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What Key Estate Planning Tools Should I Know About?

By taking steps in advance, you have a greater say in how these questions are answered. And isn’t that how it should be?

Wills and trusts are two of the most popular estate planning tools. Both allow you to spell out how you would like your property to be distributed, but they also go far beyond that.

Just about everyone needs a will. Besides enabling you to determine the distribution of your property, a will gives you the opportunity to nominate your executor and guardians for your minor children. If you fail to make such designations through your will, the decisions will probably be left to the courts. Bear in mind that property distributed through your will is subject to probate, which can be a time-consuming and costly process.

Trusts differ from wills in that they are actual legal entities. Like a will, trusts spell out how you want your property distributed. Trusts let you customize the distribution of your estate with the added advantages of property management and probate avoidance. While trusts offer numerous advantages, they incur upfront costs and ongoing administrative fees. The use of trusts involves a complex web of tax rules and regulations. You should consider the counsel of an experienced estate planning professional and your legal and tax advisers before implementing such strategies.

Wills and trusts are not mutually exclusive. While not everyone with a will needs a trust, all those with trusts should have a will as well.

Incapacity poses almost as much of a threat to your financial well-being as death does. Fortunately, there are tools that can help you cope with this threat.

A durable power of attorney is a legal agreement that avoids the need for a conservatorship and enables you to designate who will make your legal and financial decisions if you become incapacitated. Unlike the standard power of attorney, durable powers remain valid if you become incapacitated.

Similar to the durable power of attorney, a health care proxy is a document in which you designate someone to make your health care decisions for you if you are incapacitated. The person you designate can generally make decisions regarding medical facilities, medical treatments, surgery, and a variety of other health care issues. Much like the durable power of attorney, the health care proxy involves some important decisions. Take the utmost care when choosing who will make them.

A related document, the living will, also known as a directive to physicians or a health care directive, spells out the kinds of life-sustaining treatment you will permit in the event of your incapacity. The directive creates an agreement between you and the attending physician. The decision for or against life support is one that only you can make. That makes the living will a valuable estate planning tool. And you may use a living will in conjunction with a durable health care power of attorney. Bear in mind that laws governing the recognition and treatment of living wills may vary from state to state.

Charitable Donations

DEFINITION of “Charitable Donation”

A gift made by an individual or an organization to a nonprofit organization, charity or private foundation. Charitable donations are commonly in the form of cash, but can also take the form of real estate, motor vehicles, appreciated securities, clothing and other assets or services.

BREAKING DOWN “Charitable Donation”

Charitable donations often represent the primary source of funding for many charitable organizations and nonprofit organizations. In most countries, a charitable donation made by an individual will provide him or her with an income tax deduction.

Tips on Charitable Contributions: Limits and Taxes

By Barbara A. Friedberg | April 13, 2015

Gifts to charity are one of the best tax saving opportunities available. Not only does the charity recipient benefit, but the taxpayer receives a tax deduction. As with most government benefits, there are limits to charitable contributions. When donating to charity, and claiming the charitable deduction, investors, financial advisors and tax specialists should consult the Internal Revenue Service (IRS) government publication 526 for questions and clarification.

There are many charities and ways to contribute. Following are a few tips to help clarify this confusing topic. (For more, see: Give to Charity; Slash Your Tax Payment.)

Deductions and Contributions

The charity must be qualified in order to deduct the contribution. You can’t give Aunt Linda $50 and deduct it as a charitable contribution. Neither can you deduct political contributions or candidates.

Many folks donate clothes, household items and more to Goodwill, the Salvation Army and other similar charities. This is a great way to declutter and help others. But these types of noncash gifts have their own rules. Used clothing and household items must be in useable good condition, and there are additional regulations that apply to vehicle donations. You can’t claim the new value for a noncash donation, but must use the item’s fair market value. That price is similar to a thrift store value. Some tax preparation programs include a calculator to help determine items’ value. When donating noncash charitable contributions, if your total deduction is greater than $500, you must file IRS Form 8283. Additionally, if you give cash or property worth more than $250, you need a written acknowledgement from the organization as well. IRS Publication 561 is a useful resource to help you decide the value of your noncash contributions.


There is a limit to the amount of all charitable contributions allowed during a tax year. Your total charitable deduction can’t exceed 50% of your adjusted gross income (AGI). As with many government programs, there’s a caveat; certain qualified conservation contributions are eligible for a higher limit. To further complicate the matter, there are certain types of organizations that qualify for the 50% limit. These organizations include churches, educational institutions, hospitals and others as defined by the IRS. (For more, see: 5 Little-Known Tax Deductions and Credits.)

