Financial Planning Perspectives

A Family Mission Statement Can Keep Family Goals First

2007-11-25T20:53:00.000-05:00

When rich families squabble over the family legacy, it becomes headline news. Witness the recent battle over the ownership of the Wall Street Journal between members of the Bancroft family. When approached by media titan Rupert Murdoch, various family members fought over whether to preserve the family legacy at the legendary daily business paper or take the money and run. Money eventually won.

For most average Americans, such stories are an illustration not only of how money doesn’t buy happiness, but how it breeds dissention and distance between people who could be enjoying their wealth and moving in concert. With all that money, how can people be so unhappy and contentious?

Families with substantial assets – or the promise of substantial assets as a business grows – might consider creating a family mission statement. While the end product should produce a document built from discussion, argument and consensus, it’s not so much about the piece of paper as the process. When a family sits down to discuss what is really important to them, it’s an opportunity to take the machine apart and see how it works. Many families start the process as a way to build consensus about long-term financial, business, estate and philanthropic goals, but to their surprise, money can take a back seat. Families discover particular strengths, weaknesses and unexpected courses of action within their ranks. The process might identify future leaders of the family.

Trained financial advisors, such as Certified Financial Planner ™ professionals, can explain and guide the process. Some planners may be trained to facilitate such discussion based on the size and goals of the family involved.

The general creation of a family financial mission statement should have four key touchpoints: estate issues, philanthropy, business direction and family dynamics.

Here are some questions that should be asked of everyone in preparing the family’s financial mission statement. They should focus on relationship issues first, and then move into business and money matters.

• What’s most important about our family?

• What do you think our goals should be?

• When do you feel most connected to the rest of us?

• How should we relate to one another?

• What are our strengths as a family?

• Where do you think we’ll be as individuals in 5, 10 and 15 years?

• In order, what are the five things you value most in life?

• How should we behave toward each other?

• How should we resolve our disputes?

• How important is the family business to you?

• What should we be doing differently with our family money as well as our assets inside the business?

• What’s the best way for us to be building our wealth?

• What do you think the role of our family should be in helping the community?

• What should we be doing individually and as a family with regard to philanthropy?

Structurally, the written mission statement can be whatever you agree it should be – a few paragraphs or a page or two. And it needn’t be set in stone – a family should have a meeting every year or two to revise or approve its mission. The family mission statement helps your family establish its identity and the variety of voices within. It can help set goals and diffuse tensions later. It can also be used to moderate discussions that inevitably happen after major changes within the family – death, divorce or happily, an increase in the number of heirs and participants.

As for the age of the participants, it can start in very basic form with younger children and the process can mature as they age. It’s actually a good idea to bring young members into a customized version of the process for youngsters so they can comfortably adjust to working as adults with the older members of the family.

For a handy resource on writing a family mission statement, go to this site: http://www.nightingale.com/mission_select.aspx?from=homepage&element=missiontitle

November 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

Will Your Kid’s Inheritance Make Her a Monster? Not If You Plan Carefully

2007-11-25T20:49:00.000-05:00

The airwaves are full of cautionary tales of young people with too much money too soon – wretched excess is in, and responsibility seems, well, pretty boring. And your last name doesn’t have to be “Hilton” for you to worry.

Inheritances, trust funds and other benefits from hard-earned family fortunes of any size can affect the children of wealthy individuals in incredibly positive and negative ways.

Most financial experts, such as Certified Financial Planner™ professionals, will tell you the best scenarios involve early planning, solid parenting and complete family involvement from the start. Here are some suggestions on how to raise a responsible heir:

Get advice early: If you have created a successful business or amassed a fortune working for a fast-growing employer, it makes sense to sit down with tax, legal and financial advisors to talk not only about the No. 1 goal of protecting those assets, but passing them intelligently to the next generation. Because these conversations should go beyond sensible money and tax management to how these assets will affect your family’s entire life, one of the first questions you should ask is, “How do I train my kids to inherit this money?” Also, it’s critical that you include the unthinkable in your discussion – how your surviving spouse or designated guardians will continue this stewardship if you die. You need to make sure your plan is effective particularly if you’re not there to carry it out.

Start basic money training early: In most households, kids start learning about money and what it does around age 4 or 5, even if it’s only centered on how to buy a popsicle. Obviously, your kid might have some idea already that his parents have money, so you have to strike a balance between the reality of your fortunate situation and the responsibility training all kids need no matter what their circumstances. You don’t need to lie about what you have, but when kids are this young, you’re not anywhere near discussing what they may inherit when they’re older. It’s not their money anyway. Your job should be to introduce your kids to chores and a modest allowance to cover essentials, treats and savings that you’ll agree upon. Then watch closely to see how your kid is learning these skills. This is the bedrock of how they’ll be handling money the rest of their lives.

Lead by example: If a kid grows up in a house where parents spend indiscriminately and settle disputes with the kids with money and toys, chances are the kids will repeat those patterns as teens and adults. If a kid grows up in a house where parents set money priorities for themselves, participate in charity and community service and expect children to do the same, that’s a powerful lesson about wise choices in time and money for a lifetime.

Do a family mission statement each year: This may get an eye roll from some family members. But a once-a-year meeting to discuss what’s important in family life is a great mechanism not only to find out how the entire family is doing with regard to personal values and goals, but a great way to work in a purposeful wealth message that expands over time. When children are young, they should be allowed a vote in how family money is spent for particular luxuries like vacations, and as they get older, parents can elect to expand their vote in other areas, such as general investment policies for the family holdings.

Involve the kids in investment and planning: If a child is inheriting wealth at a certain age, it is entirely fair to bring them into the process of the care and feeding of that wealth at a significantly earlier age, possibly in their early teens. Before that, it might be fun for them to buy a particular stock or mutual fund that they can own jointly with you so they can see how investments perform. Eventually, you can migrate their attention to their potential inheritance, how that money is currently invested and what efforts are taken to protect its principal are essential if they are going to take over responsible management of those funds someday. Kids need to understand that wealth needs to be tended to in order to grow – you might even consider bringing them to meetings with your money managers so they can learn about the process over time.

Raise the suggestion that wealth should stay invested. Wealthy relatives need to tread carefully here, because if a young person gets money, they’re going to understandably want to have some fun with it. But it’s important to teach the message that a significant part of the inheritance should stay responsibly invested so the child can address a personal goal (advanced education, starting a business or their own philanthropy) or have wealth to pass on to their families.

Get them some independent training: The wealth management industry – including financial planners – are directing training resources toward younger clients who may come into considerable fortunes at a later date. It’s to their benefit – they want to keep that business. But if you are already working with investment experts whom you trust, why not ask them about training your kids can receive when you’re not around? As adults, they are going to eventually handle decisions on their own – it might be wise to continue their learning in an adult environment where they can take the lead in a discussion.

Afraid of the AMT? Now’s the Time to Get Some Help

2007-11-25T20:44:00.000-05:00

Unless Congress acts, the number of taxpayers hit by the Alternative Minimum Tax (AMT) in 2007 will jump to about 23 million from about 4 million in 2006. The AMT is an alternative, separate tax calculation created in 1969 to make sure the wealthiest Americans paid a fair amount of taxes. The AMT is applied to particular taxpayers’ regular taxable income when particular activities and deductions add up.

Basically, Uncle Sam wanted to keep taxpayers from writing off their tax responsibilities forever.

But why is the AMT spreading lower and lower on the tax rolls to the middle class? There are two reasons. First, since its introduction in 1969, elements of the AMT have not been adjusted for inflation while the regular income tax has. According to the Tax Policy Center of the Urban Institute, this means that if an individual’s income tax just keeps up with the annual rate of inflation, his or her income tax would remain constant in real terms while the potential AMT liability would continue to increase. Second, it’s also important to note that since its inception, the government has dropped the top tax rate from 70 percent at the start to 35 percent in this decade while the AMT rate has risen by several percentage points. The intersection of AMT and regular tax over the past 40 years is as much as story of changing tax brackets as it is the adjustment of the exemption amount.

The approaching election year might finally force some permanent change on the AMT situation, but until then, it makes sense to consult a qualified tax advisor or a Certified Financial Planner™ professional on your risk factors for the AMT. It’s too complicated to fully explain here, so advice is essential. There are many reasons people get pushed into the AMT zone. Here are some key facts and situations related to the AMT:

Who should check for the AMT? If your income is above $75,000 and you write off personal exemptions, state income taxes, property taxes and home equity loan interest, it’s best to see if you’re at risk. And if you’re simply earning over $100,000, you definitely should check for AMT eligibility no matter what your deduction status. Form 6251 requires you to add back some deductions and income exclusions to your regular taxable income in the process of computing AMT. Among them: Your personal- and dependent exemptions, or your standard deduction if you don’t itemize. You will also lose your state local and foreign income and property tax write-offs and potentially your home equity loan interest if you don’t use your home equity line for home improvements. Once computed, if the AMT is higher than your regular tax liability you pay the additional amount (in addition to regular taxes). The hit could be surprising.

Watch those stock options: If you’re thinking of exercising incentive stock options, keep an eye on the spread between the market value at the time of exercise and the exercise price. Although not immediately subject to regular tax, the spread is subject to AMT. Based on advice particular to your situation, you might want to keep those options still and not exercise them until early 2008 to gain some tax flexibility.

If you own a business, get advice: If you own a business, rental properties or hold an interest in a partnership or an S corporation, certain business depreciation deductions might be a critical trigger for the AMT lens.

Tax-free bonds can be a trigger: The AMT counts as income interest earned from municipal bonds designated as private activity bonds, so there goes that tax edge. Many tax-exempt money market funds and high-yield tax-exempt municipal bond funds may hold relatively large percentages of these bonds.

Know your AMT exemptions: For 2007, if Congress does not extend the act increasing the exemption (the so-called AMT “patch” legislation), the AMT exemption will be decreased to $33,750 for an individual, $45,000 if married filing jointly or if that person is a qualifying widow or widower and $22,500 if married filing separately. These exemptions were higher in 2006 after Congress came to the rescue. As of this year, the exemption for Hurricane Katrina victims is scheduled to expire as well as the additional exemption for taxpayers who provide housing for a person displaced by Hurricane Katrina.

More bad news: The following credits won’t be allowed against the AMT unless Congress rides to the rescue: Child and dependent care expenses, credit for the elderly or the disabled, education credits, residential energy credits and the mortgage interest credit. Also, if you live in the District of Columbia, its first-time homebuyer credit will no longer be allowed against the AMT.

The key is to work with your advisors to determine if you are a likely target and include the AMT as part of the planning process. Often, it is more something to be aware of than to be avoided. Because the AMT is so complicated (and may complicate financial decisions), the IRS provides an AMT Assistant for Individuals—an electronic version of the AMT worksheet in the 1040 instructions—go to: http://www.irs.gov/businesses/small/article/0,,id=150703,00.html

Think The Subprime Debacle Is All About Housing?

2007-10-31T19:05:00.000-04:00

If you’re planning to go into business for yourself in the next year, you need to understand that the subprime lending debacle might have a significant impact on your ability to borrow not only for your business, but for your personal needs as well.

Self-employed people with excellent credit find out very quickly when applying for a mortgage or any other loan that lenders find it hard to “verify their income.” Even if you show years of tax returns, invoices and copies of cancelled checks, individuals working for companies that track their income on a weekly basis for the IRS get a slightly better review from lenders who like to be able to see assets and liabilities that they can verify.

This doesn’t mean you won’t get a loan, but it may be a more arduous process and you very well might pay more than a person with a conventional job. You may be shifted into the “low-doc” or “no-doc” pile, which refer to low- or no-documentation loans that often cost the borrower more but allow approval based on less proof of income.

No one should pass up a chance at entrepreneurship simply because it might be tougher to get financing in a range of areas. But it does call for extra financial preparation before you take the plunge. It makes good sense to talk with a financial planner as well as a tax adviser as you plan your business. Your personal finances must be planned around it as well. Some key issues to discuss:

Consider your real estate plans before you leap: If you are happy in your current residence and believe you have the best financing option right now, then be happy to keep that situation in place. But if you want to downsize or refinance your current mortgage, it is considerably smarter to investigate those options before leaving your current employer for all the reasons we stated above. However, with the slow real estate market in most areas of the country, you need to take into consideration the average time on market for homes in your area before you list yours. It’s pretty tough to start a business with two mortgages.

Continue your retirement savings: It’s very easy in the first months of business while you’re waiting to get the rhythm of cash flow in the business going to say, “I’ll deal with retirement later.” This is not just a mistake but a ticket to disaster. With all the other important issues you’re committing to as part of starting a company, make absolutely sure you allot funds for retirement savings each year and don’t miss those contributions.

Get your insurance options in place: Whether you purchase health insurance through COBRA at your old employer or whether you buy coverage on your own, get it in place before you quit your old company, and make sure you analyze your needs closely so your major health issues are covered.

Get disability coverage before you leave your employer: This is a really crucial step because disability coverage you buy is based on a percentage of current income. In the first few years of a business, you conceivably will not match your current salary, so you wouldn’t be able to buy as much coverage as an independent. Get that coverage in place now. You should be able to specify the level of benefits you receive, up to 60 percent or 80 percent of your income from work. (Insurers won't cover 100 percent of income, because they want you to be motivated to return to work after a disability.) Generally, the higher your benefit level, the greater your premiums.

Extinguish as much debt as possible: Whether you’re starting a business or working for a traditional employer, in this new lending environment, there’s a very common piece of advice that all potential borrowers should share – pay off as much revolving debt as possible. Higher-rate revolving debt at more than 30 percent of a credit limit on an account will damage a credit score, and borrowers with lower credit scores generally get less attractive loan rates.

October 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

What You Can Do Before the Kiddie Tax Loophole Closes

2007-10-31T19:02:00.000-04:00

When President Bush signed new legislation in May to limit gifts to children that take advantage of their lower tax rate, it was the second time in just over 12 months that Congress extended the reach of the so-called kiddie tax, which subjects a child’s income to his/her parents’ higher tax rate.

Maneuvering around the kiddie tax has helped parents save for college educations for years, and given the changes, it’s a good idea to consult a financial or tax adviser to discuss your options.

Congress apparently got fed up with a particular tax strategy used by wealthy families who transfer large piles of stock, mutual fund shares and other assets to their kids (who are typically in the lowest two income brackets of 10 percent and 15 percent) so they could sell those securities at a low capital gains rate. The top rate on long-term capital gains and qualified corporate dividends is 15 percent, but since 2003, those in the lowest two income brackets had a shot at a 5 percent capital gains, which is scheduled to drop to zero for those low-income taxpayers in 2008.

So here’s what’s happening this year and next. During 2007, investment income for a child 17 years old or younger (measured as of Dec. 31, 2007) above $1,700 is subject to his parents’ higher tax rate. (Before 2006’s changes in the law, the kiddie tax applied only to kids younger than 14.)

Starting in 2008, the age limit for the kiddie tax will rise to 18 and under, or 23 and under if the child is a full-time student. There are some exceptions for kids with paid jobs – the expanded provision applies only to children whose earned income does not exceed one-half of the amount of their support needs.

What you can do now

If you had put appreciated securities in your child’s name and the child is a full-time student under the age of 23 but at least 18, your child can sell those securities this year and still claim the 5 percent capital gains rate. There won’t be a zero capital gains rate available to your student next year, so you need to act before the end of the year to take advantage of the 5 percent rate before it becomes the parents’ 15 percent rate in 2008 via the kiddie tax.

You may also want to start or redouble your efforts in the 529 college savings plans you’ve set up for your kids. Qualified withdrawals for education are tax-free and therefore wouldn’t be subject to the kiddie tax. The same is true for qualified withdrawals from Coverdell education savings accounts.

Outside of 529 plans, you might consider investments that generate little or no taxable income such as municipal bonds.

Watch out for financial aid

Whatever gift and tax strategies you apply to your college savings strategy, make sure those assets don’t undermine any efforts your child is making to secure financial aid.

Couplepreneurs: Starting a Business with Your Better Half Can Reap Huge Rewards – And Unique Problems

2007-10-31T19:01:00.000-04:00

It’s a familiar scene: A couple comes home after a long day at their respective workplaces. They spend their takeout dinner recapping the day and how much they hate their jobs. In a brainstorm, they decide to start a business where they’ll be able to determine every step of their future from now on.

After all, they love each other – why shouldn’t they be able to work and live together?

For many couples, this major decision is the ticket to wealth, self-determination and happiness. For others, it can lead to severe financial and relationship stress. Such a move takes more than planning – it requires a full assessment of your personalities and your money issues to determine whether working and living side-by-side is right for you. A good start is a visited to a trusted financial adviser.

Here are some key steps to consider:

Give yourselves a timetable to startup: You might be tempted to give notice tomorrow morning, but it’s much wiser to lay out a timetable over the coming months with specific components:

Study the viability of your business model: Talk about worst-case scenarios. Bring in some trusted advisers to ask tough questions of what you’re planning to do and the viability of your idea. Convincing each other you’ll make it work isn’t enough. You need to understand the marketplace you’re walking into and the roles each of you will fill in its success. Most of all be realistic about your workload and when you can get breaks.

Understand how your tax situation will change: Depending which business structure you choose – and you should get tax and legal advice on this before you start -- you will need to plan for income tax and self-employment tax and payroll taxes, if applicable. Payroll tax requirements are more stringent than income taxes.

Set a budget for your business and personal life: A planner can help you establish a budget for supporting your business as well as your life at home that will make cash flow more predictable. Conserving cash is critical in the startup phase of any business so critical long-term goals can be met. Couples need an emergency fund of six months to a year of expenses since successful businesses take months or years to turn a real profit. And if the two of you haven’t revised your estate plan to accommodate the business, it’s time to make that plan now.

Plan for your kids in the business. There may be very cost-effective ways to employ children in the business for work commensurate with their skills.

Get your insurance in order: Before you leave your current employer, figure out the cost of insurance you’ll need to take on for the entire family if you take on health, life, home, business, disability and if you’re over 50, long-term care coverage. These expenses may be enough to encourage one of you to stay at your old job at least for a while to keep those benefits going while the other devotes more time to the startup.

Set targets: Talk through critical milestones of the business – both good and bad. Do a proper business plan with income and cash projections. Decide what factors would lead to expansion or closing your doors. If you’re doing so well that potential buyers of the business start sniffing around, figure out a point in advance at which you’d sell.

Talk about an exit plan if you break up: It may be hard to imagine now, but a breakup of your relationship with no financial plan for the business can be devastating. Whether you’re married or living together, a successful business is an important source of wealth, and you need to plan for the day one side of the relationship wants out and potentially wants to buy the business or be bought out. If one spouse put more capital into the business than the other, provisions should be made to safeguard that investment.

Write it down: Documents and legal covenants are important – make sure you have the right ones in place.

Thinking About Borrowing from Family or Friends? Do It The Right Way.

2007-10-31T19:00:00.000-04:00

Whether it’s for a business, a home or a new car, there’s something very attractive about the idea of asking friends or family for a loan. Nobody’s worried about a credit check or the other lengthy documentation and you can still hang out with your lenders at the holidays.

In 2005, the National Association of Realtors reported that about 9 percent of first-time homebuyers made their purchase with help from a friend or relative, up from 5 percent in 1999. About 25 percent of new homebuyers get money from a relative or friend, a portion that’s remained fairly constant over the past decade.

Yet there are good and bad aspects to private loans. The good news first:

Terms can be significantly friendlier than a borrower would qualify for in the open market. For example, the rate charged on the loan can be higher than the lender would receive in a deposit account but lower than the borrower would pay a commercial lender.
They can require little or no collateral.
It’s a way to keep money in the family.
It’s a way for a borrower to be able to buy a home, a car or other critical assets even if they have a poor credit rating.
There’s no loss of tax benefits to the borrower or lender if an agreement in the case of a mortgage loan is structured and reported properly.

Then the bad news:

Unclear agreements can lead to missed payments or default.
If the borrower dies suddenly, the lender’s investment may be lost if the agreement isn’t structured correctly. A properly executed promissory note is still an obligation of the estate, and may continue to be paid to an heir or other person or entity based on the terms as agreed.
Jealous relatives could say they weren’t treated fairly.
Disagreements between borrower and lender could kill an important relationship.

The best arrangements are formal – written in proper legal language, notarized and recorded in the county where the property resides. A financial adviser can talk to both parties about what such loans – particularly real estate loans – can mean for their respective finances. It also makes sense for both parties to visit their respective tax professionals to make sure they know the correct ways to document the loan transaction over time for tax purposes.

A detailed document – prepared with the help of an attorney – can also lay out specific scenarios if either the borrower or the lender has to break or alter their agreement. Such trained experts can talk you through the benefits and pitfalls of a private loan arrangement as it affects your particular situation (either as lender or borrower) and specific laws and requirements in your state you have to follow if both borrower and lender are going to derive tax advantages from the agreement.

Generally, any private loan transaction should include a promissory note that establishes how the debt will be repaid. That’s true for business loans or loans for most types of property. In the case of a business loan, it makes sense for the potential borrower to get specific advice on how lenders in their business will be treated not only in terms of repayment, but default.

In the case of a loan made for real estate, a mortgage or “deed of trust” statement (depending on the state you live in) or an agreement specific to the type of loan that binds the property as collateral for the promissory note will be necessary. It basically says that if you don’t fulfill all the terms in the agreement the lender has the right to foreclose or repossess the property.

Even if a friend or relative makes an offer of help, it’s proper for the borrower to take the initiative to structure the arrangement in a way that’s responsible and beneficial to both. If a relative is drawing income from the loan, special provisions should be made for prepayment and other contingencies.

The most important thing to remember and plan for? When two people who are close to each other enter into such an arrangement, the most valuable thing really isn’t the money. It’s the relationship.

Making Your Employer a Partner In Your Financial Planning

2007-05-10T14:59:00.000-04:00

People who look to their employers for nothing more than a weekly paycheck and basic health care insurance are missing the boat.
It makes the most sense to ask a future employer about benefits before you agree to come to work. But even if you have been working for the same company for years, it’s never too late to go to human resources to make sure you’re getting the most mileage out of your current benefits and maybe pick up a new perk or two. See if you have the following options available, and check with your tax professional or a financial adviser before you make a selection:
Look at health savings accounts: If your employer has converted to a high-deductible healthcare plan, you may have the option of starting a health savings account (HSA). These accounts help workers to save and spend money tax-free for medical expenses not covered by the plan or your deductible. Why are they a good idea? Because you can sock away money tax-free that will cover the amount of the deductible (at least $1,050 for individuals, $2,100 for families) if you need it, and it will grow tax-free over time if you don’t.
See if a Roth 401(k) works for you: In 2006, the government gave employers clearance to offer Roth 401(k)s, employer-sponsored retirement plans that allow workers to put all or part of their 401(k)s into a Roth, which allow after-tax money to grow tax-free. Roth 401(k)s allow higher contribution limits -- $15,500 in 2007 plus an additional $5,000 if you’re over 50 – compared to traditional Roth IRAs that limit annual contributions to $4,000 with an extra $1,000 for those over 50.
Look for a finders’ fee: Companies rarely like to give away money unless they know they’re saving some in the process. Many companies are now offering finders’ fees to employees who successfully bring new workers in the door. Why? Because it costs considerable money and time to hire people, and employers are happy to see their best employees bring friends and former co-workers in the door. Also, some companies give away special bonuses for bringing in new clients, so don’t miss a chance to earn them. However, keep in mind that substantial bonuses may change your tax liability, so keep an eye on that issue.
Check your target bonus amounts: This is usually not a problem for most people who receive annual bonuses, but it makes sense to doublecheck the minimum bonus you should earn annually and what it will take to exceed that limit.
Get flexible: If your company has a flexible spending account for medical, commuting or child-care costs, estimate carefully what you’ll need to spend and get on board. While workers can get a chance to spend out their accounts into the next tax year, it’s very important to project exact numbers so you won’t lose funds at the end of the eligibility period.
Get smart: More than three-fourths of U.S. companies offer education benefits, so if you have the time and inclination, finish that degree or complete a particular course of study to prepare you for your next job or for your enjoyment. Most companies will ask you to stay a certain length of time after receiving such benefits, which is only fair. But education is worth far more than the dollar cost of tuition, so don’t pass it up.
Get fit: Some companies negotiate membership discounts to gyms and other fitness facilities, and that’s a worthwhile benefit. But these days, with company health care premiums going through the roof, some employers are actually paying employees to lose weight, quit smoking or take other steps to improve their health and lower their boss’s costs.
Have some fun: Companies get discounts to a variety of entertainments – the local amusement park, sports events, theaters, restaurants, auto shows and other local events. If they interest you – and particularly if they interest your kids – you’d be foolish to pass up such discounts.
Be proactive: If you hear friends or clients boasting about particular benefits or incentives at their companies, quiz them to find out as much as you can about how their companies afford those benefits. If the story checks out, then go to your own company and ask them if they might consider it.

