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July 31, 2006

Buy-Sell Agreements Keep Your Business Afloat

Alex and Brad, both in their mid-forties, had just celebrated the tenth anniversary of Consulting, Inc., their market consulting business. The next morning, before going to work, Brad suffered a heart attack while jogging and died later that day. Alex suddenly lost his long-time business associate. What's more, after the estate was settled, he found himself with a new co-owner -- Brad's wife.

The result was chaos. Brad's wife had little interest or experience in running the firm. She needed cash for living expenses and asked Alex to buy out her interest in the business. But because most of his assets were tied up in the business, Alex was short of cash. Unfortunately, Alex and Brad's wife were left with little choice but to sell the company on short notice for just a fraction of what they had hoped for.

How could this fictional disaster have been avoided? A buy-sell agreement and proper funding could have saved their business while providing needed income for Brad's family after his death. Buy-sell agreements lay out how ownership will change hands and how the transfer will be paid for in case of a co-owner's death, disability or retirement. Typically, the agreement provides for the purchase of the departing shareholder's stock by the surviving shareholders or the company itself.

A buy-sell agreement and its proper funding may achieve several goals: avoid liquidation of the business; facilitate an orderly continuation of the business; replace lost business income for a deceased owner's heirs; set a purchase price that can fix the estate tax value of the decedent's stock; and provide evidence to customers and creditors of the firm's stability.

Using Life Insurance

Drafting a buy-sell agreement is only the first step. It will have limited practical benefit unless the purchaser can afford to buy the deceased owner's shares. Life insurance is often used as the preferred source of cash. When a business owner dies, the policy proceeds are used to buy the shares from the deceased owner's estate at a price set forth in the agreement.


There are two basic types of buy-sell arrangements: the "cross-purchase" agreement and the "stock redemption" agreement. Life insurance can be used to fund both.

Cross-purchase agreement. In Alex and Brad's situation, each of them buys -- and is the owner and beneficiary of -- a life insurance policy on the other. Upon Brad's death, Alex receives the policy's death benefit, which he uses to purchase Brad's shares from Brad's estate. In turn, that cash payment gives Brad's family needed income to offset the loss of Brad's earnings.

Cross-purchase plans have several advantages. For example, the surviving shareholder gets a "step up" in the income tax basis for the stock bought from the deceased's estate. This could reduce income taxes if the surviving shareholder later sells the stock. Additionally, with cross-purchase agreements, the insurance proceeds are not subject to the corporate alternative minimum tax (AMT), nor to the claims of corporate creditors. But these plans can be hard to administer if there are many owners. Since the shareholders individually own policies on the lives of their fellow shareholders, absent other planning, fifty-six separate policies would be needed if, for instance, there were eight total shareholders.

·Stock redemption agreement. In this case, Consulting Inc. buys and owns policies on the lives of Alex and Brad. When Brad dies, the corporation buys his stock with the insurance proceeds. Stock redemption plans may make sense when there are multiple owners of the corporation, there are large differences in age and ownership levels among the owners, or the corporation is in a lower tax bracket than the owners. Two potential drawbacks to these plans: the death proceeds received by the corporation may be subject to the corporate AMT, and the surviving shareholders do not get the benefit of an increase in the income tax basis of their shares when the corporation redeems the stock.

Keeping Proper Balance

Often, in an effort to make things fair, business owners structure a life insurance-funded buy-sell agreement so that each owner is treated alike. But that may seemingly result in a windfall if the owner holding a minority share of the company outlives the majority owner.

Suppose the $1 million Consulting Inc. was owned 70 percent by Brad, and 30 percent by Alex. Under their agreement, each was required to buy the other's stock under identical terms. And each bought life insurance on the other's life to fund this buyout. When Brad dies, Alex collects the $700,000 of insurance proceeds and pays that sum to Brad's family for the controlling interest in the company. Alex is also likely to buy back his own insurance coverage of $300,000 for full value. Result? The minority partner, Alex, now has a 100 percent interest in a $1 million company and a $300,000 policy. Brad's family loses control of the firm, but receives $700,000 in cash and the proceeds from the sale of the insurance on Alex’s life.

Buy-sell agreements can help protect your business and your family. Seek the guidance of a professional financial adviser who can identify the various issues and considerations that will help determine what type of buy-sell agreement makes the most sense for you.

Scott Cangelosi, JD (non-practicing), CFP, CLU, a Member of the Paladin Registry

July 28, 2006

Emigrant Bank Raises Interest Rate to 5.15% APY

Emigrant Bank, sponsor of the popular EmigrantDirect American Dream Savings Account, continues to be a leader in Online Banking when they raised their interest rate this morning to 5.15% APY. This increase has admittedly caught us by surprise as Ben Bernanke, Chairman of the Federal Reserve, signaled at their last meeting that interest rate increases were likely on hold for a while. The Fed said there were signs that the economy was slowing and that although controlling inflation is important, the Fed wanted to balance that against risking pushing the economy into a recession with an overall restrictive fiscal policy. Emigrant apparently wasn't listening and has instead decided that attracting depositors with attractive interest rates is more important. We suggest investors take advantage of these high rates while they can. Guaranteed, they will not last forever.

When To Buy Long Term Care Insurance

At what age should you buy long-term care insurance? Often the advice is, the earlier the better. It’s not uncommon to see insurance carriers and some experts recommend that people buy a long-term care (LTC) policy while they are still in their 40s. Yet most people who buy individual policies wait until they are in their 60s. [Financial Planning Interactive]

There are several advantages to buying LTC coverage earlier. One reason, perhaps surprisingly, is cost. Many people delay buying coverage because they don’t want to "waste" their money paying for premiums while they are younger, figuring they will spend less in premiums overall if they wait until they are in their 60s or even 70s to buy a policy. From a cost standpoint, however, it’s usually significantly less expensive in the long run to buy earlier.

