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Why Do I Need A Financial Advisor?
It is never too soon to begin building your financial future, but the task can be daunting. Few of us have the time or expertise to analyze where we are, investigate possibilities, and sort through the dizzying array of investment vehicles and many important choices we must make in our financial lives. The ups and downs in the market can also create a lot of confusion and sidetrack you from your long-term goals.
If you are wondering…
- Whether you can retire in your desired lifestyle when you are ready
- Do you have enough saved for retirement
- When you might reach your ideal financial status
- When you should exercise your stock options
- Whether your investments and asset allocations meet your long-term goals
- If you are maximizing tax opportunities and minimizing tax exposure
- How you can improve or better manage your cash flow
- How you could preserve your estate or whether you should establish a trust
- How you might plan to finance your children's education
- Whether you have enough time to reach your goals
- How you can ensure that you or a loved one are paying bills and staying on top of the many financial tasks in today's busy and complex world
- Do your insurance policies provide adequate coverage
…working with a financial advisor could give you peace of mind.
Are Exchange Traded Funds ("ETFs") Right For My Portfolio?
We are always looking for ways to improve our investment returns, and in looking we are constantly in search of that one "perfect" investment that will solve all of our problems. Many investors have latched onto ETFs as if they are the investment that can do it all.
ETFs are pooled investments in stocks or bonds, which combine features of both traditional mutual funds and individual stocks. Similar to index mutual funds, ETFs are generally diversified portfolios of stocks or bonds that track a particular index. Similar to stocks, shares of ETFs can be bought and sold on a stock exchange throughout the trading day. The American Stock Exchange (AMEX) launched the first major ETF in 1993 in the form of SPDRs, otherwise known as “spiders”, which tracks the S&P 500 Index. Since that time, several other ETF sponsors have emerged including BlackRock, State Street, Vanguard, and Schwab.
ETFs are primarily index-based or passive (non-managed) funds, however, ETF offerings have greatly expanded and there are now several actively-managed ETFs available. ETFs offer some distinct advantages over mutual funds, but are definitely not the answer for all investors.
Let's explore some of the similarities and difference between ETFs and mutual funds:
ETFs are continuously traded, mainly on the AMEX, in a format essentially identical to trading stocks. In contrast, mutual funds are priced at the end of each day and are purchased at the calculated Net Asset Value ("NAV") which is the total market value at the end of the day of all assets of the mutual fund divided by the number of mutual funds shares outstanding.
ETFs can be redeemed in kind by large institutions with large transactions (50,000 plus shares). This allows the fund to manage capital gains more efficiently than mutual funds. Mutual funds deal directly with individual investors and must maintain cash for redemptions, or sell assets to raise cash. This can serve to increase potential capital gains distributions.
There are no restrictions or penalties for short-term trading with ETFs vs. a mutual fund that may restrict short-term trading by assessing penalties for selling within certain timeframes such as 60 days after purchase.
ETFs can be purchased through brokers (including via the internet) as mutual funds can be purchased. ETF operating expenses are generally lower than those of traditional index mutual funds.
ETFs can be sold short and are not subject to the up-tick rule (which only allows short sales after a positive price change) vs. mutual funds that usually cannot be sold short. ETFs can also be purchased on margin as can some mutual funds.
Individuals buying or selling ETFs will pay a commission (sales charge) vs. individuals buying or selling no-load mutual funds who do not pay a commission but will pay a transaction fee to purchase or sell the mutual fund.
Individuals buying or selling ETFs may pay a premium or receive a discount to the value of the underlying assets of the fund vs. individuals buying mutual funds who will pay the NAV of the underlying assets.
Points to Remember:
Active traders can use ETFs to efficiently trade baskets of stocks in the same way they trade individual stock.
Investors with longer time horizons and larger lump-sum amounts to invest should consider ETFs if they are investing in a taxable account given that they tend to manage capital gains more efficiently.
Investors investing in tax-deferred accounts may be better served purchasing no-load index mutual funds. However, make sure the expenses are lower than the average because there are index funds that have outrageous expenses which make it difficult for them to accurately track the indexes.
Review your individual objectives, look at your investment alternatives, analyze ETFs vs. mutual funds and make your choice based on what makes sense for your portfolio.
How Can I Retire in 10 Years?
First and foremost, you need to take control. To get and keep you on track, you should review and implement the following checklist:
- Don't dream about how nice your retirement is going to be; set real priorities and goals. You can't get moving without a target to aim toward. Most of us plan our vacations better than we plan our lives.
- Create a vision of retirement and define what that means. Do you see yourself with another career or maybe working part-time? Maybe playing golf in Florida or doing volunteer work in your local community?
- Understand where your money is going. This doesn't mean tracking every penny you spend. It means getting a general sense of where your money is going. Focus on saving now. Save between 10 and 20 percent of your gross income per year toward retirement. We are responsible for our future retirement today.
- Take responsibility for your retirement and don't expect your company and Social Security to provide very much to help you. Once upon a time companies provided pensions that paid us monthly checks, but these types of plans are disappearing very fast and being replaced by contribution plans.
- Learn about investments, including the costs and benefits of the many choices available today. The world of investments is becoming more complex every day. Utilize a diversified overall investment program. Diversification does make a difference over time. Don't get carried away with thinking that you can time the market and select the investment that will do the best at any one time.
- Understand what asset allocation really means in terms of reducing risk. Asset allocation means investing in several types of investments such as stocks, bonds, international stocks, even cash, or money markets. Design an overall allocation to achieve your targeted return and stick to it.
- Take full advantage of company 401(k) plans. With company-matching, you can't lose here. If your company matches 50 percent, then you have already earned 50 percent on your investment before you have invested it. You can't find a better deal anywhere.
- Treat your stock options as investments and not as found money. These dollars can build tax-deferred as long as your company is doing well. When you exercise and sell the stock, reinvest in your overall investment portfolio and watch the dollars build.
- Don't concentrate too much money in your company's stock. You don't want to put too many eggs in one basket. Make sure your 401(k) does not have too much in company stock. Think long-term when establishing an investment program and orient investments toward growth stock mutual funds or exchange-traded funds. Don't chase the hot fund or you could get burned.
- Don't get too conservative too fast in building retirement assets. Remember, you have to invest through retirement not to retirement. Just because the actuarial forecast is a life expectancy of 85 years doesn't mean you will only live that long. Remember that 85 years is an average which means many people can expect to live well beyond that age.
- Make use of IRAs, both Traditional and Roth, to help build investments for retirement. The earnings will build tax-deferred and are worthwhile even if you don't get a tax deduction.
- Think in terms of replacing 100 percent of income when planning for retirement. Even though some expenses do decrease in retirement, many other expenses such as travel and entertainment will actually increase. Target more rather than a minimum need.
- Don't tap retirement funds to finance a college education for your children, pay down debt or anything else. Your children have many years to pay off school loans if they need to but you could have a short time frame to rebuild your assets for retirement.
- Study and understand company benefits available and take full advantage of them to achieve long-term goals. It is easy to miss out on opportunities when you are not aware of them.
- Stay involved and aware of your parent's and adult children's financial situation. Be proactive in helping them manage their finances so that you don't end up using your retirement funds to support them.
- Take control of your finances today and never look back!
How Can I Start Investing For My Children's Education?
College costs continue to rise, and most parents want to begin saving for their children’s education costs earlier and earlier. So how do you make sure you have enough saved when your child is ready to leave for school? Take the time to understand all of the savings options available and establish your objectives now. The most important early decision is to set a realistic target. Do you want to have enough saved for one, two, three or four full years of higher education (or more). Be realistic about what amount you can put away monthly. Be diligent about consistent contributions. Work with an advisor to monitor your progress and to adjust for goals if necessary.
