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March 13, 2005

Stretching Your Salary & Other Savings Ideas

Even though all indications are that the economy is recovering, that doesn’t necessarily mean that a large raise is on the near-term horizon for you. Your best bet for the near term is to make your current salary stretch farther. Here are some thoughts on how to do that:

  • Deposit your paycheck directly into your bank account. That way, you’ll be less tempted to cash part of your paycheck and spend it.

  • Contribute to your 401(k) plan. Any contributions you make are deducted before income taxes, so you won’t pay any current federal income taxes on your contributions. In addition, many employers match some portion of your contribution, which can substantially increase your 401(k) balance at no cost to you.

  • Check out your 401(k) contributions. Your job isn’t finished once you make contributions to your 401(k) plan. You are also responsible for investing those contributions. Make sure you are familiar with all options in your plan and review those options at least annually. Even if you only increase your rate of return by a percent or so, that can make a big difference in your ultimate 401(k) balance over several decades.

  • Review your health insurance coverage. If your employer offers more than one option, review those choices carefully to select the most appropriate insurance for the least cost. When your spouse also has coverage, review options from both employers and determine which is the best alternative for you.

  • Take a look at other fringe benefits offered by your company. Many employers provide a variety of fringe benefits. Not only do they provide needed benefits, you often receive them without paying any income taxes. Thus, carefully assess your company’s fringe benefit package to ensure you are utilizing all appropriate ones.

Diversifying All Your Assets - Income, Home, & More

When asked how their assets are diversified, most people respond by indicating how much of their portfolio is divided between stocks, bonds, and cash. But looking at your overall financial diversification means more than simply looking at your investment portfolio — you need to examine all your assets. Some items to consider include:

  • Your most significant asset is probably your ability to earn an income. The predictability of that income will have a significant impact on your financial situation and how much money will be available to save toward your financial goals. If you work for a company in a volatile industry, your spouse might want to seek employment at a more stable company. No matter where you work, don’t purchase too much of your company’s stock, even if it is through a 401(k) plan. You may even want to avoid stocks in related industries. Since your current and future income potential is closely tied to the company you work for, you don’t want your income as well as your investments to be over concentrated in one company. That way, if your job is jeopardized due to problems at your company, hopefully your investments won’t be declining at the same time.

  • Keep an eye on the outlook for your home’s value. Your home’s appreciation potential is usually tied to economic growth in your area. If your area is dominated by a certain industry, the prospects for that industry can also impact your home’s value. Thus, you may not want to own stocks in that same industry.

  • Adequately diversify your investment portfolio. Typically, you do not know which asset class will perform best on a year-to-year basis. Diversification is a defensive strategy — it helps protect your portfolio during market downturns and helps reduce your portfolio’s volatility. Diversify your investment portfolio among a variety of investment categories, such as stocks, bonds, cash, real estate, and other alternatives. Also diversify within investment categories.

  • Consider international investments. Since U.S. stocks have outperformed international stocks for an extended period, international investments have gone out of favor. But no one knows whether this trend will continue in the future, so it may be prudent to include international investments in your portfolio. Before investing in international stocks, assess how much of your portfolio to allocate to this asset class, which will depend on your risk tolerance, time horizon for investing, and comfort level with foreign investing. Keep in mind that international investing may not be suitable for everyone. In addition to the risks associated with domestic investing, international investing has unique risks, including currency fluctuations, political and social changes, and greater share price volatility.

Is a Will Really Necessary?

Many people believe they don’t need a will. But how valid are the more common reasons for not preparing a will?

Your estate is too small. Some believe that if their estate won’t be subject to estate taxes (in 2005, your taxable estate must be over $1,500,000 before estate taxes would be owed), there is no need for a will. However, a will’s purpose is not to save estate taxes, but to provide for the distribution of your assets, name guardians for minor children, and select an executor for your estate.

All your property is jointly owned. When one owner dies, jointly owned property passes directly to the joint owner, regardless of provisions in a will. Also, the unlimited marital deduction allows you to leave any amount of your estate to your spouse without paying estate taxes. Thus, many married couples use joint property ownership as their sole estate planning technique. However, if your joint taxable estate exceeds the estate tax exclusion amount ($1,500,000 in 2005, but scheduled to increase to $2,000,000 in 2006 and $3,500,000 in 2009), your estate may save estate taxes by distributing some assets to other heirs.

A living trust will distribute your assets. Only assets actually conveyed to the living trust are controlled by the trust document. Typically a Pour Over Will is also needed, which places any asset not held by the trust at your death in the trust.

You expect your estate to grow significantly in the future. Some feel it is premature to plan their estate while it is being built. However, a will can be changed. In fact, you should periodically review your entire estate plan to see if changes in your personal situation, preferences, or tax laws require changes to your plan.