May 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA

Getting the Kids Involved in Saving for College

2007-05-10T14:56:00.001-04:00

The World War II generation got a taste of higher education through the G.I. Bill and made it a point to supplement or pay their kids’ tuition. It was a struggle, but a far more manageable one than it is in this day and age. Figures from the University of Texas in 2005 showed that since the 1960s, the price of a public higher education has risen from about five percent of median family income to more than 17 percent today.

Based on the current pace, that number could rise to 30 percent of median family income by 2020. Private universities could approach 50 percent.
Scary numbers indeed. That’s why it makes sense for families to make college affordability a family effort - with both parents and kids pitching in. That’s a big change in 40 years, where parents considered it a badge of honor to put their kids through school with no debt.
But there’s a bright side to involving your child in the process of saving for college. They’ll get an early education in money decisions that will have a direct impact on their future. Here are ways to make sure you’re well informed about the college savings process and how to involve your child:
Get advice as early as possible. Even if your child has only a short time until high school graduation, get advice tailored to your own situation from a trained expert such as a financial planner. Parents often forget that their first financial goal is retirement planning, not college saving, so they need to start with the following points:
What parents will need to support their retirement;
What they can contribute to their child’s college fund based on time to retirement and to freshman year;
The best savings strategies for parent and child based on the tax situation for both;
A primer on college financial aid in all its forms. Depending on the child’s need for financial aid, parents need to know what kind of assets they should hold in their child’s name and in what types of accounts for the best chance of securing financial aid if it’s needed.
Involve your child in the discussion. Armed with knowledge from the financial planning process or your own research, start talking with your child about their financial contribution through money from part-time jobs, savings or, as a last resort, debt after college. Parents might decide to schedule two advisory meetings with a planner – one for themselves, and a second one with the child.
Lack of money isn’t the only reason kids may be asked to contribute or shoulder debt. Blended families with ex-spouses who either don’t want to make a contribution or haven’t agreed to pay tuition as part of a divorce settlement can be a sticking point. Whatever the reason may be it needs to be presented honestly to the child.
Tackle the FAFSA first. The dreaded Free Application for Federal Student Aid (FAFSA) is a necessity for all parents who believe there will be some shortfall in paying for college after savings, grants and scholarships. It’s a good idea to fill it out even if your needs aren’t immediate; family finances can change for the worse. Your child won’t qualify for federal student loans until you fill out this form. To speed the process, get your taxes done as early as possible in the year your child will need the funds. Colleges typically dole out money on a first-come, first-served basis, so you’ll need your income documentation in order.
Once the FAFSA is processed, the Department of Education determines financial need and the parent’s EFC, or the expected financial contribution. If parents can’t cover the EFC, the student has to come up with a way to close the gap. There’s a way to rough out what your EFC might be – go to http://finaid.org/calculators/quickefc.phtml.
Start looking for free money. On the community level, you might find corporations, associations and other groups that offer scholarships and grants for local students, particularly those going off to state or local schools. Students can generally find out about local opportunities through their high school guidance counselor. If the student works for a company on a part-time basis, there might be college support there. Also, the College Board (www.collegeboard.com) Web site features a good online clearinghouse for scholarships, grants, internships and loans, as well as www.fastweb.com.

April 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA

Market Volatility Shouldn’t Rattle a Good Financial Plan

2007-05-10T14:55:00.001-04:00

On Feb. 27 this year, the Dow Jones Industrial Average slid 416 points, the biggest drop since the market reopened after the 9/11 attacks. By early May, the market had more than made up those losses and stood at record highs.

How did you react? Did you turn off the news? Did you call your broker in a panic? Or did you call your financial planner to see if your plan was solid?

It’s easy to succumb to the urge to sell if the market takes a header or buy if it’s headed upward. But sudden action is usually a mistake. In the late 1980s, Harvard psychologist Paul Andreassen made news with a research project that found that people who listened to market news actually made lower returns. Why? Because those who sold – or bought – during a market swing probably found a day later that the market was really running on hype, not fundamentals.

You pay a financial planner to devise a financial strategy that matches your risk tolerance and long-term financial goals. No, there is absolutely no way to guarantee that you’ll never lose money. But if a plan truly matches you, the noise level on TV shouldn’t make a difference. So the next time the Dow spikes or slides, ask yourself:

What’s my plan? If you’ve worked with a good financial planner, you should be able to articulate those goals all by yourself or refer to an investment policy statement you made together. Much of the riskiest investing, overbuying and panic selling during the late 1990s and early 2000s could have been avoided if individual investors had sought advice for achieving long-term specific goals such as retirement or a college education.

What’s my risk tolerance? At your first meeting with a planner, you should have discussed – and later filled out – a form asking you a number of questions about how you handle risk and what your expectations were about investment returns. You might have had to do this more than once if your risk tolerance was low but your investment expectations were high – low-risk investors can’t expect the highest returns. That’s part of the education process when you visit a planner.

Am I prepared to stay invested – no matter what? We all remember the “Tech Wreck” of 2000. At the worst of that downturn, investors bailed out of the stock market or drastically cut back, only to get back in after they were “convinced” that the market was rebounding. In reality, they missed out on stock market gains during the early stages of recovery, and that’s costly in the long run. Of course, some investors looking for that late 20th century investment high also got into the real estate market, and they perhaps learned a similar lesson when that market started heading south two years ago.

In 2004, SEI Investments studied 12 bear markets since World War II. Investors who either stayed in the market through its bottom, or were fortunate to enter at the bottom, saw the S&P 500 gain an average of 32.5 percent (not counting dividends) during the first year of recovery. Investors who missed even just the first week of recovery saw their gains that first year slide to 24.3 percent. Those who waited three months before getting back in gained only 14.8 percent.

Am I diversified? The NASDAQ lost 39 percent of its value just in 2001, and another 21 percent in 2002. Meanwhile, real estate investment trusts, which performed poorly in 1998 and 1999 when stocks were booming, had banner years in 2000 and 2001, performed so-so in 2002, and had an excellent 2003. Bonds also returned well during the bear market. Your planner, based on your risk profile, should have you in diversified investments that fit your goals.

Do I still feel the same way I used to about returns? Having a long-term investment plan doesn’t mean make the plan and leave it to gather dust. You and your planner should decide when it’s time for a review of your investment goals and your feelings about them. An annual conversation makes sense if nothing’s going on, but life events like death, divorce, kids moving out and illness are good reasons to do a head-to-toe review of a financial plan.

May 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA

What Are Exchange-traded Funds and How Do They Work?

2007-05-10T14:52:00.000-04:00

What Are Exchange-traded Funds and How Do They Work?

An exchange-traded fund (ETF) is a basket of securities created to track as closely as possible a particular market index, such as the Standard & Poor’s 500 Index or the Dow Jones Industrial Average. They’re similar to mutual funds in that they represent investments in the same types of securities, but they generally have lower fees and can be bought and sold with more pricing immediacy than mutual funds. They also have some clear tax advantages.

Since their launch in the early 1990s on the American Stock Exchange, there are now hundreds of ETFs available for investors to buy. As the market has struggled its way back since 2000, investors have embraced ETFs as a more efficient alternative to a mutual fund invested in the same securities. A financial planner can tell you whether ETFs are right for your portfolio, but here are some details to know beforehand:

How are ETFs created? An ETF is created by large institutional investors who buy stocks aligning with the shares in a particular index, and then they exchange those shares – in baskets as large as 50,000 shares – for shares in the ETF. The redemption process works the same way in reverse -- the institutional investors exchange shares of the ETF for baskets of the underlying stocks.

Are all ETFs based on indexes? Yes. Indexes, like the S&P 500 or the Hang Seng Index (the primary stock index of the Hong Kong Stock Exchange), are a listing of stocks reflecting the activity of a particular investment sector on a stock exchange. One of the first popular ETFs had an unusual nickname – Spiders – a play on its actual name, SPDR, short for Standard and Poor’s Depositary Receipts. Newer ETFs track less well-known indexes, even indexes of bonds, and some ETFs are tracking very dynamic indexes that almost act like actively managed funds.

How are ETFs traded? Unlike mutual funds, which have their prices set at the end of the trading day, ETFs are priced and traded every moment of the trading day. That’s generally more meaningful to institutional investors who buy and sell constantly than long-term investors who buy and hold. Furthermore, unlike mutual funds, ETFs can be bought on margin or sold short.

Why might ETFs be more tax-efficient? Generally, ETFs generate fewer capital gains due to the unique creation and redemption process as well as the usually lower turnover of securities that comprise their underlying portfolios. Financial planners note that investors can better control the timing of the tax treatment of ETFs relative to mutual funds. Most importantly -- by holding an ETF for at least one year and a day, capital gains will be treated as long-term capital gains, which are currently taxed at a federal rate of 15 percent (5 percent for low tax bracket investors).

Are there other advantages? Unlike traditional mutual funds, which must disclose their holdings quarterly, ETF holdings are fully transparent, and investors know what holdings are in the ETF at any given time. Each ETF also has a NAV tracking symbol for even more precise analysis. This helps keep ETFs trading within pennies of their intraday NAV.

What about fees? Shares of index-based ETFs may have even lower annual expenses than similar index mutual funds, which, in turn, tend to be lower than those of actively managed mutual funds. ETFs must, however, be bought and sold through brokers, and those trades do involve transaction costs. ETFs may prove to be more expensive than mutual funds to investors who add money each month to their portfolio.

What’s the downside? Unlike regular mutual funds, ETFs do not necessarily trade at the net asset values of their underlying holdings. Instead, the market price of an ETF is determined by supply and demand for the ETF shares alone. Usually, the ETF value closely mirrors the value of the underlying shares, but there’s always a chance for ETFs to trade at prices above or below the value of their underlying portfolios. Also, since so many new ETFs are hitting the market, investors should be aware of the maturity of the particular ETF they are considering.

April 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC , a local member of FPA

How Bunching Can Preserve Your Right to Itemize

2007-03-15T10:51:00.001-04:00

Tax laws are at times nothing if not infuriating. Indeed, with phaseouts and sunsets coming and going, taxpayers may find it difficult planning from one year to the next.

Case in point: In 2006 and 2007, the overall limitation on itemized deductions that reduces the value of certain itemized deductions claimed by upper-income individuals is scheduled to be phased out.

In effect, higher income individuals will have a small tax rate reduction, according to PricewaterhouseCoopers 2007 Guide to Tax and Financial Planning.

By way of history, the tax law limits the amount of certain itemized deductions that individuals can use to reduce their taxable income. For instance, miscellaneous deductions are limited to those in excess of 2 percent of Adjusted Gross Income or AGI.

But Congress has also placed what’s called an “overall” limitation on the deductibility of itemized deductions, according to The Ernst & Young Tax Guide 2006. For 2007, the total of this group of deductions must be reduced by 2 percent (down from 3 percent) of the amount of your AGI in excess of $156,400 for married couples filing jointly and $78,200 for married filing separately. Itemized deductions will, however, never be reduced by more than 80 percent of the amount by which they exceed a specified group of deductions, including, but not limited to, medical expenses, investment interest, and theft losses.

This reduction in itemized deductions is applied after the taxpayer has used any other limitations that exist such as the AGI limitation for charitable contributions and miscellaneous itemized deductions. The reduction falls to 1 percent in 2008 and 2009 and is phased out in 2010. Medical expenses, casualty and theft losses, investment interest expense, and gambling losses are not subject to this rule, insofar as calculating the 80 percent limitation is concerned, according to the Ernst & Young Tax Guide.

So what happens to taxpayers who for whatever reason (a bonus, a salary increase, or new job) will find themselves losing their ability to use itemized deductions fully in 2008? What kind of planning can they do in 2007?

Among other things, taxpayers may want to consider a technique called “bunching,” otherwise accelerating or deferring itemized deductions where possible. Bunching may work if the taxpayer is able to accumulate deductions so that they are high in one year and low in the next.

According to Deloitte Tax’s Essential Tax and Wealth Planning Guide, taxpayers should explore opportunities to time deductions for charitable contributions, state and local taxes, and other payments within the taxpayer’s control. In some cases, it may be better to take deductions in the current tax year; the caveat emptor of this strategy is Alternative Minimum Tax or AMT.

For instance, if the taxpayer isn’t subject to AMT in 2007, they should consider paying 2008 real estate and property taxes before yearend. Also, the taxpayer might consider paying any remaining state and local estimated income tax payments before the end of the year. State and local taxes are not deductible for AMT purposes, so taxpayers should consider the consequences of AMT before bunching these or other “non-deductible for AMT” itemized deductions in one year.

In another example, taxpayers might also accelerate mortgage payments. According to Deloitte, cash-basis taxpayers can, in most cases, deduct expenses in the year paid. Thus prepayment of mortgages due in 2008 may provide a deduction for interest to 2007.

According to Ernst & Young’s Tax Guide, in certain situations, it’s possible for the 2 percent limitation to reduce allowable itemized deductions below the standard deduction. Thus, it’s worth considering this possibility when choosing whether to itemize or not.

Taxpayers contemplating bunching should read the Instructions for Schedules A & B for Form 1040, which is available on the IRS’ Web site at www.irs.gov. In order to make sure that the strategy of bunching deductions makes sense in your particular situation, it is generally a good idea to consult with a tax professional before proceeding. At the very least it is important that you are comfortable using tax planning software and are capable of identifying all of the ramifications of any tax planning technique.

March 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA

Now Is the Time to Pick Up Low-Cost Life Insurance

2007-03-15T10:51:00.000-04:00

If you need life insurance, now may be the time to buy it. Insurance premiums are expected to drop 4 percent this year, following a 5 percent decline last year, according to the Insurance Information Institute, New York. In fact, premiums are less than half of what they were a decade ago.

There are two basic types of life insurance policies that have lowered their premiums: terms and permanent.

Term insurance is basic coverage. You pay a premium and just get life insurance for a specific period, typically from 1 to 20 years. Upon the renewal of a term insurance policy, though, you’ll pay a higher premium because you’re older.

Permanent insurance, on the other hand, provides both insurance coverage and a savings account, known as the “cash value.” Cash value policies include whole life, universal life, variable whole life, and variable universal life. Cash value insurance is permanent protection. You lock into a premium when you purchase the contract. Universal policies let you make flexible premium payments.

Why are life insurance rates dropping? People are living longer. The longer you live, the lower your insurance premiums. Life insurance rates are dropping because death rates for the 25 to 44 age group—the primary purchasers of life insurance—have decreased significantly over the past 10 years, according to Weisbart. In 1996, the death rate per 100,000 for the 25-to-44 year-old age group was 177.8. By 2004, it had dropped to 161.8, based on National Vital Statistics Reports preliminary data. That represents nearly a 10 percent drop in the death rate in less than a decade for the prime insurance-buying ages.

The drop in insurance rates can represent a substantial savings. The annual premium for a 40-year-old male nonsmoker buying a $500,000, 20-year level term life insurance policy in 2007 would run $615 if he qualifies as a “standard” risk and $340 if he meets the more stringent requirements of a “preferred” risk. Rates for women, younger people and for larger amounts of insurance would be lower.

Premium rates for traditional whole life, universal life, and variable universal life insurance also are lower. Today, someone age 35 would pay about $8 per $1,000 of coverage for permanent protection. Ten years ago it was more like $12 per $1,000 of coverage.

With rates lower than they ever have been, parents might reassess the amount of life insurance they carry, and consider purchasing more. For example, it takes, calculated in the most simplistic of ways, a $500,000 death benefit to pay a widow $2,500 a month for 17 years. Yet, in 2004, according to LIMRA International, Hartford, Conn., the average 25 year-old to 34 year-old adult with life insurance had only $145,000; the average 35 to 44 year-old adult had only $323,000 of life insurance.

So what should you do if you’re sitting on a higher rate term insurance or cash value policy? Have an experienced life insurance agent conduct an insurance needs analysis to determine how much coverage you need. On average, you need about five to eight times your wages to be adequately protected.

Most life insurance companies charge lower rates for larger amounts of insurance. So buying one larger policy rather than keeping a smaller one and starting a second policy should further lower your premium. Rates often drop at the $250,000, $500,000, and $1 million levels. Do note on the application that you plan to replace an existing policy. And, don’t drop the existing policy until the new one is in place.

The drawbacks: If your age, occupation or health has changed, you may not be able to get lower premiums from another insurer. You can check term insurance rates at Web sites such as www.accuqote.com or www.selectquote.com.

There are more factors to consider when switching a whole life, universal or universal variable insurance policy. In addition, consider:
- Although you can do a 1035 tax-free exchange to move the cash value from your old policy to a new policy, you’ll pay commissions and other insurance costs on the new policy. This can mean more than 50 percent of your premium in the first year and other commissions on the cash value that is moved to the new company.
- If the total of all prior premiums is less than the cash value in the policy you are replacing, you will owe income taxes on the difference. A 1035 tax-free exchange should be considered in this situation.
- Usually, if a cash value policy has been in force for 7 to 10 years, with a quality carrier and you are not changing the type of underlying investment from a fixed portfolio to a variable portfolio, it is unwise to make a change.
- Life insurance policies are incontestable after they have been in force for two years regardless of any errors or misstatements on the initial application. Replacing an existing policy with a new policy will start the incontestability period over again.
- Any policy loans on your old policy will have to be repaid.

Tip: Always check the financial strength of the insurance company you are considering. The strongest companies are rated A++ and A+ by A.M. Best and AAA by Standard & Poor’s.

March 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA

Most Americans Need to Prepare for Financial Impact of Disability

2007-03-15T10:47:00.000-04:00

Most Americans are not prepared to deal with the possibility of becoming disabled due to sickness or injury and leaving the workforce for an extended period of time. In fact, more than half of U.S. adults said they would be unable to pay their bills or meet expenses if they became disabled and could not work for a year or longer, according to a recent National Association of Insurance Commissioners (NAIC) study.

And the possibility of becoming disabled and unable to return to work is quite high for many Americans. One-fifth of this nation's population will actually become disabled for a year or more before reaching age 65, according to the Social Security Administration (SSA). The most common causes of long-term disability are heart disease, back injuries and cancer, followed by stress, anxiety and depression according to the U.S. Department of Education and the National Institute on Disability and Rehabilitation. By contrast, slightly more than one in 10 Americans surveyed by NAIC say that it is somewhat or very likely they would become disabled and unable to work.

These findings, according to the NAIC and financial planners, underscore the need for long-term disability insurance. Nearly half of Americans do have long-term disability insurance, but much of it is employer provided rather than individually purchased. And that means, according to the NAIC, that a significant number of people could lose their coverage in the event of a change in employment status.

So what then is disability insurance? Disability insurance is insurance designed to protect people financially by replacing some of their lost income. The two main types of disability insurance are short-term and long-term. Short-term disability insurance, which some states require employers to carry for their employees, replaces a portion of the policyholder's salary for a short-period - typically from three to six months following a disability, according to NAIC.

Long-term disability insurance coverage typically begins after the policyholder is disabled and unable to work for at least six months, according to NAIC. The coverage period can extend for a specific number of years or until the policyholder retires or turns 65, depending on the policy selected and the type of disability.

For insurance purposes, disability is typically defined as the inability to work due to an illness or injury, according to the NAIC. Of note, the insurer’s definition of disability is a key factor in how one should shop for a policy.

So what should Americans consider when evaluating disability insurance? Below are tips from the NAIC and financial planners:

First, determine how much money you'll need to cover all of your critical expenses (such as housing, food, utilities and transportation) should you become disabled. Generally, you should consider buying long-term disability insurance that covers about 60 percent of your annual income.

Those who have a pre-existing health condition, such as a back problem or heart ailment, may have to purchase a policy with an “exclusion” rider. If the disabled person can provide documentation that the pre-existing condition has improved, the insurer may remove the rider after a specified time period.

Your occupation is crucial in obtaining coverage. If possible, depending on your occupation, you want to get an “own occupation” definition.

Typically, younger, healthier individuals pay lower disability premiums. If you purchase disability insurance at a young age and can get a "non-cancelable" policy, your coverage can't be cancelled and the premiums can't be raised once your medical exam has been approved and your policy issued, assuming your premiums are paid on time. Also, consider buying an option to increase your coverage without additional medical underwriting if you’re young or if you expect your earning power to increase.

While a "guaranteed renewable" policy can't be cancelled, its premiums may be increased on the anniversary of the policy or when stated in the policy.

Most long-term disability insurance stipulates a waiting period, such as 90 days (the most comment), 180 days or one year before benefits are paid. Disability insurance also stipulates a benefit period; for example, one year, two years, five years or until age 65.

Most companies offer policies that are offset by any benefits paid from Social Security. While receiving a benefit from Social Security is not likely, this is a way to reduce the cost of the disability policy.

The federal government does offer long-term disability benefits through the Social Security Administration under the following specific circumstances: "…if you cannot do work that you did before and we decide that you cannot adjust to other work because of your medical condition(s). Your disability must also last or be expected to last for at least one year or to result in death." And you must be disabled for at least 5 months. SSA disability is an “any” occupation definition of disability.

Before purchasing any disability policy, consumers should check with their state insurance department to make sure the company offering the coverage is legitimate, solvent and authorized to do business in their state. They should also evaluate the financial strength of the company and whether there are any complaints filed about their claims-handling experience.

March 2007 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA

Taxpayers should get a head start on tax planning for 2007

2006-10-31T17:08:00.000-05:00

The indexing of many features of the tax code will bring some relief to taxpayers next year, according to CCH, a Wolters Kluwer business, which recently released estimated income ranges for each 2007 tax bracket.

Unlike many changes to the tax laws that are effective for only limited periods of time, indexing has become well established within the tax code.

Inflation Adjustments. Since the late 1980s, the Code has required that federal income tax brackets be adjusted for inflation annually, and inflation adjustments have been inserted into the Internal Revenue Code in recent years with increasing frequency. For example, the Code now requires over 50 other inflation-driven computations to determine deduction, exemption and exclusion amounts in addition to the 40 separate computations needed to inflation-adjust the tax bracket tables each year. Tax legislation in 2006 added to the number of required inflation adjustments.

The adjustments are based on Consumer Price Index figures for September through August immediately prior to the adjusted year. CCH's projections are based on the relevant inflation data released Sept. 15, 2006, by the U.S. Department of Labor.

The IRS usually releases official numbers by December each year. CCH tax bracket projections are provided for illustrative purposes only, and should not be used for income tax returns or other federal income tax related purposes until confirmed by the IRS later this year.

Some items not indexed. Some items in the Code are not indexed for inflation and stay the same, while others rise by dollar amounts already written into the tax law to ensure Congressional oversight. The exemption amounts for the alternative minimum tax, for instance, are not indexed, which means that each year Congress must either increase the amounts by statute or expose additional households to the alternative tax.

By contrast, the adjusted gross income limits on the ability to make full contributions to Roth IRAs have been established by law at the $95,000 level for singles and $150,000 for joint filers since 1998. Now they have been made inflation-sensitive through 2006 legislation. For 2007, the AGI phase-out levels rise to $99,000 and $156,000, respectively.

Standard deduction, personal exemption also rise. The standard deduction and personal exemption amounts are also subject to indexing and these are projected to increase for 2007. These increases can produce lower taxes by reducing the taxpayer's taxable income.

Single taxpayers and married taxpayers filing separately could see a $200 increase over 2006 in their standard deduction, to $5,350, while the standard deduction for joint filers will increase by $400 to $10,700. Heads of households will see an increase in their standard deduction of $300, to $7,850.

The additional standard deduction for those age 65 or older or who are blind, which did not rise in 2006 from the year before, will take a $50 jump in 2007 to $1,050 for married individuals and surviving spouses, and $1,300 for single filers. The personal exemption amount will go up in 2007 by $100 to $3,400.

These inflation adjustments can add up over time. For example, since the 1987 tax year, the standard deduction for joint filers has increased more than two-and-a-half times, from $3,780 to the anticipated $10,700 amount for 2007.

