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October 12, 2004

Discussing Inheritances with Heirs

Many people are uncomfortable discussing with heirs how they will distribute their estate. Perhaps you don't want your children to realize how much they may receive after your death. Or you may think your choice of heirs could change in the future. However, if you don't discuss your estate plan, disagreements and conflicts could erupt once the details of inheritances are revealed. For instance, siblings may resent each other if distributions are not equal. Children may resent a spouse from a second marriage if they feel that spouse is using up their inheritance. At that time, you won't be able to explain your thoughts and wishes regarding the distribution of your estate.

Discussing your estate plans will give you an opportunity to inform your heirs about the distribution of your estate and why you decided to do it in that manner. You can go into specific detail, informing heirs how each asset will be distributed, or you can give a general overview of your estate plan. If you have selected one heir as executor or trustee, explain why you chose that individual. As an alternative, you can leave a personal letter with your estate planning documents explaining these items.

Even if you reveal your plans to heirs, you may also want to include a personal letter. In that letter, include information about death and other benefits, special wishes, who should receive personal effects, your cemetery and funeral preferences, and the location of your safe deposit box and important documents. At a minimum, specify where the following documents are located: income tax returns, life insurance policies, other insurance policies, investment details, a list of household contents, outstanding loan documentation, automobile titles, important warranties and receipts, checking account information, credit card details, and information about your home. This letter will help your heirs identify all assets and benefits and avoid speculation about your wishes.

Preparing the letter will also force you to organize your records and make sure all important documents can be easily located. Since the information is likely to change, review the letter at least annually.

Locking in Low Student Loan Rates - PLUS Loans & Stafford Loans

On July 1, 2004, interest rates on federal student loans dropped to record lows. From July 1, 2004 to June 30, 2005, the interest rate for PLUS loans is 4.17% and for Stafford loans is 2.77% for students paying while in school and 3.37% for recent graduates. These rates are rounded up to the nearest one-eighth of a percent when loans are consolidated. Now may be a good time to consolidate student loans to lock in these low rates.

Once a student graduates, he/she has a one-time opportunity to consolidate all student loans and lock in an interest rate for the loan's term. Students who are just graduating have a six-month grace period before repayments must begin. However, if loans are consolidated during that period, the interest rate will be discounted by 0.6%. If you've already consolidated your student loans, you won't be able to consolidate again to take advantage of these low rates. However, if you didn't consolidate and graduated more than six months ago, you may want to wait to consolidate until the new rates are released in May 2005. If rates go up, you can consolidate before July 1, 2005 and lock in the current rates. If rates go down again, you can wait until May of the following year to make the same assessment.

Your repayment period for the consolidated loan depends on the amount owed. For example, loans of less than $7,500 must be paid back in 10 years, while loans of $60,000 or more can be repaid in 10, 12, 15, 20, or 30 years. Since there are no prepayment penalties, you may want to use a long repayment period. That will lower your monthly payment in case you run into financial difficulty, but you can always send in more than the required payment to pay the loan off more quickly.

Before consolidating, check with several lenders. While interest rates are set by the federal government, many lenders will reduce your rate by .25% if you agree to automatic deductions from an account, and will reduce your rate by 1% after you have made every payment on time for four or five years.

Review Income Tax Planning Strategies

With marginal tax rates of up to 35%, income taxes can have a significant effect on your financial situation. There are basically three strategies to help reduce your income tax bill:

  • Reduce or eliminate taxes. The objective is to receive income in a nontaxable form or to find additional tax deductions, exemptions, or credits. For instance, you might want to consider municipal bonds, whose interest income is generally not subject to federal, and sometimes state and local, income taxes. Investigate investments that generate capital gains, such as growth stocks. Gains are not taxed until you actually sell the investment, and if held for over one year, capital gains are subject to the 15% capital gains tax (5% for individuals in the 10% or 15% tax bracket). If you have realized capital gains, you might want to offset those gains by selling investments with losses. Or consider investments that pay qualified dividends, which are taxed at capital gains tax rates.

  • Postpone the payment of income taxes until some time in the future. By postponing tax payments, your earnings compound on the entire balance, including the portion that will eventually be paid in taxes. You may also be in a lower tax bracket when taxes are paid. As an example, contribute as much as possible to retirement accounts, including employer plans and Individual Retirement Accounts (IRAs).

  • Shift the tax burden to another individual. The objective of this technique is to transfer assets to other individuals so any income on those assets becomes taxable to those individuals, who may be in lower tax brackets. Typically, however, you must give up control of the asset. For instance, annually you can give tax-free gifts, up to $11,000 in 2004 ($22,000 if the gift is split with your spouse), to any number of individuals. Any future income generated on those gifts then becomes taxable to those individuals. You may also want to use your lifetime gift tax exclusion of up to $1,000,000 to make larger gifts.

Should You Even Think About Early Retirement?

Not so long ago, most working people wanted to retire early. Then came the sharp declines in the stock market. All those assumptions about how much you could earn on your investments and how long your money would last no longer seemed assured. The prospect of retiring at a young age and depending on your investments for income for decades was suddenly a scarier thought. With many retirement portfolios significantly lower than at the market peak, should you even think about retiring early?