The American Council of Life Insurers (ACLI) provided an example in a recent study of premium costs. Their sample policy is one that pays $100 in daily benefits for up to six years. (Premiums are not that much higher for lifetime benefits instead of six years, and lifetime coverage is usually better.) The sample policy provides coverage for home or community assistance, an assisted living facility or a nursing home, and, especially important, the premiums include the cost of compound inflation protection of benefits at five percent a year.

To buy this coverage today at age 45, a person would pay $857 a year. Under most plans, this premium would be designed to stay level for the remainder of the insured ’s coverage. If the person didn’t need the benefits until age 80, that would be 35 years of paying premiums, for a total cost of $29,995. That total cost is around half of the average annual cost for a stay in a nursing home—in today’s dollars. However, the ACLI predicts that costs will quadruple by 2030. Fortunately, with the five-percent inflation protection feature, the benefit payout at age 80 would have risen to $552 a day.

But let’s assume that you procrastinate ten years until age 55 to buy long-term care insurance. Compound inflation protection of five percent a year would have pushed the daily benefit to $162 a day (this assumption was not part of the ACLI’s study). But to buy a policy ten years from now, when you are 55, you’ll pay annual premiums of $2,223 (versus only $1,364 for someone age 55 today). If the coverage is not used until age 80, that means total premiums paid of $55,583, versus only $29,995 if bought today at age 45.

Similarly, waiting 20 years until age 65, you would pay $7,256 a year in premiums, for a total of $108,839 if not used until age 80. By age 75, premiums will have risen to $31,438 annually, or $157,190 total. Furthermore, not only is it less expensive in the long run to buy earlier, most retirees will find it easier to pay the lower cost premiums during retirement than to suddenly have to start paying steeper premiums for policies bought at age 65 or age 75

In addition to cost, there is the critical issue of health. The longer you wait, the greater the risk you won’t be insurable due to poor health. Here’s where a family history of health problems or personal high risk activities may suggest buying at an earlier age. Furthermore, a serious illness or injury can strike at any age.

There are arguments against buying a long-term care policy "too early." First, there is the risk that the insurance company may no longer be around when you need the benefits from the policy, especially in an industry that to date has had limited claims experience because long-term care insurance is a relatively new product.

Second, a policy held too long may become obsolete as new features emerge in new products. To upgrade, one would then be forced to buy a new, more expensive policy at an ol der age anyway.

Ultimately, of course, the decision at what age to buy depends on your individual circumstances. The important point is to not delay making a decision. It could be a very costly delay.

Author: Craig Evans Carnick, CFP, a Member of the Paladin Registry

July 26, 2006

1031 Exchanges, A Tax-Deferred Real Estate Strategy

When the time comes to sell your real estate, some owners of highly appreciated real estate could be staring at a substantial capital-gains tax bill. A section of the Tax Code may help you convert your appreciated property into an income stream—while deferring up to 100% of the capital-gains tax that would otherwise be due on the sale.

This transaction, known as a “1031 exchange,” is named for a section of the Internal Revenue Code that authorizes this exchange. With a 1031 exchange, you can dispose of an investment property without paying an immediate capital-gains tax (or triggering a depreciation recapture tax) if the entire proceeds are used to purchase full or partial interests in “like-kind” properties as defined by the IRS code.

The current capital-gains tax savings could be substantial. In addition to the federally imposed capital-gains tax of 15%, any gain on the sale of a property could otherwise be subject to state income tax. That means your total tax bill could run as much as 20% or higher.

In addition to the tax deferral, 1031 exchanges may provide real estate owners with an opportunity to help improve their lifestyles —for example, by exchanging a highly management-intensive property for one or more properties that are less demanding to manage. These transactions can be beneficial to real estate owners with appreciated properties that make up 5% to 50% of their net worth.

Reduced Stress and a Higher Level of Potential Income

It sounds simple enough, but with the Tax Code, there is always a hitch. In this case, the IRS has set out a long, stringent set of guidelines that define qualified transactions. But the principal issue is that proceeds from the sale of one property must be reinvested in a “like-kind” replacement property within a certain amount of time to avoid taking that tax hit. These properties don’t have to represent a one-for-one swap.

Investors can use the sale from one property to buy tenant-in-common, or TIC, interests in a variety of different properties, opening up an opportunity for strategic planning. For instance, investors who prefer to take a less active role in real estate management can trade a high-maintenance portfolio of rental properties for hands-off interests in other commercial ventures.

Through what’s known as a TIC transaction, you can reinvest the proceeds of those exchanges into a non-management, fractional interest in a larger commercial property. You get a share in the rental income without having to assume any responsibility for the day-today management of the property.

This option is particularly attractive for investors looking to boost income potential. The 1031 exchange may end up generating a higher level of income for the property owner than they had earned on the previous property. More importantly, you may be able to have a more diversified real estate portfolio than you might have had to begin with.

For instance, consider the case of a real estate owner who plans to reinvest the proceeds from a $5-million property into a $3-million property. The owner also plans to distribute the remaining $2-million in proceeds from the exchange across a variety of TIC investments. With the exchange of a single $2-million property, the owner could invest in as many as eight different TIC properties, assuming a standard $250,000-minimum investment in each TIC transaction.