Section 529 Plans
529 plans have become widely popular due to the benefits and flexibility that these plans provide. 529 plans allow for federal tax-deferred growth, as well as tax-free withdrawals to pay for a beneficiary's qualified college education expenses. 529 plans are sponsored by several states, and provide varying tax benefits based on the state. You do not have to be a resident of a given state to participate in its plan; however, you should review your home state's plan to determine if additional tax savings are available. These plans do not have income-level restrictions in terms of who can contribute to them and do not have annual contribution limits. A special rule allows for 5 years' worth of $14,000 ($28,000 if married) annual gifts for 2017 to be made into the plan at one time for each beneficiary. This allows for up to $70,000 ($140,000 if married) to be contributed on behalf of each beneficiary up front, without any gift tax implications.
Qualified education expenses for which tax-free withdrawals can be made include tuition, room and board, required fees, and books and supplies (with the exception of computers and software, unless specifically required by the institution). It is important to note that withdrawals made from the plan that are not directed to qualified education expenses will be subject to both income tax and a 10% penalty on earnings. If the beneficiary for whom you have established the account does not attend college, you have the option of changing the beneficiary of the account to virtually any family member, including first cousins. There are also special exceptions to the 10% penalty on withdrawals in the event that the beneficiary has died or is disabled, or if funds are not needed for college because the beneficiary has received a scholarship, or will be attending a U.S. military academy. You can either participate in 529 savings plans that allow you to make contributions to the plan and direct them to various investment options offered by the financial institution that manages the plan, or in prepaid 529 plans that allow you to pre-pay all or a part of college tuition at today's rates. These plans also provide some attractive estate planning benefits, allowing for large gifts to be made to the plan which will be removed from the donor's estate. 529 plans are unique in that they allow for contributions to the plan to be removed from the donor's estate, while still allowing the donor to maintain control over the account.
Coverdell Education Savings Accounts
Coverdell Education Savings Accounts (“ESA”) are tax-advantaged accounts that offer a way to save for your children's education costs. Although Coverdell ESAs are non-deductible, earnings on account investments are not taxed and may be withdrawn tax-free to pay the child’s qualified education expenses. In 2017, total annual contributions on behalf of a child cannot exceed $2,000, however, the ability to contribute to an ESA is phased out above certain income levels. These accounts provide a unique advantage relative to other education savings vehicles, in that they allow for tax-free withdrawals to pay for a child’s education expenses from kindergarten all the way through college. Contributions may be made to the account until the child reaches age 18, and the account must be fully withdrawn by the time the child reaches age 30, or taxes and penalties will apply.
Uniform Transfers to Minors Act
Another option available to those who want to begin saving for their child’s education expenses is to open a custodial account for the benefit of the child under the Uniform Transfers to Minors Act. A contribution made to a custodial account under the Uniform Gifts to Minors Act (“UGMA”) or Uniform Transfers to Minors Act (“UTMA”)on behalf of a minor child is considered an irreversible gift. The custodian of the account is required to manage the account in a prudent manner for the benefit of the minor, and is required to relinquish control of the funds when the minor reaches the age of majority. Although the custodian of the account is responsible for the management of the funds in the account, all assets held in a custodial account are indeed owned by the child. All income and capital gains in the custodial account are taxable to the child, but the rate will vary, depending on how much is distributed and at what age.
The “kiddie tax” rules apply to children under the age of 19, as well as dependent, full-time students age 19 through 23, and are as follows for the year 2017:
- Up to $1,050 of unearned income is not taxed;
- The next $1,050 of unearned income is taxed at the child’s tax rate;
- Any amount over $2,100 is taxed at the parents' marginal tax rate. These figures may be adjusted from time to time;
- And once the child reaches age 19 and is no longer a dependent, full-time student under the age of 24, all distributions are taxed at the child’s tax rate.
Funds in a custodial account may be used for the child’s support, maintenance, and education, and are relatively easy to establish.
Set Up an Account in Your Own Name
You also have the option of setting up an account in your name and making contributions to it. If you do this, just remember that this account is designated for your child’s education costs, and keep the account separate. You should begin a regular investment program, and continue to contribute at an appropriate level based on potential college costs. As a general rule, you should be more aggressive in the early years, and gradually shift to a more conservative stance as your child nears their first year of school. You will not have to turn these funds over to your child at any point in time and will have full flexibility and control over the investment of the funds in this account.
As An Entrepreneur And Business Owner, How Do I Diversify My Assets?
The first point is that not all companies are successful, so there is a need to have investments that aren't directly related to your company. For many people, this means investing in other companies in the same industry because they are more comfortable with things they know. However, companies within the same industry are usually subject to similar types and sources of risk.
There are some things that you should think about in order to continue to build your assets and diversify some of that single asset exposure, or concentrated risk. The following are some things to consider:
- Build retirement assets outside the business, using the business as leverage for funding a retirement plan. This can help you diversify your investment risk, reduce your taxes and help build your assets in tax-deferred accounts. This can also help you attract and retain employees.
- Overtime build additional non-retirement savings outside of the business. If possible, take periodic distributions from the company to help fund a balanced investment strategy for long-term growth. This will make you less dependent on the company to provide for overall growth in your asset base.
- Establish personal emergency reserves outside the company. Business owners hate to see money sitting around, but that credit line is not always going to be available or may not be the best choice. Having cash on hand for personal needs, instead of leveraging the business for personal needs can be a good decision.
- Maintain a diversified portfolio of mutual funds and Exchange Traded Funds ("ETFs") of assets that have different characteristics than your business, or the industry in which you operate. This will allow you to participate in opportunities other investable assets may provide. A diversified portfolio does not have to be dull and boring. You can have an aggressive diversified portfolio and still reduce the risk of owning only one major asset.
- Calculate or even estimate the value of your business if you were to sell it tomorrow and use it to gauge how you need to invest your overall portfolio. Having an idea of the value will help you back into an overall investment strategy outside of your business. If the value is not sufficient to provide for the lifestyle you desire, aggressive savings outside of the business may be appropriate.
- Invest to balance some of the risk in your business.
- Think global. If you are in a business that derives most of its revenues from domestic sources you should have international investment exposure as well. As the global economy becomes more and more important, having exposure to various segments beyond your core business is becoming increasingly important.
The key is to think about what really makes sense for you and your family in order to assure that you're able to meet your objectives for accumulating, growing and ultimately preserving your assets. Beware of the get-rich-quick investment schemes. If it sounds too good to be true, it probably is. Many scam artists target business owners because they are risk takers.
If you want to trade stocks as part of your investment program, set up a separate account and limit the dollars to less than 5 – 10% of your total portfolio. Keep the balance of your investments in diversified long-term focused mutual funds or ETFs. Plan your overall financial future the same way you plan your business future. Create the vision, define the objectives and then make it happen!
Business owners are risk takers by nature, but usually calculate the odds of a successful landing before making the jump. That is really what we are talking about here. No matter how good you are or how much you believe in your business, you need more. The odds of your overall financial success are increased significantly if you build that investment program outside the business to serve as your parachute. When you do decide to jump or if you have to jump, it will definitely be a softer landing.
How Can I Control Credit Card Spending And Manage Credit Card Debt?
Controlling Credit Card Spending
Credit card bills sometimes take over our mailboxes, especially after the holidays. If you end up with more debt than you know what to do with, follow these tips on effective ways to use credit cards and manage credit card debt:
- Before the holiday, define your objectives. Put together a budget and decide how much money you will spend. Stick to that budget!
- Be realistic. Don't set yourself up for failure. If you set your budget too low, you won't be able to stick to it. If you fail the first year, you may never be able to face a budget again.
- Reduce impulse buying. Many of us spend a lot on ourselves, especially during the holidays because we spend more time in stores and keep seeing such “good deals.” Close your eyes and keep walking. It will probably be a better deal after the holidays.
- Add up what you have spent and keep track of it. This is where most of us have difficulty because if we know how much we have spent, it isn't as much fun.
Managing Credit Card Debt
- If there is any way possible, try to pay off those credit card bills every month or at least every few months. Don't let that debt get so high that you can't figure out when you will be able to pay it off.
- If you carry balances on several cards, pay off the cards with the highest interest rates first, with as much as you can afford to pay off. Work your way down to the cards with the lowest interest rates until all cards are paid off.
- Add extra dollars to the minimum monthly payment. Even if you only pay $5 extra, it will reduce the interest cost and help you get it paid off more quickly.