Much will depend on your definition of early retirement. If your definition means to quit working completely so you can travel extensively and pursue expensive hobbies, then you might want to postpone those plans for a while. However, if your definition means to change careers to work part time at a less stressful job, cut back on your living expenses, and only take minimal amounts from your retirement savings until Social Security and pension benefits kick in, then your early retirement plans might still be feasible. If you want to seriously consider early retirement, review these tips:

  • Make sure you know what you're going to do with your time. When you're working full time, it seems like you could fill all your waking hours with the things you don't have time to do. But if you're used to a fast-paced life, can you really expect to spend the next 20 to 40 years of your life just puttering around the house and golfing? Make sure you have concrete plans to fill your days, so you don't get bored early in retirement.

  • Calculate your numbers carefully. You want to be sure your retirement savings and other income sources will support you for what could be a very lengthy retirement. When calculating how much you need for retirement, be very conservative. Don't expect to draw more than 3% to 4% annually from your retirement investments. Now, can you really afford to retire early?

  • Cut back on your standard of living. Cutting back your expenses now will serve two purposes. It will provide more money to save for retirement, and it will reduce your living expenses now and during retirement.

  • Work at least part time during retirement. Even a small amount of income after retirement can go a long way in helping to fund your retirement expenses. Consider working at a less stressful job, starting your own business, or turning a hobby into a paying job.

  • Move to a less expensive city. The cost of living in different cities across the country and in different countries can be vastly different. If you live in a city with a high cost of living, moving to a different location can dramatically lower your living expenses. However, this is not just a financial decision. You need to consider whether you'll be happy living somewhere else, away from family, friends, and other ties.

While retiring early certainly seems more challenging than it did even a few years ago, that doesn't mean it can't be done. But you do need to make sure your plans are realistic before retiring.

Focus on Investment Fundamentals

When faced with all the decisions that need to be made to ensure you select the proper investments to meet your long-term financial goals, it's easy to become overwhelmed. How do you choose the right combination of investments to help you reach a goal that may be decades away? The answer is to focus on the fundamentals. Make sure to get these basics right:

  • Don't wait -- invest now. To put the power of compounding to work for you, start investing now. It's easy to put off investing, thinking you'll have more money or more time at some point in the future. Typically, however, you'll be better off saving less now than waiting and saving more later.

  • Live below your means so you can invest more. It's a basic fact that most people have trouble coming to grips with -- the amount of money you have left over for investing is a direct result of your lifestyle. Don't have money for investing? Ruthlessly cut your living expenses. Redirect all those reductions to investments. This should help significantly with your retirement. First, you'll be saving significant sums for your retirement. Second, you're living on significantly less than you're earning, so you'll need less for retirement.

  • Maintain reasonable return expectations. When developing your financial goals, you'll typically decide how much you need, when you'll need the money, and how much you'll earn on those savings. Those factors will determine how much you need to save on an annual basis to reach your goals. The higher your expected return on your investments, the less you need to save every year. However, if your assumed rate of return is significantly higher than your actual rate of return, you won't reach your goals. Thus, it's important to come up with reasonable return expectations. While past returns aren't a guarantee of future returns, you'll want to start by reviewing historical rates of return for investments you're interested in. You can then adjust those returns based on your expectations for the future.

  • Understand that risk can't be avoided. All investments are subject to different types of risk, which can affect the investment's return. Cash is primarily affected by purchasing-power risk, or the risk that its purchasing power will decrease due to inflation. Bonds are subject to interest-rate risk, or the risk that interest rates will rise and cause the bond's value to decrease, and default risk, or the risk that the issuer will not repay the bond. Stocks are primarily subject to nonmarket risk, or the risk that events specific to a company or its industry will adversely affect a stock's price, and market risk, or the risk that a particular stock will be affected by overall stock market movements. These risks make some investments more suitable for longer investment periods and others more suitable for shorter investment periods.

  • Diversify your portfolio. When stocks had above-average returns for an extended period, diversification acted as a drag on total return. By definition, allocating anything other than all of your portfolio to the best-performing asset lowers your return. But when stocks declined substantially, the disadvantage of investing only in one asset class became apparent. Typically, you do not know which asset class will perform best on a year-to-year basis. Diversify your investment portfolio among a variety of investment categories. Also diversify within investment categories.

  • Only invest in the stock market for the long term. Stocks should only be considered by investors with an investment time frame of at least five years. Remaining in the market over the long term reduces the risk of receiving a lower return than you expected.

  • Don't try to time the market. Timing the market is a difficult strategy to accomplish successfully, since so many factors affect the market. Remember that most people, including professionals, have difficulty timing the market with any degree of accuracy. Instead, concentrate on setting up an investment program that works in all market environments and that you can stick with.

  • Pay attention to taxes. Ordinary income taxes on short-term capital gains and interest can go as high as 35%, while long-term capital gains and dividend income are taxed at rates not exceeding 15% (5% if you are in the 10% or 15% tax bracket). Using strategies that defer income for as long as possible can make a substantial difference in the ultimate size of your portfolio. Some strategies to consider include utilizing tax-deferred investment vehicles, minimizing portfolio turnover, selling investments with losses to offset gains, and placing assets generating ordinary income or that you want to trade frequently in your tax-deferred accounts.


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