There is a lower 30% limit to charitable contributions for certain types of organizations. The 30% limit applies to veterans’ organizations, fraternal societies, nonprofit cemeteries and certain private foundations. Your word is not good enough for the IRS. The taxpayer must keep detailed records to support the contributions. In order to claim a deduction for cash, you must have a written record, canceled check, letter from the organization, or bank/payroll debit. (For more, see: Can I Donate Stock to Charity?)

The Bottom Line

Don’t let the rules and regulations deter you from claiming the charitable deduction. Download a copy of IRS publication 526 and Form 8283 (for noncash charitable donations) for easy reference. To clarify any potential charity contribution limits, visit the website. By claiming this deduction you help others as well as yourself. Additionally, by claiming all IRS allowed deductions you save money and avoid paying the government any more than is legally required. (For more, see: It Is Better to Give and Receive.)

DEFINITION of “Proof of Charitable Contributions“

Substantiation required by the Internal Revenue Service for a taxpayer to claim a donation of money, property or financial assets as an itemizable federal income tax deduction. Acceptable forms of proof of charitable contributions include bank statements, payroll deduction records and written statements from the recipient charity containing the charity’s name, contribution date and contribution amount.

BREAKING DOWN “Proof of Charitable Contributions”

The IRS has slightly different rules for proof of charitable contributions depending on the contribution amount. One of the above three forms of proof is required regardless of the amount, but for contributions of $250 or more, the charity must specify whether it provided the donor with any goods or services in exchange for the gift.

Taxpayers claiming a deduction for more than $500 in noncash contributions must also fill out IRS form 8283 and file it with their annual tax return. In addition, the IRS requires an independent substantiation of value, such as an appraisal, for noncash donations exceeding $5,000. Taxpayers can consult IRS publication 561 for help determining the value of donated property.

Benefits of A-B Trusts


A trust created by a married couple with the objective of minimizing estate taxes. An A-B trust is is a trust that divides into two upon the death of the first spouse. It is formed with each spouse placing assets in the trust and naming as the final beneficiary any suitable person except the other spouse. The trust gets its name from the fact that it splits into two upon the first spouse's death – trust A or the survivor's trust, and trust B or the decedent's trust.


The surviving spouse has complete control over the survivor's trust, which contains his or her property interests, but has limited control over the assets in the deceased spouse's trust. However, this limited control over the assets in the decedent's trust will still enable the surviving spouse to live in the couple's house and draw income from the trust, provided these terms are stipulated in the trust. Upon the death of the surviving spouse, the property in the decedent's trust passes to the beneficiary(s) named in this trust. As this property is not considered part of the second spouse's estate for purposes of estate tax, double-taxation is avoided.

DEFINITION of "Marital Trust"

A fiduciary relationship between a trustor and trustee for the benefit of a surviving spouse and the married couple's heirs. Also called an "A" trust, a marital trust goes into effect when the first spouse dies. Assets are moved into the trust upon death and the income generated by the assets goes to the surviving spouse. Under some arrangements, the surviving spouse can also receive principal payments. When the second spouse dies, the trust passes to its designated heirs.

BREAKING DOWN "Marital Trust"

There are three types of marital trusts: a general power of appointment, a QTIP trust and an estate trust. A marital trust allows the couple's heirs to avoid probate and take less of a hit from estate taxes by taking full advantage of the unlimited marital deduction, which allows spouses to pass assets to each other without tax consequences. However, when the surviving spouse dies, the remaining trust assets will be subject to estate taxes. To further avoid estate taxes when the surviving spouse dies, a marital trust is sometimes used in conjunction with a credit shelter trust (also called a "B" trust).

An example of when a marital trust might be used is when a couple has children from a previous marriage and wants to pass all property to the surviving spouse upon death but provide for their individual children upon the surviving spouse's death. In case the surviving spouse remarries, the deceased spouse's assets will go to his or her children instead of to the new spouse.

DEFINITION of “Credit Shelter Trust – CST”

A type of trust that allows a married investor to avoid estate taxes when passing assets on to heirs. The trust is structured so that upon the death of the investor, the assets specified in the trust agreement (up to a specified maximum dollar value) are transferred to the beneficiaries named in the trust (normally the couple's children). However, a key benefit to this type of trust is that the spouse maintains rights to the trust assets and the income they generate during the remainder of his or her lifetime.

This type of trust is also referred to as an "AB Trust".