- Get a picture of how many months it will take to pay down the debt and make that your longest term target. You will see the light at the end of the tunnel! Check out financial calculators at www.nfcc.org to help you calculate this.
- Avoid using a home equity loan to pay down your credit card debt. If you move your credit card debt to a home equity loan, you are taking your consumer loan and putting your home at risk. Just continue to pay it down in a systematic way, the same way you would pay off a car.
- Negotiate! There is tremendous competition among credit card companies. Offer to transfer balances to one credit card in exchange for a lower rate. If you have a large balance, you have negotiating power.
- Once all cards are paid down, do not start the debt cycle again! Manage your spending and pay off new balances each month. Buy only what you can afford to spend.
- Use only one credit card if possible. This will help you to better track and control spending.
- Plan before you spend, keep track of credit card charges, and look forward to a debt-free future!
How Can I Make The Most Of Found Money?
Did you get an unexpected bonus this year? Or maybe the bonus was a little higher than expected. Maybe your parents decided to start a gifting program, or your stock options have done so well it is time to cash them in. Or you inherited money that you never expected from an aunt, or better yet, you actually won the lottery.
However you ended up with that found money, don't let it waste away without a plan. Seize the opportunity. Whether it is $10,000 or $10 million, it can make a major difference in your long-term financial health.
Review and implement the following checklist to put these dollars to work for you and take advantage of that found money:
- Give yourself time to think about it. Don't take off for that tropical island yet.
- Think about your overall goals and objectives and how these dollars can work with your financial plan. How can you use these dollars to help you achieve your goals faster?
- If you don't have a financial plan, here's a really good reason to develop one starting right now. Planning now means a lot fewer regrets later.
- Hire a professional Fee-Only CERTIFIED FINANCIAL PLANNER™ to help you work through the issues. Make sure you go down the right path for a secure financial future.
- Think about your vision for the future. Do these dollars change your vision or help you get there more quickly? If your vision will change, make sure you understand what that really means.
- Newly found wealth can really complicate your life. You may find yourself chased by people who want to help you spend these dollars. Use your professional advisors to run interference for you and recognize that some of those long-lost friends aren't really friends.
- Learn the basics of investment even if you hire a professional to help you manage your money. You need to understand the reasoning behind how your dollars are managed.
- If you are still working, these extra dollars may mean you can now take full advantage of your company 401(k).
- Make sure you understand what these dollars really mean to your overall finances. People often get an unrealistic idea of how much cash flow this found money can provide for them. Assume you inherited $500,000, and invest in a diversified portfolio of stocks and bonds, earning an average annual return of 8%. That means you can take out approximately $20,000 or a maximum of 4% of the account balance per year without depleting your principal, and allowing the account to continue growing.
- Understand where your money is going. Establish that expense plan and stick to it. More money does not mean you can spend what you want. No matter how much money you have, it still makes sense to understand where you are and what you can afford to spend.
- Take a small percentage of the money and have some fun. You don't have to limit the fun, just the dollars you spend.
- If the dollars are less than $50,000, think about funding those IRAs or maybe your children's college fund. Consider investing some of these dollars a little more aggressively than your regular diversified program.
- If the dollars you receive are up to about $300,000, you can afford to use some for a vacation or that car you haven't been able to afford. But don't quit that job unless you have some funds of your own.
- If your found money is more than a million, you now have more choices. Are you close to retirement? Is there something different you would like to do with your life? Spend some serious thinking time before making that big leap.
- Focus on your overall investment goals and objectives. Structure your investment allocation to reach your long-term goals.
How Do I Find A Financial Advisor?
Once you make the decision to look for a financial planner or advisor, you have several important decisions to make. The first is how to go about starting the process. First, make sure you understand the categories, and how you will pay for services. Second, understand the qualifications and credentials of professionals. And finally, make sure you take the same amount of time to make this decision as any other major personal decision.
Here are some categories:
- may provide you with specific advice regarding investments you should make.
- may provide you with more general suggestions about your financial affairs, which may and usually does include investment advice, insurance, estate and retirement planning, and tax planning.
The next step is to define the way planners charge for their services:
This financial planner can only receive compensation directly from clients and does not sell products of a broker or another party for a commission, such as stocks or real estate partnerships.
These planners may charge either an annual fee based on a percentage of assets and investment activity, a flat fee based upon service provided or an hourly fee. The type of fees charged is disclosed in the ADV Part 2A form that all SEC-registered investment advisors are obligated to provide to new clients and offer to existing ones.
Many financial planners obtain at least some of their income from commissions earned on the products they sell for third parties to implement the plans they create for their clients. Any commission or remuneration derived from the sale of an investment product should be disclosed. These folks may sometimes call themselves Fee-Based.
Some financial planners charge their clients no fee at all, but do get commissions on the investment products they sell. Commission costs may not be obvious to the client on some products. The client should always ask about the total costs involved, including commissions on all products.
There are advantages and disadvantages to each type of financial professional. You must decide what type is best for you.
The next step is to gain a clearer understanding of the credentials and qualifications of individuals who provide financial planning services:
Here are a few that you definitely need to be familiar with before starting to make your inquiries:
Chartered Financial Analyst (CFA) - courses and testing covering investment analysis, valuation, portfolio management, and wealth planning. A CFA is typically an investment professional such as a portfolio manager or research analyst. The designation has education and/or experience requirements and does not require continuing education. The CFA Institute grants the designation, 915 East High Street, Charlottesville, VA 22902, 800-247-8132, www.cfainstitute.org.
Certified Financial Planner™ (CFP®) - courses and comprehensive examination. The examination includes case studies and client scenarios designed to test the ability to correctly diagnose financial planning issues and apply knowledge of financial planning to real world circumstances. The designation has education, experience and ethics requirements, and requires continuing education. Certified Financial Planner Board of Standards (CFP Board) grants the use of the designation, 1425 K Street, NW, Suite 800, Washington DC 20005, 800-487-1497, www.cfp.net.
Chartered Financial Consultant (ChFC) - courses and testing covering Financial Planning: Process and Environment, Fundamentals of Insurance Planning, Income Taxation, Planning for Retirement Needs, Investments, Fundamentals of Estate Planning, Personal Financial Planning: Comprehensive Case Analysis, Applications in Financial Planning I and Applications in Financial Planning II. The designation has experience and ethics requirements and requires continuing education. Designation is granted by The American College, 270 S. Bryn Mawr Ave., Bryn Mawr, PA 19010-2196, 888-263-7265610-526-1000, www.theamericancollege.edu.
Certified Public Accountant/Personal Financial Specialist (CPA/PFS) - courses and testing covering Professional Responsibilities, Personal Financial Planning Process, Fundamentals of Financial Planning, Income Tax Planning, Insurance Planning, Investment Planning, Financial Independence (Retirement Planning), Employee Benefits, Estate Planning, Charitable Planning, and Other Personal Financial Planning Issues. The designation has education and experience requirements and requires continuing education. Designation granted by the American Institute of Certified Public Accountants (AICPA) Personal Financial Planning (PFP) Division, 1211 Avenue of the Americas, New York, New York, 10036-8775, 212-596-6200, www.aicpa.org.
Now you are ready to begin the process of finding and hiring a financial planner. Here are the steps:
1. Get a list of names of financial planners from friends and family, but don't assume they will be right for you.
2. Get a list of names from organizations that refer planners. Here are two that you can access on-line or by telephone.
- National Association of Personal Financial Advisors (NAPFA) - This is the only Fee-Only membership organization for financial advisors. You can get a complete list of fee-only planners in your area that are members by calling 888-FEE-ONLY or going to www.napfa.org. NAPFA members sign a Fiduciary Oath stating they will always put their clients' interests first.
- Financial Planning Association (FPA) - This membership organization is the result of the merger between the Institute of Certified Financial Planners (ICFP) and the International Association of Financial Planning (IAFP). You can get names of the financial planners in your area by either calling 800-322-4237 or www.plannersearch.org.
Now that you have your list of prospective financial advisors, you can call to get additional information on each of the candidates.