Putting the ‘Estate’ in Estate Planning

TIC exchanges may have the ability to be customized to fit into a real estate strategy. For instance, you may be able to increase your cash flow by exchanging a piece of raw land and investing in one or more income-producing properties. Or you could possibly decrease your current tax liability by exchanging a fully depreciated property and using those gains to buy more leveraged property, thereby increasing your depreciation expenses.

TIC exchanges may be a particularly important part of an estate plan in which the primary asset is a single piece of property—for instance, a family farm that future generations don’t want to maintain. The owner can exchange that land and then divvy that money up into several smaller properties. After the owner’s death, each heir will inherit their own piece of property that they can manage as they see fit. And with the death of the owner, the heirs receive a one-time step-up in cost basis, effectively erasing the deferred tax liability.

As with any valuable asset, managing the exchange of real estate tax efficiently is a complex undertaking. But with a 1031 exchange you may be able to diversify your holdings without any current capital gains tax liability.

A 1031 Exchange is available to accredited investors only. ($200,000 yearly income and $1,000,000 net worth). A 1031 exchange may be subject to special risks including illiquidity. A 1031 prospective investor should consult with their own legal, tax, accounting and financial advisor before investing as tax advantages may be lost if not executed within established time constraints. A 1031 exchange prospective investor should carefully consider the charges, expenses and risks of a 1031 exchange and whether it is appropriate for them based on their financial situation, objectives and time constraints.

Author: Chris Torchiana, a Member of the Paladin Registry

July 24, 2006

You can Protect Your Assets from Catastrophic Medical Expenses

It is a personal nightmare. You are sick, really sick and need time off to get well and whole again. You feel vulnerable, scared, ache and you are physically exhausted, unable to function. Your friends and family are really worried about you.

Money. You think about money. You need money for medical bills that keep mounting. You need living expenses and bills are getting past due. You wonder if you can afford to get well. Without looking tell me what is your maximum out of pocket limit on your health insurance for covered services including deductibles and co-pays in addition to your premiums? $2,000? $10,000? $20,000? Do you have it set aside or available somewhere for this medical need?

Where is your income coming from if you are not earning it to pay installment debts and living expenses? Did you ever put that disability coverage in place? Sadly, some of you will not have a job to go back to when you are well again. Nearly 48% of all personal mortgage foreclosures are income and health related.

You honestly do not want to think about this, because it only happens to “other” people, not you, right? Wrong! Did you know that in the last ten minutes 390 Americans became disabled? 30% of all employees in the US between the ages of 35-65 will suffer a disability and will be out of work at least 90 days. 1 in 7 of all employees in the US will be disabled for 5 years at some point. These statistics are not meant to use scare tactics to be the catalyst for action on your part, merely factual information you need to know according to the Health Association of America. But if scare tactics are necessary, read this paragraph again.

CQ Healthbeat recently reported a “typical” insured family of four in the US will spend about $13,382 this year on medical care. That figure represents only out of pocket costs and premiums. That was a 9.6% increase over last year. Overall, medical costs have increased an average of 10% annually the last five years, so it is this author’s opinion this inflationary trend will not likely decrease and you should plan for these kinds of budget increases going forward.

The difference between you and one of these sobering statistics above is a five part solution designed to control your out of pocket costs, limit your overall financial exposure, reduce your income taxes, provide an income stream for illness or injury and secure peace of mind on the issue millions of American’s are lacking, controlling catastrophic illness costs.

Step one: Secure a Health Savings Account Qualified (HSA) medical plan that pays 100% of covered expenses after the deductible is met. For a single person this could limit your medical expense exposure to a maximum of only $2,650 annually, or an annual maximum for a family of only $5,250 regardless of the number of family members covered by the plan. The eligible deductible amounts are indexed annually for inflation.

Step two: Fund the tax deductible HSA to the maximum allowed by law to have tax free monies ready to pay medical expense as needed, up to your maximum exposure. This will save you money by lowering your income tax bills.

Step three: Purchase a critical illness product that is triggered to pay a $100,000 tax free cash lump sum benefit upon any one of 15-20 occurrences such as heart attack, cancer, blindness, etc.

Step four: Purchase a Long Term Care (LTC) policy that pays benefits when you cannot perform two adult daily living activities, or have a cognitive, or Alzheimer’s loss. These differ from the older reimbursement plans in that receipts for every daily service, from every provider do not need to be submitted for reimbursement, a time consuming task for someone else if you cannot manage all this paperwork yourself. You either qualify or you don’t for payment based on the inability to perform two adult daily living activities to trigger benefits, a much simpler and less costly insurance plan to administrate, which results in significant premiums savings to you, the insured.

Portions or all LTC premiums could be deductible to you if you meet tax guidelines. Most states give tax breaks to residents to who purchase LTC policies.

Individual Disability plans could provide the income stream, although depending on your age and occupation may be more expensive than a similar monthly benefit provided by a LTC policy as an alternative. Disability premiums are not tax deductible.

Step Five: Set aside an emergency cash cushion equal to your elimination period on your LTC plan. Some creative ways to help reach this goal while you build the actual cash reserve amount could be to earmark a portion of cash values in life insurance, ROTH IRA contributions (not earnings), identify an asset that could be sold quickly, etc.

The next natural question: “Is this affordable?”. Most likely the answer will be “Absolutely! Yes!” if you work with qualified agent who will search the market for the best fit for your needs, existing resources and preferences.