BREAKING DOWN “Credit Shelter Trust – CST”

In certain circumstances, such as the need to fund healthcare expenses, the surviving spouse may even tap into the principal of the trust assets, not just their generated income. When the surviving spouse eventually dies, the assets are transferred wholly to the beneficiaries (children) without any estate taxes levied. This can amount to significant tax savings and can be very valuable, especially considering that the surviving spouse essentially maintains full use of the assets while they are in the trust anyway.

Charitable Lead Trusts

DEFINITION of “Charitable Lead Trust”

A trust designed to reduce beneficiaries' taxable income by first donating a portion of the trust's income to charities and then, after a specified period of time, transferring the remainder of the trust to the beneficiaries.

BREAKING DOWN “Charitable Lead Trust”

The whole idea of a charitable lead trust is to reduce taxes upon the estate left by the deceased. This is done by donating to charities from the estate until all taxes are reduced. Once this is accomplished, the estate is then transferred to the beneficiaries, who typically will face lower taxes.

Many different organizations offer information regarding the set-up of these types of trusts. Examples are universities, colleges, and non-profit societies.

Why You Should Set Up a Charitable Trust Now

By Mark P. Cussen, CFP®, CMFC, AFC | December 22, 2015

Charitable trusts allow donors to take a substantial tax deduction in the current year and then receive income from the trust for the rest of their lives. These vehicles ultimately provide donors with a tax-advantaged way to gift a substantial asset out of their estate and benefit the receiving charity as well. But now may be the best time to set up this type of arrangement for your clients, as interest rates are bound to rise before too much longer.

Why Rates Matter

When donors use a charitable lead trust to donate assets in a split interest arrangement, the asset has to be valued in order to determine the amount of the income tax deduction that can be taken. This valuation involves a time-value-of-money calculation in order to determine the net present value of the asset, and the interest rate that is used for this calculation is the Charitable Midterm Federal Rate (CMFR). Of course, the lower this rate is, the greater the deduction that can be taken, because the net present value of an asset that is discounted at 6% will obviously be much lower than the value of an asset that is discounted at half of that rate. (For more, see: Choosing the Right Charitable Remainder Trust.)

Charitable Lead Annuity Trusts vs. Unitrusts

It should be noted that not all trusts use the CMFR rate to determine the asset’s net present value. Charitable lead unitrusts use the actual payout rate of the trust to determine this value instead of the CMFR. Donors and trustees should therefore think carefully about the rate of return that they seek from the trust, as a higher level of income will equal a lower tax deduction. Changes in interest rates can therefore affect the value of charitable lead annuity trusts, because changes in the Fed Funds Rate are reflected in the CMFR. (For more, see: How Advisors Can Build a HNW Estate Planning Niche.)

Unitrusts are affected by changes in interest rates in a different way. The amount of income that must be generated from the trust is determined by the trust’s corpus, or the value of the assets inside the trust. When interest rates fall, the amount of income that the trust generates will also likely decline, and if the trust cannot meet its minimum payout that is required for the year, then it will invade the trust corpus to make up the balance. But the trust assets will then be less the following year, which means that the required payout will also decline, so no liquidation of trust assets may be necessary that year.

The rate of distribution is also set in a lead annuity trust at inception, so if interest rates exceed the CMFR in a given year, then the trust will theoretically produce more income than is necessary for that year and will add that amount to the trust corpus and vice-versa for years when interest rates fall below the CMFR. Donors also have the choice of using either the current CMFR or the rate for one of the two months prior when they establish their trusts. (For more, see: Estate Planning Tips for Financial Advisors.)

The Bottom Line

Interest rates remain at historic lows, but they will inevitably rise at some point. Those who are planning to gift substantial assets to charity will need to make the necessary arrangements before the Federal Reserve raises rates in order to get the best possible valuations and payouts on their donation. A qualified estate planning attorney and tax advisor should be consulted before doing this in order to ensure that the right type of trust is used and the transfer is done properly. (For more, see: Estate Planning: Charitable Trusts.)

DEFINITION of "Charitable Remainder Trust"

A tax-exempt irrevocable trust designed to reduce the taxable income of individuals by first dispersing income to the beneficiaries of the trust for a specified period of time and then donating the remainder of the trust to the designated charity.

BREAKING DOWN "Charitable Remainder Trust"

The whole idea of a charitable remainder trust is to reduce taxes. This is done by first donating assets into the trust and then having it pay the beneficiary for a stated period of time. Once this time-frame expires, the remainder of the estate is transferred to the charities deemed as beneficiaries.

Estate Planning: Charitable Trusts

by Cathy Pareto, CFP®, AIF® (Contact Author | Biography

Philanthropy through charitable contributions generates not only goodwill, but also has significant income and estate tax benefits for donors. For wealthy individuals, this may translate into hundreds of thousands of dollars in estate and income tax savings. A great way to accomplish this goal is through the use of charitable trusts.