It may help to narrow down your choices to go through some of the basic questions in the telephone interview before you schedule an initial meeting.
Many advisors may deal only with clients in certain situations such as teachers or retirees. Others may have a minimum assets requirement. Ask about these to make sure there is a fit before you waste your time going further. Review the information package that you receive from each of the planners to determine if they meet your basic criteria.
Next, schedule a meeting to talk face-to-face with your prospective planners
Many planners are very qualified, but you may not be comfortable with his or her style. It is critical that you have a high comfort level because you will be working with this individual for a long time.
Here are some sample questions to ask:
- What are your qualifications?
- What services do you offer?
- Do you have other clients who are in situations similar to mine?
- Will you be the only person working with me?
- How will I pay for your services?
- Have you ever been publicly disciplined for any unlawful or unethical actions in your professional career?
(These questions were taken from “10 Questions to Ask When Choosing a Financial Planner” which can be found at www.cfp.net)
You may also want to check your candidates to see if there have been complaints filed against them.
Here are a few government organizations you can check out.
The U.S. Securities and Exchange Commission (SEC) - Any investment advisors or financial advisors who give investment advice and have regulatory assets under management of over $100,000,000 are required to register with the SEC. 800-732-0330 or www.sec.gov.
North American Securities Administrators Association (NASAA) - This is the organization for the State Securities Administrators and can provide the name of the contact person in your state. Investment advisors or financial advisors who give investment advice and who have less than $100,000,000 of regulatory assets under management are required to register in the state in which they are doing business. (202) 737-0900 or www.nasaa.org.
Living Trusts - Are They For Me?
Is a revocable living trust the right answer to your estate planning questions? Maybe, but maybe not. The answer is much more complicated than we are led to believe by many of those who sell books, seminars, and software systems on living trusts. These individuals are trying to sell us a simple solution to a complex problem. So how do I decide whether or not a revocable living trust is right for me? First, let's think about what we are trying to accomplish.
What are my estate planning objectives?
For many of us, our objectives are pretty straight-forward. We want to make sure our family is taken care of financially when we are not around to take care of them. Or maybe we are concerned about estate taxes taking too high a percentage of our accumulated wealth. Or maybe we want to make sure that our family can't spend it all. There are many different objectives, and we each may see them from a different perspective. The point here is an important one. We are all different, and there is no simple solution to everyone's estate planning problem.
There are many ways to leave your assets to family members, and we will provide a few to put the living trust into context for discussion. The first is you can leave your assets directly by naming individuals as beneficiaries of IRAs, insurance policies and even brokerage accounts today. These assets will pass directly to the individuals or organizations named regardless of what your will states. The second way to direct the distribution of your assets is by will. This means that assets not having direct beneficiaries named would normally be covered under your current will and would go to the designated beneficiaries under your will. The third alternative is establishing a trust during your lifetime so that assets pass directly to the named beneficiaries after your death. This answer does not cover many technical aspects and we are not a legal firm so we can't give legal advice; but hopefully you now have a basic framework for the next level of discussion concerning the living trust.
What is a revocable living trust?
A revocable living trust is a trust to which you transfer all or part of your assets during your lifetime. There is a wonderful description in an estate planning book where they refer to the trust as a box. So picture a box where you can place all your assets but still retain control of the box. You retain the right to the trust's income, to withdraw assets or add to the trust and the right to end the trust and take back all the assets. The major thing to remember here is that as the name implies, the revocable living trust can be revoked or cancelled at the whim of the grantor (the individual) who set it up.
Why would someone want to set up a living trust?
One of the primary reasons that people are encouraged to establish a living trust is to avoid probate. Probate is technically the process of proving a Will was in fact the Last Will and Testament of an individual who has passed away. Whether or not it makes sense to “try to avoid” probate depends on the process in your state. For many states, like New Jersey, the probate process is a very simple one and takes very little time. For these states, avoiding probate is not a sufficient reason for establishing a living trust. And probate is not necessarily a bad thing. It does serve many useful purposes, including serving as a forum to resolve disputes. If you live in New York or one of the states that require all heirs to sign off before probate can be concluded, a living trust may make sense.
A living trust can allow a selected trustee to both manage the assets during your lifetime and distribute them after your death with the least number of complications. You may be too busy and want someone else to handle the assets, pay bills and basically administer your assets. This type of arrangement provides the opportunity to do that while still maintaining the basic control by being able to revoke the trust at any time (assuming this is written into the trust document by your attorney).
If you become mentally incompetent, the successor trustee named in your trust document can take control of the trust and avoid the cost of a conservatorship in many cases. A court-appointed Conservator is often required in situations in which someone can no longer manage his or her financial affairs or personal care. A revocable trust can help avoid the expensive, complex, and frustrating court process if your family has to request that a court declare you legally incompetent. Note that you may need other legal documents such as a durable power of attorney to work through this process.
A revocable living trust allows you to retain almost total control of the assets during your lifetime and may provide the ability to control the timing and manner of distribution of assets. It also provides privacy. There will be very few people who would have access to the information about your assets, the beneficiaries you have named, etc. By contrast, the probate process makes your will public, so if privacy is a concern, you may want to avoid probate.
A revocable living trust can provide effective and efficient transfer of assets. Because a trust can be named as recipient of almost any type of asset, you can consolidate your holdings into your trust for monitoring and administration. Upon your death, your estate can be structured so that other assets can “pour over” into this trust.
If you are having difficulty with dealing with wills and your estate plan, a revocable living trust might be a way to get past the psychological barrier of signing a will. It can be a starting point for getting your estate plan moving in the right direction to protect your family.
Now that we have covered some of the reasons for establishing a revocable living trust, let's look at some of the disadvantages.
A living trust may cost more because you have to manage and administer the trust during your lifetime. Your overall setup cost will be higher because you will need a will and a trust document. The trust does not replace the will. This trust document needs to be comprehensive and flexible enough to cover issues that arise during your lifetime. That means it will take more time in working with your attorney to make sure you include everything you might need.
Transferring assets to the trust involves costs and paperwork not required for less elaborate estate plans, such as a will. Changing the title on real estate or business interests may require the services of an attorney or other professional assistance and can require a significant amount of time.
Living Trusts will not save you income and estate taxes.
Many people are under a major misconception that a Living Trust will save taxes. This simply is not true. There are many ways to save income and estate taxes, but this is not one of them. Whether or not there is an advantage to “avoiding probate” depends to a great extent on the laws of the state in which you live. For many people, avoiding probate is not a good reason to go to the expense of establishing living trusts.
A revocable living trust is one of many available estate planning tools. It can be a very flexible and helpful tool when properly drafted by a knowledgeable and competent estate planning attorney. But it is not a one-size-fits-all solution and can be potentially harmful when used without a clear plan. Regardless of what some sellers of books, seminars and software may tell you, revocable living trusts are not needed by everyone.
Define your objectives, meet with your financial advisor and your estate planning attorney, and draft an estate plan that will help you sleep well knowing you and your family are protected.
Should I Exercise My Stock Options And What Method Should I Use?
Generally, there are two main types of stock options awarded in executive compensation plans. Each of these options can be taxed differently and requires different considerations before any action is taken.
INCENTIVE STOCK OPTIONS (“ISO”):
ISOs are qualified stock options. Being qualified, they carry the ability to defer taxation on the value of the award upon exercise. In order to defer this taxation, individuals are required to hold the shares after an exercise for at least a year. After the year threshold has passed, individuals can sell the stock and realize gains at preferential capital gains tax rates, which are typically lower than ordinary income tax rates. ISOs, however, do have Alternative Minimum Tax (“AMT”) implications. Individuals should consult with a professional prior to exercising an ISO. It is worth noting that no more than $100,000 in ISOs can be exercised in any given year. In general, ISOs are less popular today than nonqualified stock options or restricted stock awards as forms of executive compensation.
NONQUALIFIED STOCK OPTIONS (“NSO”):
NSOs, as the name implies, are not qualified for preferential tax treatment. The value of the award is fully taxable as ordinary income upon exercise. Since the award is taxed immediately, there is no limit on the amount an individual can exercise in any given year.