Taxpayers can, however, lose a good portion of the value of personal exemptions and itemized deductions when their incomes rise above certain levels. Those "phase-out" levels are also adjusted for inflation. For 2007, married couples filing jointly will begin to lose some of the value of any itemized deductions when their adjusted gross income exceeds $156,400. Likewise, they will begin to lose some of the value of their personal exemptions when their adjusted gross income exceeds $234,600.

In 2006 and 2007, the reduction in personal exemptions and itemized deductions is scheduled to be only two-thirds of what it was in 2005. That's because "phase outs," first started under the Revenue Reconciliation Act of 1990, are themselves now scheduled to be phased out by one-third in 2006 and 2007, two-thirds in 2008 and 2009 and completely repealed for 2010.

"Kiddie" deduction, Gift tax exemption. In general, inflation adjustments are rounded to the next-lower multiple of $50, so if the adjustment produces an increase of less than $50, no increase is made. The "kiddie" standard deduction, used on the returns of children who are claimed as dependents on their parents' returns increased in 2001, from $700 to $750, and jumped next to $800 for 2004. For 2006, it increased to $850, where it will remain for 2007.

The tax code only allows the gift tax exemption to rise when the inflation adjustment would produce an increase of $1,000 or more. The last increase occurred at the beginning of 2006, when the exemption increased to its current $12,000. This year's inflation figures aren't enough to push it over the next threshold, so it will stay at $12,000 for 2007.

October 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

A guide to withdrawing retirement assets

2006-10-31T17:07:00.001-05:00

A lot is being written about how much money Americans can withdraw from their investments to fund their retirement years. Now, a new research institute launched by Fidelity Investments has outlined the order in which money should be withdrawn from various tax-deferred and taxable investment accounts. Described as the ‘withdrawal hierarchy,’ the Fidelity Research Institute suggests the order, with modifications made courtesy of other financial planning experts.

1. Take your minimum required distributions (MRDs) from qualified accounts and IRAs. If you are age 70½ or older, make sure you know which of your accounts require such distributions and how large those distributions need to be, and then meet the requirements and deadlines, avoiding the application of the 50 percent income tax penalty that will be assessed if you fail to make timely withdrawals of required distributions.

2. Liquidate loss positions in taxable accounts. Some investments in your taxable accounts may be worth less than their tax basis. In addition to offsetting realized losses against realized gains, at the federal level you can usually use up to $3,000 ($1,500 for married couples filing separately) of net losses each year to offset ordinary income including interest, salaries, and wages. Unused losses can be carried forward for use in future years.

3. Sell assets in taxable accounts that will generate neither capital gains nor capital losses. Such assets generally include cash and cash-equivalent investments as well as capital assets which have not increased in value. If your withdrawals from this tier in the hierarchy largely come from cash-equivalent investments, sufficient liquid assets holdings should remain intact in order to cover short-term financial emergencies. And be especially mindful of portfolio rebalancing issues.

4. Withdraw money from taxable accounts in relative order of basis, and then qualified accounts or tax-deferred saving vehicles funded with at least some nondeductible (or after-tax) contributions, such as variable annuities and Traditional IRAs that contain non-deductible contributions. The choice depends on the circumstances, and in some cases it might make more sense to tap the tax-deferred vehicle first, but for most retirees, capital gains rates are lower than ordinary income tax rates and generally liquidating capital assets first would be beneficial.

Assuming there is a significant difference in the basis-to-value ratio of the assets to be liquidated in two accounts, the better tactic for choosing between these two types of withdrawals may be to liquidate the assets with the higher ratio. That is, the assets that have generated the smallest gain or the largest loss as a percentage of their basis. If the basis-to-value ratio of the assets to be liquidated in each account is relatively low due to significant investment gains, it often will be preferable to liquidate the assets in the taxable account. Conversely, if the basis-to-value ratio of the assets to be liquidated in each account is relatively high, it may be preferable to liquidate assets in the tax-deferred account if portfolio demands require it. Note that IRAs are generally subject to certain aggregation requirements when allocating basis. When liquidating gain positions in taxable accounts, it usually makes sense to sell assets with long-term capital gains first, since they should be taxed at lower rates than short-term gains.

5. Withdraw money from tax-deferred accounts funded with deductible (or pre-tax) contributions such as 401(k)s and Traditional IRAs, or tax-exempt accounts such as Roth IRAs. It may not make much difference which account you tap first within this category since all withdrawals from any tax-deferred accounts funded

with fully deductible (or pre-tax) contributions are taxed at the same rate. When withdrawing money from tax-deferred accounts funded with fully deductible (or pre-tax) contributions, you may wish to request that taxes be withheld.

If you believe that the withdrawals you make may be subject to different tax rates over the course of your retirement (whether due to changes in tax law or to varying tax brackets as a result of fluctuations in income) you may be better off liquidating one type of account within all of these guidelines before another. For example, it may make more sense to leave your Roth account intact if you thought your ordinary income tax rate was likely to rise in later years, increasing the value of the Roth’s tax exemption.

Estate planning considerations may also significantly impact the entire hierarchy. Generally, qualified and tax-deferred assets may be given a higher order within the withdrawal hierarchy in the case of larger estates expected to hold “excess” assets which will pass to heirs or be subject to estate taxes. Capital assets receive a step-up in basis at death, while qualified and tax deferred assets are considered to contain “income in respect of a decedent” and do not receive a step-up. A number of other issues may also have an effect on the recommended order of withdrawal, like if the retiree’s income approaches the threshold of paying taxes on Social Security income.

October 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

A Time and Place for Life Settlements

2006-10-31T17:06:00.000-05:00

Sales of existing life insurance policies to third parties—often referred to as "life settlements"—have grown exponentially in recent years, and that trend appears likely to continue, according the NASD.

The NASD recently issued a notice to brokerage firms and associated persons that life settlements involving variable insurance policies are securities transactions, and firms and associated persons involved in such transactions are subject to applicable NASD rules.

But what are life settlements? Until recently, the NASD reports that the owner of a life insurance policy who no longer wanted or could not afford it had two options: to let it lapse or surrender it to the issuer for its cash surrender value. But now, the emergence of a secondary market for existing life insurance policies provides a third alternative: to sell the policy to a third party for less than the net death benefit, but more than the cash surrender value. Such transactions, the NASD says, are typically referred to as life settlements. The value of a particular life settlement depends on a variety of factors, including the insured's life expectancy and the nature and terms of the policy.

According to the NASD, the life settlement market emerged as an offshoot of the viatical settlement industry that developed in the 1980s as a source of liquidity for AIDS patients and other terminally ill policyholders with life expectancies of less than two years. Unlike viaticals, however, the NASD says that life settlements involve policyholders who are not terminally ill, but generally have a life expectancy of between two and 10 years. Life settlements also tend to involve policies when the insured is older and there has been a change in health since the policy was issued. Policies with lower cash values and higher net death benefits seem to draw more interest from investors.

The life settlement market has expanded rapidly in recent years. One recent study, for instance, estimates that existing policies with a collective face value of $5.5 billion were sold by policyholders to investors in 2005, while others suggest that the potential market exceeds $100 billion. Although business models vary, in a typical scenario, an insured sells an existing policy to a life settlement provider, which either holds it to maturity and collects the net death benefit, or sells the policy or interests in multiple, bundled policies to hedge funds or other investors. The insured may contact the life settlement provider directly, or through a financial adviser, or may use a life settlement broker, which solicits bids from multiple life settlement providers on behalf of the insured. It is not uncommon to hold out for a higher bid by not accepting the first bid or by letting the providers bid against each other.

In most states, both life settlement providers and life settlement brokers are subject to licensing and other requirements, the NASD says.

According to the NASD, most life settlement providers claim to target only those policyholders who have already made the decision to surrender a policy or allow it to lapse, either because the policy is no longer wanted or needed, or because the policyholder can no longer afford to pay the premiums. However, as more providers enter the life settlement industry, the NASD reports that there is increasing competition to find policyholders who fall into that relatively narrow category. And this, says the NASD, has led some life settlement providers to aggressively encourage financial service providers, including broker-dealers, to canvass their books of business for seniors or other eligible customers who may be interested in selling their life insurance policies in the secondary market, even if they do not need to or had not previously considered surrendering or allowing their policies to lapse. Significantly, the commissions paid in connection with life settlements are typically quite high—in some cases, up to 30 percent or more of the purchase price.

Accordingly, the NASD is concerned that aggressive marketing tactics, fueled by high commissions, may lead to inappropriate sales practices in connection with these transactions.

By way of background, the NASD reports that a variable life insurance policy is a security, and the sale of such a product in the secondary market is a securities transaction subject to NASD rules. What’s more, those involved in selling or buying a variable life settlement should understand fully the issues related to suitability, due diligence, best execution, supervision and training, and compensation in connection with variable insurance contracts.

Generally, the NASD requires that, before recommending the purchase, sale or exchange of a security, members must have a reasonable basis for believing that the transaction is suitable for the customer.

The NASD reports being concerned that some of the marketing materials prepared by life settlement companies to encourage financial service providers to recommend life settlements to their customers do not present a fair and balanced view of life settlements, and may encourage broker-dealers to recommend unsuitable transactions.

A variable life settlement may be a valuable option for insured’s who otherwise would surrender their policies or allow them to lapse, the NASD says. But variable life settlements are not for everyone. There can be significant costs associated with such transactions, and NASD cautions firms that a variable life settlement is not necessarily suitable for a customer simply because the settlement price offered exceeds the policy's surrender value. Other relevant factors may include the customer's continued need for coverage, and, if the customer plans to replace the existing policy with another policy, the availability, adequacy, the underwriting, and cost of comparable coverage. Depending on the circumstances, including the customer's stated financial needs and investment objectives, firms also may need to consider the basic tax and other relevant implications of selling a variable policy. Settlements paid in excess of the cumulative premiums paid on the policy constitute ordinary income to the policy owner, compared to the death benefit which is tax-free. In order for the settlement provider or investment group to receive the death benefit, they must file a claim with the insurance company which requires an original copy of the death certificate.

October 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

College Planning in the Wake of New Tax Laws

2006-08-31T10:55:00.000-04:00

Planning for college has never been easy. But such planning became a bit easier when President Bush signed the TIPRA and DRA into law earlier this year. Among other things, DRA and TIPRA changed the treatment of pre-paid tuition plans and 529 plans, two popular vehicles Americans use to save for and pay for college.

Chief among the changes are those that pertain to the so-called “kiddie tax.” Effective in 2006, the new law calls for the "kiddie tax" to remain in effect until a child turns 18. Previously, unearned income attributable to children age 14 and older was usually taxed at the child's tax rate. The new tax law, however, raises the age to 18 effective January 1, 2006. Exceptions apply for minor children who are married and file a joint tax return, and distributions from certain qualified disability trusts.

This change affects parents and grandparents who were or continue to use custodial accounts such as UTMAs (Uniform Transfer to Minors Act) or UGMAs (Uniform Gift to Minors Act) for college savings instead of 529 college savings plans. At present, UTMA and UGMA dollars are considering the child’s asset in the financial aid formula. But selling funds, or at least selling funds that have appreciated in value, in an UTMA or UGMA prior to a child turning 18, could create a significant tax bill. What’s more, assets in UGMA and UTMA accounts become the child’s at the age of maturity, which varies by state.

For many parents and grandparents, the new law makes 529 plans a more viable savings vehicle. With a 529 plan, contributions will grow tax-free and withdrawals are tax-free through 2010 as long as they are used for qualified education expenses. In addition, financial planners note that with 529 plans, the parent or grandparent controls the money.

Of course, parents and grandparents who established UTMA and UGMA accounts to pay for college education do have options. Under the act, UTMA or UGMA assets can be invested in a 529 plan, although assets have to be liquidated and cash invested in the plan. Doing so may create a tax burden, but financial planners note that it may be more than offset by preferential treatment of 529 plans in the financial aid formula. A tax analysis should be performed to determine the impact.

According to SavingforCollege.com, 529 plans do indeed receive preferential treatment. Sometimes referred to as the “529 loophole,” the new law removes student-owned 529 plans and Coverdell education savings accounts from the expected family contribution (“EFC”) in the federal financial aid formula. A 529 account or Coverdell ESA is considered an asset of the account owner; however, 529 accounts or Coverdell ESAs owned by a dependent student are excluded from the Free Application for Federal Student Aid or FAFSA. Most undergraduates are dependents for FAFSA purposes.

This is exceptional treatment, reports SavingforCollege.com. Under the federal financial aid rules, college savings plans are counted as an asset of the parent (if the parent is the account owner) and assessed at a rate of 5.6 percent. This means that 5.6 percent of the funds are deemed available for college expenses in the year a student applies for aid. By contrast, 35 percent of assets owned by the student are used to calculate the EFC.

In addition, parents and grandparents who have been using prepaid tuition plans to save for their children's college education received some good news on July 1, 2006 when the federal government began treating 529 prepaid tuition plans the same as 529 college savings plans for financial aid purposes.

Distributions (withdrawals) from a college savings plan that are used to pay the beneficiary's education expenses are not counted as either parent or student income. Prepaid tuition plans will now be treated the same way.

By way of background, prepaid tuition plans prior to July 1, 2006 were treated differently than college savings plans under the government's financial aid formula. A prepaid tuition plan wasn't counted as an asset of either parent or student, but any distributions from the plan were considered a "resource" that reduced the cost of attendance at any given college. And that resulted in a corresponding dollar-for-dollar reduction in financial aid. That is, every dollar that flowed out of a prepaid tuition plan reduced the beneficiary's aid award by one dollar. The new financial aid rules ensure that both types of 529 plans will be treated equally.

August 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA

Navigating Interest Rates, Inflation and the Economy

2006-08-31T10:52:00.000-04:00

These are tricky times for American investors and consumers in general. The economy seems to be cooling down! The second quarter GDP rose just 2.5 percent, down from 5.6 percent in the first quarter of 2006 and below its average of 3 percent during the recent expansion. And the housing market, perhaps in reaction to 30-year fixed rate mortgages above 6 percent in late July, also seems to be slowing down: Sales of new homes fell 3 percent to 1.13 million homes in June and revisions to data released by the Commerce Department also showed the U.S. housing market was weaker in the first quarter than previously reported.

Meanwhile, recent inflation and spending data show inflation to be at an 11-year high. For instance, The Federal Reserve’s favored inflation gauge -- the core personal consumption expenditure price index -- increased 0.2 percent for the third straight month in June. Core inflation, excluding food and energy, has risen 2.4 percent in the past 12 months, matching the largest year-over-year gain since the spring of 1995. Consumer prices including food and energy also rose 0.2 percent in June, and were up 3.5 percent in the past year. As a reference, the 20-year average annual rate of inflation was 3 percent.

The cross currents of a cooling economy and housing market with rising prices and the threat of wage pressures has left the Federal Reserve in a bit of bind. For the past two years, the Federal Reserve has been increasing short-term interest rates as part of an effort to slow down the economy and inflation. But while the Federal Reserve has indeed slowed the economy, it has yet to bring inflation under control. The main culprits are surging raw material and energy prices – the average gallon of unleaded gasoline hovering around $3 – over which the Fed has little control.

This coincidence of an inflationary threat with a slowing economy has led some to raise the prospect of the return of something not experienced in decades – stagflation.

Stagflation occurs when economic growth stalls and inflation continues to rise. According to Wikipedia, the online encyclopedia, stagflation is considered to be a problem because most tools for influencing the economy using fiscal and monetary policy are thought by some analysts to be based upon the trade off between growth and inflation. “Either they slow growth to reduce inflationary pressures, or they allow general increases in price to occur in order to generate more economic growth.” Stagflation creates a policy bind wherein attempting to correct one problem exacerbates another. However, although some similarities exist in the form of rising oil prices and inflationary risks, there is little in the current situation to indicate the return of the stagflation of the ‘70s. Economic growth, while showing some signs of slowing, remains generally strong. And the forces of globalization and the global competition that results, in the context of world wide central bank restraint, make serious inflation less of a threat than in the earlier period. The more serious threat today is that the Federal Reserve will go too far, resulting in a recession.

For investors, the upshot of the unholy combination of rising inflation in a cooling economy might be devastating. What can an investor do? Investors might consider repositioning your investment portfolio by shifting a portion from stocks to bonds. Putting a larger portion of funds into high-quality, long-term bonds, such as the 10-year Treasury bond, is one strategy since these had a yield of 4.98 percent at the end of July.

Page 2/Navigating Interest Rates, Inflation and the Economy

According to financial planners, if the Fed keeps pushing the button marked “increase short-term interest rates” too long, a mild recession could result. Should this happen, market interest rates would come down in response and a bull market for long-term bonds would result, with the price of bonds increasing. Likewise, experts also recommend using five-year certificates of deposit to produce income. High quality CDs that mature in five years had a recent yield of 5.04 percent.

On the equity side of a portfolio allocation, investors might also want to consider investing more in high-quality, dividend-paying stocks. Stocks of companies that pay out a good percentage of their earnings as dividends generally have less price fluctuation than stocks of non-dividend payers. The dividend represents a big part of the return, which often smooths out price volatility of those stocks. More often than not, large companies, such as those that are part of the Standard & Poor’s 500 stock index, pay high dividends. The current yield of the S&P 500 is, for instance, 1.86 percent.

Gearing Up for Life on the RV Road

2006-07-18T18:01:00.001-04:00

More than 30 million Americans are RVing these days. But as romantic as it may appear, would-be buyers or renters of recreational vehicles need to do more than test drive a “home on wheels” before joining the avid community of those who live life on the road.

Would-be RVers should examine all aspects of RV living, including how to choose the right RV, how to negotiate with dealers, how to buy the right insurance, and how to drive an RV before chasing such an idyllic life.

Of course, would-be RVers should first examine whether to RV or not. An RV is defined as a vehicle that combines transportation and temporary living quarters for travel, recreation and camping. According to “The Complete Idiot’s Guide to RVing,” the typical RVer enjoys: the ability to travel where and when they want; the chance to spend time with loved ones; a way to travel relatively inexpensively; the ability to avoid the hassles of commercial travel; and the opportunity for those who have special needs to travel in comfort.

RVers, contrary to popular opinion, are not just retirees. They come from all walks of life, according to a University of Michigan study commissioned by the Recreational Vehicle Industry Association (RVIA). The typical RVer is 49 years old, married, with an annual household income of $68,000. RV owners are likely to own their homes and spend their disposable income on traveling – an average of 4,500 miles and 26 days annually, according to RVIA. Would-be buyers and renters should note that many dealers, in light of rising fuel costs, are now offering discounts, including gas cards and loyalty programs.

Getting a handle on the various types of RVs for sale is another necessary step. RVs come in all shapes and sizes, the two major types being motor homes (motorized) and towable (towed behind the family car, van or pickup). According to RVIA, Type A motor homes are generally the largest; Type B motor homes or van campers are the smallest and Type C motor homes generally fall in between. Types of towable RVs are folding camping trailers, truck campers, conventional travel trailers and fifth-wheel travel trailers.

No matter which type you choose, your RV should have a place to sleep, a place to cook, and a place to live. After that, choosing an RV that’s right for you is a function of budget and preference. According to RVIA, prices for new RVs are typically $4,000-$13,000 for folding camping trailers; $4,000-$26,000 for truck campers; $8,000-$65,000 for conventional travel trailers; $48,000-$140,000 for Type C motor homes and $58,000-$400,000 for Type A motor homes.

Doing one’s homework before purchasing an RV is essential. RVIA and others suggests the following: Attend an RV show or visit an RV dealer to comparison shop; examine different models, vehicle types and floor plans; learn about RV financing and insurance options; and check out other resources and Web sites including those of www.rv.net, www.rv.org, Recreation Vehicle Dealer Association, Escapees, Family Motor Coach Association, and Trailer Life magazine. Renting an RV can be an ideal way to “try before you buy.”

Would-be RVers need also to examine driving or towing abilities, how many passengers will be in the RV, and how they plan to use the RV – for recreational use or as a place to live. At a minimum, would-be RVers should examine how livable the RV is. That means testing the beds, showers, and living spaces. What’s more, those buying a used RV should inspect inside and out for signs of previous repairs, rusts and leaks. And would-be RVers should take the vehicle for a rigorous road test, listening for signs of engine trouble. If you plan on buying a towable RV, check its weight. Would-be RVers don’t want to find out after the fact that they have to buy a new car or truck to tow their new RV.

Other homework is required. Lemon laws, which guarantee consumers replacement motor vehicles or refunds after a certain number of problems or days in the shop, vary by state and often don't apply to RVs, The Wall Street Journal recently reported. Thus, RV owners, stuck awaiting repairs, often have little legal recourse. RVs tend to have more problems than other vehicles because they are made in much smaller quantities than cars and without the same sophisticated manufacturing methods.

Buying an RV requires special skills and tactics, according to “The Complete Idiot’s Guide to RVing” and other resources. Private sellers offer lower prices but no warranties or returns. If you buy from a dealer, be sure to “audition” them with respect to price, knowledge of staff, service facilities and reputation. If you learn the invoice price, you will likely reap the best deal. Also, negotiate slowly and don’t sway from the price you want to pay. If you want peace of mind, buy an extended warranty. If not, choose the warranty that covers the full vehicle for the longest period of time.

Other tips to consider:

Check whether the dealer and manufacturer you plan to work with have any complaints against them with the Better Business Bureau or regulators.
Make sure your dealer has service department with RV-certified mechanics.
If you are buying a used RV, get as much history as you can, especially repair records.
Make sure the RV has a RVIA seal.

And no matter your final decision in the process, get out there and enjoy the open road!

July 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA

A Primer on the Tax Increase Prevention and Reconciliation Act of 2005

2006-07-18T18:01:00.000-04:00

On May 17, 2006, President Bush signed into law the Tax Increase Prevention and Reconciliation Act of 2005, or TIPRA for short. TIPRA affects taxes on capital gains and dividends, the alternative minimum tax or AMT, the so-called kiddie tax, and Roth conversions. Given all the changes, including those affected most by the sunset measures introduced in 2001 and 2003, the new tax law heightens further the need to do financial planning now rather than later. Here’s a summary of the changes:

Capital gains and dividends

The Jobs and Growth Tax Relief Reconciliation Act of 2003 established a maximum tax rate of 15 percent for long-term capital gains and “qualified” dividend income. These rates were scheduled to expire after 2008, but TIPRA extends the rates that apply in 2008 for two years, through 2010. For taxpayers in the top four tax brackets, this means the tax rate on long-term capital gains and “qualified” dividends will be 15 percent for all years through December 31, 2010. For taxpayers in the lowest two tax brackets (10 and 15 percent), the capital gains and qualified dividend rates will be five percent through 2007 and zero percent from 2008 through 2010.

Among other things, the extension may make it attractive for wealthy families to give appreciated assets—up to the annual gift tax exclusion limit ($12,000 in 2006 or $24,000 for married couples who gift split)—to children who are age 18 or older, but still in the lowest tax brackets. In essence, any appreciation after the date of the gift should not be subject to gift taxes, so experts suggest gifting securities that may have growth potential. The extension also creates the opportunity for Americans with low taxable income, including many retirees, to harvest small amounts of capital gains at zero percent in 2008-2010.

Alternative minimum tax (AMT)

AMT exemption amounts, which were expanded under various tax laws in 2001, 2003 and 2004, expired at the end of 2005. TIPRA increases AMT exemption amounts beyond their 2005 levels for the 2006 year only. New AMT exemption amounts for 2006 are:

$62,550 for married individuals filing jointly

$42,500 for single filers

$31,275 for married individuals filing separately

The Act also resurrects, at least for 2006, the rules that allow non-refundable personal tax credits (the dependent care credit, the credit for the elderly and disabled, the Hope credit for certain college expenses and the Lifetime Learning credit, for instance) to offset the AMT.

In 2005, an estimated four million taxpayers were subject to the AMT, but a recent report from Congressional Research Services estimates AMT will affect 23 million Americans in 2007 without further tax law change. That’s because the AMT is not currently indexed for inflation, while the regular tax system is, and consequently every year more average-income households cross over into the AMT. Experts say the current relief is not substantial and it’s uncertain whether AMT will either be reformed or repealed because of the substantial tax revenue cost.

Roth IRA conversions

TIPRA eliminates the restriction that heretofore prevented individuals with adjusted gross income exceeding $100,000 from converting a traditional IRA to a Roth IRA. This change is not effective, however, until 2010.