A charitable trust is not tax exempt, and its unexpired interests are usually devoted to one or more charitable purposes. A charitable trust is allowed a charitable contribution deduction and is usually considered organized as of the first day on which it is funded with amounts for which a deduction was allowed.

Charitable Trust Terminology You Need to Know


Corpus is the Latin word for "body". In the case of a trust, the trust corpus is the assets with which the trust was funded. It does not include gains, income, etc. produced by the trust assets.


The person donating the assets to the charity.

Why Consider Leaving Assets to a Charity?

As a general rule, outright gifts to charity at death are deductible without limit and reduce the taxable estate.

The Charitable Remainder Trust

A charitable remainder trust (CRT) is an incredibly effective estate planning tool available to anyone holding appreciated assets with low basis, like stocks or real estate. Funding this trust with appreciated assets allows the donor to sell the assets without incurring a capital gain. CRTs provide investors with an efficient way to transfer appreciated property, benefit from the charitable income tax deduction and reduce estate taxes while still reaping the benefits of the underlying assets for income purposes.

There are two sets of beneficiaries: income beneficiaries, typically you and your spouse, and the charities that you choose to name in the trust. As the grantor, you will generally receive income from the trust during your lifetime or for a fixed number of years. If you are married and either you or your spouse dies, the surviving spouse continues to receive income. Provisions can also be made to continue making income payments to successor beneficiaries, and the charities will receive the residual principal of the trust when all the other beneficiaries die.

The following are two types of CRT than can be considered:

Charitable Remainder Annuity Trust
A charitable remainder annuity trust (CRAT) is used in situations where the donor wishes to provide a non-charitable beneficiary with a stream of income to last for a specific time period (i.e., for the life of the recipient or for a fixed number of years). If a term of years is used, it cannot surpass more than 20 years. The income stream must represent at least 5% of the corpus each year.

In this type of arrangement, the recipient receives an income tax deduction from the present value of the remainder interest. At the time the period ends, the remainder interest in the property passes to a qualified charity, or it can also remain in trust for the charity. However, the remainder interest is required to be at least 10% of the contributed amount. It should be noted that the donor can make only one initial transfer of property to the corpus and there can be no additions or increases to the corpus in later years.

Charitable Remainder Unit Trust
The charitable remainder unit trust (CRUT) is similar to CRAT with the difference that in the CRUT the donor can make more than one transfer to the trust. The other difference is that once the trust is established, the corpus must pay out a specific amount of income each year, as a fixed percentage of at least 5%. Depending on how the trust is set up, the payments will continue for a fixed period of time or until the death of the beneficiary.

Charitable Lead Trusts

The purpose of a charitable lead trust (CLT) is to reduce the donor's current taxable income. The way this type of trust works is that a portion of the trust's income is first donated to a charity, and after a specified period of time (usually until all taxes are reduced), it transfers the remainder of the trust to the trust beneficiaries. By doing this the beneficiaries will face lower gift taxes and estate taxes. The federal tax deduction you receive from this type of trust will be equal to the estimated value of the annual trust payments to the charity.

You can get a lot of help in setting up these types of trusts from different charities, universities and other organizations that would be interested in getting the income for a few years. A charitable lead trust works best for wealthier, estate tax-conscious individuals, as long as those individuals are willing to defer receiving substantial income and own highly appreciating assets.

Property Ownership

7 Unusual Property Ownership Rules

By Amy Fontinelle | July 08, 2011

Owning real estate is challenging for most people. Few of us have all the financial, legal and handyman training that would make us top-notch property owners. In some jurisdictions, all the usual difficulties are compounded by unusual rules, procedures and customs. Let's take a look at seven of these factors.

TUTORIAL: Exploring Real Estate Investments

1. You Can't Own the Land In some jurisdictions, it is possible to own property, but not the land on which the property is located. One such location is Vietnam, where all land is considered communal property. Similarly, in China, all land is owned by either the government or by a collective. Thailand prevents foreigners from owning land unless they do so in conjunction with a private limited company that is at least 51% Thai-owned. There are some communities in the United States where it is possible to buy property on leased land, but it is not the dominant U.S. ownership structure. (Learn more in Should You Buy Property On Leased Land?)

2. You Can Only Own One Home In 2010, Shanghai and Beijing's municipal governments decided that families would only be allowed to own one home in those cities. The stated purpose of the law was to help slow the rapid price increases in the Chinese real estate market. At the time of enactment, no end date for the new rule was established. A seeming consequence of this law has been a decrease in new home sales.