Determining whether or not to exercise a stock option can be a complicated and difficult decision to make. Investment, tax, and education planning considerations are just a number of factors that can complicate the decision. Each individual’s circumstance will vary, making blanket rules regarding exercising stock options difficult to make. However, there are a number of general considerations that should be reviewed which can influence the decision.
- Is a significant portion of your investable assets tied up in your company stock? Many individuals have exposure to their employer’s stock in the form of stock options and stock held in retirement plans. Reducing your investment concentration in any one security and diversifying the dollars into a balanced investment strategy is often a prudent decision.
- Are the stock options nearing their expiration dates? As time passes and your options near their expiration dates, a sudden drop in stock price can materially affect their value. If the time until expiration is not sufficient for the stock price to recover, significant value may be lost or options may expire worthless altogether.
- Is the option value at risk? Besides general market risk that all stocks experience, there may be extraordinary events that can depress the price of the stock over a period of time. If you feel these company-specific risks are present, it may be prudent to realize some of the value within your options.
- Can the dollars be better used elsewhere? If the company’s stock has struggled while the overall market has done well, it may be to your benefit to exercise the options and use the proceeds to invest in a balanced investment strategy to better utilize these dollars.
- Do you need to limit the realization of income for a p articular purpose. Generally tax considerations should not dictate investment decisions. However, in certain circumstances it may make sense to defer, or accelerate, the exercise if a reason exists to shift taxable income into a specific year.
Making a decision on the method of exercising your stock options can have investment and tax implications well beyond the initial exercise. Depending on your goals, the following methods may be appropriate for you:
“CASHLESS EXERCISE” OR “EXERCISE AND SELL”
In this method, the employee is not required to provide the cash up front to perform the exercise. The company’s executive compensation plan administrator can typically work with a broker to use the shares being exercised to fund the exercise itself.
In this scenario, the shares are sold immediately and the taxable value of the exercise, usually net of tax withholdings and broker’s commissions, is released to the employee. This is typically the desired approach for individuals with nonqualified options who are looking to invest the proceeds in a balanced investment strategy, or use the cash for some other expenditure.
“EXERCISE AND HOLD”
In this method, the shares being exercised will be retained by the employee. In order to do this, the employee must come up with the dollars to perform the exercise. This is typically done either using cash, or borrowing on margin. After the exercise, the broker will release the shares to the employee to be held. This is typically the preferred method for individuals with nonqualified options who believe in the long-term success of their company and do not mind having their investments concentrated in the company stock. For qualified options, this is typically the preferred method of exercise since holding the stock for a year will allow the employee to pay capital gains tax rates on a subsequent sale.
Stock options have the potential to create significant wealth for many people. Depending on the type of stock options you have and your long term goals, different exercise strategies may be appropriate for you. Whichever method you pursue, it is prudent to consult with a professional prior to making a decision to ensure you understand all of your "options.”
What Are Some Tax Saving Strategies?
Since the demise of the tax shelter, strategies for saving individual income taxes are harder to come by, but they do exist. This Financial Guide provides tax-saving strategies for deferring income (often through the use of retirement plans) and maximizing deductions. It includes some strategies for specific categories of individuals, such as those with high income and those who are self-employed.
Before getting into the specifics, however, we would like to stress the importance of proper documentation. Many taxpayers forgo worthwhile tax deductions because they have neglected to keep receipts or records. Keeping adequate records is required by the IRS for employee business expenses, deductible travel and entertainment expenses, and charitable gifts. But don't do it just because the IRS says so—neglecting to track these deductions can lead to overlooking them. You also need to maintain records regarding your income. If you receive a large tax-free amount, such as a gift or inheritance, make certain to document the item so that the IRS does not later claim that you had unreported income.
The listed items are of general application only and should be tailored to your specific situation. If you think one of them fits your tax situation, discuss it with your tax adviser.
Avoid or Defer Income Recognition
Deferring the taxability of income makes sense for two reasons. Most individuals are in a higher tax bracket in their working years than during retirement. Deferring income until retirement may result in paying taxes on that income at a lower rate. Additionally, through the use of tax deferred retirement accounts, you can actually invest the money you would have otherwise paid in taxes to increase the amount of your retirement fund. Deferral can also work in the short term if you expect to be in a lower bracket in the following year or if you can take advantage of lower long-term capital gains rates by holding an asset a little longer.
Max Out Your 401(k) or Similar Employer Plan
Many employers offer plans where you can elect to defer a portion of your salary and contribute it to a tax-deferred retirement account. For most companies these are referred to as 401(k) plans. For many other employers, such as universities, a similar plan called a 403(b) is available. Check with your employer about the availability of such a plan and contribute as much as possible to defer income and accumulate retirement assets.
These types of plans have been around for years. The law has allowed employers to add a Roth feature to these plans. If you make a Roth 401(k) contribution, you pay tax on the contribution when you make it, but any future earnings are permanently excluded from taxation. So, although there are no immediate tax savings here, the future tax savings can add up.
If You Have Your Own Business, Set Up and Contribute to a Retirement Plan
If you have your own business, consider setting up and contributing as much as possible to a retirement plan. These are allowed even for sideline or moonlighting businesses. Several types of plans are available which minimize the paperwork involved in establishing and administering such a plan.
SEP-IRAs can be established and funded as late as October 15th for the previous year, provided that the taxpayer filed an extension. The maximum contribution is 20% of the person's net self-employed income, with a maximum dollar limit of $53,000 for 2016 and $54,000 for 2017. "Net self-employment income" means self-employed income minus one-half of the self-employment tax.
SIMPLE IRAs can also be funded as late as October 15th (with an extension), but the plan needs to be established by the taxpayer no later than October 1st of the tax year for which the contributions will apply. SIMPLE plans consist of a salary deferral portion with a maximum of $12,500 for both 2016 and 2017, plus a matching contribution of up to 3%. Taxpayers age 50 or older can defer up to $15,500 in 2016 and 2017.
Solo 401(k) plans combine a deferral portion with a matching portion. The maximum elective deferral is $18,000 for 2016 and 2017 (or $24,000, if age 50 or older in 2016 and $25,000 in 2017). The maximum matching portion is 20% of net self-employment income. The total of both the deferral and the matching cannot exceed $53,000 for 2016 and $54,000 in 2017 ($59,000 if you're 50 or older in 2016 and $60,000 in 2017). Solo 401(k) plans need to be set up by December 31st, but contributions can be made as late as October 15th of the following year with an extension.
Contribute to an IRA
If you have income from wages or self-employment income, you can contribute up to $5,500 ($6,500 if age 50 or over) in 2016 and 2017 to a traditional or a Roth IRA. You may also be able to contribute the same amounts to a spousal IRA —even where the spouse has little or no earned income. All IRAs defer the taxation of IRA investment income and in some cases can be deductible or be withdrawn tax-free. Your eligibility for some benefits depends on your income and whether you or your spouse is in an employer-sponsored retirement plan.
The main differences between Traditional and Roth IRAs are these:
Contributions to Traditional IRAs in many cases are deductible; withdrawals from Traditional IRAs are taxable income, except for withdrawal of previously non-deductible contributions. Contributions to Roth IRAs are never deductible; withdrawals from Roth IRAs are completely tax-free if certain tests are met.
Contribution Rules for Traditional IRAs are Briefly These:
Contributions are deductible regardless of your income if neither you nor your spouse is an active participant in an employer-sponsored retirement plan. For 2016, if your spouse is a participant but you aren't, the deduction is allowed if joint income is below $184,000 (deduction phases out at $194,000), and for 2017, if joint income is below $186,000 (deduction phases out at $196,000). In 2016, if both you and your spouse are participants, the deduction is allowed on a joint return if income is less than $98,000 (deduction phases out at $118,000)--and on a single return with less than $61,000 (phases out at $71,000). In 2017, if both you and your spouse are participants, the deduction is allowed on a joint return if income is less than $99,000 (deduction phases out at $119,000)--and on a single return with less than $62,000 (phases out at $72,000).