Here is a real life example. For a family with a Male age 48, female age 44 and four children, not the “typical” family of four, a family of six with $5,250 HSA plan in place:

Monthly policy premiums on HSA Plan $260 x 12 $ 3,120

Annual Family Deductible $ 5,250

Co-pays after deductible 0% ZERO

25% estimated tax savings on HSA + 1,288

$100,000 lump sum catastrophic illness policies $ 2,377

$5,400 a month, 30 day elim. period LTC alternative

policy on both spouses with benefits for up to 7 years

Plus a full return of premium if benefits are not utilized $ 1,379

Amount available to fund emergency income cushion $ 2,544

Total $13,382

(Plus a $5,400 a month income stream is available in this structure for up to 7 years)

Minimum medical exposure is premiums only $ 6,876

Maximum medical exposure with full deductible,

less 25% tax credits $10,838

You can see how the cost and benefit arrangement of the “typical” family spending their $13,382 on only premiums and out of pocket costs pales in comparison to the family above who planned a better scenario with the same resources.

I have examined instances just like this one where the costs of the current group health insurance premiums alone are more than the cost of this income and asset protection strategy secured on an individual basis.

This is an area you should definitely implement to protect your assets from being sold to cover your health needs, avoid bankruptcy, reduced standard of living and even worse results due to a lack of timely planning.

This is a great idea to take to your HR person as an HSA group alternative to compare against traditional in force policy arrangements when a business is attempting to improve or control spiraling benefit costs.

Author: Amy Rose Herrick, a Member of the Paladin Registry

July 23, 2006

Grandparents: The Do's and Don'ts of Planning for Your Grandchild(ren) with Special Needs

Grandparents want the best for their children and grandchildren. They often give gifts while alive, or make provisions for their loved ones after they are deceased. Grandparents who are in a position to leave money to grandchildren often want to do something for their grandchild(ren) with special needs. They often worry about a severely handicapped or disabled grandchild, who may need additional assets or assistance to lead a quality life. Grandparents are sometimes told not to leave their grandchild(ren) with special needs anything because the child(ren) may lose government benefits. People are often confused as to what to do or not to do. Grandparents can leave money to their grandchild(ren) with special needs. There are very special ways to do it!

Money has to be left in such a way so that government benefits are not lost. Assets in excess of $2,000 will cause the loss of certain government benefits for the person with special needs.

Money should not be left to the grandchild directly, but should be left to a special needs trust. The special needs trust was developed to manage resources while maintaining the individual's eligibility for government benefits. The trust is maintained by a trustee on behalf of the person with special needs. The trustee has discretion to manage the money in the trust and decides how the money is used. The money must be used for supplemental purposes only. It should only supplement, or add to benefits (food, shelter or clothing) that the government already provides through Supplementary Security Income (SSI). It must not supplant or replace government benefits. If properly structured by a knowledgeable special needs attorney, the special needs trust assets will not count towards the $2,000 SSI limits for an individual.

Brief Summary of Do’s and Don’ts!

Do’s:

1) Make provisions for your grandchild(ren) with special needs. Leave money to the child’s special needs trust. The

special needs trust is the only way to leave money without losing government benefits.

2) Coordinate all planning with the child’s parents or other relatives. Notify the parents when you plan for grandchild(ren). Plan with others.

3) Leave life insurance, survivorship whole life policies and annuities to the child’s special needs trust. The special needs trust can be named as the policy beneficiary. When the insured or annuitant dies, the death benefit is paid to the special needs trust. The special needs trust then has a lump sum of money to be used in caring for the grandchild(ren) with special needs.

4) Consult with trained financial and legal professionals with specialties in special needs estate planning.

Don’ts:

1) Do not disinherit your grandchild(ren) with special needs. Money can be now left to a properly drawn special needs trust. It does not make sense to disinherit any of your grandchild(ren) with special needs.

2) Don’t give money to your grandchild(ren) with special needs under UGMA or UTMA (Uniform Gift or Transfer

To Minors Act). Money automatically belongs to the child(ren) upon reaching legal age. Government benefits can be lost!

3) Don’t leave money to a grandchild with special needs through a will. Money left will be a countable asset of the child and may cause the loss of government benefits.

4) Don’t leave money to a poorly set up trust. Money left in an improperly drafted trust can result in the loss of government benefits.

5) Do not leave money to relatives to “keep or hold” for the child with special needs. The money can be attached to a lawsuit, divorce, liability claim or other judgment against the relative.

Due to the complexity of federal and state laws, you may require specially trained professionals to help you plan for the future of your child(ren) with special needs.

Author: Jason Cowans, a Member of the Paladin Registry

July 22, 2006

5 Tips to Protect Yourself from Credit and Identity Theft

Today’s fast paced world of electronic convenience has made identity theft an ever-increasing problem. You probably know someone who this has happened to – it may have happened to you. It can be a nightmare – and an expensive and time consuming one at that. There are simple actions you can take that can help to protect your identity and your credit rating:

1. When you order checks, don’t use your full first or middle names; use your initials with your full last name instead. Who’s going to guess that "B" stands for "Barbara" or "Bertram" when attempting to forge your signature?

2. Instead of using your home phone number on your checks, put your work number. In addition, if you have a PO Box, use it for your address and never, ever publish your Social Security number on your checks.

3. Make photocopies of every piece of identification that you carry with you daily – and be sure to copy both sides. Keep the copies in a safe and handy place. If you’re wallet is ever stolen, all the information you’ll need – auto license and registration, credit card account numbers, and customer service hot lines, will be available to you in one place.