3. You Can Own Corporate Shares, but Not the Actual Property In cooperative housing arrangements such as New York City's co-ops, residents don't actually own the units they occupy. What they really own is a share in the corporation that owns the entire building or development, plus the right to occupy a given space. The corporation holds the title to the property.

This type of ownership structure is not unique to New York, though it is not as common in other U.S. cities. It also exists abroad. Belize is one country that offers a similar arrangement in some housing developments. (For related reading, see An Introduction To Buying A Condominium.)

4. You Have to Wait for Water Rights Since 1986, Cambria, Calif., has had a waiting list to acquire water rights. Without these rights, a property cannot have any water or sewer hookups. What's more, the waiting list was closed in 1990. There are three waiting lists: one for single-family properties, one for multi-family properties and one for commercial properties. No new water permits have been issued since November, 2001 because of a lack of water supply, so the waiting lists are currently stagnant. The single-family wait list has 666 listings. Real estate listings for land in Cambria note the property's position on the water rights waiting list.

5. You May Have Difficulty Obtaining a Clear Title In some countries, getting a free and clear title is not as simple as doing a title search and purchasing title insurance. Many traditional, older homes in Morocco do not have a formal title and have multiple owners. This makes it difficult for a buyer to acquire full and indisputable ownership of the property. Cypress is another country where it can be challenging to acquire a title. (For related reading, see Holding Titles On Real Property.)

6. Your Historic Home Can't Have a Modern Door Properties located in official historic districts in the United States are often subject to numerous regulations when it comes to modifying the property. In the St. Louis neighborhood of Soulard, which is listed on the National Register of Historic Places, a combination of historic standards and city building codes determine how property owners maintain and modify their buildings. Here are a few of the district's codes governing doors:

  1. Doors shall be one of the following:
    1. The original wood door restored
    2. A new wood door which replicates the original
    3. A finished metal door of a style which replicates the original
    4. Based on a Model Example.
  2. The following types of doors are prohibited:
    1. Flush, hollow-core doors with or without applied moldings
    2. Flush doors of any material.
  3. Doors shall have one of the following finishes:
    1. Paint
    2. When hardwood, a natural finish

7. You Should Sell Your Property at Auction. In the United States, property auctions are only common among foreclosure and tax lien sales, and bidders are primarily professional real estate investors. In Australia, however, it's not unusual for the average person to buy or sell a property at auction. Sellers establish the minimum price they are willing to accept; if no bidder meets this price, one of the highest bidders may be able to negotiate a deal with the seller. Auction sales represent roughly 33% of sales in Melbourne, Canberra and Sydney. (The traditional real estate market isn't the only place to conduct your home search. For more, see Should You Buy A House At Auction?)

The Bottom Line If you own property in a jurisdiction that is relatively free of unusual situations, consider yourself fortunate. Having water rights, a clear title and the freedom to own multiple properties aren't a given everywhere in the world.

Tax Deductions For Rental Property Owners

By George D. Lambert | September 27, 2006

Do you own real estate that you rent out? Besides the potential for an ongoing income and capital appreciation, such investments offer deductions that can reduce the income tax on your profits. But first, what kind of real estate investor are you: a passive investor or real estate professional? In this article we'll show you how your classification could make a big difference in the number of tax breaks you get.

If you spend the majority of your time in the real estate business as a real estate professional, your rental losses are not passive. This means that your losses are fully deductible against all income, passive and non-passive. Otherwise, your losses are passive and only deductible up to $25,000 against your rentals' income (deduction phases out if your modified adjusted gross income (MAGI) is between $100,000 and $150,000). However, losses of more than $25,000 can be carried over to the following year.

The IRS defines a real estate professional as someone who spends more than one-half of his or her working time in the rental business. This includes property development, construction, acquisition and management. You must also spend more than 750 hours per year working on your real estate rental properties. (To find extra resources about owning rental properties, see Investing In Real Estate and Tips For The Prospective Landlord.)

Common Income Sources
Rental Income
Money you receive for rent is generally considered taxable in the year you receive it, not when it was due or earned; therefore, you must include advance payments as income.

For example, suppose you rent out a house for $1,000 per month and you require that new tenants pay first and last months' rent when they sign a lease. In this case, you'll have to declare the $2,000 you received as income, even though a $1,000 of that $2,000 covers a period that might be several years in the future.

Tenant-Paid Expenses
Expenses your tenant pays for you are considered income. This would include, for instance, an emergency repair on a refrigerator a tenant has to have done while you are out of town. You can then deduct the repair payment as a rental expense.