Contribution Rules for Roth IRAs are Briefly These:
In 2016, Roth IRA contributions up to $5,500 ($6,500 if age 50 or over) are allowed on joint returns with income below $184,000 (phases out at $194,000) and single returns below $117,000 (phases out at $132,000). In 2017, Roth IRA contributions up to $5,500 ($6,500 if age 50 or over) are allowed on joint returns with income below $186,000 (phases out at $196,000) and single returns with income below $118,000 (phases out at $133,000). Roth contributions are not deductible. Earnings in a Roth accumulate tax free. Above those Roth IRA income levels, nondeductible contributions may be made to Traditional IRAs.
Defer Bonuses or Other Earned Income
If you are due a bonus at year-end, you may be able to defer receipt of these funds until January. This can defer the payment of taxes (other than the portion withheld) for another year. If you're self-employed, defer sending invoices or bills to clients or customers until after the new year begins. Here, too, you can defer some of the tax, subject to estimated tax requirements. This may even save taxes if you are in a lower tax bracket in the following year. Note, too, that the amount subject to social security or self-employment tax may change.
Accelerate Capital Losses and Defer Capital Gains
If you have investments on which you have an accumulated loss, it may be advantageous to sell prior to year-end. Capital losses are deductible up to the amount of your capital gains plus $3,000. If you are planning on selling an investment on which you have an accumulated gain, it may be best to wait until after the end of the year to defer payment of the taxes for another year (subject to estimated tax requirements). For most capital assets held more than 12 months the maximum tax rate for 2016 and 2017 is 20%. However, make sure to consider the investment potential of the asset. It may be wise to hold or sell the asset to maximize the economic gain or minimize the economic loss.
Watch Trading Activity in Your Portfolio
When your mutual fund manager sells stock at a gain, these gains pass through to you as realized taxable gains, even though you don't withdraw them. So you may prefer a fund with low turnover, assuming satisfactory investment management. Turnover isn't a tax consideration in tax-sheltered funds such as IRAs or 401(k) s. For growth stocks you invest in directly and hold for the long term, you pay no tax on the appreciation until you sell them. No capital gains tax is imposed on appreciation at your death.
Use the Gift-Tax Exclusion to Shift Income
You can give away $14,000 in 2016and 2017 ($28,000 if joined by a spouse) per donee, per year without paying federal gift tax. You can give these amounts to as many donees as you like. The income on these transfers will then be taxed at the donee's tax rate, which is in many cases lower. Note: Special rules apply to children. Also, if you directly pay the medical or educational expenses of the donee, such gifts will not be subject to gift tax.
Invest in Treasury Securities
For high-income taxpayers, who live in high income tax states, investing in Treasury bills, bonds, and notes can pay off in tax savings. The interest on Treasuries is exempt from state and local income tax. Also, investing in Treasury bills that mature in the next tax year results in a deferral of the federal tax until the next year.
Consider Tax-Exempt Municipals
Interest on state or local bonds ("municipals") is generally exempt from federal income tax and from tax by the issuing state or locality. For that reason, interest paid on such bonds is somewhat less than that paid on commercial bonds of comparable quality. However, for individuals in higher brackets, the interest from municipals will often be greater than from higher paying commercial bonds after reduction for taxes. Gain on sale of municipals is taxable and loss is deductible. Tax-exempt interest is sometimes an element in computation of other tax items. Interest on loans to buy or carry tax-exempts is non-deductible.
MAXIMIZE YOUR DEDUCTIONS
Give Appreciated Assets to Charity
If you're planning to make a charitable gift, it generally makes more sense to give appreciated long-term capital assets to the charity, instead of selling the assets and giving the charity the after-tax proceeds. Donating the assets instead of the cash prevents you from having to pay capital gains tax on the sale, which can result in considerable savings, depending on your tax bracket and the amount of tax that would be due on the sale. Additionally, you can obtain a tax deduction for the fair market value of the property.
Keep Track of Mileage Driven for Business, Medical or Charitable Purposes
If you drive your car for business, medical or charitable purposes, you may be entitled to a deduction of 54, 19 and 14 cents per mile, respectively, using 2016 rates, and 53.5, 17 and 14 cents per mile, respectively, for 2017. You need to keep detailed daily records of the mileage driven for these purposes to substantiate the deduction.
Take Advantage of Your Employer's Benefit Plans to Get an Effective Deduction for Items Such as Medical Expenses
In 2016 medical and dental expenses are generally only deductible to the extent they exceed 10% of your Adjusted Gross Income. For those 65 years of age or older, the threshold is 7.5% for 2016 only. After 2017, there is no special rate for those over age 65. For most individuals, particularly those with high income, this eliminates the possibility for a deduction. You can effectively get a deduction for these items if your employer offers a Flexible Spending Account, sometimes called a cafeteria plan. These plans permit you to redirect a portion of your salary to pay these types of expenses with pre-tax dollars. Another such arrangement is a Medical Savings Account which is available for some small businesses. Ask your employer if they provide either of these plans.
Check Out Separate Filing Status
Certain married couples may benefit from filing separately instead of jointly. Consider filing separately if you meet the following criteria:
One spouse has large medical expenses, miscellaneous itemized deductions, or casualty losses and the spouses' incomes are about equal.
Separate filings may benefit such couples because the adjusted gross income "floors" for taking the listed deductions will be computed separately. On the other hand, some tax benefits are denied to couples filing separately. In some states, filing separately can also save a significant amount of state income taxes.
If Self-Employed, Take Advantage of Special Deductions
You may be able to expense up to 100% of the equipment purchased in 2016 and 2017 for use in your business instead of writing it off over many years (there are limitations). Additionally, self-employed individuals can deduct a portion of their health insurance premiums. You may also be able to establish a 401(k), SEP or SIMPLE plan.
If Self-Employed, Hire Your Child in the Business
If your child is under age 18, he or she is not subject to employment taxes from your unincorporated business (income taxes still apply). This will reduce your income for both income and employment tax purposes and shift assets to the child at the same time.
Take Out a Home-Equity Loan
Most consumer-related interest expense, such as from car loans or credit cards, is not deductible. Interest on a home-equity loan, however, can be deductible. It may be advisable to take out a home-equity loan to pay off other nondeductible obligations.
Bunch Your Itemized Deductions
Certain itemized deductions, such as medical or employment-related expenses, are only deductible if they exceed a certain amount. It may be advantageous to delay payments in one year and prepay them in the next year to bunch the expenses in one year. This way you stand a better chance of getting a deduction.
What Are Some Tips On Consolidating IRAs?
Do you have more IRAs then you know what to do with? Is the paperwork making you crazy? Then maybe it's time to think about consolidating some of those IRA accounts.
Why do people end up with a lot of different IRA accounts?
Years ago, people would set up their IRAs with banks. They would set up an account one year, and then set up a new account the next year, and so on. Before long, you would end up with numerous accounts at different banks. Today, mutual fund companies and brokerage firms are also providing IRAs, so there are even more choices. And with the large number of providers of IRA accounts, it can be easy to end up with several different IRA accounts over the years.
Why don't they just add money into the IRA account they already have?
Many people think they need a new IRA account each year. In addition, job changes occur quite frequently these days, and many people think they need to establish a separate IRA account to hold the funds rolled over from each of their prior employer’s retirement plans.
Should investors consolidate their IRAs? What are the benefits?
Yes. The benefits are:
- You will have a better view of your investment program.
- You can move dollars around more efficiently, and potentially lower your overall trading costs.
- It reduces the amount of paperwork.
- It can save you dollars if your IRA accounts charge fees.
- When you start taking out your minimum distributions, you will have a better sense of what you have - and what you need.
When I do consolidate, what should I be careful of?
Make sure you keep your Roth IRA separate from your regular IRAs, and your SEP IRAs separate from your other accounts. You have to be really careful of this. You may also want to keep any non-deductible IRA contributions in a separate IRA. It is also a good idea to keep funds rolled over from a prior 401(k) or other retirement plans in a separate rollover IRA account, and not mix these dollars with the IRA account you contribute to on an ongoing basis.