How to Select a Financial Advisor

Selecting a Financial Advisor is not unsimilar to picking a doctor for a major surgery. Make a mistake and the results can be devastating, but pick the right one and your life can be much improved. While there is no fool-proof method that guarantees success in selecting a Financial Advisor, here are 7 guidelines to increase your chances:

  1. Try to get a referral.

    A referral from someone you trust is probably the best way to start your search for a Financial Advisor. Ask your friends and relatives. If they have not “gotten rippled off” or lost their money, this at least implies that the Advisor is honest and reasonably competent. Ask for referrals from individuals that are financially more sophisticated than yourself and that have worked with the Advisor for preferably five years or greater.

  2. Ask about their education background.

    When interviewing prospective Advisors, ask them about their formal education. While college degrees do not guarantee they listened in class, at least they attended. Particularly look for educational backgrounds in Finance, Economics, and/or Business. While someone who majored in Art or who did not receive a degree could still be competent, it has to make you worry a little whether they truly understand some of the finer nuances of helping someone organize their financial life.

  3. How experienced are they?

    While everyone was the “new kid” at some point in their career, you do not want to be the “guinea pig”. A well-educated Advisor with no “real-world” experience has yet to achieve wisdom. Wisdom comes with time and experience. The more the better. Financial Advisors who have been in the business at least 10 years have likely weathered one or two business cycles and a stock market crash or panic along the way.

  4. Any professional designations?

    Be careful with these, as too many initials can be blinding and are not a replacement for a solid education. In fact, Advisors without a formal education may try and use professional designations as a replacement. Both education and designations are best, as it shows the Advisor has continued to improve their knowledge base over the years and are therefore more likely to be abreast of current trends. Since there are too many designations to list, ask your potential Financial Advisors what areas of expertise their particular designations imply.

  5. What company do they represent?

    A “big name” does not guarantee success, as you are getting advice from the Advisor, not the company. If the company hires someone incompetent, you are the one that suffers financially. However, bigger companies have deeper pockets in case something goes wrong and you have to sue. Also bigger companies can usually afford to have additional expertise on staff. If your potential Financial Advisor works for a smaller firm, ask if they carry “Errors and Omissions Insurance” and whether they will work with your other Advisors, such as your Attorney or CPA.

  6. Check their disciplinary record.

    This is one thing most people do not do, but it should be done. Make sure there are no obvious skeletons in the closet. You can go to www.nasd.com to check on a Financial Advisor’s background and you should also check with your particular State Securities regulator. It is not unusual for someone who has been in the investment business for a long time to have had some complaints, but you should look for a pattern and/or particularly egregious claims.

  7. Follow your instincts.

    Remember, if something sounds too good to be true it probably is false. Everything a Financial Advisor recommends to you should make good common sense. Follow your instincts and be sure you get along with the Advisor, as you may be in the relationship for many years. A competent, experienced, honest Advisor can help you reach your financial goals much quicker and more efficiently than you probably could do on your own.

Estate Planning Tips

Current tax laws have made estate planning more complicated. The estate tax is scheduled to phase out gradually until 2009, be repealed in 2010, and then reinstated in 2011 based on 2001 tax laws. That assumes there will be no future tax legislation during that time. But don’t let these evolving tax laws prevent you from planning your estate. Instead, consider the following tips:

  • Plan your estate, even if it won’t be subject to estate taxes. The amount you can distribute to heirs other than your spouse without paying estate taxes will increase from the current $1,500,000 to $2,000,000 in 2006 and $3,500,000 in 2009. Estate taxes will be repealed in 2010, but then reinstated again in 2011 based on 2001 tax laws. However, there are reasons other than minimizing estate taxes to plan your estate. For instance, parents with minor children should name guardians and provide for their children’s support, while individuals in other than first marriages may want to protect children from prior marriages. You may also need a will, durable power of attorney, and health care proxy.

  • Leave written instructions for heirs. You can provide heirs with important financial and personal information and clarify requests made in other legal documents. You can also explain your rationale for distributing assets, especially if they aren’t split equally among heirs.

  • Decide whether to leave your entire estate to your spouse. With the unlimited marital deduction, you can leave all your assets to your spouse without paying any estate taxes. However, if you have assets in excess of the estate tax exclusion amount (detailed above), your heirs will not be able to utilize that exclusion amount when all assets are left to your spouse. Thus, when your spouse dies, they may pay more estate taxes than if you had left some assets to them, either outright or through trusts. If your spouse needs those assets after your death, you can set up a trust that allows your spouse to use income during his/her life, with the balance distributed to heirs after your spouse’s death.

  • Name executors, trustees, and guardians carefully. An executor (or personal representative) administers your estate through probate court, locates and values all assets, pays your estate’s obligations, and distributes your estate to heirs. A trust manages your estate and distributes income and principal. A guardian takes physical care of your minor children and handles their finances. All three roles significantly impact your estate, so choose these individuals carefully and ensure they can handle the responsibilities.