Trade for Services
Your tenant might offer to trade his services in exchange for rent. However, you must include a fair market value of the services as income. As an example, if your tenant offers to paint the rental house in exchange for one month's rent (valued at $1,000), you must include the $1,000 as income, even though you didn't actually receive the money. However, you will be able to deduct the $1,000 as an expense.

Security deposits
Security deposits are not taxable when you receive them if the intent is to return this money to the tenant at the end of the lease. But what if your tenant does not live up to the lease terms?

For example, suppose that you collect a $500 security deposit and then your tenant moves out and leaves holes in the walls that cost $400 to repair. You can deduct that amount from the security deposit during the year that you return it. At that time, though, you must include the $400 that you used to repair the wall as income. You will also be able to show the $400 as a deductible expense.

Repairs Vs. Improvements
Rental property owners may assume that anything they do on their property is a deducible expense. Not so, according to the IRS.

A repair keeps your rental property in good condition and is a deductible expense in the year that you pay for it. Repairs include painting, fixing a broken toilet and replacing a faulty light switch. Improvements on the other hand, add value to your property and are not deductible when you pay for them. You must recover the cost of improvements by depreciating the expense over your property's life expectancy. Improvements can include a new roof, patio or garage.

Therefore, from a tax standpoint, you should make repairs as the problems arise instead of waiting until they multiply and require renovations.

Common Deductions
Mortgage Expenses
Expenses to obtain a mortgage are not deductible when you pay them. These include commissions and appraisals. However, you can amortize them over the life of your mortgage.

Once you start making mortgage payments, remember that not all of the payment is deductible. Since part of each payment goes toward paying down the principal, this amount is not a deductible expense; the portion paid toward interest is deductible. Your mortgage company will send you a Form 1098 each year showing how much you've paid in interest throughout the year. This is deductible. Also, if a part of your payment includes money that goes into anescrow account to cover taxes and insurance, your mortgage company should report that to you as well.

Travel Expenses
Money you spend on travel to collect rent or maintain your rental property is deductible. However, if the purpose of the trip was for improvements, you must recover that expense as part of the improvement and its depreciation.

You have two choices on how to deduct travel expenses: the actual expenses or the standard mileage rate. You can read more about the IRS's requirements and current mileage allowance in Publication 463.

Other Common Expenses
In addition to repairs and depreciation, some of the other common expenses you can deduct are:

  • Insurance
  • Taxes
  • Lawn care
  • Tax return preparation fee
  • Losses from causalities (hurricane, earthquake, flood, etc.) or thefts

Condominiums and Cooperatives If you own a rental condominium or cooperative, each has some special rules.

With a condominium you might pay dues or assessments to take care of commonly-owned property. This includes the building structure, lobbies, elevators and recreational areas.

When you rent out your condominium, you can deduct expenses, such as depreciation, repairs, interest and taxes that relate to the common property. However, just as with a single-family rental, you cannot deduct money spent on capital improvements, such an assessment for a cabana at the clubhouse. Instead you must depreciate your cost of any improvement over its life expectancy.

Expenses you have for a cooperative apartment you rent out are deductible. This includes the maintenance fees paid to the cooperative housing corporation. Capital improvements are treated differently - you cannot deduct the cost of the improvement, nor can you depreciate it. You must add the cost of the improvement to your cost basis in the corporation's stock. This will reduce your capital gain when you sell the apartment.

Keep Good Records
Under the IRS's Schedule E there are spaces for numerous categories of expenses. Therefore, the IRS gives you flexibility in the items you can deduct. But be prepared to back up your claim, and be sure to break out expenses that are for repairs and maintenance from those that are capital improvements. Remember, money you spend on improvements could reduce your tax liability when you sell.

In addition, if you claim to be a real estate professional, you should keep supporting documentation (appointment books, diaries, calendars, logs, etc.) to prove your active participation and the time spent on your properties each year.

All in all, there are quite a few types of deductions available to real estate investors and it pays to know which ones you qualify for.



A retirement plan that can be used by most small businesses with 100 or fewer employees. SIMPLE stands for “Savings Investment Match Plan for Employees”; IRA stands for “individual retirement account.” Employers can choose to make a mandatory 2% retirement account contribution to all employees or an optionalmatching contribution of up to 3%. Employees can contribute a maximum of $12,000 annually in 2013; the maximum is increased periodically to account for inflation.