What Are The Asset Classes And Why Are They Important?
An asset class is a category of investment securities that has similar characteristics and which behave in a similar manner in any given market environment.
The three most basic asset classes are cash, bonds and stocks. These basic asset classes can be further divided into more meaningful sub-asset classes based on various characteristics.
Stocks can be divided into sub-asset classes based on the size of the companies in each sub-asset class, such as large, mid-sized or small companies. They can also be classified by geography or stage of economic development, such as developed or emerging market stocks.
A well-diversified stock portfolio should contain exposures across sub-asset classes including domestic stocks, international stocks and emerging market stocks.
Bonds can be divided into sub-asset classes based on the length of time until their maturity, on the type of entity that issues the bond, the degree of credit risk entailed, and on the geographic location of the issuer.
Bonds can be issued by corporations, federal governments, or state and local governments.
Bonds issued by government entities other than the federal government have certain tax advantages. Under present federal income tax law, the interest income you receive from investing in municipal bonds is free from federal income taxes. In most states, interest income received from securities issued by government entities within the state is also exempt from state and local taxes.
When classified by maturity, bonds can be divided into short, intermediate, or long term sub-asset classes. Other sub-asset classes are high yield and international bonds. Just as for stocks, international bonds can be further divided into developed market bonds and emerging market bonds.
As an example, a well-diversified portfolio could hold short-term US corporate bonds or mutual funds as well as intermediate-term emerging market sovereign debt.
Aside from stocks, bonds and cash, a well-diversified portfolio can hold investments in real estate, commodities and other types of “alternative” investments such as hedge strategy funds. These sub-asset classes serve to broaden even further the diversification in investment portfolios.
Holding a portfolio which is well-diversified across asset classes remains the prudent choice for maximizing investment returns with lower risk.
What Are The Types Of Planned And Deferred Gifts?
There are several types of planned and deferred gifts: (1) life insurance, (2) charitable remainder annuity trust, (3) charitable remainder unitrust, (4) charitable income or lead annuity trust, (5) charitable income or lead unitrust, (6) charitable gift annuity, (7) pooled income fund. These are discussed briefly below:
1. Life Insurance
You name a charity as a beneficiary of a life insurance policy. With some limitations, both the contribution of the policy itself and the continued payment of premiums may be income-tax deductible.
2. Charitable Remainder Annuity Trust
You transfer assets to a trust that pays a set amount each year to non-charitable beneficiaries (for example, to yourself or your children) for a fixed term or for the life or lives of the beneficiaries, after which time the remaining assets are distributed to one or more charitable organizations. You get an immediate income tax deduction for the value of the remainder interest that goes to the charity on the trust's termination, even though you keep a life-income interest. In effect, you or your beneficiaries get current income for a specified period and the remainder goes to the charity.
3. Charitable Remainder Unitrust
This is the same as the charitable remainder annuity trust, except the trust pays the actual income or a set percentage of the current value (rather than a set amount) of the trust's assets each year to the non-charitable beneficiaries. Here, too, you or your beneficiaries get current income for a specified period and the remainder goes to the charity.
4. Charitable Income Or Lead Annuity Trust
You transfer assets to a trust that pays a set amount each year to charitable organizations for a fixed term or for the life of a named individual. At the termination of the trust, the remaining assets will be distributed to one or more non-charitable beneficiaries (for example, you or your children).
You get a deduction for the value of the annual payments to the charity. You may still be liable for tax on the income earned by the trust. You keep the ability to pass on most of your assets to your heirs. Unlike the two trusts above, the charity gets the current income for a specified period and your heirs get the remainder.
5. Charitable Income Or Lead Unitrust
This is the same as the lead annuity trust, except the trust pays the actual income or a set percentage of the current value (rather than a set amount) of the trust's assets each year to the charities. Here, too, the charity gets the current income for a specified period and your heirs get the remainder.
6. Charitable Gift Annuity
You and a charity have a contract in which you make a present gift to the charity and the charity pays a fixed amount each year for life to you or any other specified person. Your charitable deduction is the value of your gift minus the present value of your annuity.
7. Pooled Income Fund
You put funds into a pool that operates like a mutual fund but is controlled by a charity. You, or a designated beneficiary, get a share of the actual net income generated by the entire fund for life, after which your share of the assets is removed from the pooled fund and distributed to the charity. You get an immediate income tax deduction when you contribute the funds to the pool. The deduction is based on the value of the remainder interest.
What Is The Correlation Between Risk And Return?
Risk and return are positively correlated or related. This is one of the most fundamental concepts in finance. To put this concept in the most straightforward terms, the lower the risk, in general, the lower the return. The higher the risk, the higher the return may be, but with this higher return also comes a higher potential for loss.
There are several types of risk in investments. Different types of investments exhibit different types of risk. All types of risk show a positive correlation or relationship with return.
For fixed income or bond investments, some of the most important risks include the following:
- Default (Credit) risk - the possibility that the company whose debt you are considering buying will not be able to make future interest and principal payments as they come due
- Interest Rate (Price) risk - the possibility that market interest rates can rise and thereby negatively impact the price of a fixed income investment
- Inflation risk - the potential for loss in purchasing power as price levels rise across the economy
Risks which should be considered by investors in equities or stocks include the following:
- Market risk - also known as systemic risk or beta risk, this is the economy-wide uncertainty to which all stocks are subject and which cannot be diversified away
- Firm specific risk – this is the uncertainty associated with investment in a particular stock – this risk can be diversified away through holding a diversified portfolio
- Liquidity risk – describes the difficulty which a stock investor can have in selling a stock investment. Highly liquid stocks that trade freely can be sold quickly for fair value. Less liquid stocks are harder to sell because there are fewer interested buyers.
According to Ibbotson SBBI, for the period from 1926 - 2014, small-cap stocks have returned 12.2%, large-cap stocks 10.1%, long term government bonds 5.7%, and cash 3.5%. Inflation over this time frame has compounded at 2.9%.
Stocks are generally considered “riskier” than bonds because their returns are more “volatile” or more widely dispersed than returns on bonds. Over the long term, however, stocks have provided the best protection against inflation risk of the three main asset classes, i.e., stocks, bonds and cash.
Another factor to consider is that interest rates have been declining for over 30 years now and this has been a great benefit to bond returns. Bonds are unlikely to have this tailwind in their favor over the next 30 years, given how low interest rates are today. In other words, interest rate risk should be considered carefully in making any bond investment at the present time.
How Do I Plan A Money Smart Marriage?
Are you planning a spring or summer wedding? Did you know that issues with money can really cut that honeymoon short? Money is the number one reason for problems in a marriage, and yet, few couples take the time to talk about money to head off the issues.
Follow these tips and get your merger off on the right foot:
- Schedule regular meetings to discuss all the areas of your finances. Most people find it uncomfortable to discuss money, but the best way to head off future misunderstandings is to develop open communication.
- Be open in your communication now and don't let your future spouse be surprised by your finances, whether you have a lot of debt or you have been a great saver. Surprises early on can undermine trust in the future.
- Agree on how you will track spending and who will be responsible for tracking. Discuss your spending and saving philosophy and begin to establish mutual objectives.
- Establish a preliminary expense plan in consolidating both income and expenses. Agree on levels of spending for each of you and what level of spending will require discussion. This can prevent many heated discussions after a purchase.
- Talk about your dreams and long-term goals. What do you need to do with your financial planning to make those dreams happen? How can you save enough to purchase your first house or have your first baby? Develop a list of short and long-term goals and begin to establish priorities.
- Will you pool your money or does it make more sense to maintain some separate accounts for saving and investment? This is both a financial and an emotional decision, and it is an important one that you need to make consciously and not leave things "as is" by default. There are benefits to pooling resources like higher interest rates or maybe a better credit rating, but some level of separate accounts can make sense.
- Maintain separate credit card accounts. If one of you has credit difficulties, you will have more options by maintaining the separation. Actively manage your debt by reviewing it on an ongoing basis. This is especially critical if you bring large education loans or credit card debt, etc. with you. These types of debt require discussion and agreement on how you will pay them down and over what time frame.
