, we are closely monitoring client investments and performing in-depth due diligence as new developments arise.  Our intention is to make objective and thoughtful decisions that will benefit clients and their portfolios over the long-term.

Thank you,

The Parsec Team

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How do I Apply for Social Security Benefits?

You’ve worked hard, met with your financial advisor, determined when to take Social Security and you are set to retire… now what? Many retirees get to this point and are not sure what the next steps are when applying for Social Security. Thankfully, you have three options!

  1. Online: Prefer to handle things on your own? Today, it’s easier than ever to apply for Social Security by applying online. Visit their website to get the process started. If you don’t finish the application, they make it convenient by allowing you to return and finish the application later.
  2. By Phone: Not savvy with the computer? You can also call Monday through Friday from 7:00 a.m. to 7:00 p.m. at 1-800-772-1213 to speak with a representative and apply for your benefit.
  3. In Person: Prefer to handle things face to face? You can visit your local Social Security office to apply for your benefit. Please visit their office locator to find the office closest to you.  I’d recommend either calling to set up an appointment, or getting there early. Like the DMV, you may end up waiting a while!

It’s important to be prepared when starting the application process for your benefit. Below are some of the items that you may need to be prepared to provide when applying.

  • Birth Certificate – this needs to be an original certificate or one certified by an issuing agency. They will not accept a photo copy.
  • Proof of citizenship or lawful alien status.
  • Copies of W-2 forms and/or self-employment tax return for the previous year.

If you don’t have all the appropriate documents, don’t let that stop you from applying.  The Social Security office will take what you have, allowing you time to collect the other documents.  Any original documents that you have provided will be returned to you once you have completed the application process.  If you don’t know how to get all the documents required, I recommend speaking with a representative at your local office.  They can help point you in the right direction.

It’s important to note that the Social Security Office recommends that you apply for benefits at least three months prior to the date you wish to start receiving your benefit.  The earliest you can sign up for your benefit is 61 years and 9 months of age.

If you are nearing retirement, and would like to determine the best time start receiving your benefit, please call your financial advisor to discuss. We are here to help!

Ashley Gragtmans, CFP®

ashley_woodringb

 

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Ten Things you can do to Protect Your Accounts from Fraudulent Activity

  1. Protect your account information. If you must e-mail your advisor or others your account number, social security number, or date of birth, be sure to use encrypted e-mail.
  2. Heed the No-Nos:  Do not repeat the same password for multiple sites. Do not use really easy passwords. Do not use your dog’s name followed by the number 1 as your password.
  3. Use a Password manager. Password managers are free tools that you can download to your computer that manage your passwords for you. You no longer have to remember complicated passwords, which frees you from the No-Nos.
  4. Ask your custodian or bank if they offer two-factor authentication. This is a device or app that provides a unique number each time you log in to your account.
  5. Check your credit report annually to ensure no one has taken out credit in your name.
  6. Keep your Social Security and Medicare cards some place secure.
  7. Consider freezing your credit if you don’t plan to take out a loan in the next few years.
  8. Don’t fall prey to phishing scams. If someone calls you on the phone telling you they’ve detected fraudulent activity on your behalf, do not give them your private information. The same goes for someone contacting you over e-mail.
  9. If your e-mail is hacked, change your password immediately and notify pertinent parties.
  10. Encourage your family to do the same – even children’s credit can be stolen.
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(Tax loss) Harvest Season is Almost Here!

The kids are back in school, the leaves are changing colors, and pumpkin spice lattes – the age-old harbingers of harvest season – are everywhere. At Parsec, we are preparing for the harvest…of tax losses.

Every year, beginning in late October/early November, Parsec’s portfolio managers will scour clients’ taxable accounts for meaningful losses, which we can use to offset realized gains created from trading throughout the year. These tax-efficient trading strategies provide value to clients by minimizing their tax burden while keeping the portfolio aligned with their financial planning goals.

You might see trades from one security into another one that is similar, but not exactly the same – we do this so that you can recognize a loss while maintaining exposure to the same industry or sector, yet avoid incurring a wash sale. According to IRS publication 550, “a wash sale occurs when you sell or trade stock or securities at a loss and within 30 days before or after the sale, you buy substantially identical stock or securities,” either in the same account or in another household account, including IRAs and Roth IRAs. Stocks of different companies in the same industry are not considered “substantially identical,” nor are ETFs that track the same sector but are managed by different companies (like a Vanguard Emerging Markets ETF vs. an iShares Emerging Markets ETF).