4. If your credit cards are stolen, file a police report in the jurisdiction where it was stolen immediately. You’ll want enough back-up proof as possible for your credit card issuers that you were diligent.

5. If your credit cards are stolen, call all national credit reporting organizations immediately to place a fraud alert on your name and Social Security number. The alert lets any company that checks your credit to know that your information was stolen and that they are to contact you by phone to authorize any new credit. Their numbers are: Equifax, 800-685-1111, Experian, 888-397-3742, and Trans Union, 800-888-4213. In case your Social Security card or number is stolen, it may be best for you to notify the Social Security Administration at 800-269-0271, too.

While no amount of caution can be totally fool-proof, being aware of the potential identity and theft possibilities and of how to protect ourselves –even if we fall victim - are simple steps to give us added defense.

Author: Martin "Marty" I. Friedman, CPA/PFS, CLU, ChFC,
CFP(R), a Member of the Paladin Registry

July 20, 2006

Reviewing Your Portfolio's Performance

At least annually, you should review your portfolio’s performance, comparing it to relevant benchmarks and determining whether you are making progress toward accomplishing your financial goals. Consider these steps in the process:

1. Measure the performance of each investment in your portfolio. Many investments and investment managers will provide you with periodic performance information. When reviewing this information, keep in mind the following points:

• Often, an investment’s return is reported on a time-weighted basis, which does not consider when you invested.

• Information that reports your portfolio’s return is generally expressed on a dollar-weighted basis, which measures the investment return based on when cash inflows and outflows occurred. While this is a more relevant measure when evaluating your portfolio, time-weighted returns can make it easier to compare the returns of different investments.

• Investments often report cumulative annualized returns over a period of time, representing the average annual performance over that time. Since returns can fluctuate significantly on a year-to-year basis, this annualized return can help you evaluate the long-term performance of an investment.

If you invest in individual stocks and bonds, you may need to calculate those returns yourself. Conceptually, your total return on an investment equals the change in market value plus any dividends, interest, or capital gains, divided by the beginning market value. Total return can be difficult to calculate, especially if you make additional investments or withdrawals during the year. You may need the help of a computer program to calculate your total return precisely.

2. Find an appropriate benchmark to compare to each component of your portfolio. A wide variety of market indexes now exist, covering different segments of the market. You should be able to find ones that track investments similar to each component of your portfolio. Making comparisons to a benchmark should help you identify portions of your portfolio that may need to be changed or that you should start monitoring more closely.

3. Calculate your overall rate of return, comparing it to your estimated return. When designing your investment program, you probably assumed a certain rate of return, which determined how much you need to invest to reach your financial goals. Calculating your actual return will help you determine if you are on track. If your actual return is below the return you estimated, you may need to increase the amount you are saving, invest in alternatives with higher return potential, or settle for less money in the future. Performing this analysis annually should allow you to make these changes gradually.

4. Review your overall investment allocation to determine if changes should be made. This annual review is a good time to compare your actual allocation to your desired allocation. You may find you need to make changes for a variety of reasons. If certain portions of your portfolio have performed well, you may find they make up a larger percentage of your portfolio than originally planned. You may also find you need to sell certain investments that are not performing well. You may also need to refine your asset allocation percentages, since your strategy will change over time.

You should review your portfolio’s performance annually to ensure your investment strategy is on track.

July 19, 2006

Buy-Sell Agreements: Taking Care of the Eight D's

Most closely held businesses, especially multi-owner corporations and partnerships need to have a buy-sell agreement in place. Individually owned businesses can also profit from the use of a buy-sell agreement. This is essential for smooth transition of ownership upon the occurrence of several events, namely the “Eight D’s.” We’ll discuss each one individually in the corporate context, however, most would also apply to partnerships. In a single-owner business, the buyer could be key employee(s), a competitor, a supplier, or even a customer.

1. Death of a shareholder. In the event of death of an owner, the business can suffer a financial setback (key person loss). This problem can be compounded if the surviving shareholders have to take in a new partner, the deceased owner’s spouse. He/she may have very little knowledge of the business, but yet expect a salary and profits from the business. Harmonious transition of the business can be accomplished with a buy-sell agreement fully funded with life insurance coverage.

2. Disability of a shareholder. While most buy-sells take into account death (even though the agreement value may be low or underfunded), many totally ignore what could be a more serious financial drain, disability (the living death). Usually, disability is poorly defined (if at all), not funded or underfunded. A disabled shareholder would expect his/her salary to continue, as well as to get a share of profits. If the disability was extended, how long could the business keep paying? All of these decisions should be outlined in the agreement. It should be a business decision based on previously agreed-upon terms, not on emotions. And, of course, the disability agreement needs to be fully funded.

3. Departure of a shareholder. When a shareholder leaves, whether for regular retirement or early voluntary retirement, his/her business interest should be purchased. The purchase price can be the same as or less than the death price (it cannot be more). A lower purchase price might be set for early termination. As for retirement planning, a life insurance policy can provide the death benefit and also be used as a retirement supplement.

4. Divorce of a shareholder. It would not be unusual for a spouse to end up with one half the business interest of a closely-held business, in the event of a divorce. There should be a provision in the buy-sell to have such a spouse forced to sell stock back to either the: (a) corporation; (b) original shareholder; or (c) other shareholders. Again, the price cannot be higher than the death price.

5. Deadlock. If equal owners come to a major disagreement, the business can become “deadlocked” and unable to further conduct normal operations. In this case the business may have to be liquidated. This may have to be taken into consideration in the agreement.