In addition, TIPRA enables individuals who convert a traditional IRA to a Roth IRA in 2010 will automatically spread the resulting reportable income over the following two years, including the income ratably in 2011 and 2012. Individuals can elect to report 100 percent of the resulting income in 2010 if they wish. Of note, income tax is due on the full amount of the traditional IRA conversion.

With this change to Roth IRA conversions, individuals who have traditional IRA balances can weigh the benefits of converting some or all of their balances to a Roth IRA. The true potential benefit of Roth IRA conversions is this: the taxpayer would pay an income tax at current rates because they believe the rate will be higher in the future (either because the person who withdraws the money will have higher income then, or because they believe that Congress will raise tax rates in the future).

Kiddie tax

According to the IRS, the investment income of a young child may, under some circumstances, be taxed at the child's parents' top marginal income tax rate. This is commonly referred to as the "kiddie tax." TIPRA increases the relevant age of children that are affected by the kiddie tax rules from 14 to 18. Retroactively effective to January 1, 2006, children under the age of 18 are subject to the kiddie tax rules. Exceptions apply for minor children who are married and file a joint tax return, and distributions from certain qualified disability trusts. The implication of this change is that it prevents parents from shifting any of their investment income to their children in a lower tax bracket.

This change affects families wealthy enough to gift assets with significant appreciation or short-term appreciation potential. It also affects parents who were or are still saving for their children’s college using custodial accounts and affects a wide swath of young teenagers who simply saved enough of their own money for future college (or other purposes), who now get taxed at their parents’ rates for the income they saved entirely on their own.

TIPRA brought about a number of tax law changes, so it’s a good idea to consult with your financial planner to see how it might affect your own situation.

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ILITS Remain a Popular Estate Planning Tool and Technique

2006-07-18T17:43:00.000-04:00

The federal estate tax may or may not be repealed or reformed anytime soon. But such discussions in Washington should not dampen the use of irrevocable life insurance trusts as a still very viable and valuable planning tool and technique which has applications beyond the tax efficient payment of estate taxes.

Indeed, financial planners say irrevocable life insurance trusts, or ILITs, can fulfill many estate-planning goals, not the least of which is avoiding federal estate taxes on the death benefit amount of the life insurance policy. By way of background, there are two major types of trusts: revocable—which can be changed as often as you want—or irrevocable—which generally cannot be amended or changed without the permission of a court, and then only for limited purposes. These trusts can either be funded (assets that will produce premium dollars are put in the trust) or non-funded (premiums are contributed annually). Typically, a person would either transfer an existing insurance policy on their life into a trust (or have a trust purchase a new insurance policy) if they were interested in controlling the distribution of the death benefit in a manner beyond the ability of the contract provisions to do so, if they wished to remove the proceeds from their taxable estate, or, in some cases, beyond the reach of the creditors of beneficiaries.

As the name suggests, an ILIT is a trust that cannot be changed or revoked by the creator or “trustor” once it is executed. Generally the trustee cannot be changed, the beneficiaries or the terms of the trust cannot be changed, and assets in the trust cannot be removed by the person who created the trust. By way contrast, a revocable trust can be changed by the trust’s originator, beneficiaries can be added or removed, assets can be withdrawn, and the trust can be terminated.

In general, here’s how it works: The life insurance trust is created first, and then the trust buys a life insurance policy in its own name on the trustor. The trustor, in an unfunded trust, annually adds funds to the trust, which in turn, buys (and continues to pay for) the policy in its own name, and pays the policy's premium against its own account. An independent trustee is generally required in this case if ”incidents of ownership” of the life insurance policy are to be avoided on the part of the person creating the trust.

It is possible to transfer an existing life insurance policy to such a trust however; in this case, the policy death benefit will remain part of the trustors’ estate for three years after the transfer. It’s important that the trustor irrevocably relinquishes to the trust absolutely all control over the policy. It’s best to work with an estate planning attorney when creating an ILIT.

In essence, the trust takes over ownership of the policy. The trustor then makes contributions to the trust, which, in turn, uses the contributions to pay the policy's premium against its own account.

As mentioned, a major reason for an ILIT is that the assets in the trust -- the proceeds of the life insurance policy or the face value after the insured dies -- will not be included in insured’s taxable estate at their death. As long as they do not retain any incidents of ownership in the life insurance policy, the proceeds should not be taxed in their estate. Most people will use an irrevocable life insurance trust if they anticipate that their assets will be above the applicable exclusion amount (and, thus, subject to tax).

But having assets pass outside on a taxable estate is just one reason for using an ILIT. The combination of life insurance and a trust assures the management, investment, and timing of that wealth. And it does so with a great deal more flexibility than the name might suggest.

The combination of life insurance and trusts have amazing creditor protection potential – far more than either alone. Once an individual has parted with (or never owned) life insurance and it’s safely in an irrevocable trust containing the proper “spendthrift” provisions, it’s almost impossible for the creditors of the beneficiaries to reach it. In other words, one of the most effective ways to assure the financial security and future of loved ones (or a charity) is life insurance in an irrevocable trust.

The combination of life insurance with a trust can avoid the costs, delays, and aggravation of probate – not just once – but over several generations. The life insurance/trust combo offers flexibility impossible to achieve through life insurance alone – while the life insurance in the trust makes a much larger and therefore more economical/practical/cost effective trust possible and in most cases is the only instrument capable of providing a benefit at precisely the time it is needed.

In addition, cash payments to an irrevocable life insurance trust may qualify for annual gift exclusion. In order to qualify, beneficiaries of the irrevocable life insurance trust are given what are called Crummey powers or “present interest rights” to the monies which when structured correctly will be declined by them so that the monies can be used to pay premiums.

As a reminder, it’s best to work with an estate planning attorney when creating an ILIT.

Taking Responsibility for Retirement: How Today's Scary Headlines Can Help Your Retirement Plan

2006-06-21T18:24:00.000-04:00

First, it was the combined whammy of the tech wreck and the post-9/11 recession that battered our 401(k) accounts. Next was inflation in health care and education costs that further diverted indebted consumers from concentrating on retirement. Now come the headlines that any company facing tough times – or intense shareholder pressure – can pull the rug out from under its retirees hoping for the traditional three-legged stool of retirement – pension, Social Security and savings.

All three legs are in trouble – we aren’t saving enough, Social Security is under attack and traditional pensions are disappearing – fast.

For retirees facing a sudden loss of pensions and benefits, there are really very few options save going back to work or turning home equity into a personal bank. So the time to start taking on the lion’s share of your retirement responsibility is now, whether you’re five, 10, or 20 years away from hanging it up, if that’s your plan.

One general tip. If you’re not really certain where you stand, get some help. If you’ve never sat down with a financial adviser it may be time to get a second opinion on your retirement readiness. The meeting may yield some ugly news, but it’s better to know the options than cross your fingers.

Here are some things you may want to discuss:

What does ‘retirement’ mean to you? It’s arguable that traditional retirement is going to be dead for many of us. So you may want to start thinking about a second part-time career or new ways to earn.

Think about an annuity: Annuities are investments that provide fixed or variable payments to the investor over a set period of time. The collapse of traditional plans is putting new focus on the annuity business, and it’s worth talking about with an expert.

Do a retirement spending dress rehearsal: In the last few years before retirement, see how much you can live like you’re already retired. Give up the lattes and the pricey clothes and dinners; see if you can live with a smaller car or a used one. Retirement is easier if you can downshift into it, both from a monetary and activity standpoint.

Get in shape -- physically: It may be strange to hear health advice tied to your financial wellbeing, but it should be one of the first things you consider. That’s because the numbers on a bathroom scale, blood pressure monitor or cholesterol report can dramatically affect the cost of your healthcare and insurance premiums going into retirement. You’ll find that pre-existing conditions can boost your premiums – or possibly deny you coverage. That’s a very ugly surprise going into the years when you’re going to need healthcare coverage the most.

Consider a career shift: It may be a bit extreme to switch careers just because a particular employer has better benefits and savings options. But if the job appeals to you and you can make a move without endangering what you’ve already accrued, why not consider it?

Use your catch-up options: Various IRA and 401(k) options allow you to make additional contributions over standard savings limits above the age of 50. Make sure you know what those additional amounts are and take full advantage of them.

Don an investment inventory: In a 30-to-40-year career, an individual may have gathered bits and pieces of pension benefits and personal savings and investments along the way. Likewise, there might be insurance policies, savings bonds and other small investments that may have slipped one’s attention. A re-evaluation of retirement options should begin with a full accounting and reorganizing of all investment and savings assets, preferably in an organized outline that’s easy for you and your adviser to access.

Think about health savings accounts: Today, there are strict limits and spending rules for health savings accounts, but if some lobbyists get their way, there might be a day when health savings accounts can become a long-term savings solution similar to a 401(k) plan. Getting into the pre-tax savings habit with health care dollars is a good habit to get into in case there’s more flexibility awarded to these accounts in the future.

June 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

Getting Started with ETFs

2006-06-21T18:20:00.000-04:00

Conceived more than 80 years ago and now owned by 91 million individuals from 54 million households in the U.S., mutual funds owe their strong appeal to a combination of features: professional management, instant diversification for low minimum investments, prices based on net asset value (NAV) and marked to market daily, and easy reinvestment of dividends and capital gains.

Known legally as open-end investment companies, they issue new shares when investors want to buy them at NAV per share—plus sales charges unless they are no-load funds—but they must redeem shares at NAV (less sales charges unless they are no-load funds) when holders want to sell.

These characteristics have long distinguished mutual funds from a second type of investment company, closed-end funds, whose issued shares are fixed at creation. This means that bid-and-ask prices may be above or below NAVs.

The third type of investment company are Unit Investment Trusts, which are a fixed basket of stocks (not an evolving index) held for a pre-determined time.

If mutual funds have been found by some to be lacking a feature, it often has been the opportunity to buy or sell their shares at any time when markets are open at known prices—just like publicly traded stocks, bonds, and closed-end investment companies.

Exchange-traded “equity” funds (ETFs) were introduced in 1993 by a subsidiary of the American Stock Exchange. They are designed to give investors a vehicle that resembles mutual funds but also provides the opportunity to have buy or sell orders promptly executed at known prices on a securities exchange (through a broker) whenever markets are open.

Named the SPDR Trust, whose shares were referred to as “Spider (for SPDR, or Standard & Poor’s Depositary Receipt), the first ETF was formed as a UIT with the investment objective of tracking the S&P 500 Index, thereby permitting its portfolio to be changed when S&P changed the composition of its index.

Its investment policies thus were similar to those of the mutual funds that had been passively managed to match the performance of the S&P 500, beginning with Vanguard 500 in 1976, or other domestic and foreign stock and bond price indices.

Over the next three years, three more ETFs, organized as UITs, followed the SPDR model, matching the following underlying stock indices, the S&P MidCap 400, the Dow Jones Industrial Average, and the NASDAQ 100. By 1996, a major change occurred when the first two ETFs organized as open-end investment companies were introduced.

ETFs have experienced phenomenal growth. By the end of 2005, ETF total assets had reached $296 billion. Some193 ETFs were organized as open-end funds, representing 68 percent of total ETF assets and eight were organized as UITs, representing 32 percent. At the time, as much as 63 percent of ETF assets were broadly diversified across domestic equity sectors while 10 percent were concentrated in individual market sectors or industries. Another 22 percent of ETF assets were invested internationally; the remaining 5 percent, in bonds.

Why have ETFs been so successful in attracting investors?

1. Whatever their investment characteristics, the offer of professionally managed portfolios resembles mutual funds—whether invested in diversified or concentrated pools of domestic or foreign stocks and bonds.

2. The cost of ETFs is much-debated, but many financial planners tend to agree these vehicles can be cost-effective when used correctly. For instance, shares of ETFs structured like index funds may have even lower annual expenses than index mutual funds, which, in turn, tend to be lower than those of actively managed, low-cost mutual funds. ETFs must, however, be bought and sold through brokers and those trades do involve sales commissions. Of note, some financial planners say ETFs tend to be good vehicle to use when a large amount of new cash comes into an account. But, due to commission charges, ETFs are not recommended for people with small accounts or those that are dollar cost averaging.

3. ETFs are transparent investments. Unlike traditional mutual funds, ETF holdings are fully transparent. Investors know what holdings are in the ETF at any given time. Each ETF also has a NAV tracking symbol for even more precise analysis. This helps keep ETFs trading within pennies of their intra-day NAV.

4. Taxes may be managed. While well-managed index mutual funds may distribute less in taxable capital gains than actively managed funds, the SEC’s 2001 release noted that “the ETF structure may allow an ETF to avoid capital gains to an even greater extent…”

“This is a really big deal for taxable accounts – it is almost an unfair competitive advantage for ETFs,” said one financial planner member of the Financial Planning Association.

Many ETFs have not distributed any long- or short-term capital gains in five years or more and if they have, the distributions are very tiny. Financial planners also note that because ETFs trade like stocks, an investor is able to control the tax treatment of an investment. By holding an ETF for at least one year and a day, capital gains will be treated as long-term capital gains which are currently taxed at 15 percent (10 percent for low tax bracket investors.)

6. Trading flexibility—the ability to buy and sell ETF shares any time during the trading day and at a known price—that index mutual funds cannot provide. Unlike mutual funds, ETFs can be bought on margin or sold short, the normal up-tick rule when shorting ETFs is not applicable.

ABOUT THAT DREAM VACATION HOME.

2006-06-21T18:13:00.000-04:00

With observance of Memorial Day behind us and vacation season at hand, it’s time in many American households for two perennial questions:

· “Where shall we go this year?”

· “Should we pay rent in a hotel or resort again, or does it make more sense to apply the money toward getting a place of our own, which we will then have whenever we want to go there in the future?”

Many households answered the second question with a “yes” last year, and others are expected to do so again this year.

Vacation homes—of which the U.S. Census Bureau identified 6.8 million at last count—accounted for 12.2 percent of all homes purchased in 2005, and, at a record 1.02 million, such purchases were up 16.9 percent from 872,000 in 2004, a recent survey by the National Association of Realtors reported.

Their median price—whether detached single-family homes, cabins or cottages, or multi-unit buildings—was $204,100, up 7.4 percent from 2004’s $190,000. Their median size: 1,480 square feet.

Vacation homes’ share of 2005 purchases lagged the 27.7 percent of homes which were bought for investment—whether to generate rental income, diversify assets, or both.

To David Lereah, NAR’s chief economist, it was not surprising that the two categories of second homes combined would constitute almost 40 percent of residential sales, up from 2004’s 36 percent. (Although commonly used, the term “second” home is a bit deceptive: about 6 of 10 second home owners surveyed by NAR were found to own two or more homes—for vacation and/or investment—beyond their primary residences.)

“The baby boom generation is driving second-home sales,” Lereah said in a statement. “They’re at the optimum point in life when people become interested in second homes. They’re at the peak of their earnings (and) interest rates remain historically low.”

Economic conditions remain relatively strong despite inflationary pressures due mostly to rising commodity prices and lower consumer spending. The resulting higher interest rates have lead Lereah to expect a decline in purchases of investment homes this year. “There are fewer incentives to speculate in the market with price appreciation cooling in much of the country,” he adds.

“Vacation home sales will remain strong for the foreseeable future, given the fact that baby boomers are favorably positioned in terms of affordability, as well as being at the stage in life when people are most interested in making that kind of a lifestyle purchase.”

That, to be sure, is not to suggest that the vacation home market is going to be as firm everywhere in 2006 as in 2005. As Barron’s concluded in its May 29 issue following a survey of the broad second-home market across the country: “After a long string of double-digit annual price increases, a number of second-home Meccas across the country are suddenly suffering from plunging sales volume and burgeoning inventories of unsold homes.”

Though the official figures on sales prices have yet to reflect the current round of cuts, interviews with real estate pros and others strongly suggest that the averages are deteriorating in a number of key markets.

An April 14 overview of coastal resorts by its sibling, The Wall Street Journal, reported not only price cuts (“offers that would have been an insult a year ago are now being accepted,” according to a Cape

Cod real estate broker), but also other steps to promote sales: cuts in brokers’ commissions, increases in housing ads large enough to inflate a newspaper’s size, and supplemental devices such as listings under glass tabletops at an ice cream parlor.

Despite the weaker prospects for 2006, the longer-run trends underlying the vacation home market are expected to remain on track, mostly due to the aging of the baby boomers.

“Vacation home buyers are making lifestyle choices and purchasing primarily for their own enjoyment,” Lereah emphasized, citing NAR’s 2005 survey findings for illustration: 72% percent of owners said they planned to use the houses for vacations and family retreats. Moreover, 18 percent expected their vacation homes to become their primary residences in retirement.

Economic motives seem to have played a minor role. While one-third bought to achieve greater diversification of their assets—well below the one-half of investment home owners who had that motive—only 13 percent bought to earn rental income vs. two-thirds of investment home owners. (Of vacation homes which their owners rent out, the median number of nights rented is only 12 per year, far fewer than the number of nights that owners of investment homes rent out theirs.)

The typical vacation home owner participating in the NAR survey was 59 and earned $120,600 last year. As many as one-third had paid cash, commonly out of savings or from proceeds of real estate sales, and of those who got mortgages, the median down payment was 27 percent. Of the total universe, 82 percent owned their vacation homes free and clear.

The median distance between a vacation home and the owner’s primary residence was 220 miles; 34 percent bought within 100 miles of their primary residences, and, ironically, another 34 percent bought 500 or more miles away, enough to get them to an ocean, river, or lake (66 percent of preferences), recreation or sporting activities (39 percent), vacation or resort areas (38 percent), and mountains or other natural attractions (31 percent).

Among the leisure activities of interest, beach, lake or water sports led the list at 57 percent of owners. Boating was next at 38 percent, followed by hunting or fishing (32 percent).

Of course, it’s imperative that those evaluating whether to buy or rent a vacation home should crunch the numbers. Most financial planners would recommend a thorough quantitative analysis showing the cost/benefit of buying or renting a vacation home.

THE IMPORTANCE OF AN ANNUAL FINANCIAL CHECKUP

2006-05-25T13:04:00.000-04:00

It’s one of the six steps of the financial planning process. But, oftentimes, it’s the one step that gets overlooked. It’s the sixth step – the annual financial check-up.

The annual financial check-up is indeed the most important of the financial planning steps. And yet, financial planners and clients sometimes downplay its significance.

What is the annual review and why is it so important? In short, the annual review is the opportunity to measure a client’s progress against their plan of action. It’s also the one time when planners and clients can examine the many changes that typically occur any given 12-month period – the birth of a child, the death of a loved one, the loss of a job, a major purchase – and then readjust the client’s financial plan, charting a new course if need be or further affirming the client’s progress towards their personal financial goal achievement.

Indeed, lives are seldom static and that’s why financial plans are not necessarily set-and-forget documents. But what exactly should financial planners and clients examine in their annual meetings? And when should they conduct their annual meetings.

Typically, financial planners will collect a client’s data, prioritize their goals, examine their resources, make recommendations, and implement a plan as part of the financial planning process. In an annual review, the financial planner will do much of the same and then some. They will first typically examine a client’s progress against the plan time frames. This sort of monitoring benefits both planners and their clients. Clients get an opportunity to step back from their busy lives and review their goals and confirm that their priorities remain the same Planners have a chance to reconnect with their clients to affirm their positive actions towards goal achievement or to help refocus them so that they don’t get too far off track. And planners get a chance to enhance the relationship and trust.

In some cases, planners and clients will want to establish a regular appointment, meeting on an annual basis, and in some cases on a quarterly or semi-annual basis. Typically, the planner and client will review in these meetings short-term goals, examining what if anything may have changed. In some cases, the planner will make changes to a client’s investment portfolio in light of tactical or strategic asset allocation models in place. In other cases, a planner will suggest changes based on certain life events. The birth of a child or grandchild may require a discussion about 529 plans. A divorce may require changing beneficiary designations on retirement accounts and life insurance policies.

In addition a planner may want to review with their clients new research that has become available in the interim to either confirm rationale or provide a basis to alter a client’s short-term or long-term strategies. For instance, new research that shows the escalating costs of nursing homes or health care in retirement wouldn’t change the goal of “secure long-term retirement,” but it would change the strategy to achieve that goal.

Besides reviewing family developments, planners would also address in an annual review regulatory and other changes that could affect adversely or positively a client’s financial plan. The new Medicare Part D plan or the introduction of the Roth 401(k) could prove useful to some clients. In other cases, the annual review is a chance to review potential changes, changes in the federal estate tax laws, for instance, and devise possible plans of actions.

Planners and clients will often want to measure the “performance” of the investment portfolio as part of the annual review. Typically, performance should be measured against several benchmarks, the most important of which is the client’s own personal goals. For instance, if the planner and the client established that a portfolio should grow by 5 percent per year before taxes then the performance should

be measured against that yard stick. To be sure, it’s important that portfolios be measured against standard benchmarks. But only as a point of reference. Meeting personal investment goals is far more important that over performing or underperforming the Dow Jones industrial average. By and large, it’s imprudent for planners and clients to make wholesale changes to a portfolio bases solely on one quarter as well as one year of performance.

In summary, annual reviews provide a chance for planners to examine a client’s long-term goals. These reviews can establish whether the client is generally on course to meet their goals. It’s also a chance to review changes that have occurred and begin to anticipate changes that may occur. It’s a chance to implement any new plan of action that has been developed in light of changing goals or changing performance. And then last, the annual review provides the perfect opportunity to establish future review meetings.

One of the most important worksheets to review is a balance sheet or net worth statement. If reaching all of the client’s goals will require a net worth of $1 million at some point in the future, it is the balance sheet that will demonstrate movement toward or away from that goal. It is a road map. When going out of town, a map is almost always consulted before and during the trip. Progress toward your ultimate destination is noted by each passing town or landmark. It is easy to see when you move off track and what corrections should be made to get you back on the correct path in the least amount of time or distance. The balance sheet measures your progress toward your monetary goal in a finite manner. What the numbers show from year-to-year are not as important as what they show after several years looked at as a whole.

May 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

THE TRUTH ABOUT SMALL-BUSINESS SUCCESSION PLANNING

2006-05-25T13:03:00.000-04:00

Of all the things facing a man or woman from the moment he or she becomes chief executive officer of a large company, few have a higher priority than determining who will succeed him or her when it becomes necessary.

This is critically important for a large public company with thousands of employees and thousands upon thousands of stockholders. It is no less important for a small company with relatively few employees depend on it for their livelihood.

While large companies typically have board committees and/or staff whose sole responsibility is to develop and implement detailed procedures for identifying potential CEO’s both within and outside the company, small companies usually have less structured practices.

They may be as simple as choosing an obvious candidate, such as an only child of the founder or, perhaps at least on an interim basis, the most senior employee if the child is too young. “Though inevitable, succession is often the least planned and, consequently, the most perilous event for a family business,” the U.S. Small Business Administration asserts in a paper entitled Family-Owned Business Success: Leveraging Advantages and Mastering Challenges. “History has shown that only one in three firms will survive the transition to the second generation. Only 10 percent of the original group will survive into the third generation of ownership.”

Given the increasingly complex challenges that small and large businesses alike face these days—whether from government regulation, international competition, new technologies, rapid obsolescence of products, or other factors—simple procedures and searches limited to family or current staff may no longer suffice. In order for a business to have a future, serious issues must be addressed and answered over and over again, often with the help of a financial planner or adviser who can help a business owner through the process. Among these are:
· If a family member is the obvious heir apparent, is he or she really able and willing to handle the job for the indefinite or possible immediate future? “It’s never too early to start” training a successor from within the family, the SBA points out. “By elementary school age, youngsters can stuff envelopes and help with office housekeeping chores. As they mature, their participation can grow accordingly…Experts also recommend that the incoming generation work in the broader business world before permanently joining the family venture.”
· If the obvious heir apparent is not the best choice, is another family member, perhaps not previously considered, better able and willing to do the job? The decision must be based on the ability of whomever is considered to do the job well, not based on age, relationship, gender, or education. “Separation of family relationships and business is especially essential at this juncture,” the agency advises. “The decision must be based on qualifications regardless of family dynamics.” Business owners also need a backup plan should family member or other heir apparent fail to run the business appropriately.
· If no family member is able and willing to lead the company for the foreseeable future, does it make sense to look elsewhere within the company before going outside, or does it make more sense to sell the business?
· In former case, would the most senior employee necessarily be the best qualified candidate or would a younger one be a better prospect?
· If no employee is qualified and willing to lead the company at this point in its history and it would become necessary to go outside, would current employees who considered themselves to be eligible become sufficiently disappointed, risking the loss of their experience?
· What sort of compensation and benefits package would it take to attract a suitable candidate, and can the company afford to offer it?
· If the compensation package were to involve equity, does anything need to be done to facilitate consensus among current owners to accept the arrangement? Business owners will need to determine the value of the business as part of any succession planning exercise. Likewise, owners need to structure the sale of the business to children or other successors.
· Given the importance of retaining principal current employees, what plans must be made (a) to properly communicate to them the rationale for going outside and (b) to enhance compensation and/or benefits to keep them? “These key players need reassurance that they have a place after the incumbent retires,” the SBA stresses. “Conversely, incumbents need to help them understand that they must enthusiastically support the succession process and the incoming leadership.”