Sometimes it makes sense to place a loss-harvesting trade and leave the proceeds in cash for 31 days, then repurchase the same security. We may do this for clients who have cash needs during the holiday season, with the intention of placing rebalancing trades in January when there is no more need for liquidity. When liquidity is not an issue, however, we prefer to keep the funds fully invested in another high-quality name. We may later choose to reverse the trade, once the wash sale period has expired, or we may leave the trade in place if we think it is appropriate and suits the clients’ needs.

Sarah DerGarabedian, CFA
Director of Portfolio Management

 

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What does a Weaker U.S. Dollar Mean for Companies & Consumers?

Earlier this year the U.S. dollar reached a 10-year high compared to the currencies of its major trading partners*.  However, the greenback has declined about 8% year-to-date through July.  In this email we’ll explore what drove the U.S. dollar to record levels, how dollar weakness or strength impacts corporations and consumers, and what may lie ahead for the world’s most widely-held currency.

Many factors affect a currency’s strength or weakness.  Some of these include interest rate levels, inflation, central bank policy, investor sentiment and the health of the economy.  The U.S. dollar is unique in that it is the largest foreign exchange reserve, accounting for over 60% of global reserves.  As a result, other countries’ need for reserves and investors’ fears or confidence also affect how much the dollar appreciates or depreciates.

Following the financial crisis, the U.S. dollar appreciated versus many other currencies due to its perceived safety and ultimately, a quicker U.S. economic recovery compared to its peers.  This happened despite the Federal Reserve’s ultra-accommodative monetary policy in which it pumped trillions of dollars into the economy – an action that might normally depreciate the dollar due to an increased currency supply.  Instead, the Fed’s actions helped lead the U.S. economy out of the financial crisis which helped support corporate earnings and sales growth.  This in turn led to increased foreign demand for U.S. stocks and bonds.  As U.S. dollars are required to purchase our stocks and bonds, growing foreign investment in U.S. securities led to greater demand for the greenback, and subsequent dollar appreciation.

During the last ten years of dollar appreciation, we’ve experienced both positive and negative effects.  On the positive side, a strong dollar makes traveling abroad more affordable for U.S. citizens and effectively lowers the prices consumers pay for imports.  As consumers account for roughly two-thirds of U.S. GDP growth, the savings gained on lower-cost imports due to a strong dollar can lead to significant gains in disposable income, all else being equal.

On the downside, a strong dollar may hinder tourism in the U.S. and could result in weakened demand for U.S. exports as those goods become relatively more expensive for foreigners.  Another drawback is negative foreign currency translation for U.S. multinational companies.  U.S.-based firms that earn revenues abroad will have to exchange foreign currencies back to U.S. dollars at a less favorable rate.  This acts as a headwind to sales and earnings growth, and contributed to the recent “earnings recession” we saw among companies in the S&P 500 Index in 2015 and 2016.

In contrast, recent U.S. dollar weakness has started to help boost corporate earnings growth and could be a support for stocks going forward.  While it’s impossible to know if the dollar’s strength will continue to moderate, a few factors suggest it might.  One is an improving global economic outlook relative to the U.S.  The U.S. economy was a bright spot in the early years following the last recession, but emerging market economic growth is gaining ground and European GDP growth recently outpaced U.S. GDP growth.  Another factor is that the Federal Reserve has shifted to a less accommodative monetary policy stance.  Ordinarily this would support further U.S. dollar appreciation (via a reduced supply of dollars and higher interest rates attracting foreign investors); however, investor concerns that restrictive monetary policy could slow down the current economic expansion are outweighing the shift in the Fed’s policy stance.

Considering the above factors and given several years of strong gains, recent U.S. dollar weakness could continue.  While there are pros and cons to a depreciating dollar, we would welcome the shift as this would help reduce import costs for consumers and businesses, while supporting sales and earnings growth for U.S. multi-national corporations.

*Powershares DB US Dollar Index Bullish Fund (UUP) – compares US dollar to euro, yen, pound, loonie, Swedish krona and Swiss franc

The Parsec Team

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QCD – A Bigger Tax Benefit

What, another financial acronym? Yes, in late 2015, Congress passed the PATH (Protecting Americans from Tax Hikes) Act, which made the QCD permanent in early 2016. QCD stands for Qualified Charitable Distribution. This type of charitable gift is made directly from an IRA and isn’t included in taxable income. The QCD was introduced in 2006, but fell into the on-again, off-again bucket of acceptable tax strategies until the end of 2015.