6. Disagreement among owners. If ownership is unequal, and there is a major disagreement, a minority shareholder could be forced out of active employment. In that case, it would also probably make sense to purchase his/her interest. This possibility should be taken care of in the agreement.

7. Default. In most closely-held corporations, the individual shareholders must personally guarantee corporate loans from banks and/or contribute payments to the bank or business. There should be a provision whereby if a shareholder defaults, a buyout would be triggered for his/her interest.

8. Determination of value. The most important item in a buy-sell is the valuation of the business interest. No one wants to over-pay for a business interest. In addition, each owner would want to be sure him or her or their family received fair value in event of a living buyout or death. Appraisals may be viable and even required if family members are involved. Another reason for proper valuation is to fix the value in the deceased’s estate for federal estate tax purposes. One of the stipulations is that the value must be fair market value at the time the agreement is entered into. If appropriate life insurance is not purchased to fund the full value, then an installment purchase arrangement should be provided for the balance.

When buy-sells are drafted or reviewed, perhaps the “Eight D’s” would make a good checklist for consideration. It’s far easier to make business decisions regarding these situations then, than to make emotional decisions after the event has taken place.

Author: Rick MacBarron, JD (non-practicing), CFP, ChFC, CLU, a Member of the Paladin Registry

July 18, 2006

How Much Will Social Security Replace?

When determining how much income you will need after retirement, it is typically expressed as a percentage of your preretirement income. Thus, if you earn $75,000 per year and estimate you’ll need $70,000 after retirement, you need 93% of your preretirement income. Rules of thumb estimating how much is needed range from 70% to over 100% of preretirement income. Since the amount needed is dependent on your lifestyle after retirement, you should thoroughly analyze your situation to decide how much you will need.

Once you have calculated this amount, you should determine where that income will come from. Traditionally, there are four sources of retirement income : Social Security benefits, pension benefits, savings, and work income.

How much can you expect Social Security benefits to contribute? One study found that the median replacement rate is 37% for men and 52% for women. Since men have higher earnings levels than women and the system is progressive, their replacement rates are lower. The overall replacement rate is 42%, but that number varies significantly depending on income level. Individuals with the lowest fifth of earnings had a 72% replacement rate, while those with the highest fifth of earnings had a 31% replacement rate. When couples are considered, the median replacement rate is 56% when one spouse did not work and 42% when both spouses worked (Source: Center for Retirement Research, November 2005).

To find your personal replacement rate, check your estimated benefits in your annual Social Security Statement, which details three different benefit amounts — those at age 62, at full retirement age for Social Security purposes, and at age 70. Your annual benefits divided by your annual income equals your replacement rate. You might want to calculate the replacement rate for each of the three different benefit amounts. Then consider other sources of retirement income, including pension benefits and savings, to find out how close you are to the amount you need for retirement.

If your replacement rate is under what you need, consider delaying your Social Security benefits. Most people start benefits before age 65, with 74% of men and 78% of women starting benefits before age 65 in 2003 (Source: Social Security Administration, 2005). Approximately 59% of women and 53% of men started benefits at age 62, even though delaying benefits permanently increases Social Security benefits.

Married couples should consider this option carefully. Since women are often younger and live longer than their husbands, they will receive benefits for a longer period of time, with the amount of those benefits often dependent on the age their husbands start benefits. When the husband is alive, the wife is entitled to the larger of 100% of her benefit based on her earnings or 50% of the husband’s benefit at full retirement age. However, if the husband elects benefits before full retirement age, the wife’s benefit will be reduced by a higher percentage than his benefits were reduced. After the husband’s death, the wife receives 100% of the husband’s benefit if she is over full retirement age. If not, the wife receives between 71.5% and 100% of the husband’s benefit. Thus, the larger the husband’s benefit, the larger the wife’s benefit will be after his death.

Another study conducted by the Center for Retirement Research (October 2005) recommends that the husband delay Social Security benefits until at least age 66. For most couples, it was recommended that the husband start benefits at age 69 and the wife start benefits at age 62. When the couple was close in age and earnings, benefits for the husband should start between ages 66 and 68.

July 17, 2006

Plan Ahead for Your Company's Survival

As the founder, owner and manager of your family business, you probably have a hard time imagining anyone else running your company as well as you. You may be right, but that attitude spells trouble. Even though they know better, many successful entrepreneurs choose to ignore the need for planning for their business succession.

For many, it's a question of facing up to their own mortality. For others, it means making a difficult choice of a successor from among their children or valued employees. Since many owners' income and assets are tied up primarily in the business, passing it on means not only giving up control, but also their financial security.

Family businesses face other problems too: sibling rivalry, squeamishness among family members about addressing tough business issues, and a lack of talented or willing management to carry on the business into the next generation. In order to avoid a family rift, many families avoid the difficult question of what will happen to the business after the entrepreneur retires or dies. True, emotions are part of nearly every decision affecting the future of the company, but the business owner must be able to objectively assess the business from both a personnel and financial point of view.

Failure to adequately prepare for the future has been the death knell of many family businesses. According to a study by the Wharton Business School of the University of Pennsylvania, only about one-third of family-owned or controlled businesses survive into the second generation. And the odds of continuing into the third generation are even slimmer.

Waiting too long to put a business succession plan into place can also damage the business. Customers, creditors, suppliers, and even employees grow nervous about whether the company will fall apart once the owner is gone. Without a clear-cut program of succession, your family business may begin and end with you.