  • Review the distribution of assets that bypass your will. Jointly owned property will transfer directly to the co-owner, while assets with named beneficiaries will transfer directly to those beneficiaries. If you don’t keep this in mind, some heirs could receive a higher percentage of your estate than intended. Beneficiaries of assets such as life insurance policies, 401(k) plans, and Individual Retirement Accounts (IRA’s) should be reviewed after major personal changes, such as marriage, divorce, death, or birth.

  • Consider adding a disclaimer provision to your estate planning documents. This provision details what happens if your heirs disclaim all or a portion of their inheritance. That way, heirs can decide after your death how much to place in various trusts. For instance, a husband can leave all assets to his wife with the condition that any disclaimed assets go into a trust paying her income for life and distributing the remaining assets to their children after her death. This gives the wife the opportunity to divide assets based on her needs and the estate tax laws at the time of her husband’s death.

  • Implement an annual gifting program. You can make annual gifts, up to $11,000 in 2004 ($22,000 if the gift is split with your spouse), to any number of individuals without paying federal gift taxes. Since estate tax repeal is only scheduled for one year, this strategy removes assets from your taxable estate as well as any future appreciation or income generated on those gifts. Over a number of years, an annual gifting program can remove substantial assets from your estate. You may also want to use your $1,000,000 lifetime gift tax exclusion.

  • Skip a generation on a tax-free basis. Leaving assets to children who already have sizable estates may mean the assets will be taxed again when they bequeath them to your grandchildren. A better strategy may be to transfer those assets directly to your grandchildren, although you can only transfer a lifetime amount of $1,500,000 in 2005 before triggering an additional tax called the generation-skipping transfer tax. This amount follows the estate tax exclusion.

  • Consider making charitable contributions during your lifetime. While charitable contributions made after death are free of estate taxes, that may not provide any benefit due to higher exemption amounts. Charitable contributions made during your life will still lower your taxable estate and provide a current income tax deduction.

  • Understand when a revocable living trust is appropriate. Living trusts can provide substantial estate planning benefits, such as removing assets from probate and preserving the use of your estate tax exclusion. However, these trusts do not reduce estate taxes unless used in conjunction with other trusts.

  • Shelter life insurance proceeds from estate taxes. While life insurance proceeds are always free from federal income taxes, owning the policy yourself will cause the proceeds to be included in your taxable estate. Instead, you may want another individual or trust to own the policy, so the proceeds are excluded from your taxable estate.

  • Realize a wide variety of trusts exist to meet specific estate planning needs. Trusts can be established to meet a variety of objectives — to reduce estate taxes, to control asset distribution, to make gifts to charities, to provide for the possible incapacity of the creator, to protect heirs from themselves or others, to avoid probate, to allow a professional to manage assets, or to ensure provisions are made for minors.

March 12, 2005

Thinking Through a QTIP Trust

A common estate plan for married couples is to set up two different trusts:

  1. The first trust, commonly referred to as a credit shelter or bypass trust, holds assets to preserve the estate tax exclusion amount. That amount is currently $1,500,000, but is scheduled to increase to $2,000,000 in 2006 and $3,500,000 in 2009. The spouse of the deceased can then use the income and even some of the principal from the trust, with the remaining assets distributed to heirs after the spouse’s death.

  2. The second type of trust is a Qualified Terminable Interest Property Trust (commonly referred to as a QTIP trust). This type of trust is used when the spouse wants to control the remainder of his/her estate. Any assets not placed in the bypass trust are placed in the QTIP trust, with income distributed to the spouse during his/her lifetime. This qualifies for the unlimited marital deduction, so estate taxes won’t be assessed at the first spouse’s death. After the surviving spouse’s death, the principal is distributed to heirs designated by the first spouse.

    The main objective of the QTIP trust is to allow use of assets by your spouse while you still determine the distribution of those assets after your spouse’s death. That way, should your spouse remarry after your death, his/her new spouse won’t inherit any of your assets. Or, if you have children from a previous marriage, this trust will ensure those children receive part of your estate. But if you do decide to use a QTIP trust, think through all provisions so you don’t impose unnecessary hardship on your spouse. Some items to consider include:

  • Decide how much discretion to give your spouse in making withdrawals. A spouse can become resentful if an outside trustee places too many restrictions on withdrawals or requires extensive documentation for withdrawals. You may want to discuss these items beforehand and give your spouse broad discretion in this area.

  • Consider allowing your spouse to change trustees. If your spouse has difficulty dealing with the trustee, you may want to give him/her the ability to change trustees or select investment managers.

  • Review the trust’s ultimate beneficiaries with your spouse. Make sure your spouse understands the trust’s purpose and why you have chosen its ultimate beneficiaries. No matter what happens to his/her personal or financial situation after your death, your spouse won’t be able to change the trust’s beneficiaries.


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