Any individual over the age of 70 ½, who receives an annual RMD (required minimum distribution) from his/her IRA, is eligible to take advantage of a QCD. Now that the strategy is permanent, it’s worth a discussion if you’re already gifting to charity each year, over 70 ½, and the owner of an IRA.

As everyone knows, a gift to charity is tax deductible. So how is the QCD different and potentially more tax beneficial?

The amount of the QCD is excluded from income, which effectively lowers AGI (adjusted gross income) by that same amount. AGI is the threshold by which most itemized deductions are measured to determine if allowable or not. For example, unreimbursed medical and dental expenses are only deductible to the extent that they exceed 10% of AGI. Therefore a lower AGI may translate into an allowable or larger medical/dental itemized deduction.

Another benefit of the QCD is the possibility to reduce Medicare Part B premiums. This year, the standard premium for Medicare Part B is $134/month if you’re a single filer and your 2015 AGI was below $85,000 or married filing jointly and your 2015 AGI was below $170,000. To the extent your AGI was higher that these amounts on your 2015 return, your Medicare Part B premiums this year also increased. Currently, four AGI brackets determine the Part B premium amount that’s deducted from an individual’s monthly Social Security check.

 

MAGI* Limits for Medicare Part B Premiums
Single Tax Filer: Married Filing Jointly:
2015 MAGI: 2017 monthly premium: 2015 MAGI: 2017 monthly premium:
Less than $85,000 $134.00 Less than $170,001 $134.00
$85,001 to $107,000 $187.50 $170,001 to $214,000 $187.50
$107,001 to $160,000 $267.90 $214,001 to $320,000 $267.90
$160,001 to $214,000 $348.30 $320,001 to $428,000 $348.30
Greater than $214,000 $428.60 Greater than $428,000 $428.60

*MAGI (modified adjusted gross income) = AGI + tax exempt interest

 

The maximum QCD amount is $100k per individual (or $200k per couple as long as $100k is given from each taxpayer’s IRA). So, in a year where one spouse gifts the maximum QCD, AGI will be reduced by $100k and the bracket which determines Medicare Part B premiums will also be lowered by $100k. For example, Billy and Betty’s 2015 AGI was $245,000 which translates to 2017 Part B premiums of $6,429.60/year. This year, Billy and Betty gifted $100k through a QCD to their alma mater to establish a named scholarship fund. The QCD lowered their AGI to $145k (assuming all other items remain constant), which reduced their bracket for determining Medicare Part B premiums. The new lower premium of $3,213/year (premium reduction of 50%) will take effect in 2019. Remember the premium change does not happen until the year after the tax return effecting the change is filed.

One further point to make – a QCD must be given to a public charity. A private foundation or donor advised fund does not qualify.
Parsec’s client service team processes QCDs on a regular basis for our clients. Here’s an outline of the simple steps to follow:

  1. Call your Financial Advisor
  2. Complete an IRA distribution form from your custodian – ensure that the gift is coded as a QCD.
  3. No tax withholding selected – the distribution is non-taxable.
  4. Check must be payable to the charity, not to the IRA owner. The check may be mailed directly to the charity or to the individual to hand to the charity.
  5. Make sure that your accountant is aware of the QCD.

Please contact your advisor with any questions.

Thank you,

Betsy Cunagin, CFP®
Senior Financial Advisor

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Update on I Bonds and Other Interest Rates

With interest rates remaining at very low levels, there are few options for earning any sort of a return on cash balances.

Current yields:

Charles Schwab Bank High Yield Savings 0.35%
Bank Money Market 1.30% (same as in my 2011 article)
3 Month U.S. Treasury Bill 1.12%
6 Month U.S. Treasury Bill 1.14%
1 Year CD, National Average 1.42%
5 Year Treasury Note 1.85% (same as in my 2011 article)
10 Year Treasury Note 2.26%
5 Year Treasury Inflation Protected Securities 0.02% (plus inflation)
10 Year Treasury Inflation Protected Securities 0.45% (plus inflation)
Series I Savings Bonds 1.96% (for the next 6 months, then 0% plus the inflation adjustment)

One thing to consider for smaller balances is Series I Savings Bonds (“I Bonds”) issued by the U.S. Government.  The new rates came out May 1, and I Bonds are currently earning an annual rate of 1.96% for the next 6 months.  You can visit www.treasurydirect.gov for a more detailed description of I Bond features.

