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.