Creating a Solid Succession Plan

If you want your business to be in the one-third of businesses that survive, planning is essential. In essence, a business succession plan is a documented road map for your partners, heirs, and successors to follow in the event of your death, disability, or retirement. It can include a strategy for distributing business stock and other company assets, buy-sell agreements, life insurance policies for estate tax liabilities, debt retirement schedules, and the division of responsibilities among successors. A plan may also be used to orchestrate the sale of your business if your children aren't interested or capable of running it.

Plan for the Unpredictable

A viable business succession plan is, above all else, flexible. Business, family, health, and partnership situations can change at any moment. You should be able to easily modify and amend your plan to adapt to any changes that may lie ahead. Consider these examples:

· For years, your son has been an active player in your business; he's come up through the ranks and his last three deals netted a hefty profit for the company. Now it turns out your daughter wants in, too. Her legal background will be a big plus. But how will you divide company ownership and leadership responsibilities between them without causing family friction?

· What happens if someone on your management team is suddenly disabled and most likely won't be returning to work? What if your partner and her husband divorce and the settlement calls for a division of a portion of the business? Or, what if you need an infusion of capital to take advantage of a sudden expansion opportunity? Whatever situation may arise, is your business structured to handle unexpected changes and opportunities? Be prepared with a plan that can help meet the challenges of life's twists and turns.

Who Will Carry the Torch?

Is there really anyone out there who can run your business with that same inimitable style and acumen that you've brought to it? There won't be unless you're there to teach that person how. By grooming a successor now, you'll be able to impart the knowledge and experience you've accumulated over the years, and be assured of continuity in leadership style and, hopefully, profitability after you're gone. Picking a successor can be a minefield, however, especially if you have a choice of equally qualified children or employees.

With more than one child involved in the business, you must decide which one gets to be boss and which merely get voting stock. How will you divide assets equitably among your heirs if some are active business participants and others are off in their own careers? The distribution of power and assets among siblings can be a highly divisive issue, even in the happiest of families. More than one family business has folded because of discord over these problems.

Your challenge: divvy up business responsibilities and assets in a way that allows your business to survive while preserving family harmony. If you're lucky, you may already have a capable child whom you'd be pleased to pass the reins to. Once you've chosen your successor from among your children, the only hitch then is keeping the others interested, loyal, and productive despite being passed over.

No likely candidates among family members or your employee pool? That's a warning sign you shouldn't ignore. Your management style may be hampering employees from turning into leadership material. Or, your hiring and training programs simply may not be doing the job. It is difficult for any business owner to let go, but letting go and training the next generation of leadership is the only way to protect your company's future. Be sure to make career advancement and management training programs a top priority.

Don't wait until it's too late. With the guidance of qualified financial and legal professionals, put in place a business succession plan that will give your business the solid financial and leadership base it needs to survive.

Author: Scott Cangelosi, JD (non-practicing), CFP, CLU, a Member of the Paladin Registry

July 13, 2006

Where Are All the Jobs Going?

Almost daily, it seems like there is another news item indicating that service jobs in the United States are being outsourced to other parts of the world. When manufacturing jobs were lost to overseas markets, it was painful for those who lost their jobs, but seen as positive overall for the economy. The end result was lower prices for consumers, a more efficient economy, and a higher overall standard of living.

Of course, that did not take into account how painful that transition was for the workers who were displaced. One study over a 21-year period found that 17 million workers lost jobs in the manufacturing sector — 6.4 million due to high import competition. Approximately 21% of those workers were high school dropouts. About 70% of those workers found other jobs, but with approximately 13% lower wages. Almost 25% of those workers experienced earnings losses of 30% or more. Those who had the highest earnings losses were the older, less-educated, and lower-skilled production workers with the longest tenure at their jobs (Source: Federal Reserve Bank of Cleveland, January 15, 2005). While the overall economy benefited, many individuals found themselves worse off.

While imports were partially responsible for that shift, it was also seen as part of a broader shift from a manufacturing to a service economy. In fact, service occupations account for almost 90% of employment now (Source: Federal Reserve Bank of Cleveland, January 15, 2005). It was generally thought that service jobs could not be outsourced to other countries. But with increasing reports of call centers, customer service areas, programmers, and other jobs going overseas, all jobs suddenly seem vulnerable.

How much risk are service jobs exposed to? Many of these jobs could not have been transplanted without the advent of computers, the Internet, and global telecommunications networks, which integrated the United States more completely with other parts of the world. Computers have also made it easier to disseminate information needed to perform a job. For instance, customer service representatives in any country can find answers to common questions about a company’s products, or telemarketers in any country can read call scripts.

Estimates of the number of service jobs at risk for outsourcing to other countries vary. One widely quoted figure estimates that 3.3 million jobs will locate overseas (Source: Economic Perspectives, Second Quarter 2005). Another estimate indicates that up to 14 million jobs are vulnerable to offshoring, but that leaves 96 million jobs with a low risk of offshoring (Source: Economic Review, Third Quarter 2004). Actual loss of service jobs in the early 2000s is estimated at approximately 100,000 jobs a year, or less than .1% of total employment (Source: Economic Review, Third Quarter 2004).

The main reason that service jobs are being sent overseas is the lower labor costs in other countries, including lower costs for benefits such as health insurance and retirement benefits. Yet, U.S. workers tend to be more productive than their overseas counterparts, due to more advanced technology and large amounts of capital per worker.

Some service jobs will probably never be sent overseas, because the work must be performed near the customer. Examples would include a hair stylist or doctor. But not all jobs in a sector will be secure. For instance, doctors typically need to be close to their patients, but x-rays are now routinely screened by radiologists in India. The following job characteristics are more likely to result in offshoring a job:

Labor-intensive — Because labor costs are much higher in the United States, jobs where labor is a high percentage of production costs are more susceptible to being sent overseas.