Recommending that family businesses should begin to plan for succession “a decade or more” before the events, the SBA explains, “Having time to discuss issues and options will increase the odds for success while building family acceptance…

“Once the succession process is put in motion, the family needs to set a date when the retiring owner cedes full control to the new leadership.”

Retiring founders need to prepare themselves for the changes, too. They will have to move from a time in which their businesses were their lives, where most of their friends were business associates, and where they had few outside interests to a time in which they may find fulfillment elsewhere, perhaps mentoring, or serving non-profit organizations, charitable organizations, or other businesses. Some may want to start all over again, founding new businesses in new fields.

May 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC, a local member of FPA.

A BRAVE NEW FINANCIAL WORLD FOR BABY BOOMERS

2006-04-25T14:58:00.000-04:00

On any given day, you will find not one but several studies that examine the current state of affairs for Baby Boomers, the 77 million Americans born between 1946 and 1964 that are now slowly approaching retirement. And what’s emerging is an interesting, though at times bleak, picture of one of the most analyzed groups in America.

Here are some of the highlights of that research and the financial planning implications.

Retirement security: The 2006 Employee Benefit Research Institute's annual retirement confidence survey recently reported that just 25 percent of workers are very confident about having adequate funds for a comfortable retirement. In some ways, that should come as no surprise given that half of all workers say they've saved less than $25,000 toward retirement, and even among workers 55 and older, more than four in 10 have retirement savings under $25,000. The implication for workers is that they will need to start saving more money toward retirement, with some financial planning experts suggesting that workers might need roughly 20 times their annual pre-retirement spending set aside toward retirement.

What’s more, workers are underestimating the percent of retirement income they might need in retirement. At present, many financial planners suggest replacing at least 75 percent of pre-retirement income in retirement, if not 100 percent given longer life expectancies and increasing healthcare costs.

Retirement is a state, not a date. A new MetLife Mature Market Institute study indicates that 78 percent of respondents age 55-59 are working or looking for work, as are 60 percent of 60-65 year-olds and 37 percent of 66-70 year-olds. Across all three age groups, roughly 15 percent of workers have actually accepted retirement benefits from a previous employer, and then chose to return to work or are seeking work. These employees, who have become known as the ‘working retired,’ represent 11 percent of 55-59 year-olds, 16 percent of 60-65 year-olds, and 19 percent of 66-70 year-olds. Their motives for doing so are mixed, with 72 percent of those age 55-59 (and 60 percent of those age 60-65) citing the need for ‘income to live on’ as a primary reason for working, but among 66-70 year-olds, 72% percent of employees cited the desire to ‘stay active and engaged’ as a primary reason to work, followed by ‘the opportunity to do meaningful work’ (47 percent) and ‘social interaction with colleagues’ (42 percent). Of note, many financial planning experts suggest that working part-time or full-time during retirement years is one way to make up any retirement income shortfall. But odds are high, about one in two, that some workers will be unable to work during retirement because of an illness or disability, corporate downsizing and restructuring, or the need to provide financial support to a family member of loved one. And it’s also important to understand the tax issues of working during retirement.

In the meantime, much has to change in America to make the workplace of the future “work” for boomers. According to AARP’s “Reimagining America,” pension and other laws need to change for older workers so they don’t get penalized for working longer. Employers need to accommodate the needs of older workers, providing flex-time schedules or low-stress jobs, and older workers need to invest in education and skills-training to meet the demands of a constantly changing market for skills, knowledge and experience.

Healthcare costs: A recent Fidelity Investment study suggests that a 65-year-old couple retiring today will need about $200,000 set aside just pay for healthcare costs in retirement. The 2006 estimate, which assumes that the individuals do not have employer-sponsored retiree healthcare, includes expenses associated with Medicare Part B and D premiums (32 percent), Medicare cost-sharing provisions (co-payments, coinsurance, deductibles and excluded benefits) (36 percent), and prescription drug out-of-pocket costs (32 percent). It does not include other health expenses, such as over the counter medications, most dental services and long-term care. And many employers who offer (or had offered) some level of retiree healthcare benefits, are now phasing out or significantly constraining such benefits because they feel they can no longer afford them in the current competitive global environment. While it is uncertain exactly how much of a burden will be placed on the shoulders of retirees for these costs, it appears likely that the costs will “eat up” an expanding portion of retirees’ savings and investments during their golden years.

Given that the average balance in a 401(k) retirement plan for a Baby Boomer turning 60 is now $100,000, financial planning experts suggest that workers will need to plan on funding retiree healthcare expenses in a variety of ways, such as health savings accounts. In addition, those who are able may need to continue working for employers that provide health insurance or retiree health insurance plans.

Volunteerism: Half of Americans age 50 to 70 want jobs that contribute to the greater good now and in retirement, according to a MetLife Foundation/Civic Ventures New Face of Work Survey. According to that survey, Baby Boomers will invent not only a new stage of life between the middle years and true old age but a new stage of work. “Boomers may give back as volunteers, but this survey suggests that their most important contributions to society will likely be through work,” said the study’s author. The planning implication is that Boomers should consider volunteering now, if able, to get a sense of what sorts of work and organizations will best suit them in retirement.

The reality for Baby Boomers is that they’re living longer, fuller lives. They need the help of planners now more than ever.

April 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC a local member of FPA.

A NEW APPROACH TO SELECTING A FINANCIAL PLANNER

2006-04-25T14:57:00.000-04:00

Selecting a financial planner has never been an easy task. Yes, experts have long advised checking such things as a person’s experience and education, as well as their regulatory record. But in recent years, selecting a planner has become especially difficult given so many financial professionals, including stockbrokers, insurance agents and bankers, often provide similar services, such as comprehensive financial plans and investment products.

Resolution of an upcoming court case involving the Financial Planning Association® (FPA®) and the Securities and Exchange Commission (SEC), may soon make it easier to tell the difference between a financial planner and other types of financial and investment representatives.

In the meantime, however, experts say there are a number of ways to distinguish a financial planner from other types of financial professionals.

Consumers should focus on the following issues: regulation, fiduciary responsibility, disclosure and values. First, the issue of regulation. The SEC regulates the actions of registered investment advisors (RIAs), some of whom are financial planners and some who are also investment advisers who do no financial planning. By contrast, NASD regulates the actions of registered representatives, or what are more commonly called stockbrokers, and insurance agents who deal with securities and mutual funds.

The SEC regulates the actions of financial planners, who must comply with the Investment Advisers Act of 1940. Under that Act, financial planners must provide—and periodically update—clients and the SEC (or state securities regulators) with information about themselves and their records; brokers are required to provide much less information. Financial planners also perform more comprehensive services for clients, including recommendations of appropriate asset allocations. Brokers need only recommend (and handle orders for) securities purchases and sales, being careful to limit recommendations to those which they consider “suitable.”

In short, RIAs who are financial planners are obligated to place the clients’ interests above their own. Stockbrokers were traditionally exempt from registering under the 1940 Act and were exempt from fiduciary responsibility when buying and selling securities on behalf of their clients, including non-discretionary accounts. Therefore stockbrokers need not place their clients’ interests above their own but merely meet the standard of “knowing their customer” and making “suitable” recommendations. In many cases, stockbrokers or insurance agents who provide a financial plan or investment plan do so as an “incidental” service. According to FPA, the current SEC rule presently allows stockbrokers to avoid the fiduciary and disclosure standards of the 1940 Act while being able to provide the same services as financial planners. The SEC presently prohibits stockbrokers from calling themselves financial planners, although it allows them to use similar titles such as financial consultant and financial advisor, and to provide fee-based advisory services such as retirement planning under more lenient broker-dealer sales regulations.

As for disclosure, financial planners who are registered as RIAs with the SEC are required to disclose conflicts of interest and their qualifications.

Of note, financial planners (and others) registered under the Investment Advisers Act face the risks of higher liability for violating fiduciary and disclosure standards; brokers registered only under the Securities Exchange Act of 1934 are not considered fiduciaries and do not have to disclose as much about themselves and their businesses. Insurance agents who call themselves financial advisers may face even less regulatory oversight than brokers.

When searching for a financial planner, consumers might consider asking whether the financial planner is legally required to act in the client’s best interest, and whether the broker’s recommendations are “solely incidental advice” or not. This is especially important given that both financial planners and stockbrokers may derive compensation from fees based on percentages of assets managed and/or hours of consultation and related services. Brokers offering fee-based advice must also provide a consumer warning statement to new clients that the account is a brokerage, and not an advisory account.

When searching for a planner, it’s typically a good idea to take advantage of resources that provide access to financial planners. FPA’s PlannerSearch, which can be found at www.fpanet.org/public, is one such service. In addition, FPA has several consumer publications designed to help people choose the right planner to meet their needs. FPA suggests that consumers request a written disclosure document from the planner, such as the Form ADV. Consumers can also review the NASD Web site to find disciplinary action taken against registered persons. The Form ADV answers many questions, including those regarding a planner’s work, disciplinary actions, experience, compensation, method of planning, areas of specialization, and business relationships the planner has that might present a conflict of interest. Consumers may also want to ask whether a potential planner will provide an Agreement of Engagement Letter documenting and describing all services to be provided and all fees that will be paid by the client -- and/or all compensation to be received by the planner from “outside” sources.

Some further issues to consider when selecting a financial planner:
Experience with the client’s issues
Credentials and education
Price and methods of compensation
Investment philosophy
Approach to financial planning

Since trust is at the heart of any working relationship with a planner, it’s important that the consumer work with someone whose actions and words are consistent with the letter and spirit of laws and rules related to financial planning.

April 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC a local member of the FPA.

ALTERNATIVES TO TRADITIONAL INVESTMENTS

2006-04-25T14:55:00.000-04:00

Investors sometimes get bored with traditional investments, such as U.S. stocks, investment-grade bonds, and the mutual funds that are invested in those asset classes. Especially when such investments fail to generate adequate returns as they did in 2005. And when that happens, investors often tend to hunt for what some refer to as “alternative” investments, investments with exotic names that hold out the promise of higher returns.

Alternative investments are, in simple terms, nothing more than investments that offer investors the chance to diversify their portfolio with instruments that may reduce overall risk of the portfolio and potentially improve returns. Typical alternative investments include hedge funds, commodities (futures and options), direct ownership of real estate, REITS (public and private), limited partnerships, private-equity funds, venture capital or angel investing, mutual funds (absolute return funds, long-short funds, and covered writing funds) and managed futures.

Besides the potential for higher returns and lower portfolio risk, alternative investments also have these general characteristics: higher fees, higher investment minimums, minimum net worth and income requirements for investors, and illiquidity (3 to 5 year commitments are not uncommon). In addition, investors may find it difficult to find appropriate benchmarks against which to measure performance and risk, unlike, for example, using the Dow Jones Industrial Average or the S&P 500 to measure the performance of stocks.

As with all investments, alternative or not, it would be useful to remember what the Romans used to say: “caveat emptor” - or “let the buyer beware” – when researching such investments.

So, if you are considering adding alternative investments to your portfolio be sure to get a sense of your current assets’ combined potential for return and risk and consider whether it would be realistic to make changes that could significantly enhance your potential return without an excessive increase in your potential risk. Often, a major benefit of adding alternative investments is that it tends to reduce the overall risk of a portfolio because the value of such investments doesn’t always follow that of stocks and bonds. In other words, traditional investments and alternative investments are not “correlated.”

Here’s a closer look at some of the more common alternative investments out there:

Hedge Funds. Hedge funds are nothing more than investment partnerships and, as such, are often precursors of mutual funds. Some do nothing more than allow the investor to share the results of the expertise, experience and talents of a respected manager. Others may pursue very conservative strategies focused on principal protection. The key thing to recognize, according to financial planners, is the focus on absolute returns as opposed to relative returns and benchmarking. That said, it’s important to note that hedge funds may resemble mutual funds but are far from identical. For instance:

The costs of owning them are a lot higher because they not only charge annual management fees (around 1-2 percent), they also commonly charge performance fees of 20 percent of the funds’ profits.
They may use speculative techniques, such as borrowing money to supplement investors’ money and investing in illiquid securities that can make them more risky.
Neither the funds nor most hedge fund managers are required to register with the SEC.
Because of their higher level of risk and little or no SEC oversight, hedge funds tend to be made available only to the wealthy—those who have net worth of at least $1 million.
They may only accept redemption requests quarterly, as opposed to daily, and may impose “lockup” periods of a year or more during which no shares may be redeemed.

Futures and Options. Futures contracts commit you to buying or selling something for delivery in the future at a certain price while options contracts give you the right—but not the obligation—to do so.

Once primarily used for agricultural commodities, futures contracts now are also available in a growing variety of markets from metals and fuels to financial instruments including foreign currencies, U.S. and foreign government securities, and U.S. and foreign stock indices.

Prices can be highly volatile to reflect ever-changing balances between supply of and demand for the underlying assets.

Precious Metals. The volatility of the price of gold, for example, the most widely watched metal worldwide, illustrates why it is, at best, a speculative asset when not purchased for actual use. Now trading near $600 an ounce, it remains far below its all-time high of around $1,000 about 25 years ago—but more than double its most recent lows around $250 at the end of the 1990s.

Anyone who bought gold 25 years ago as a long-term investment and held it would have lost a lot of money if he or she sold today—not to mention the missed opportunities for capital gains in securities. The lesson to be learned is that alternative investments are available for those who want to diversify their portfolios, however, they should be fully understood before you invest in them.

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April 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC a local member of FPA.

The Return of Uncle Sam's 30-Year Bond

2006-03-26T14:31:00.000-05:00

Nearly five years after offering its last issue of 30-year bonds to individual and institutional investors—causing some to warn of a bond shortage—the U.S. Treasury has returned to the market place with a $14 billion issue of its longest maturity, perhaps leading you to ask yourself whether you should consider adding some to your portfolio.

The likely answer? Probably not.

To be sure, U.S. Treasury securities have the highest credit quality of all private and public sector U.S. debt issues, given that the Federal Government could always tax or borrow to repay principal and pay interest on time—a meaningful reassurance if you’re lending your money to somebody for as long as 30 years. Moreover, being available in denominations of only $1,000, they are easily affordable for most investors.

But, bearing 4.5 percent coupons, the new bonds provide little compensation in both absolute and relative terms for lending money to the Treasury—or anybody else—until February 2036:
Given that yields of debt securities are lowest for those of the highest credit quality—and highest for those of the lowest quality, called “junk bonds”—they pay a bit less than high-quality corporate issues (and nearly 1 percentage point less than the 5-3/8 percent 30-year Treasury bonds issued in February and August 2001).
Given that the Treasury’s left hand (Internal Revenue Service) likes to take away at least some of what little the right hand (Bureau of Public Debt) gives, their income is reduced by federal income tax as much as income from corporates securities, even if, unlike corporates, it is exempt from state and local taxes.
Given that yields on debt securities of comparable credit quality nowadays differ little from the shortest to the longest maturities, they pay Treasury bond owners locked in for 30 years about the same as Treasury bill owners who risk their money for only 90 days. As if to underscore the point, the $21 billion of 3-year notes and $13 billion of 10-year notes that were also auctioned at February’s $48 billion quarterly refunding also had identical coupon rates of 4.5 percent.

Because marketable bonds’ prices—and thus their yields—fluctuate continually during the maturation process, it is quite possible that those who have to sell them before maturity may lose money on them despite the Treasury’s high credit quality. (As if to underscore that point, interest rates in general crept up slightly before they were a week old—and, thus, their prices drifted slightly lower.)

So why did the Treasury resume issuing 30-year bonds?

To “diversify (its) funding options and expand its investor base”…”finance the government’s borrowing needs at the lowest cost over time”… and ”stabilize the average maturity of the public debt,” it said in statements.

That is to say:
To meet demand that it expected after canvassing investors—and that it found at its February 9 auction—such as institutional investors, who worry less about their companies’ mortality than most individuals who regard 30-year investment horizons as a bit long.
To lock in relatively low interest rates, which have prevailed in recent times, for the long-term part—albeit, a small part—of the public debt. By locking in low interest rates, Treasury will not be subject to unknown future borrowing costs when shorter-term debt must be rolled over.
To address the average length of the marketable interest-bearing public debt held by private investors, which dropped from 6 years 1 month at the end of fiscal 2001 to 4 years 10 months at the end of fiscal 2005.
Like individuals, who save toward long-term goals such as college tuition for children and retirement (but who may have more flexibility when taking risks), treasurers of institutions have to be sure that they are always able to meet liabilities when due—whether benefits to life insurance policyholders’ survivors or to pensioners.

Of $4.1 trillion of the Treasury’s total marketable debt held by the public at the end of fiscal 2005, as much as $500 billion was accounted for by long-term bonds. Short-and intermediate-term Treasury notes, ranging from 2 to 10 years, accounted for $2.3 trillion (and about three-fourths of the increase in total publicly held marketable debt from $2.9 trillion at the end of fiscal year 2001). Treasury bills and Treasury inflation-protected securities (TIPS) made up the rest.

Although the Treasury stopped selling new 30-year bonds in 2001, its 30-year issues had not disappeared, as some may have thought last August, when it announced that it would re-introduce them in semi-annual auctions beginning this month. Talk with your financial adviser today about whether 30-year bonds are right for your portfolio.

March 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC a local member of the FPA.

The Perplexing World of Social Security and Earnings in Retirement

2006-03-26T14:30:00.000-05:00

Launched in 1935 during the Great Depression as a principal component of Franklin D. Roosevelt’s New Deal recovery program, the Social Security System has earned an unquestionable reputation for the reliability of its stream of monthly checks to retirees, the nation’s first comprehensive source of retirement income.

But did the laws that authorized the checks and ensured their reliability also:
· Permit the checks—based on your lifetime income —to be large enough to sustain seniors in comfortable retirement?
· Require Social Security checks to be taxed too much by the same Treasury Department which issued them?
· Reduce the checks too severely for those who needed money before becoming 65.
· Enable beneficiaries to get back all of the money they had paid into the system over the years?

While these questions—and the question of the system’s continuing reliability as the ratio of beneficiaries to taxed active workers increases—are debatable and debated by lawmakers, the most baffling for many individual workers as they plan for the approach of retirement is: when do you start receiving Social Security checks?

The answer, partly rooted in changing regulations, is not easy. Nor is it the same for all individuals.

Yet, it is very important. On it depends not only when you start to receive checks,
how large your checks will be—the earlier you start, the smaller your checks—and how much you may earn from other work once you start, but also how much net Social Security income you will have left after income taxes.

To understand how these things are determined, you first have to understand the regulatory concept of your “normal retirement age” (also called your “full retirement age”) at which your retirement benefits equal your “primary insurance amount.” For those born in 1937 or earlier, it is 65. For those born in 1960 or later, it is 67. For those born in 1938 through 1959, it is in-between. (Useful tables which spell out this and other relevant regulations appear on the Social Security Administration’s Web site, www.ssa.gov).

If you decide to start withdrawing Social Security before your “normal” retirement age, you may retire as early as age 62, but your benefits may be reduced as much as 30 percent if you were born after 1959 or 25 percent if you became 62 in 2005—a reduction that shrinks your monthly checks permanently.

If you decide to defer getting Social Security past your “normal” retirement age (delayed retirement credits), your benefits may be increased by percentages depending on when you were born: from 3 percent if you were born in 1917-1924 to 8 percent if you were born in 1943 or later. You would receive your largest benefit by retiring at 70.

Whatever the SSA determines you should get monthly (to be further adjusted annually for inflation unlike most private sector pensions) may be (further) reduced if you get work for pay before you reach your “normal” retirement age: $1 in benefits for each $2 you earn above an annual limit. Last year, that limit was $12,000; this year, it’s $12,480. In the year you will reach “normal” retirement age, the reduction is less—$1 in benefits for each $3 you earn above $33,240 in 2006, until you reach the point at which you can earn all you are able to without penalty. This point is reached once the recipient arrives at their normal retirement age.

For example, a retiree with earned income of $25,000 and a Social Security benefit of $1,000 per month would receive just $478 each month after a reduction due to earnings.
Done with the SSA, you now emerge on the radar screen of the Internal Revenue Service, which is required to get its share and finds you an especially fertile target if you have substantial income beyond Social Security. A SSA Web site calculator helps you to understand how the earnings test would apply to you.

If you are filing a federal income tax return as an individual and have “provisional income”—defined as adjusted gross income plus nontaxable interest (such as interest from tax-exempt bonds and income dividends from municipal bond mutual funds) plus 50 percent of your Social Security benefits—between $25,000 and $34,000, you may have to pay income tax on that 50 percent. If your combined income exceeds $34,000, up to 85 percent of your benefits may be taxable.

If you file a joint return and you and your spouse have provisional income (as defined above) of between $32,000 and $44,000, you may have to pay tax on 50 percent of your Social Security benefits. However, up to 85 percent of your benefits become taxable when your combined income exceeds $44,000. This is a complex rule, so consider contacting the Social Security Administration or your tax adviser for more information.

March 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC a local member of the FPA.

The Trials and Tribulations of Measuring and Comparing Investment Returns

2006-03-26T14:24:00.000-05:00

Measuring and comparing investment performance is not an easy task. Consider, for instance, something as simple as the daily comings and going of the stock market. One month the Dow Jones industrial average (DJIA) is up and the next month it’s down. But do those changes really tell the whole story?

Not really. The continuous changes in the DJIA merely represent the change in the market value of the 30 stocks that make up the DJIA. The actual change would reflect not just the change in market value but the income from the dividends from the companies comprising the Dow. And since the DJIA currently has a dividend yield of 2.5 percent, the actual investment performance, or what some refer to as the actual total return of 30 stocks in the Dow, would be different from what is typically reported based only on price changes. In addition, the DJIA is a “price weighted” index, so that higher priced stocks have a higher impact on index performance. Most of the other common indexes are “market weighted,” reflecting the relative market composition of the stocks in the index.

So what then are some of the best ways investors and planners should measure and compare investment performance?

According Herbert Mayo, author of a time-honored textbook on the subject of investments, the simplest way to calculate a return on an investment is by considering the flow of income, such as dividends, plus price gains (or loss) relative to the amount invested for a given holding period. So for example, if a person buys a share of stock for $40, collects a $2 dividend and then sells the stock for $50, the holding period return would be ($50 + $2 - $40) divided by $40. Thus the holding period “total” return would be 30 percent. A shortcoming of holding period returns, however, is the failure to consider how long it took to earn the return. After all, if the difference in time between buying and selling is 10 weeks, then a 30 percent return is great; if it is 10 years, 30 percent is not as impressive.

According to Mayo, this problem is avoided by calculating the so-called internal rate of return. A simple example of internal rate of return is the yield to maturity on a bond. Yield to maturity equates the present value of the cash flows (interest payments and principal repayment) with the present cost of the investment while assuming that interest income as received is reinvested at the same (yet to be determined) yield. Though a tad complicated, the key difference between a holding period return and compound annual return is that the

latter return considers all cash inflows to an investor when they occur and compares them with the cost of the investment. But in comparing portfolio returns where money is being added and subtracted from holdings, we must decide how to weight the returns of the individual holdings.
Weighting the performance of each individual investment relative to the size of the investment (a dollar-weighted return) may give predominant weight to recent large investments and may not truly represent portfolio performance over an extended holding period

An alternative to this misrepresentation on the part of a dollar-weighted rate of return is the time-weighted rate of return. Simply computing the average of a series of returns can also be misleading. So, for instance, if an investor buys a stock for $40 and collects a $1 dividend in year one and the stock closes the year at $42, the time-weighted return would be ($42 + $1 - $40) divided by $40, or 7.5 percent. If the investor held that very same stock for another year, closing at $50 and collecting another $1 dividend, the holding period return for that year would be 21.43 percent, or ($50 + $1 - $42) divided by $42. The simple average return would be 7.5 + 21.43 divided by 2 or 14.47 percent.