- Save for retirement separately. It is important to maximize your long-term savings by taking advantage of different plans that are available such as 401(k) s and IRAs.
- Talk about your investment philosophy and be open with one another. Agree on your targeted average annual return on your investment accounts, including your retirement accounts. If one of you is a conservative investor and the other is very aggressive, you may need to compromise on the overall target return and the risk level.
- Review your insurance. Do you have enough life insurance and disability insurance to protect one another?
- Think about a prenuptial agreement. This is especially important if either of you is bringing significant assets to the marriage, own a business or have children from a previous marriage. This can help head off serious future issues with money.
- See an attorney and get those wills drafted soon. The purpose of a will is to make sure your loved ones are taken care of according to your wishes, so make sure you take care of this one.
- Hire a financial advisor to help draft that foundation financial plan. Establishing your roadmap early can be a great boost to your long-term planning, and many times it is easier to work with a third party to work through some of the differences in perspectives. Getting off to a really positive start is important. For parents and grandparents out there, this could make a great wedding gift.
Remember, money is a scarce resource, and the decision on how to allocate it is an important one. Open discussions and positive financial planning can help you sustain that marital bliss for the long-term and can help you make your dreams come true.
How Do I Improve My Investment Returns?
We are all looking for ways to improve our returns in the current market environment, and one of the most important ways to do this is asset allocation. Most people have heard about this investment principle but don't focus enough attention on what it really means. This principle tells us that how we allocate our dollars across asset classes is more important than the actual specific investments we select. That means we need to spend as much time deciding what percentage of our money is invested in different asset classes as we do selecting our specific investments. Examples of asset classes include domestic and international stocks and bonds, in addition to alternatives such as real estate and commodities.
Diversification among asset classes is a key tenant within the concept of asset allocation. In general, a diversified portfolio across asset classes’ offers favorable long-term risk and return attributes when compared to a non-diversified portfolio. By spreading investment across various asset categories, we reduce our dependence on any one market or investment.
Investment expenses are one of the few direct contributors to returns that we can control. In general, lower-cost investments will outperform higher-cost investments. By understanding the total expense profile of a portfolio we can work to reduce expenses where practical in order to increase investment returns over time.
After we have achieved the proper level of diversification in our asset allocation, and have selected lower-expense investments to implement those allocations, ongoing management of the investments is another tool to improve returns. By establishing targets to specific asset classes, we have defined our risk and return parameters. Over time, the actual exposures to each asset class will deviate from the targets based on market performance. Periodically rebalancing the portfolio to its initial targets is a structured approach to improve performance and maintain the intended risk exposures. For example, as assets appreciate the current exposure will be higher than the original target. Conversely, assets that have not performed as well may be below their intended targets. Rebalancing allows the investor to take profits in the appreciated assets and use the proceeds to buy the underperforming asset. It is a structured method of buying low and selling high.
In addition to asset allocation, diversification, expenses and ongoing management, here are some other items to keep in mind when trying to improve investment returns.
- Avoid overly concentrated investment in one security. For example, if 20% of your investments are held in one stock, you may be exposed to higher risks than you are actually comfortable with.
- Always maintain cash reserves outside of your investment portfolio. By maintaining sufficient cash for your needs you’ll be able to avoid selling to raise cash in bad markets. Over time, as markets perform well you can take profits to replenish your cash.
- Don’t be afraid to take profits. Even if you have to pay taxes, profits are a good thing.
- Invest tax-efficiently. Asset location refers to the policy of using tax sensitive assets in tax-deferred accounts such as IRAs, while less tax-sensitive assets can be owned in taxable investment accounts.
- Avoid chasing returns. Just because an investment has performed well in the past doesn’t mean it will continue on its hot streak.
How Can I Protect My Portfolio From Volatility?
Wouldn’t it be wonderful if you could invest your money and your portfolio would grow at a steady 9% or 10% year after year? Not only would your portfolio grow, but the value would just go up instead of up and down, and it would never cause you to lose any sleep. Unfortunately, this kind of return isn't available today without taking significant risk. But there are things you can do to protect your portfolio from the market's gyrations and keep yourself on track to meet your long-term investment goals.
Here are some things you need to know and understand:
- The meaning of the term market volatility.
- What causes volatility in different asset categories?
- The real value of diversification.
Allocating your portfolio's assets or deciding how much of your portfolio will be invested in certain types of investment assets will be the single most important investment decision you make in reducing or controlling volatility.
What is Volatility?
Most people don't really understand what volatility has to do with risk. Targeting high returns means you may become very good friends with high risk and high volatility. Volatility is a measure of how much the value of your portfolio goes up and down and up and down. You get the general idea.
Sometimes financial markets can almost make you seasick. This volatility or the risk of your portfolio is measured by just how much your portfolio goes up and down over time, and it is measured by something we call the standard deviation. In order to make sure you don't fall asleep reading the rest of this answer, we will not provide a detailed explanation or calculation at this point. However, remember that standard deviation is a measure of risk. Another measure of risk is how many times you wake up in a cold sweat at night thinking about your portfolio when the market starts making wild moves either up or down.
In general, over longer time periods, bonds have lower returns with lower risk. Shorter maturity bonds (two or three years) have lower yields than longer maturity bonds (seven to ten years). Stocks normally provide higher returns with higher risk. There are many categories within stocks, such as large-cap companies that are more stable with lower expected returns and small cap companies with higher expected returns and higher risk. Foreign stocks can be even more volatile than domestic small cap stocks. Of course, there will be times when bonds actually do better than stocks or may even become a higher risk. This leads to our next topic.
You probably already know the difference between a bond and a stock, but did you know that these are just broad categories? Even among bonds, which you might generally think of as a “sure bet investment,” you can invest in high-yield bonds or international bonds that can be just as volatile if not more so than some stocks. There are government bonds, municipal bonds, corporate bonds, asset-backed bonds and on and on. But don't let all the categories stop you. You don't have to understand all the bond categories in order to invest in basic bonds or bond funds. Mutual funds can be a great way to invest your portfolio in many types of bonds that fit your investment plan.
You may think of all stocks as “risky,” but did you know that some of the larger, blue-chip-company stocks could provide a stable stream of income just like a bond? Of course you do have more aggressive stocks – like the small-company stocks, technology stocks or international stocks. Most stocks are grouped into the following general categories: Large-cap, mid-cap, small-cap. And over time, each category has had (and will have again) its performance beat the others. The key is to spread your dollars over several categories, including bonds, in order to reduce the overall volatility of your portfolio.
Another aspect to be aware of when investing in mutual funds is the manager's style of investing. This means that the portfolio manager has an investment philosophy that they follow to pick the stocks in their portfolio. The main styles are growth and value.
Growth managers are looking for companies that are growing at a faster rate than other companies in their industry or sector. Value managers are looking for good companies that are selling at a “bargain” price. Some mutual fund managers blend both styles when picking stocks. Over time, both styles have had periods of time where they have done well and where they have performed poorly. Utilizing core funds that blend both styles may be a good way to achieve style diversification amongst your investments.
Your Time Frame
A very important factor in reducing your volatility is your time frame. If your goals are short-term (less than five years), you need to avoid the more aggressive investment and stick with money markets, CDs and short-term bonds. If your goals are longer term, you may have very little allocated to bonds and be more heavily weighted in stocks that will increase your potential return and your potential risk and volatility. The best strategy is to always look to the longer term and stick with your allocation. If you are constantly chasing performance by changing your allocation, you will miss out when one category or style has its best performance.
Remember that you want your portfolio to meet your investment goals over the LONG term. There is no glory in chasing the hottest stock or the hottest fund. And we all know that no one has a crystal ball when it comes to predicting what will happen in the financial markets. So allocate your portfolio over the asset categories (government bonds, municipal bonds, high-yield bonds, large-cap stocks, mid-cap stocks, small-cap stocks, etc) and investment styles (growth and value). Keep your portfolio diversified and you will dampen the volatility, stabilize your performance and portfolio value, and hopefully, sleep much better at night.