The earnings rate for I Bonds is a combination of a fixed rate, which applies for the life of the bond, and an inflation rate that changes semi-annually (think “I” as in “inflation”). The 1.96% earnings rate for I Bonds purchased through October 31, 2017 will apply for their first six months after issuance. I Bonds cannot be redeemed for 12 months after issuance, and there is a penalty of 3 months’ interest if they are redeemed before 5 years.  Purchases are limited to $10,000 per Social Security Number annually, so a couple could purchase up to $20,000 per year.

What if there is an emergency and you need the money?  Since you cannot redeem the bonds for 12 months, you need to leave some liquid cash on hand.  After 12 months, a penalty of 3 months’ interest is deducted from the redemption value.  But even after paying the penalty you would still be ahead of a bank CD, and considerably ahead if the change in inflation continues at its current level. In addition, I Bond interest is exempt from state income taxes and is tax-deferred until you redeem the bond.  Also, if you buy the bonds on the last day of the month, you still get interest for the full month (I like to call this the “Mendelsohn Option”, in memory of the man who first pointed this anomaly out to me many years ago).

All I Bonds have the same inflation component.  The only difference is in the fixed rate that each bond offers.  If the fixed rate increases significantly in the future, just redeem some bonds and pay the penalty.  Then buy some new bonds with the higher fixed rate (but remember the $10,000 annual limit on purchases for each Social Security Number).  After 5 years, there is no penalty on redemption.

Another possibility for liquidity needs is a short-term, high quality bond fund.  However, you should be aware that these do carry some interest rate risk.  For example, a popular short-term bond fund has a current yield of 1.96% and an effective duration of 2.60 years.  This means that if interest rates were to suddenly move up by 1%, the value of the fund would be expected to fall by about 2.6%.  This would wipe out over a year’s worth of interest, making it a less attractive alternative for cash balances. I Bonds cannot go down in value (unless the Government fails, in which case we all will have much bigger problems to contend with).  The worst that can realistically happen is if the inflation adjustment was to be negative for a period of time.  In that case, there would be no interest paid on the I Bonds until the inflation adjustment turned positive.  However, we believe that the probability of negative inflation over the next several years is minimal.

An examination of interest rates reveals current market expectations about inflation. We look at this by calculating break-even inflation rates over the next 5-10 years using current yields on Treasury securities.  The break-even inflation rate is simply the difference between the yield on a Treasury Note of a particular maturity and the corresponding TIPS, or Treasury Inflation Protected Security.

For example, using the yields listed previously, the current 5 year break-even inflation rate is 1.83%. This is the difference between the 1.85% yield on 5 the 5-year U.S. Treasury Note and the -0.02% yield on 5 year TIPS). If you believe inflation is going to be lower than the break-even value for a particular investment horizon, you are better off in a Treasury Note. If you believe inflation is going to be higher than the calculated break-even rate, then you should purchase TIPS or I Bonds.

 

Bill Hansen, CFA

 

 

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Value Stocks May be Poised to Outperform

Since Parsec’s founding in 1980, we’ve touted the benefits of long-only equity investing.  This includes owning individual stocks, mutual funds, and exchange traded funds (ETFs).  We’ve also maintained the same investment style over the last thirty-seven years.  Regarding funds, Parsec’s investment policy committee (IPC) focuses on low fees, higher-quality holdings, and managers with long track records of outperformance.  When researching individual stocks, we take a value approach, favoring higher-quality companies that trade at a discount to history or peers.

While history shows that value stocks have outperformed growth stocks over most market periods, in recent years growth stocks have delivered higher returns.  In this email we’ll discuss what we mean by value versus growth investing and why we believe value stocks are poised to outperform going forward.

Different stock investors define “value investing” differently.  However, most agree on a few basic principles.  In general, value investors prefer stocks that trade at discounts to their intrinsic values.  Often this happens when a stock’s valuation falls below its long-term historical average or that of its peers.  Another tenet of value investing is margin of safety.  This means selecting stocks that can deliver healthy total returns even if current growth assumptions fall short of expectations.  While we consider ourselves value investors, we will add select growth stocks to the Parsec buy list when expectations look reasonable and a company has a competitive advantage.  In other words, when we think a stock has a reasonable margin of safety.

In addition to a value-based stock selection approach, Parsec’s investment philosophy also has a quality bias.  This means we prefer companies with strong cash flows, consistent earnings growth, a long history of dividends, and above average returns on invested capital.  We also favor companies with strong balance sheets that can withstand different market environments and even gain market share during difficult economic periods.

Looking back over the market’s history, value stocks have outperformed growth stocks by an average of 4.4% annually from 1926 to 2016 (Bank of America/Merrill Lynch).  More recently from 1990 to 2015, value stocks outperformed growth stocks by just 0.43% annually.  The spread has since reversed and in the last ten years value stocks have lagged growth stocks by 3% annually through the second quarter of 2017*.