So which method of calculating is preferred? According to Mayo, there is no absolute right answer. Typically, the investor is concerned with the return earned on all the money invested, making dollar-weighted the more preferred method. However, Mayo says one can make the argument for the use of time-weighted returns to evaluate the performance of portfolio managers. By way of history, a study published in 1968 by what was then called the Bank Administration Institute (BAI) suggested that measurements of performance should be based on asset values measured at market, not at cost; the returns should be “total” returns; that is, they should include both income and changes in market value (realized and unrealized capital appreciation); the returns should be time weighted; and the measurements should include risk as well as return.

No matter the method of calculating investment performance, it’s also especially important that planners and investors compare the investment performance of their portfolios to appropriate benchmarks. Typically, according to The Financial Analyst’s Handbook, there are three useful standards against which portfolios can be measured, including comparison with an absolute goal; comparison with market indexes, and comparison with other portfolios. Of note, financial planners say that dollar-weighted returns compare very poorly against benchmarks when there are large cash flows; time-weighted returns are the only ones that are really appropriate for benchmark comparison purposes.

March 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Hillebrand Financial Planning, LLC a local member of the FPA.

Taking Time to Understand the 2006 Tax Changes

2006-02-14T21:26:00.002-05:00

The Internal Revenue Code is not ordinarily thought of as a gift that keeps on giving, but, with 2005 having given way to 2006, it does contain several sections which provide for keeping more of what you will be earning and saving more for your retirement—on a tax-sheltered basis—out of what you keep.

They also provide, in some cases, for siphoning slightly more of what you earn—as your income increase with inflation—but these cases are far less numerous.

Therefore, as you make spending and saving plans for 2006, it should be helpful to note of significant federal income tax changes that became effective on New Year’s Day, such as:

Tax rates: For married couples filing jointly and surviving spouses, for example, the 25p percent marginal tax rate begins to apply to those with taxable income of from $61,301 to $123,700, instead of $59,401 to $119,950, after adjustment for inflation. For single taxpayers, the 25 percent bracket was increased to taxable income of $30,651 to $74,200, from $29,701 to $71,950. Similar changes were made for lower and higher tax brackets, and for married individuals filing separately, heads of household, and trusts and estates. (See IRS Form 1040 booklet and the Internal Revenue Service’s Web site, http://www.irs.gov.)

Social Security and Medicare: The Social Security tax rates for employers and employees were maintained at 6.2 percent, but the maximum amount of salaries and wages subject to the tax was raised from $90,000 to $94,200. The maximum earnings for beneficiary under full retirement age were increased from $12,000 to $12,480 annually.

The additional Medicare hospital tax on both employers and employees of 1.45 percent also was unchanged, but monthly Medicare Part B premiums went up from $78.20 to $88.50.

Standard deduction: The standard deduction for married taxpayers who do not itemize deductions and who file jointly, as well as for qualifying widows and widowers, was increased to $10,300 from $10,000, for single taxpayers and married taxpayers filing separately to $5,150 from $5,000, and for heads of household to $7,550 from $7,300.

Deductions for use of car: Standard rates per mile of deductions for use of a car for business purposes was changed to 44.5 cents from 40.5 cents in 2005’s first eight months and 48.5 in the last four and for medical or moving purposes, to 18 cents from 15 and 22 cents, respectively. The rate for use of a car for charitable purposes was held at 14 cents per mile except for taxpayers using a vehicle only in connection with aid to Hurricane Katrina victims, whose deduction is 70 percent of the business mileage rate in effect on the date of the contribution.

Long-term care insurance deductions: Limits on annual deductions for premiums for eligible long-term care insurance policies were raised across the board—for those over 70, from $3,400 to $3,530; for those 61 to 70, from $2,720 to $2,830, and for younger taxpayers, significantly less.

Exemptions: The amount that may be deducted for each exemption was increased from $3,200 to $3,300, as were the levels of adjusted gross income at which exemptions begin phasing out, from $218,950 to $225,750.

Retirement plan contributions: Just when slippage in average annual returns on stock and bond investments underscores the importance of having more money at work for a retirement nest egg, the annual limit on contributions to IRS-qualified retirement plans has gone up again, making it easier.

Under salary reduction agreements permitting deferral of income taxes for contributions to 401(k)s, 403(b)s, SAR-SEPs, and the Thrift Savings Plan for federal employees (456(b)s), participants may now contribute $15,000 instead of $14,000, some or all of which may be matched by employers. The limit on additional “catch-up” contributions to 401(k), 403(b) and 457(b) plans by individuals of 50 or older was raised from $4,000 to $5,000, with a resulting higher limit on total contributions of $20,000. The 2006 limit on contributions to traditional and Roth IRAs is $4,000, the same as 2005; but the “catch-up” limit was lifted, from $500 to $1,000.

Gift tax: The annual exclusion from gift tax was increased from $11,000 to $12,000 per person.

Estate tax: The exclusion from federal estate tax of estates’ market values was raised from $1.5 million for people dying in 2005 to $2 million for people dying in 2006, and the maximum tax rate for taxable estates was reduced from 47 percent to 46 percent.

This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC, a local member of the FPA.

Figuring out the College Financial Aid Formula

2006-02-14T21:26:00.001-05:00

Few areas of financial planning are more complicated for parents than ensuring that their children will have enough money to pay for tuition, room, board, books, transportation and other related expenses. But the payoff—the likelihood that a good college education will expand their children’s opportunities to enjoy gratifying careers and higher lifetime incomes—is worth planning for.

What makes the task so complicated is that, on the average, college bills have been rising—and continue to rise—faster than after-tax personal income. Even more challenging, especially when college is still years away, is the uncertainty inherent in the never-ending kaleidoscopic changes among government and college financial aid programs and relevant federal and state income tax provisions—not to mention lower real after-tax returns on savings and investments.

Parents unable or unwilling to plan until a child is a high school junior may have to contend with less uncertainty, but, deprived of the prospects of many years of even average returns on their savings and investments, they have the disadvantage of having to cough up a lot of money out of assets and current income in a short time.

Those who start as soon as a baby is brought home from the hospital may maximize the benefits of compounding interest or equity returns—even if only at lower rates —over at least 18 years, but they are aiming at unknowable targets which even skilled financial planners can’t forecast with certainty. Among them: Will the baby grow up to be a prospect for Harvard—with its high costs—a community college, or a vocational school?

In the face of all the unknowns the best that parents and planners can do is start with what is known—such as the year in which the child is expected to start college—and split the others between the likely and the unlikely. The year provides not only the probable period for accumulating asset to meet college expenses, but also the probability and extent of other liabilities, including retirement.

In planning the financing of a child’s college education, it may be helpful for parents to know how the share of the total cost that they may be required to pay will be determined by the child’s school on the basis of:

What they estimate, when filling out the federal student aid form, to be their “expected family contribution” (EFC), subsequently converted into an “official” EFC.

What the school calculates to be the amount that the family is expected to pay and the amount of federal student aid for which the family is eligible, based on school policies as well as federal law. The calculation takes into consideration more than easily predictable things such as parents’ compensation and assets. For example:

Whether a family has other children who will be going to college—helpful to wealthy as well as poor families;
Whether a child is admitted to a high-cost private university or a state college;
Assets in the child’s name, which may reduce financial aid eligibility.

Whatever the family’s share, the rest—for over one-half of all undergraduate students—comes from financial aid:

Federal programs, which provide two-thirds of all student financial aid through (a) grants, such as Pell grants, that are based on need, cost of attendance, and enrollment status, and (b) direct or guaranteed loans, such as Stafford loans, on which interest may be deferred until graduation and may be deductible from taxable income up to $2,500 annually. The Free Application fr Federal Student Aid (FAFSA) is a great place to start: http://www.fafsa.ed.gov/.
Loans and grants from universities and colleges. While most of their aid is in the form of loans, grants account for a growing share. Some base their aid on merit as well as need, which may also be helpful to upper-income families.
Scholarships from a large variety of organizations ranging the alphabet from the American Legion to the YMCA. A great Web site for scholarship is http://www.fastweb.com/.

Not knowing years earlier what loan and grant possibilities are likely to be, it is

essential for parents to start early to accumulate the family’s share—after determining whether tax law would make accounts’ ownership by the child, parents, or other relatives more advantageous.

Aside from conventional taxable and tax-exempt investments, there are special tax-sheltered vehicles, such as 529 Plans and Coverdell Education Savings Accounts (ESAs).

Changes in Store for Medicare and Medicaid

2006-02-14T21:26:00.000-05:00

President Bush signed into law in February the Deficit Reduction Act, otherwise known as the fiscal year 2006 budget reconciliation bill. That law, which contained more than $39 billion in cuts, including $6.4 billion from Medicare and $4.8 billion from Medicaid, has plenty of changes in store for seniors.

Under the new law, for instance, most Medicaid beneficiaries would be required to pay higher co-payments for health care services and could be denied service for lack of payment. Provisions affecting Medicare include higher premiums for beneficiaries, with greater increases for higher-income beneficiaries, and a freeze in payments for home health care providers. The bill also cancels a scheduled cut in Medicare reimbursements to physicians and provides medical care to some hurricane survivors.

Here, according to Bernard A. Krooks, founding member of Littman Krooks in New York City and White Plains and Harry Margolis, founder and president of ElderLawAnswers.com, are the three major changes to Medicaid eligibility rules under the new law.

1. The look-back period will be 60 months for all asset transfers

Under the old law, outright transfers were subject to a 36-month look-back period and transfers to or from certain trusts were subject to a 60-month look-back period.

Under the new law, the look-back period – though some asset transfers will be grandfathered – has been increased from 36-months to 60 -months for all transfers. And all transfers made within the look-back period will have to be documented and explained to Medicaid authorities.

2. Start of eligibility deferred

Under the old law, the “penalty period” for institutional Medicaid started on the first day of either the month in which the transfer is made or the first day of the following month. But the new law postpones the beginning date for any transfer penalty to the first day of the month in which the individual is (1) in a nursing home or receiving “waivered” home care, (2) has spent down his or her savings, and (3) would be eligible for benefits but for the transfer.

States do have, however, the option of starting the penalty period in the month of asset transfer or in the month following asset transfer. For example, in New York, it's the month following the month of transfer and in Massachusetts it's the first day of the month in which the transfer occurs.

The point, basically, is this: Imagine you transfer $50,000 that would normally disqualify you for 12 months based on your state’s costs. Before, if you transferred $50,000, you’d be free and clear after a year (measuring from transfer date). Now, the measuring doesn’t even start until the person would otherwise be eligible (but for the transfer), so they will have to wait an entire year from the date they are already impoverished and seeking care, or will have to wait for the five-year period (from #1 above) to expire. This could even unwittingly affect gifts for someone made years earlier before they even anticipated needing Medicaid.

The upshot of this change? Individuals, in most states, must own less than $2,000 in non-exempt resources when applying for Medicaid. To establish this date, the nursing home resident or any prospective applicant must apply for Medicaid coverage and be approved (but for the transfer).

3. Equity in home will count

Under the old law, a person's home was exempt regardless of value, if certain conditions were met. Under the new law, the equity in a Medicaid applicant's otherwise exempt home will be countable to the extent it exceeds $500,000. Thus, a person with equity in a home of more than $500,000 would not be eligible for Medicaid. Of note, states will have the option to raise the limit to $750,000.

Seniors and their adult children may need to consult with qualified and competent professionals who can evaluate issues and recommend potential solutions, including long-term care insurance, reverse mortgages and home equity loans.

Another provision of the new law will give all states the authority to set up Long Term Care Partnership programs, or programs that encourage residents to buy private long-term care insurance by relaxing Medicaid nursing home benefit qualification rules for private policy holders who exhaust private benefits. Up till now, only California, Connecticut, Indiana and New York have been permitted to operate partnership programs.

EVALUATING THE NEED FOR INSURANCE IN RETIREMENT

2006-01-19T19:58:00.001-05:00

Of all the changes that come in retirement, few are likely to give you more concern than dealing with money. Your concern is, of course, understandable and widely shared because so much of what will happen is unpredictable. That’s especially true of how long and how well you may live—whether you live long enough to have to lower your standard of living so that you can stretch your nest egg to avoid the horror of outliving your money.

Although you may improve your situation by taking good care of your health and living without extravagance, you should be adequately covered against unforeseen losses by the right kinds of insurance. If you think of insurance as a product to be bought and focus only on its costs, you may consider it a luxury that you cannot afford.

But if you regard it as a vehicle for managing risk—at a time in your life when you probably will be more vulnerable to the risk of substantial losses and less able to recover quickly—you may think of certain types of insurance as necessities while considering others only as optional. During retirement there are three major risks: risks to health, longevity and to our property. Some of these risks are ones should be addressed before the age of retirement.

NECESSITIES

Medicare supplement (Medigap) or Medicare Advantage insurance. This coverage helps you to pay Medicare deductibles and the portion of hospital and medical charges that are approved by Medicare but not paid by it in a year when your total hospital and/or medical charges are high—something that can happen when you get older. Those who are willing to pay more to have a greater choice of services generally choose a Medigap policy. Those who prefer to save money and use a limited pool of medical service providers might prefer to use the Medicare Advantage program.

Prescription drug coverage. At a time when your need for prescription drugs may grow, be sure that you have insurance to cover a substantial share of those costs. In some cases, a retiree will have the choice of using a prescription drug plan offered by a former employer. In other cases, a retiree’s only choice will be to sign up for the new Medicare Part D drug plan. The latter is a voluntary program, however, so don’t hesitate to sign up if that’s your only option.

POSSIBLE NECESSITY

Long-term care (LTC) insurance. This insurance is designed to help you to meet the high costs of nursing facility, assisted living and/or home care that you might incur if and when you are not able to handle the activities of daily living such as bathing and dressing.

While LTC insurance might not be for everyone, it is very important to evaluate such insurance while you are young and healthy, generally in your early 50s. The cost of this coverage is based on your age and health at the time you apply for coverage. By waiting to consider LTC insurance, many people risk the onset of health conditions that may subject them to higher risk classes with higher premiums, or, even worse, may make them uninsurable for LTC insurance. One of the biggest mistakes made when purchasing LTC insurance is to inadequately cover for inflation of LTC costs. LTC insurance can be purchased as an employee benefit, through an association or individually. Group plans often provide discounts or underwriting concessions.

OPTION

Additional life insurance. If you have sufficient life insurance coverage—under a group and/or individual policy—and/or financial assets to provide for your spouse and/or other beneficiaries, including enough to help them during the first year after your passing, you probably won’t need additional life insurance coverage. If not, shop among strong insurance companies for the plan that best meets your personal needs and is priced reasonably.

CONTINUING COVERAGE

In retirement, of course, you must maintain and budget for other insurance policies—such as for your home and cars—because retirement does not change your need to protect yourself against the risks of fires, floods, natural disasters, accidents, or other potential causes of losses. However, you should examine these policies to see whether you should add or delete anything—or raise or reduce the values of specific items such as jewelry or electronic equipment. You may find that you are still paying a premium for an item that you disposed of years ago. It’s always a wise move to reevaluate your insurance needs as you transition into retirement.

January 2006— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC, a local member of the FPA.

CARING FOR ELDERLY LOVED ONES FROM AFAR

2006-01-19T19:58:00.000-05:00

There was a time when family members – grandparents, parents and children alike – lived in close proximity to each other, often in the same house. But that was then and this is now. And now, it’s becoming increasingly common for family members to live in different parts of the country. That trend is fast colliding with care-giving for the elderly.

According to the MetLife Mature Market Institute’s Since You Care guide, there are some 34 million Americans providing care to older family members. And 15 percent of these caregivers, or 5.1 million, live one or more hours from the person for whom they are providing care.

According to MetLife, these “long-distance caregivers,” in many instances, are caring for a parent or other older relative and are also employed and have dependent children of their own. Because of this, they are often referred to as the sandwich generation. “In some circumstances, due to actual physical distance and/or other constraints, the long-distance caregiver may be unable to provide the direct, everyday, hands on care, but is responsible for arranging for paid care and coordinating the services that are provided.”

And that’s no easy task. In many cases, long-distance caregivers must often juggle the demands of two households. Often, they have to rely on reports from others about daily events. Just as often, they have to arrange and then rearrange work schedules, business trips and doctors’ appointments. In short, the task can be difficult, stressful, and time consuming, according to AARP. But there are a number of steps you can take to make the task more manageable.

Gather information and assess the need. Adult children should determine with their parents (and other family members) what help is needed. In some cases, adult children should consider hiring a professional geriatric care manager who can assess a family member’s needs and who, if need be, can provide ongoing case management. Geriatric care mangers are often familiar with the services that are available to aging parents. Finding a professional geriatric care manager is easy enough, say experts. The National Association of Professional Geriatric Care Managers has a Web site that provides links to association members, many of whom are former nurses or social workers (www.findacaremanager.org). A professional geriatric care manager might charge $100 to $500 for an assessment and $60 to $90 an hour for on-going care. If you choose this option, work with geriatric managers who are licensed or certified by the states in which they work and be sure to conduct a full background check before you hire. Many states and municipalities typically have benefits and resources that can be used by qualifying individuals to help cover the costs of some of these services. Another resource, the Eldercare Locator (800.677.1116) can tell you which local agencies provide services and will refer you to the area agency on aging in your parents' community.

Be prepared. Before a crisis occurs, caregivers and older family members should complete and distribute widely a “caregiver emergency information” kit. That kit should contain all necessary medical, financial, and legal information, including doctors, medications, insurance information, assets, and Social Security numbers, wills, living wills, durable powers of attorney and health care proxies. Adult children should ask their parents to complete privacy release forms, HIPAA compliant, and keep copies on file with their parent’s doctor’s office. That way, the parent’s doctor can discuss an older family member’s health. MetLife has a caregiver booklet that can be downloaded from its Web site, www.maturemarketinstitute.com. AARP also has useful long-distance care-giving resources at its Web site, www.aarp.org. Caregivers might also consider using a personal medical alert emergency response system.

Develop an informal network. Experts say adult children should establish an informal support network composed of family, neighbors, friends, clergy, and others who might help. Adult children, when visiting their parents or older family members, should introduce themselves to neighbors and friends and keep their phone numbers and addresses handy. If an adult child can't reach a parent, calling that informal network can provide peace of mind. Plus, they may also be able to help with some needed tasks.

Visit as often as you can. Long-distance caregivers should visit their older family members every few months to check for signs of trouble – which might include changes in personal hygiene, old food in the refrigerator and chores not done. Long-distance caregivers should note, however, that such care can be expensive. According to MetLife, caregivers spend an average of $193 per month on out-of-pocket purchases and services for the care recipient and another $199 per month in traveling and long-distance phone expenses.

It might make sense to consult your financial planner early-on, to ensure that your loved ones are properly cared for in the future.

January 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC a local member of the FPA.

NAVIGATING THE FEDERAL AND STATE ESTATE TAX MAZE

2006-01-19T19:53:00.000-05:00

To taxpayers, the Economic Growth and Tax Relief Reconciliation Act of 2001 may have meant income tax cuts resulting in more current after-tax income, but to financial planners it has meant more work for clients to develop strategies to minimize both federal and state estate taxes, a less widely-publicized section of the 114-page law.

Why? For starters, it has changed the basic provisions of federal estate tax law, culminating in their expiration in 2010, which planners have had to factor into existing and new estate plans:

• A gradual increase in the portions of estates’ values that are exempt from the federal estate tax from $675,000 for those of people dying in 2001 to $3.5 million for those of people dying in 2009.

• A gradual reduction in the maximum tax rate from 55 percent to 45 percent for estates of people dying in 2007, 2008, and 2009.

• The uncertainty as to whether such changes will be made permanent, be amended under some future law, or be undone in the improbable, but not impossible, absence of any new legislation applicable to 2011 and beyond.

At year-end 2005, exemption from the federal tax rises from $1.5 million to $2.0 million for estates of those dying in 2006 (and as its maximum rate falls from 47 percent to 46 percent). But consumers will also have to cope with the continuing proliferation of changes at the state level resulting from the act.

Why? Since 1926, states have been able to piggyback on the federal estate tax, enacted in 1916, by adopting state estate taxes for which they siphoned off a limited share of the revenues collected from their deceased residents’ estates in accordance with the federal tax’s provisions—without raising estates’ total tax bills. The limit: 16 percent of taxable estates’ values, equal to the maximum for which estates could claim credit for state taxes on their federal tax returns.

As adoption of the “pick-up” tax spread, states came to rely more on it and less on other wealth transfer or “death” taxes. In 1980, as noted by Daphne A. Kenyon in State Tax Notes last May, 12 states relied exclusively on pick-up taxes, 29 on a combination of inheritance and pick-up taxes, and eight on free-standing estate and pick-up taxes. By 1998, the number relying exclusively on pick-up taxes had jumped to 33, the number imposing both inheritance and pick-up taxes had slumped to 13, and the number collecting both free-standing estate and pick-up taxes had fallen to four.

The 2001 act impacted this pattern in three major ways:

It repealed the credit for state estate taxes in 25 percent increments over a 4-year period ending this year, raising revenue going to the Treasury and leaving states—of which 37 relied on the pick-up tax exclusively by last year—scrambling for a substitute source of funds. In the aggregate, all forms of state wealth transfer taxes accounted for only 1.2 percent of all state tax revenues in 2003, according to Kenyon.

It precipitated a flurry of activity in state capitals to decide how to make up the lost revenue. States without estate taxes were encouraged to adopt them. States with estate taxes were encouraged to raise their rates and/or otherwise raise more funds. The result: a varied pattern with differences in maximum estate tax rates and exemptions among the states as well as between the states and the federal government, even leading to cases of states taxing estates whose values are too low to be taxed by the feds, now that exemptions are higher. State governments have not been alone in being engaged in a flurry of activity to deal with estate tax reform. With the changes in state taxes and a decline in their uniformity, financial planners have had to scurry to develop suitable estate plans for clients in a wider range of circumstances, giving unprecedented attention to state estate taxes.

It allowed estates to deduct state estate taxes on federal estate tax returns, starting this year.

With estate tax credits and the pick-up tax becoming only a memory, will the same fate be in store for other state wealth transfer taxes, relieving financial planners from having to deal with them?

Kenyon seemed to think so. “I expect over time the remaining states with wealth transfer taxes will come under pressure to repeal them,” she wrote, “and unless the federal estate tax and accompanying state credit is reenacted, I think state wealth transfer taxes will eventually disappear.”

FINANCIAL PLANNING FOR LIFE

2005-12-12T22:24:00.000-05:00

If the term “financial planners” evokes visions of equities and equity mutual funds—selected to implement financial plans they developed for clients in accordance with their investment goals and tolerance for investment risk—it should not be surprising.

Equity Ownership in America, 2005, a study recently released by the Investment Company Institute and the Securities Industry Association, found that more than 75 percent of the millions who own equities and equity funds outside employer plans bought them through financial planners and other professional financial advisers.

But financial plans leading to ownership of portfolios of equities and equity funds are hardly planners’ only services. They not only have delved increasingly into areas beyond investment advice, they also have met clients’ needs for more of their life goals, giving rise to the concept of financial life planning.

Some may think that financial planning is a one dimensional process involving technical skills, such as Monte Carlo projections, retirement income calculations, investment analyses and asset allocation. But with financial life planning, planners may ask questions like, “If you could live your ‘ideal calendar,’ what activities would be on that calendar?” Questions like this get more to the heart of really good financial planning and its natural extension… ‘life planning.’

The underlying premise is self-evident: people have different goals during different stages of their lives and may not have the confidence—or the necessary time—to deal with them on their own. Life planning is also about raising a person’s awareness of the things they do daily, which they may do automatically, which really should involve choices. By helping people think outside the box of their daily assumptions and helping them identify choices, life planning helps them get more from their financial resources. The roles of financial life planners, as they see them, are essentially to help clients to do at least four things:

When initially formulating plans, define and rank clients’ goals at each stage
Identify what the goals require of them as they approach each stage
Implement plans by advising clients on managing their affairs to realize goals
Monitoring implementation and changes in clients’ circumstances to modify plans, goals, and goals’ requirements as necessary.

The number of stages into which clients’ lives are divided will, of course, vary based on a number of factors such as the ages at which plans are initiated, the paths which careers take, and the career vs. leisure activity decisions made along the way.