SIMPLE IRAs have minimal paperwork requirements--just an initial plan document and annual disclosures to employees. The employer establishes the plan through a financial institution that administers it. Startup and maintenance costs are low, and employers get a tax deduction for contributions they make for employees. To be eligible to establish a SIMPLE IRA, the employer must have 100 or fewer employees. To participate in the plan, employees must have earned at least $5,000 in compensation in any two previous calendar years and be expected to earn at least $5,000 in the current year. Employers can choose less restrictive participation requirements if they wish. An employer may also choose to exclude from participation employees who receive benefits through a union. Employers establish the plan using IRS form 5304-SIMPLE, if they want to allow employees to choose the financial institution where they will hold their SIMPLE IRA, or using form 5305-SIMPLE, if the employer wants to choose the financial institution where employees will hold their IRAs. Employees must fill out a SIMPLE IRA adoption agreement to open their accounts. Once the plan is established, employers are required to contribute to it each year unless the plan is terminated. However, employers may change their contribution decision between the 2% mandatory contribution and the 3% matching contribution if they follow IRS rules. A drawback of SIMPLE IRAs is that the business owner can’t save as much for retirement as with other small business retirement plans, such as a SEP or 401(k).

Are the deferred earnings in a SIMPLE IRA subject to FICA taxes?

By Denise Appleby

Answer: While salary deferral contributions to a savings incentive match plan for employees of small employers (SIMPLE) IRAs and SIMPLE 401(k)s are not subject to income tax withholding, they are subject to tax under theFederal Insurance Contributions Act (FICA), the Federal Unemployment Tax Act (FUTA) and the Railroad Retirement Act (RRTA).

SIMPLE IRAs: Distributions

Distributions from SIMPLE IRAs must occur eventually. Until the required minimum distributions (RMDs) rules apply, distributions are usually elective . The tax and penalty treatment of distributions are determined by the SIMPLE IRA owner's age at the time of distribution.

Two-Year Rule During the first two years after an employee's SIMPLE IRA is established, assets held in the SIMPLE IRA must not be transferred or rolled to another retirement plan. This two-year period begins the first day the employer deposits a contribution to the SIMPLE IRA. After the two-year period, assets in a SIMPLE IRA may be moved to another eligible retirement plan by means of a transfer, rollover or as a Roth conversion.

The two-year waiting period does not apply to transfers or rollovers between two SIMPLE IRAs.

Distributions that occur during the two-year period are subject to an early-distribution penalty of 25% if the SIMPLE IRA owner is under age 59.5 when the distribution occurs. If an exception applies, however, the 25% penalty is waived. Distributions that occur when the SIMPLE IRA holder is age 59.5 or older are not subject to the early-distribution penalty, even if the distribution occurs within the two-year period.

Distributions That Occur Before Age 59.5
Distributions that occur before the individual reaches the age of 59.5 are subject to a 10% early-distribution penalty. For SIMPLE IRAs, this 10% penalty is increased to 25% if the individual receives a distribution within two years of the first contribution made to his or her SIMPLE IRA account. The 10% penalty is in addition to any income tax owed on the amount. There are certain instances where the IRS will waive the early-distribution penalty and the 25% penalty for distributions that occur during the two-year period. The IRS waives the penalty when distributions are used for reasons which include the following:

For Unreimbursed Medical Expenses
If the distribution is used to pay unreimbursed medical expenses, the amount that exceeds 7.5% (10% after 2012) of the individual's adjusted gross income (AGI) for the year of the distribution will not be subject to the early-distribution penalty. In other words, the amount paid for the unreimbursed medical expenses minus 7.5% of the individual's adjusted gross income for the year of the distribution can be distributed penalty free.

Example: SIMPLE IRA Distributions for Medical Expenses

Jack's AGI is $25,000, and he paid $4,000 for unreimbursed medical expenses.
The amount that exceeds 7.5% of his income = $4,000 - ($25,000 x 7.5%).
The amount that exceeds 7.5% of his income = $4,000 - $1875.
The amount that exceeds 7.5% of his income = $2,125.
The maximum amount Jack may claim for the early-distribution exception is $2,125.

To Pay Medical Insurance
Individuals can make a penalty-free distribution to pay medical insurance for themselves, their spouses and dependents, provided the distribution occurs under the following four conditions:

  • The individual has lost his or her job.
  • The individual has received unemployment compensation paid under any federal or state law for 12 consecutive weeks.
  • The individual receives the distributions during either the year he or she receives the unemployment compensation or the following year.
  • The individual receives the distributions no later than 60 days after he or she has been re-employed.

For a Disability
If an individual becomes disabled before age 59.5 and makes a distribution from his or her Traditional IRA because of the disability, the distributions are not subject to the early-distribution penalty. Individuals are considered disabled if they furnish proof that a physical or mental condition inhibits them from engaging in substantial gainful activities. A physician must determine that this condition can be expected to result in death or to continue for an indefinite duration.