The shift in leadership from value to growth stocks coincided with the start and continuation of the Federal Reserve’s massive monetary accommodation programs known collectively as quantitative easing (QE I, II, and III).  Those programs put additional downward pressure on interest rates.  In the face of low or no yields and the slowest economic expansion after a deep recession in over 120 years, investors demonstrated a preference for growth stocks over value stocks.  They were willing to pay up for companies delivering higher growth in a world where growth had become scarce.  Throughout the last ten years value stocks have occasionally outperformed, but usually in tandem with a steepening Treasury yield curve and thus improving growth expectations.

Because asset prices and interest rates are inversely correlated, very low interest rates over the last decade have led to above-average asset valuation levels.  This has been even more pronounced among growth stocks as investors have been willing to pay a premium to own them in a slow growth environment.  As a result, typically higher-priced growth stocks are even more expensive today.

Sticking to our value- and quality-biased investment approach has admittedly been a headwind in recent years.  However, we believe higher-quality stocks trading at a discount are poised to outperform.  Growth stocks currently trading at premium valuation levels will have further to fall in the event of a market downturn.  As well, low interest rates have prompted corporations to take out record debt levels.  As rates begin to rise, higher-quality companies or those with strong balance sheets and robust cash flows will be better able to service their debt levels, even during an economic downturn.  While maintaining our investment approach through the current environment has been challenging, we feel confident that investing in higher-quality companies trading at discounted valuations will reward clients over the long-term.

*References the Russell 3000 Growth Index and the Russell 3000 Value Index

The Parsec Team

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Medicare: The Basics

Medicare is a complex topic but also an important tool for financial planning during your retirement. You will no doubt be inundated with flyers, pamphlets, and marketing materials from multiple companies and organizations—as you approach your 65th birthday. It can become very overwhelming, so here are five quick things that will help you get a basic understanding of Medicare and what you need to do now to prepare for the big 6-5!

1.) Medicare is health insurance for people 65 or older and people under 65 with certain disabilities. Original Medicare (Parts A & B) pays for about 80% of your health care costs. There are (4) main ‘Parts’ you will hear when talking about Medicare.

Part A– Hospital Coverage- part of Original Medicare
Free to most people

Part B– Doctor Coverage- part of Original Medicare
Has a monthly premium (based on income*) and a yearly deductible (the 2017 deductible amount is $183

Part C– Medicare Advantage- offered by private insurance companies
Takes the place of Original Medicare and usually combines Rx coverage

Part D– Rx Drug Coverage- offered by private insurance companies
Separate monthly premium

Original Medicare pays approximately 80% of qualified expenses, which leaves a gap of 20% that would be out-of-pocket for you.

There is currently no cap on the amount that the 20% could reach.

2.) It is important to know what qualified expenses are. Your ‘Medicare & You’ guide will have detailed information on this but here are a few examples of things Medicare does not cover: long-term care, eye exams for glasses, most dental care, dentures, hearing aids or exams, prescription glasses or exams, cosmetic surgery, routine foot care and acupuncture.

3.) You have options! You can choose Original Medicare (Parts A & B) or you can choose a Medicare Advantage Plan instead.You can also choose to add Supplemental coverage (for an additional monthly premium) to Original Medicare that would cover the approximate 20% gap in out-of-pocket expenses.

4.) There are penalties and fees for failing to enroll into Parts A, B, and D within a specified time frame. There is a 7-month window around your 65th birthday in which you can sign-up for Medicare and have guaranteed approval for any Rx drug, Advantage, or Supplement Plan you choose. You need to enroll in Medicare during this 7-month window to avoid late enrollment penalties/fees.

The 7 months covers 3 months prior to, the month of, and 3 months after your 65th birthday month.

You can enroll in Medicare online (www.medicare.gov) or at your local Social Security office.

5.) Use your resources! Medicare’s website (www.medicare.gov) is a wonderful tool to research, compare and shop for plans, companies, etc.If you are currently employed or covered by an employer health plan, talk to someone in your HR or benefits department as soon as you turn 64; the timing for signing up and your coverages may vary from the normal Medicare process.

As the time approaches, make sure that you complete the necessary steps to take advantage of the Medicare benefits which you have earned. For more detailed information, click here for our upcoming Parsec Newsletter  for an article called “Medicare: What you need to know before you turn 65.”

 

Lori King, RP®, Client Service Specialist

 

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