A few examples will illustrate the types of life stages that people experience and the types of goals associated with them:

Start of career

· Analyses on which to base a choice of employer when lucky enough to be faced with more than one job offer. Of note, the job offer analysis may well be a financial one only, which in life planning would be part of it. A life planner might dig deeper to find out lifestyle requirements of different jobs, longer range opportunity and wealth building opportunity. They might even ask the question, “Which one would you love?” It's not that the planner is trying to become a career counselor, but rather to help a person make good choices towards a more rewarding and secure life.

· Budgeting to provide for both paying off student loans and contributing to employers’ tax-deferred savings or retirement plans as soon as eligible.

· Choices among employer plan options.

Marriage

· Economic considerations associated with decision as to whether both spouses will have jobs.

· Choice of residence, factoring in economics of renting vs. buying.

· Integration of investment portfolios beyond employer plans (if any).

· Optimizing taxes on investments and other income sources to maximize after-tax income (including handling of capital gains and losses).

Obtaining appropriate life insurance coverage.
Revision of wills.
Initiating savings for college if children are in the future.

Mid to Late Careers

Adjust portfolio and employer plan’s asset allocation.
Advise—and, if necessary, oversee—parents with respect to their retirement assets and residence.

Acquisition of retirement cottage, factoring in economic considerations such as estate taxes.

End of Careers

Early vs. “normal” retirement.
Decisions regarding Social Security.
Need of long-term care insurance.
Updating wills, including provisions for universities and other nonprofits.

These are just a few of the functions performed in financial life planning. A financial life planner will explore much more deeply with his or her clients those personal characteristics that influence their financial choices, including fears, dreams, family circumstances, work-life balance, values and volunteer commitments.

Once the financial life planner has explored the above (and more), a financial plan can be designed within the context of life stages that reflects what is most meaningful in the client's life and how they define true wealth.

December 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC, a local member of the FPA.

MAKING AND KEEPING INVESTMENT PORTFOLIO AND FINANCIAL PLANNING RESOLUTIONS FOR 2006

2005-12-12T22:22:00.000-05:00

Even if you aren’t among those who normally make New Year’s resolutions—and keep them—this may be a time when you will want to make and keep them in the year to come.

With the Standard & Poor’s 500 Stock Index up 1.05 percent through October and the average U.S. taxable investment grade bond returning an almost identical 1.12 percent, as indicated by the Citigroup Broad Investment-Grade Bond Index, barring a year-end rally, 2005 could wind up as a flat year in both stock and bond markets.

Whether the ultimate results are flat, up a little, or down a little, you could be thinking of adjusting your portfolio to improve its performance by taking bigger risks—perhaps more than would be appropriate for you. Given the potential losses inherent in such a strategy, the following resolutions may be helpful as you consider your year-end strategy:

Allocate your assets among bonds, stocks, money market instruments, and funds in proportions that reflect the amount of risk necessary to achieve your goals. In some cases, that may mean that portfolios don’t need to be or shouldn’t be more conservative ‘just because’ someone is older. It should really be about allocating for your particular goals and needs, not ‘just because’ you are at a certain age or spending level. Disregard recommendations of all-purpose model portfolios’ asset allocations. They may indicate how various investment strategists feel about the near-term attractiveness of stocks and bonds but weren’t offered with your particular investment goals and risk tolerance in mind.

Have realistic expectations of performance. The years of exceptional annual returns for stocks, on the average, are a memory now. Annual returns averaging below the long-term average of about 10 percent annually seem more likely in the foreseeable future. Whatever they are, the average returns for balanced portfolios are likely to be single-digit.

Resolve to maximize your net returns by holding down (a) excessive commissions when buying or selling individual securities and mutual funds and (b) excessive expenses when investing in mutual funds. When investing in taxable accounts, be mindful of the tax consequences of owning mutual funds that make large taxable distributions of realized short- and long-term capital gains. Recent research published in the Journal of Financial Planning suggests that funds with low turnover and long-term capital gains still belong in taxable accounts and that funds that have large amounts of short-term gains distributions should be placed in retirement accounts, such as IRAs, 401(k)s, or other tax-deferred accounts.

When investing for income, resist the temptation of chasing high yields. Higher yields are generally associated with higher risk, and with some investments what appears to be yield may actually be a return of capital.

Don’t forget bond funds. Tax-exempt state or local government bonds or “municipal” bond funds, whose yields are usually lower than those of taxable issues of comparable credit quality and maturity, may pay you more than you’d have left after taxes when investing in the comparable taxable securities. Do the math: compare your prospective after-tax income from the taxable securities with what you’d get from the tax-exempts.

Accept that there is no shortcut to mutual fund selection. Whether you do it or an adviser does it for you, funds have to be studied—primarily in funds’ own, SEC-mandated literature—to determine their suitability. Data indicating superior past performance—which funds must report in accordance with SEC regulations and update periodically—don’t assure you of superior future performance. Neither do ratings, such as the 5-star ratings for risk-adjusted performance calculated by Morningstar. They may provide you an additional dimension of past performance, but, as Morningstar has long reminded investors, they don’t have predictive value. Such data constitute the beginning, not the end, of the selection process, indicating which funds’ literature you might study.

Don’t be too impressed by high absolute returns. Compare past performance data for an equity fund with performance data for the same periods for the S&P, Russell, or other index—for the broad stock market, for large or small companies’ stocks, for growth or value stocks, and so on—which the fund management has chosen as its benchmark. You may also compare them with data for peer funds computed by Lipper or Morningstar. By focusing on relative returns, such comparisons tell you whether the fund has performed as well as could be expected, better, or worse, given the stocks it owns.

Always remember that stocks and bonds—and the funds that own them—are long-term investments, requiring patience and the ability to ride out market volatility. Stocks and stock funds are unlikely to be, as magazine covers will have you believe, “the 10 (whatever) you must own in 2006.”

EQUITY-INDEXED ANNUITIES DEMYSTIFIED

2005-12-12T22:14:00.000-05:00

There is perhaps no financial product more confusing today than equity-index annuities or EIAs. On the surface, EIAs are somewhat simple. Like most annuities, EIAs are nothing more than a contract between you and an insurance company in which the company promises to make periodic payments or a lump-sum payment to you, starting immediately or at some future time, according to the NASD.

But EIAs are more complex than traditional fixed annuities or variable annuities. As with fixed annuities, they provide a guaranteed minimum return, typically 90 percent of the premium paid at a 3 percent annual interest rate. However, EIAs also typically provide a potential upside amount tied to an equity index, similar to variable annuities.

Herein lies much of the confusion. EIAs give you more risk but more potential return than fixed annuities but less risk and less potential return than variable annuities. How so? According to the Securities and Exchange Commission (SEC), EIAs work as follows: During the accumulation period – when you make either a lump-sum payment or a series of payments – the insurance company “credits” you with a return that is based on changes in an equity index, such as the S&P 500 Composite Stock Price Index, but not necessarily equal to the full total return of the index.

The variations in insurance company crediting procedures add much to the complexity of EIAs. These deviations from a uniform standard often contain several features that can affect your return. And you should fully understand how an EIA computes its index-linked crediting rate before you buy such a product. EIAs typically include one or several of the following three common features used to compute the return:

Participation Rates. The participation rate determines how much of the index’s increase will be used to compute the index-linked interest rate. For example, if the participation rate is 90 percent and the index increases 5 percent, the return credited to your annuity would be 4.5 percent.

Crediting Rate Caps. Some EIAs set a maximum rate that the equity-indexed annuity can be credited in a year. If a contract has an upper limit, or cap, of 7 percent and the index linked to the annuity gained 7.2 percent, only 7 percent would be credited to the annuity.

Margin/Spread/Administrative Fee. The index-linked return for some EIAs is determined by subtracting a percentage from any gain in the index. This fee is sometimes called the “margin,” “spread,” or “administrative fee.” In the case of an EIA with a “spread” of 3 percent, if the index gained 9 percent, the return credited to the annuity would be 6 percent (9 - 3 = 6).

Another feature that can affect an EIA’s return is its “indexing method,” which identifies how the amount of change in the relevant index is determined to calculate the crediting rate. According to the SEC and NASD, common indexing methods, which may apply annually or only at the end of a set number of years, include:

Point-to-Point. This method credits an index-linked return according to any increase in index value from the beginning to the end of the contract’s term.

Monthly Averaging. This method determines the amount of return to credit based on the average value of the index over a period of months (typically calculated over 12-month periods, on the contract anniversary date).

High Water Mark. This method credits an index-linked return according to any increase in index value from the index level at the beginning of the contract’s term to the highest index value at various points during the contract’s term, often annual anniversaries of when the EIA was purchased.

EIAs can also be confusing because of other potentially pricey features. If you surrender your EIA early, you may have to pay a significant surrender charge to the insurance company, plus a 10 percent tax penalty on earnings to the IRS if you are below 59½ years of age. The SEC also says you can still lose money if your guarantee is based on an amount that’s less than the full amount of your purchase payments. And, in some cases, the SEC says insurance companies may not credit you with index-linked interest if you do not hold your contract to maturity, foregoing all of your credited returns over the years to instead receive only the minimum guarantee.

In short, do your homework before you purchase an EIA. Understand how it works, what factors to consider in making your decision, and how you can avoid common problems. It may be possible, less expensive and less complicated to accomplish the same investment goal with a combination of a no-load equity index mutual funds and zero-coupon bonds.

YEAR-END TAX PLANNING TIPS

2005-11-12T10:59:00.000-05:00

Although it’s too early to know what your taxable income will be in 2005, it’s not too late to plan strategies to lower it by means of legitimate tactics that can impact your total income, the expenses you may deduct against it, or both.

You might want to hold down your taxable income for 2005 by deferring income to 2006 and accelerating expenses when you have the opportunities—especially if you expect to be in a lower tax bracket next year. But you would want to do the opposite—accelerate income and defer expenses—to lift your 2005 taxable income if you expect to be in a higher bracket next year.

Even if you expect your tax bracket to be the same, it would be smart to consider other moves to hold down your tax bills. To determine which strategies are suitable for you, consider them in the sequence in which topics appear in IRS Form 1040, starting with Line 7, “Wages, salaries, tips, etc.”

Salary reduction. There is usually little that you can do about the compensation portion of your taxable income with one very important exception: putting more money into a tax-deferred retirement plan:

Sign up to participate in your employer’s 401(k) plan, if you have not already done so.
Raise the portion of compensation that you may defer and have invested in a 401(k), if you have not already authorized your employer to withhold the maximum for this purpose ($14,000 this year, $15,000 next year). Invest additional money in an IRA, if you meet the income requirements, so that you can deduct it on Line 25. The contribution for traditional IRA’s will be fully deductible if your income is $70,000 or less if you are married filing jointly, or $50,000 or less if filing individually. The contribution amount for a traditional IRA is $4,000 or $4,500 if you are 50 or older.

Taxable and tax-exempt interest. If you are now or plan to be invested in taxable bond funds or individual bonds outside a tax-deferred retirement plan, determine whether you would be better off in tax-exempt bonds or bond funds. Calculate whether your income from tax-exempt securities would be more, or less, than your after tax return on income from taxable issues. To make your determination meaningful, be sure to compare funds and bonds of comparable credit quality and maturities.

Dividends. You may have no control over whether dividends which you receive from equity funds or stocks are classified as “ordinary” or as “qualified,” which are taxed at a lower rate. If you get the latter, be sure to confirm that you are differentiating these amounts on your return. Locate the amount in your payers’ Forms 1099—DIV the amount to use in Line 9b of your Form 1040. Whichever class of dividends you get, avoid “buying dividends” by not buying stocks or funds just before their year-end distributions.

Income from a Business. If you operate a business from your home and report your receipts and expenses on Schedule C, you may also be able to deduct a portion of your home’s insurance, repairs and maintenance and utilities costs. You can report them on its Form 8829 attachment.

Capital Gains and Losses. If you want to sell individual securities or fund shares on which you have gains and which you have owned for less than a year, you have a choice: hold them until you have owned them for more than a year and pay taxes at the long-term capital gains rate or swallow the higher short-term rate. If you own securities which are worth less than they cost or their adjusted basis, you may want to sell them in order to take a loss to offset the gains. Capital losses are netted against capital gains. If you have more realized losses than gains, you can take an additional $3,000 of loss to offset your ordinary income. More than that and you will need to rollover that loss to be used in future years. If you do sell a security to realize a loss to offset a gain, note that you must not buy back that security for 30 days to avoid disallowing the loss. Note also that you are allowed to use losses to offset the capital gains on the sale of your home as well as the sale of securities.

Deductions. If you itemize deductions and you expect income to be higher next year, you may have some opportunities to defer or accelerate expenses before year end or defer outlays to 2006. Among them: costly medical and dental procedures, real estate tax payments due early next year and charitable contributions. Or vice versa if you are looking to accelerate expenses into the current year. Paying January’s mortgage payment in December will add mortgage interest to your deductions. If an individual is subject to AMT the early payment of property taxes is not effective in reducing taxable income.

November 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC, a local member of the FPA.

A PRIMER ON CHARITABLE DONATIONS

2005-11-12T10:53:00.000-05:00

Americans have long responded generously to people in need. Witness the torrent of checks to the victims of recent hurricanes and earthquakes. But while such acts remind us of the generosity of Americans, they also serve as reminders about the financial side of charity, including:

The proliferation of charitable organizations formed to complement the American Red Cross, Salvation Army and other charities in receiving public contributions and in distributing aid to those who find themselves in need of food, clothing, shelter and medical care. The urgent need to be cautious about which organization to give money to in case you know nothing about the one that is soliciting your contribution. If you don’t have time to check it out, it would be better to stick with organizations with which you are familiar.

The notion that, if you itemize deductions on your income tax returns, you can make tax-deductible charitable contributions that could reduce your taxable 2005 income and, thus, what you will owe on April 15. The Katrina Emergency Tax Relief Act (KETRA) allows unlimited gifts to charity up to a donor’s total income until the end of 2005—and for individuals the gifts do not have to be for hurricane relief efforts. The emergence of new vehicles which may make it easier for large donors to make contributions in accordance with Internal Revenue Service regulations.

It may be useful, therefore—while hurricane, forest fire, mudslide and earthquake victims are on your TV screen—to review a few pointers about today’s individual philanthropy as seen through the eyes of the IRS.

While the IRS does not address all acts of generosity—such as gifts made directly to individuals—it does address the majority of appeals for help which you are likely to receive or hear about from organizations to which contributions do qualify.

You get the idea in a definition on the cover page of the IRS’ essential 19-page Publication 526, Charitable Contributions: “A charitable contribution is a donation or gift to, or for the use of, a qualified organization. It is voluntary and is made without getting, or expecting to get, anything of equal value.” That publication, which can be found at the IRS’ Web site (www.irs.gov), also notes that such organizations “include nonprofit groups that are religious, charitable, educational, scientific or literary in purpose, or that work to prevent cruelty to children or animals.”

Descriptions of such groups as well as examples of both organizations that are not qualified (such as labor unions and chambers of commerce) and contributions from which you may benefit (such as country club dues and university tuition) are in the IRS’ booklet. Be sure to ask whether the entity to which you are making a charitable contribution is a qualified organization or not.

Given the consequences of hurricanes Katrina and Rita, one IRS reminder is especially timely: “You can deduct contributions earmarked for flood relief, hurricane relief, or other disaster relief to a qualified organization (but not) contributions earmarked for…a particular individual or family.”

If you have given used clothing or household goods to flood victims or other needy—or plan to by December 31—you may claim deductions if they went to qualified organizations. Knowing how much you may deduct per item is tricky. The IRS requires that deductions be at fair market value, for which it gives a textbook definition—“the price at which property would change hands between a willing buyer and a willing seller, neither having to buy or sell, and both having reasonable knowledge of all the relevant facts”—which is easier to articulate than to implement. (Publication 526 offers a few helpful suggestions.)

To ensure compliance, the IRS warns that donors may be liable for penalties if they overstate the value of donated property. Knowing how much you may deduct in total can also be tricky unless your contributions constitute no more than 20 percent of your adjusted gross income. If they exceed 20 percent, you need to wrestle with an IRS worksheet to determine your limit.

If you know that you will be able to contribute a five-figure total, which you are not yet prepared to allocate among qualified organizations, you may wish to consider a donor-advised fund. Donor-advised funds offer you immediate tax benefits and flexibility in the timing of your actual distributions to charities. You open an account with an irrevocable contribution of, say, $10,000 in cash, marketable securities, and/or mutual fund shares; tell the firm how the money should be invested among several investment pools for growth and/or income, and report your contribution on your 2005 tax return. When ready this year or next, you tell the donor-advised fund firm which organizations should get how much and the firm handles the grants for you.

If your contributions are on a very large scale and you can absorb the costs of its organization and operations, you could establish a tax-exempt private foundation for your charitable contributions under Section 501(c)(3) of the Internal Revenue Code, which you would fund with deductible contributions.

No matter your decision, it pays to do a little research beforehand to make sure that your contribution goes as far as it can to help those it’s intended for.

November 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC, a local member of the FPA.

RULES FOR HIRING FAMILY MEMBERS

2005-11-12T10:44:00.000-05:00

Many self-employed people want to hire family members to work for them. But as with many things in life, there’s a right way and a wrong to do this. Doing it right can promote family togetherness. But it can also create tax savings for you.

How so? In essence, you are shifting business income to a relative. And your business can take a deduction for reasonable compensation paid to an employee, which in turn reduces the amount of taxable business income that flows through to you according to the AICPA’s financial literacy Web site, www.360financialliteracy.org.

Of course, you have to do it right. The IRS can, for instance, question compensation paid to a family member if the amount doesn't seem reasonable, considering the services actually performed. Also, the AICPA says to be sure that your business complies with child labor laws when hiring a family member who's a minor.

There are other benefits to hiring a family member. As a business owner, you are responsible for paying Federal Income Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) taxes on wages paid to your employees. FICA is the law requiring employers and employees to pay Social Security and Medicare taxes. FUTA is the law that establishes federal unemployment taxes.

As with wages paid to all employees, wages paid to family members are subject to withholding of certain taxes in some states. Typically, the payment of these taxes will be a deductible business expense for tax purposes. But if you hire family member – a child, spouse, or parent as an employee – to work for your business you may not have to pay FICA and FUTA taxes.

For instance, you don’t have to pay FUTA taxes for services performed by your child who is under 21 years old. And you need not pay FICA taxes for your child who is under 18 and works in your trade or business or a partnership owned solely by you and your spouse, according to Working for Yourself (Nolo Press, $39.99). For family members under age 18, the parent does not have to withhold for FICA, Medicare, FUTA and SUTA. If the spouse is employed, one does not have to withhold for FUTA and SUTA, but must withhold for FICA and Medicare.

For example, Jacob, age 15, proofreads press releases for his mother’s public relations business, which is operated as a sole proprietorship. Jacob is his mother’s employee, but she doesn’t have to pay FUTA taxes until Jacob turns 21 and need not pay FICA taxes until he reaches 18.

Of note, these rules don’t apply if you hire your child to work for your corporation or your partnership, unless all the partners are parents of the child. In other words, you must pay both FICA and FUTA taxes in the aforementioned cases. For example, Jack works in a landscaping business that is half owned by his father and half owned by his father’s brother. FICA and FUTA taxes will have to be paid because it’s a partnership and not all the partners are Jack’s parents.

Also of note, if your child has no unearned income (dividend income or interest) then you must withhold income taxes from your child’s pay only if it exceeds the standard deduction for the year. The standard deduction for 2004 was $4,850, but it’s adjusted every year for inflation. Children who are paid less than this amount need not pay any income taxes on their earnings. You must, however, withhold incomes taxes if your child has more than $250 in unearned income for the year and his or her total income exceeds $750. If you pay your child more than $600 or more during the year, you must file a Form W-2 reporting the earnings to the IRS. Regardless of how much you pay your child, each year you should fill out and have your child sign IRS Form W-4, Employee’s Withholding Allowance Certificate. If you pay your child more than $200 per week, keep a copy of the form for your records and file a copy of the form with the IRS.

For small business owners who are engaged in what is often called succession planning, hiring children can provide non-tax benefits as well. Children who play a role in a business can help it survive past the owner’s involvement. “Family Affair: The Emotional Issues of Succession Planning,” which can be found in the Journal of Financial Planning’s July 2005 issue, is one story worth reading on the subject.

Meanwhile, if you employ your spouse to work in your trade or business, the payments are subject to FICA taxes and federal income tax withholding, but not FUTA taxes. This rule doesn’t apply if your spouse works for a corporation, even if you control it, or a partnership, even if your spouse is a partner along with you. In that case, you will have to pay FUTA taxes.

If you employ a parent in your trade or profession, meanwhile, his or her wages are subject to income tax withholding and the FICA taxes, but not FUTA taxes.

November 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC, a local member of the FPA.

TIPS ON FILING HOMEOWNER'S INSURANCE CLAIMS

2005-10-08T13:38:00.001-04:00

Whether your home was damaged by Hurricane Katrina or Rita or by other causes—or whether it has been spared—it is important to know what to do and what to expect when you file a claim for losses under your homeowners insurance policy.

Having paid premiums for years to be covered in case of a disaster, you will want to do whatever is necessary to make certain that you will be properly compensated for your loss and help to speed your family’s return to a normal life.

The Insurance Information Institute (III) has established a hurricane insurance information center at www.disasterinformation.org to provide helpful information for:

Your insurance company, in case you don’t know how to contact your agent.
Your state’s insurance department.
The federal government’s National Flood Insurance Program (800-427-4661), in case you have flood insurance through it but don’t know who your insurer is.

The III’s publication, “Settling Insurance Claims after a Disaster,” is also well worth reading. The publication, which can be found at III’s Web site, describes what you will—or would—need to know and do, including:

Filing a claim. Contact your insurance agent or company to report your damages. Confirm that your policy’s terms cover it so that you can file a claim, your claim exceeds your deductible, you need estimates for repairs, and so on.

Get ready for adjuster. Fill out a form that you will receive with descriptions of damaged and destroyed items, dates of purchase, original costs, and replacement costs. When the company sends out an adjuster to assess the damage, be prepared to show him/her all the structural damage in and around the house and to give him/her the description of damages—keeping a copy for yourself—and copies of detailed estimates for repairs from contractors whom you are considering. Also be prepared to show the adjuster damaged items and give him/her sales slips, invoices, or cancelled checks, which you have kept since their purchases, as well as receipts for any necessary temporary repairs, for which you will be reimbursed.

How much you may get. The amount of money you may get from your insurance company depends primarily on the type of policy that you have.

Replacement cost policies provide you with whatever is needed to replace damaged items with similar ones of equal quality.
Actual cash value policies pay what’s left after deducting depreciation from replacement costs, which can leave very little.

If your home is so damaged that it cannot be repaired, a typical replacement cost policy will pay to replace it within specified limits; an inflation-guard clause will help you to keep up with increases in building costs.

Under an extended replacement cost policy, a company will pay 20 percent or more above the specified limits to give you protection against very large cost increases. A guaranteed replacement cost policy pays whatever it costs to rebuild your home—but not to improve on it.

Temporary quarters. If you and your family have to live elsewhere until your home is repaired or replaced, your company probably will pay for your loss of use: reasonable additional living expenses—such as rent, eating out, utility installation costs, added transportation costs—which may be 20 percent or more of the insurance on your house. (Be sure to keep records of your expenses.)

Water damage. Homeowners’ policies don’t cover flood damage but do cover other kinds of water damage, such as rain coming through a hole made in the roof during a hurricane. If you have a flood policy and can substantiate flood damage, you need to get actual repair costs for payment.

Trees and shrubbery. Companies typically pay for removing trees that fell on your house but not for those that fell on your lawn or for replacing damaged trees and shrubbery.

Getting the money. You usually get two insurance checks when both house and contents are damaged. If you have a mortgage, the check for home repairs will be made out to both you and the lending institution. The lender is likely to put the money into an escrow account, pay for the work as it is completed, and inspect it before making the final payment.

If your property was destroyed or damaged due to an “unusual” event such as a hurricane, you may be entitled to an income tax deduction. Read IRS Publication 547, “Casualties, Disasters, and Thefts,” on the IRS Web site, www.irs.gov.

October 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC, a local member of the FPA.

PREPARING FOR THE NEW MEDICARE DRUG BENEFIT

2005-10-08T13:38:00.000-04:00

Starting January 1, 2006 Medicare will offer for the first time in its 40-year history coverage for prescription drugs. The coverage, which is called Medicare Part D and is voluntary, will be available to all people with Medicare, regardless of income level and resources, pre-existing conditions, or current prescription expenses, according to the Centers for Medicare & Medicaid Services (CMS).