Information-based — Jobs such as customer service or billing and accounting, where information can be centralized and made available to all workers, are easier to send overseas.

Codifiable — Jobs that can be reduced to a set of rules or guidelines are easier to send overseas.

Once a job goes overseas, the displaced worker is unlikely to be called back to the company to perform a similar job. Typically, displaced workers must then find work in a different occupation or different location. This can lead to longer unemployment periods and long-term income losses.

But if the experience of displaced manufacturing workers is any indication, it will be the displaced service workers with the highest levels of education and skills who will more readily adapt to these changes. If education is important in our economy now, it is bound to become even more important in the future.

July 10, 2006

Do You Really Need an Estate Plan?

Of all the reasons people find for not planning their estates, perhaps the most convincing is that their estate will not be subject to estate taxes. In 2006, your taxable estate must exceed $2,000,000 before being subject to estate taxes. However, an estate plan can provide numerous benefits in addition to reducing estate taxes.

Some benefits include distributing your assets based on your wishes, avoiding conflict among heirs after your death, naming a guardian for minor children, making financial provisions for heirs, naming someone to handle your financial affairs in the event you become incapacitated, reducing delays in settling your estate, reducing the costs of administering your estate, ensuring the continuation of a family business, and planning your funeral arrangements.

Admittedly, most people would prefer not to think about their death. Others may not wish to address certain issues with a spouse. For instance, you may not agree on who should be named guardian of your minor children or which assets should be left to which heirs. If you are in a second marriage, distributing assets among children from both marriages may cause disagreements.

But if you care for your family and want to ensure they will be adequately provided for after your death, you need to get past these hurdles and plan your estate. The planning process will force you to organize your financial records and to make difficult decisions, like who should receive which assets and whether additional life insurance is needed.

Perhaps the last memory your family will have of you is how easy or difficult you made it for them to handle your estate. Leaving a well-organized estate with all your wishes easily laid out, as well as enough resources for your family to continue their present lifestyle, will show your family just how much you cared about them.

To obtain do-it-yourself Legal Documents such as Wills, Powers of Attorney, Health Care Directives and more, go to ManagingMoney.com's Legal Center. You can also obtain do-it-yourself Legal Documents for your business needs as well.

July 5, 2006

Helping Your Parents with Their Finances

Discussing financial matters with your parents can be difficult. You don’t want to seem concerned about how much money they may eventually leave you, while they may fear you are interfering in their lives. Yet, without discussing these matters beforehand, you may have trouble finding all their financial records or determining their wishes if you need to take over their finances.

Consider discussing financial matters with your parents when they are in their early 60s. Include all immediate family members to prevent future misunderstandings, making sure to cover the following:

Where are personal records kept? You don’t need to know specifics, but you should find out where important records are located. Determine where details about insurance policies, investments, deeds, birth and marriage certificates, pension information, bank statements, estate planning documents, credit card information, and outstanding debts are kept.

Who are their advisers? Ask for a list with names, addresses, and phone numbers of all advisers and physicians. Get details about medical conditions and medications being taken.

What are their monthly income and expenses? This will help you determine whether they have sufficient income to pay bills. If they don’t, you may be able to help them change investment selections or find ways to increase their income.

Do they have adequate insurance? Make sure your parents have adequate health insurance coverage and have made provisions for long-term-care needs. Have them investigate long-term-care insurance when they are still healthy and young enough to qualify for reasonable premiums. If they aren’t interested in this coverage but you fear the burden of long-term care may fall on you, you may want to obtain the insurance for them.

Do they have up-to-date estate planning documents? Don’t ask for specifics; just make sure documents are in place so their wishes will be carried out. Find out if they have a durable power of attorney and a health care proxy. With a durable power of attorney, they designate someone to control their financial affairs if they become incapacitated. If your parents are concerned that this person may assume control prematurely, suggest leaving the document with their attorney, who can deliver it to the appropriate person when necessary. A health care proxy delegates health care decisions to a third person when your parent is unable to make those decisions. Usually, this document also outlines procedures to be used to prolong life. To obtain do-it-yourself legal documents such as Wills, Health Care Directives, Powers of Attorney and more, visit ManagingMoney.com's Legal Center.

What are their preferences for the future? Find out where your parents would like to live if they’re not physically able to live in their current home. Do they want to move in with relatives or live in an assisted-living facility? Discuss in detail what procedures they want performed to prolong life in the event of a terminal illness. Determine their preferences for funeral arrangements.

While these topics are sometimes not easy to discuss, they are important to know in case you need to help your parents with their financial matters.

July 4, 2006

Emigrant Bank Goes to 5.00% APY

Emigrant Bank, sponsor of the popular EmigrantDirect American Dream Savings Account, increased their interest rate to 5.00% APY this morning. Happy July 4th! Three of the nations top Banks are now at 5% or greater on their savings accounts. Emigrant today followed the earlier lead of Citibank and Everbank which went to the 5% range immediately after Ben Bernanke, Chairman of the Federal Reserve, last raised rates. At the risk of being wrong, we think this is it for a while. The Fed implied that any rate changes going forward will be based on the health of the economy, not inflation concerns. As the economy is showing some weakness in Real Estate and the consumer is dealing with high energy prices, we feel the Fed will hold off on any more rate increases for a while. If we end up being wrong, we would appreciate someone sending us a new crystal ball.

 

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