Open enrollment for 2006 Part D coverage, which may cost less than $20 per month for some plans, begins in November and runs through May 15, 2006. Companies that were approved by CMS in late September to offer such plans along with consumer advocacy and other institutions began a massive information blitz starting in October.

In essence, the Medicare Part D plan is insurance provided by private companies. According to CMS, eight insurance companies will offer coverage nationwide, while other insurers will offer coverage regionally. Beneficiaries will have at least 11 plans to choose from and those in larger states, such as New York and Texas, will have a choice of about 20 plans. The eight companies offering nationwide coverage are Aetna Life Insurance Company, Connecticut General Life Insurance Company, Memberhealth, Pacificare Life and Health Insurance Company, Silverscript Insurance Company, Unicare, United Health Care Insurance Company and Wellcare Health Plans.

As with any insurance program, the plans offered by CMS-approved companies may differ in terms of costs and coverage so it’s important that you comparison shop. For instance, each Part D drug plan will have a government-approved list of drugs it covers, often called a formulary or a preferred-drug list. But the formulary will vary from plan to plan so you should compare plan formularies to see which one fits your needs best. Another difference might be what pharmacies you can use. If you join a Part D plan and you use the plan’s network of pharmacies, you will likely receive discounted prices on prescription drugs. Medicare prescription drug coverage can help you by covering both brand name and generic prescription drugs at participating pharmacies.

Given the vast choice in plans, consumers are well advised to seek out the help of trusted advisers, including physicians, pharmacists and financial planners. Purchasing Medicare Part D is as much a financial decision as it is a health-care decision. You will be able to change plans once per year.

Medicare beneficiaries should also take note of the fact that the new prescription drug plan is open to all people with Medicare. But Medicare Part D prescription drug coverage will work differently from Medicare Part A and Part B. To get coverage, you’ll choose a plan from a private company approved by CMS. And you will have to pay a monthly premium, over and above any premiums you pay for Medicare Part B coverage or Medigap insurance plans, to participate in the plan.

The Medicare Part D plans come in two basic types: the most simple is the prescription drug benefit or PDP plan, which covers only drugs and can be used with your traditional Medicare and or Medicare supplement plan. The other type combines a prescription drug plan with a Medicare Advantage plan which includes medical coverage for doctor visits. If you already have good drug coverage through a retiree plan or Medicare Advantage Plan, Medicare can provide help for its cost.

If you already have prescription drug coverage, you will likely want to compare the plan you have now with the new plans being offered under Part D. If you don’t have coverage now, it’s important for you to look at Part D plans.

A typical person with Medicare could see his or her total drug expenses drop by about 50 percent, according to CMS. Don’t, however, expect free drugs. For each prescription you’ll pay a portion of the cost. Qualified people with limited income and resources will, however, have almost no drug expenses. And, if you have high out-of-pocket prescription drug costs, Medicare will pay 95 percent of your prescription drug costs, after you pay $3600.

Of note, if you don’t sign up with a plan by May 15, you may have to pay a penalty. The late enrollment fee is about 1 percent of your premium for each month you delay and you’ll pay it for as long as you stay in a Part D program. Your next chance to enroll will be November 15 through December 31 of each year. Even if you do not need a lot of prescription drugs now, it’s still good to consider joining. As people age, they need prescription drugs to stay healthy.

You can learn more about this historic addition to Medicare at the following Web sites: AARP, www.AARP.org; Medicare, www.Medicare.gov; Social Security, www.SocialSecurity.gov; Kaiser Family Foundation, www.KFF.org; State Health Insurance Assistance Program, www.shiptalk.org; Medicare Rights Center, www.Medicareinteractive.org; and National Council on Aging, www.benefitscheckup.org.

CMS recommends keeping an eye out for community meetings on the subject of Medicare Part D. Also, CMS notes that more detailed information about Medicare Part D is being mailed to beneficiaries.

A PRIMER ON THE NATIONAL SAVING RATE

2005-10-08T13:37:00.000-04:00

The Commerce Department recently announced that the nation’s personal saving rate, calculated as a percentage of disposable (or after-tax) personal income, had fallen to a negative number for the first time since October 2001. The national savings rate fell to a negative 1.1 percent in July 2005, followed by a negative 0.7 percent in August

What’s happening to savings in America? In the short-term (and prior to the impact of Katrina), the Commerce Department says consumers remained in a spending mood: personal consumption expenditures rose 0.7 percent in real (or inflation-adjusted) dollars from June to July, and by another 0.9 percent in July.

But in the long-term, the recent declines serve as a reminder of how long the savings rate has been declining. After peaking in 1944 at 26.1 percent and dropping during the early post-World War years to 4.3 percent in 1947, the annual rate fluctuated within a narrower range until reaching a post-war high of 11.2 percent in 1982. From there it trended down, ending the 1990s at 2.4 percent, dropping to 1.8 percent in 2001 and 2004 and never exceeding 2.4 percent again. In the first half of 2005, the seasonally adjusted annual rate fell below 1 percent.

To understand what these figures mean, it is important to know how the Commerce Department defines personal saving: what’s left of employee compensation after personal taxes, self-employment income, rental income, personal interest and dividend income on assets, plus transfer payments (formerly classified as non-tax payments, these are payments by people to government including donations, fees, and fines), minus current personal taxes after subtracting personal outlays.

It excludes capital gains from sales of assets, which have been substantial in some years. According to the Commerce Department, “Saving from current income may be near zero or negative when outlays are financed by borrowing (including borrowing financed through credit cards or home equity loans), by selling investments or other assets or by using savings from previous periods.”

By contrast, the Federal Reserve measures personal saving as the difference between households’ net acquisitions of assets (excluding cars and other consumer durables) and the net increase in their liabilities. It excludes capital gains, too.

Whatever the differences, the long-term trend in Fed-basis personal saving as a percentage of disposable personal income has been the same: down. From the early postwar low of 7 percent in 1949, it rose to the low double-digits and remained there with few exceptions through 1990’s 11.5 percent. It slipped in ensuing years, falling to a negative 0.7 percent in 2000—when the Commerce-basis rate was a positive 2.3 percent —and has remained in the low single digits since.

Do lower rates of household saving matter in the face of higher household debt, as some suggest? Not to Fed Governor Susan Schmidt Bies, who, in two speeches this year, said that she takes a “considerably more sanguine” view than those who are concerned that households “have become overextended and will need to rein in their spending.”

Fed staff analyses, she explained, “indicate that households in the top income quintile can account for nearly all of the decline in the aggregate saving rate since 1989 (when estimates of saving by income quintiles were first disseminated). “Given that these higher-income households have more financial resources to weather shocks, the significant decline in savings is less troublesome than if it had occurred in the lower part of the income distribution.”

Governor Bies also noted that some analysts consider changes in net worth to be a more relevant measure of saving adequacy than the portion of current income set aside for saving. “In this regard, the picture of household saving looks more favorable than suggested by the saving rate,” she said.

At some point, the Governor said, consumers, who have passively relied on markets to raise the value of their assets, will need to set aside more of their earnings for investment in new assets for their future needs.

Addressing the personal saving rate’s impact on the economy, Fed vice-chairman Roger W. Ferguson, Jr., recently said that a near-term return to the average rates prevailing through the 1980s may not be needed. “In the aggregate, an economy needs to generate savings for two basic purposes—to invest in new plant and equipment with the aim of raising future consumption growth and to expand the residential housing stock,” he said. “As the growth rate of the labor force slows with the retirement of the baby boom generation, less investment will be required to equip each worker with the same amount of capital.”

Other economists point to the imbalances in the global economy as being unsustainable, and are less comfortable relying on asset bubbles and low mortgage rates to drive economic expansion.

Understanding the New Roth 401(k)

2005-09-20T21:03:00.000-04:00

There are plenty of ways to save for retirement. And come January 2006, many Americans will be faced with evaluating and deciding whether to use a new tax-sheltered way of investing for retirement -- the Roth 401(k).

Starting next year, employers sponsoring 401(k) and 403(b) plans will be able to offer “it” to participants as an added option, in accordance with the Economic Growth and Tax Relief Reconciliation Act of 2001, which President Bush signed into law on June 7 of that year and which was much better known for its major income tax reductions. While the Treasury Department has yet to release its final regulations, major elements of Roth 401(k)s are known, based on the 2001 act, on the Treasury’s proposed regulations which were released for public comment last March 2, and on the retirement plan concepts long associated with the terms, “Roth” and “401(k).”

“Roth” IRAs were named in honor of the late Sen. William V. Roth, Jr., (R-DE), chairman of the Senate Finance Committee from September 1995 to January 2001, at whose initiative they were made available to individuals in 1998 as an alternative to traditional IRAs. Traditional IRAs generally permit individuals to (1) invest a sum of their pre-tax earned income, which means they may be able to deduct the contribution from their current taxable income, and (2) let the money grow tax-deferred, but (3) require them to pay taxes on withdrawals at then-prevailing tax rates (and with potential penalties for withdrawals before age 59 ½). Roth IRAs, on the other hand, enable individuals to (1) invest after-tax earned income (no tax deduction on contributions), (2) let it grow tax-deferred, and (3) take entirely tax- and penalty-free withdrawals (provided certain conditions are met). One additional major difference between a traditional IRA and a Roth IRA is that owners of a Roth IRA do not have to take required minimum distributions or RMDs. Those are the distributions that traditional IRA owners must take after reaching age 70 ½.

401(k) plans, long available to eligible employees of companies that offer them, more closely resemble the traditional IRAs. Participants may (1) have pre-tax income withheld to invest in employers’ stock and/or a menu of mutual funds and other alternatives (employers may partially match contributions but the matched funds will be taxed as traditional 401(k) contributions), and (2) enjoy tax-deferred growth in their accounts, though they must pay taxes on the total amount of their pre-tax deferrals and any account growth at the time of distribution. 403(b)s, also known as Tax-Sheltered Annuities (or TSAs), are available to employees of schools and universities, churches, public hospitals, and charitable tax-exempt organizations. Some 403(b)s allow for employers to match contributions (similar to a 401(k) plan.)

Participants in these plans may be able to contribute (and deduct from taxable income) significantly more than the current $4,000 ($5,000 if age 50 or older) they are generally permitted when investing in IRAs. Thanks to the 2001 law, they may contribute and deduct $15,000 in 2006—up from this year’s $14,000—plus an additional $5,000 under a “catch-up provision” for individuals 50 or older.

Employers interested in sponsoring Roth 401(k) and 403(b) plans are presently (as of August 31, 2005) waiting for the Treasury to issue its final regulations—after completing its review of comments on its proposed set—so that they can know all they need to know to complete their plan designs and ensure that payroll and recordkeeping systems are ready for the additional work.

How many are likely to add Roth 401(k)s to their plans? No one knows, of course, but surveys of two overlapping groups of 450 and 200 large employers by Hewitt Associates, a major human resources services firm, have indicated that about 30 percent are somewhat or very likely to add such accounts to their plans in January. A Vanguard survey of its 401(k) plan clients indicates a similar level of interest.

Who should consider using a Roth 401(k)? Candidates include those who want to avoid required minimum distributions and those who predict that using the Roth will produce tax savings after factoring current and future income and current and future tax rates. In essence, participants – especially younger employees and low- to middle-income employees (those taxed at 10 or 15 percent) – who expect their tax rates to be higher during retirement (when they are likely to take a distribution from a retirement plan) could benefit from a Roth 401(k). Older employees who may be in the peak earning years and those who expect to be in a lower tax bracket during retirement might consider using the traditional 401(k), which allows them to defer taxes at high rates now and pay them at lower rates in the future. Of note, a person can contribute in aggregate no more than the $15,000 (in 2006) maximum allowed, no matter which account is used - Roth 401(k) or traditional 401(k). But you can invest a portion of your deposits in both types of accounts, if both are available. Also of note, the Roth 401(k) has RMDs, but a rollover to a Roth IRA would avoid the RMD requirement.

According to the Vanguard Center for Retirement Research, participants who do get the chance to evaluate whether to use a Roth 401(k) may fall into other categories, including:

Maximum savers, mostly earning high-income or having high net worth, who will be contributing at the limit of $15,000 (or $20,000 including the age 50 catch-up of $5,000) and who may account for 10 percent of 401(k) participants. By keeping the maximum limits the same for pre-tax and Roth plans, Congress has effectively increased the savings that individuals can shelter from taxes in their retirement plans.
Participants who are well prepared for retirement by saving more than the 6 percent median contribution rate, who are likely to be in the same tax bracket in retirement as today, and who face a risk of being in a higher bracket, in part because withdrawals from pre-tax plans would accelerate taxes due on Social Security benefits.

Those broad categories notwithstanding, 401(k) participants faced with the opportunity to use a Roth 401(k) should definitely consult a financial planner, asking them to prepare an analysis that incorporates likely tax rate and income scenarios. To be sure, the Roth 401(k) is likely to be an excellent retirement savings vehicle. But using it without proper analysis could lead to unintended consequences, namely this: choosing to make after-tax deposits now (i.e., paying taxes immediately) to get tax-free growth in the future may be a losing proposition if you’re actually going to be in a lower tax bracket in the future - you will have voluntary paid high tax rates to avoid low ones. In a nutshell, the choice boils down to paying taxes now (Roth IRA or 401(k)) or paying taxes later (Traditional IRA or 401(k)), with the variable being what the individual thinks their tax rates will be in the future compared to now.

September 2005— This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Bold Financial Planning, LLC, a local member of the FPA.

Exploring Identity Theft

2005-09-20T20:49:00.001-04:00

It used to be enough for financial planners to help clients minimize losses by making them aware of the risks inherent in various financial assets—even securities backed by the U.S. Treasury—and by steering them away from imprudent asset allocation and unsuitable investments.

If these seemed like challenges, they were relatively easy to defend against when compared with the potential for losses of money and credit standing which virtually anyone may face today when Social Security numbers or other personal data fall into the hands of criminals and are used for illegal gains at their owners’ expense.

“Identity theft” is, to boil down the definition of the 1998 law that made it a federal criminal offense, the unauthorized transfer or use of “a means of identification of another person with the intent to commit…any…activity (which violates federal, state, or local law).”

It can result in losses of money and reputation which may not be discovered for weeks and which may require more time, at possibly significant costs, to recover, if possible at all.

Increasingly vulnerable to such dire circumstances, clients of financial planners have much to do to help themselves, of course, but would surely welcome advice from planners going beyond their traditional responsibilities when opportunities arise.

To help clients to be protected against identity theft, it is important for them to have a sense of the many ways in which it may occur.

Incidents typically involve the unauthorized use of Social Security, bank account, credit card, charge account, driver’s license, and telephone calling card numbers; Personal Identification Numbers (PINs), user IDs and passwords, whether unknowingly given to the wrong people or obtained in other ways. A mother’s maiden name, a favorite pet’s name, or the last four Social Security digits, which are often used to verify identity, are also subject to abuse.

They may be copied from plastic cards, statements (presumably including financial planners’ statements), charge slips, or other documents. They may be discerned when criminals watch people punching numbers into ATMs or public telephones, or when they eavesdrop on people giving numbers over phones. They may be retrieved from discarded checks, statements, other records—or discarded forms sent with “pre-approved” credit cards, which are activated without the recipients’ knowledge.

According to a U.S. Justice Department advisory on identity theft, the Internet has become an appealing place for criminals to obtain identifying data, such as passwords or banking information. Many people respond to unsolicited e-mail that promises them some benefit, but requests identifying data.

“With enough identifying information about an individual, a criminal can take over that individual’s identity to conduct a wide range of crimes: for example, false applications for loans and credit cards, fraudulent withdrawals from bank accounts, fraudulent use of telephone calling cards, or obtaining other goods or privileges,” says the Justice Department advisory.

Criminals’ e-mails also “lure their targets into a false sense of security by hijacking the familiar, trusted logos of established, legitimate companies,” says a Securities and Exchange Commission advisory.

Whatever the technique, illegally obtained personal information can result not only in withdrawals of money or in large debts but also in crimes that are traced to the victims. How can such incidents be minimized?

Do not give anyone—on the phone or Internet—a Social Security or other personal number unless sure that the request is legitimate.
Do not carry your Social Security card or number with you. If your state uses your Social Security number on your driver’s license, ask them to change it to a random number.
Be cautious when pressing ATM or telephone buttons or dictating numbers on telephones in public.
Retrieve sales and charge slips, safely retain them, and shred them before discarding them.
Check statements for charge, bank, brokerage, and other accounts for unauthorized transactions, retain them, and shred them when they are no longer needed.
Shred unneeded cancelled checks and “pre-approved” credit card offers.
Delete unsolicited e-mails requesting information from firms you do not know, and verify—by phone, not by e-mail response—the legitimacy of those appearing to be from firms you know.
Log out when finished with a secure Web site before going to the next.
Consider using a lockable mailbox or a P.O. Box.
For optimum security, a cross-cut shredder should be used (not any shredder will do).
Contact the credit bureaus to opt out of solicitation credit offers via the mail.
Do not offer personal information over the phone, unless you initiated the call, and the number called is from a reliable source.
Make your computer safer. There are free programs that can do the trick. For a firewall, zonealarm (www.zonealarm.com) is free. For spyware, adaware (www.lavasoftusa.com) or spybot search and destroy (www.safer-networking.org) are both free. A firewall can keep intruders from pulling information from your hard drive. Spyware is necessary because there are spy programs that can track the Web sites you visit and track your keystrokes on those sites.
Also, do not carry a checkbook in your wallet or purse.

If identity theft occurs, notify:

The fraud department of one of the three major credit bureaus (Equifax, 800.525.6285; Experian, 888.397.3742, and Trans Union, 800.680.7289), the police (and obtain a copy of their report), and the Federal Trade Commission (877.438.4338).
Postal Inspection Service, if an unauthorized change of address form has been filed to redirect mail.
Social Security Administration (800.269.0271), if a Social Security number has been fraudulently used.
Creditors and financial institutions, if fraudulent transactions are suspected.

The definitive source for identity theft information on the web:
www.consumer.gov/idtheft/.

A Primer on Living Benefits

2005-09-20T20:49:00.000-04:00

Baby boomers, as they move toward retirement, are beginning to question how they will maintain their standard of living during their golden years. For many, the need to create lifetime income will require the use and integration of many investment products, perhaps including variable annuities.

For those of whom variable annuities are a suitable solution, the big question to answer is “which one?” Variable annuities today come with a variety of riders, all of which are designed to address specific investment objectives and risk profiles, but especially principal risk and longevity risk. Most of those features come in the form of guarantees, chief among them the guaranteed death benefit and the guaranteed living benefit. What are some of those guarantees and what are the risks and benefits associated with those guarantees?

Variable annuities with a guaranteed death benefit are suitable for individuals who would like to be heavily invested in the market, yet would like to have guarantees about the amount of money that their heirs will receive even if the market declines, and who want at least some access to the cash value in the meantime. In other words, they do not plan to or need to “annuitize” their variable annuity. Often, the basic death benefit is equal to the greater of (1) the contract value, and (2) purchase payments less withdrawals (or what is also called a “return of premiums” guarantee) and is made to the beneficiary upon the death of the owner and/or annuitant, according to RetireOnYourTerms. Nearly all contracts sold these days have additional death benefit features, including guaranteed accruals on premiums and/or so-called “high water marks” that pay the highest value on any previous contract anniversary date, according to “The Annuity Advisor” by John Olsen and Michael Kitces, MSFS, CFP®, CLU, ChFC.

Some variable annuities also have guaranteed living benefits, which are designed for investors who desire current protection of principal, income, or the ability to take withdrawals, while they are still alive. In some cases, obtaining the protection features may require them to “annuitize” their investment. In other cases, principal may be recovered through guaranteed withdrawals over a specified period, and annuitization is not required. Other forms of living benefits guarantee a floor of principal that will be restored if the annuity has experienced losses over a set time period. With a guaranteed living benefit, the owner or annuitant is purchasing protection against investment risk or the risk of not being able to generate an adequate amount of income, and the variable annuity contract will either guarantee the level of account values which may be accessed through current withdrawals or the amount of annuitized payments that can be received in the future.

Typically, these guarantees come with some restrictions of one form or another depending on the guarantee. What’s more, variable annuities with guarantees may be confusing. Contracts, for instance, may make a distinction between the payout base of a variable annuity that can be used to generate guaranteed income (but not available for withdrawal) and the actual contract cash value that can be surrendered at any time.

The most popular forms of guaranteed living benefits features are guaranteed minimum income benefit (GMIB) riders, guaranteed minimum accumulation (or account) benefit (GMAB) riders, and guaranteed minimum withdrawal benefit (GMWB) riders. Immediate annuities with for-life guarantees can be nice retirement income tools, but may not always be the best fit for your client.

The variable annuity with a GMIB rider ensures that under certain conditions the owner may annuitize the contract based on the greater of (1) actual account value or (2) an adjusted 'payout base' equal to premiums credited with a specified minimum interest rate or a step-up in value based upon the maximum annual anniversary value of the account value prior to annuitization. In essence, these products are designed to provide a steadily growing base for generating annuitized income, even in the face of a large or extended bear market. Most GMIBs provide an annuitization value based on the greater of premiums accumulated at a 5 or 6 percent return, or an annual step-up of the contract value. Some contracts require a waiting period of as much as 10 years prior to the implementation of the guaranteed payments.

These annuities have several restrictions. An annuity owner must annuitize in order to exercise the guarantee; there may be a minimum exercise age; and the guaranteed annuity payout rates are typically much lower than current rates on new immediate annuity contracts. What’s more, the annuity owner, after annuitizing their investment under the guarantee, may not participate in any stock market gains (if a fixed annuitization is required or selected). And, the annuity owner who dies after annuitizing the contract may not be able to pass any money to beneficiaries, depending on the form of benefit selected or required under the guarantee Also of note, the contract for these products should always be read carefully since it contains language that defines exactly how the GMIB payout base is determined, as well as disclosure of additional fees resulting from the GMIB benefit. These fees directly reduce the performance of the contract and may range from 25 to 65 basis points.

The variable annuity with a GMAB rider promises that, at specified periods, the account value will not be less than purchase payments, sometimes with an additional minimum rate of interest.

After a specified waiting period the annuity owner’s losses are immediately restored to the guaranteed minimum account value, without any annuitization requirements. Thus, even if investment losses are otherwise incurred, the annuity owner will at least get back their original investment. A drawback is that investors who purchase a GMAB cannot take current income from the product during the waiting period without a potential reduction in the guarantee. Companies offering GMABs typically reserve the right to reallocate unilaterally the annuity owner’s investments. As with the other benefits, the fees incurred in exchange for the GMAB should be carefully considered.

The variable annuity with the GMWB rider allows contract holders to take a set percentage of the original investment, usually from 5 to 7 percent, as distributions per year, regardless of investment performance. Thus, even in a period of declining stock prices where the account value goes to $0, an annuity owner will eventually get back their entire principal a bit at a time. In addition, in a bull market, some riders allow the annuity owner to step up their guaranteed amount to the highest contract value, usually every three to five years, but sometimes annually. As with the other benefits outlined, the cost of the benefit may be “wasted” if the guarantee isn’t actually utilized. On the other hand, the psychic support provided by the guarantee may allow a particular investor to subject long-term assets to market risk (and the prospect of higher returns) when otherwise she would not do so. Withdrawals in excess of the guaranteed amount reduce the amount of principal protected or may forfeit the guarantee. Of note, the annuity owner doesn’t have to annuitize as they do with the GMIB and they may have to wait to withdraw money as they do with the GMAB.

With a GMWB, there are specific restrictions. This form of guaranteed benefit does not provide permanent income and it will take a specified time period, usually 14 or more years (at 7 percent withdrawals per year), to get the initial investment back. In some cases, there may be a waiting period of up to five years before withdrawals can be exercised. Typically, taking out any withdrawal in excess of the GMWB allowable amount can substantially reduce or completely lose the underlying guarantee.

Regardless of the rider, an investor must understand what costs are incurred in order to manage the risk negated. Generally, the insurance companies who provide these benefits do so in order to support investors that want to take on market risk when they otherwise might not do so, and expect few contract holders to exercise the benefit. And since some companies were hurt by mistakenly priced products during the last bear market, few benefits are now likely to be offered without corresponding, fully priced costs. Fully informed investors will select benefits carefully based upon their priorities and after a full consideration of the cost and associated risks.