As Distributions to the IRA Beneficiary
Amounts distributed from the IRA by the designated beneficiary , after the IRA owner's death, are not subject to penalty.

As Part of an SEPP Program
For penalty-free distributions that are part of a series of substantially equal payments over the life of the IRA holder and or his or her beneficiary, the payments must last five years or until the IRA owner reaches age 59.5 - whichever is longer - and the payments must also follow certain IRS-approved methods.

For Qualified Higher Education Expenses
Amounts are penalty free if they must go toward qualified higher-education expenses of the IRA owner and/or his or her dependents. These qualified education expenses include tuition, fees, books, supplies and equipment required for the enrollment or attendance of a student at an eligible educational institution. An eligible educational institution is any college, university, vocational school or other post-secondary educational institution eligible to participate in the student aid programs administered by the Department of Education. These eligible educational institutions include virtually all accredited post-secondary institutions, whether public, nonprofit or proprietary (privately owned and profit making). The educational institution should be able to indicate whether it is an eligible educational institution.

To Purchase a First Home
The IRA owner can make penalty-free distributions to purchase, build or rebuild a first home:

  • For the IRA owner
  • For the IRA owner's spouse
  • For a child of the IRA owner or of the IRA owner's spouse
  • For a grandchild of the IRA owner or of the IRA owner's spouse
  • For a parent or other ancestor of the IRA owner or of the IRA owner's spouse

The first-time homebuyer distribution must be used to pay qualified acquisition costs before the end of the 120th day after the IRA owner receives the distributed assets.

The total distribution the IRA owner uses for first-time home purchases cannot exceed $10,000 during the IRA owner's lifetime. For married individuals, the $10,000 applies separately to each spouse, which means that the total for both is $20,000.

For Payment of an IRS Levy
The IRS may levy against an IRA, resulting in a distribution. The distributed amount is subject to income tax, but the early-distribution penalty is waived.

Additional Information
The early-distribution penalty does not apply to amounts that are not subject to income tax. These include amounts distributions that occur after the two-year period and are later deposited to an eligible retirement plan as a rollover contribution within 60 days of receipt.

Distributions That Occur on or After Age 59.5
Distributions that occur on or after the SIMPLE IRA owner reaches age 59.5 may be subject to income tax, but will not be subject to any early-distribution penalty. These distributions are also subject to the two-year rule and cannot be rolled over to an eligible plan during the first two years after the SIMPLE IRA is established.

Required Minimum Distributions
Traditional IRA distributions cannot be deferred indefinitely. An IRA owner must begin RMDs for the year he or she reaches age 70.5, at which time the IRA owner may distribute the full balance of the IRA or distribute a minimum amount each year. (For background reading, check out 6 Important Retirement Plan RMD Rules.)

The first RMD must be distributed by April 1 of the year after the IRA owner reaches age 70.5. For example, an IRA owner who reaches age 70.5 in June of 2013 must take his or her first RMD by April 1, 2014. RMDs for subsequent years must be distributed by December 31 of the year for which they are due. This means that if the IRA holder defers the first RMD until April 1 of the next year after he or she turns 70.5, the IRA holder will be required to take a second RMD amount in this next year, which counts as the second year of the RMD.

Example: RMD Distribution Rules

Jill turns 70.5 in June of 2012, and she decides to defer her first RMD until April 1, 2013.
Jill is required to take a second RMD (for 2013) by December 31, 2013. For subsequent years, Jill must distribute her RMD amounts by December 31 of each year.

Generally, the IRA custodian/trustee will calculate the RMD amount and send the notification to the IRA holder. Alternatively, the IRS custodian/trustee may send an RMD reminder to the IRA holder with an offer to calculate the RMD amount upon request.

RMD amounts not distributed from the IRA by the due date are subject to a 50% excess-accumulation penalty.

Example: IRA Excess Accumulation Penalty

John is 75 years old and his RMD for 2013 is $5,000. By December 31, 2013, John has only distributed $4,000 from his IRA. Because John\'s RMD was short by $1,000, he must pay the IRS a 50% excess-accumulation penalty ($1,000 x 50% = $500).

The excess-accumulation penalty must be paid when the individual files his or her federal tax return. If the individual feels that the failure was due to reasonable circumstances, he or she may write to the IRS and request that the penalty be waived. In such cases, the penalty should not be paid unless the IRS denies the request for the waiver.

SIMPLE IRAs: Contributions

By Denise Appleby

A Savings incentive match plan for employees (SIMPLE) is an IRA-based employer plan under which eligible employees are allowed to make contributions to their SIMPLE IRAs, and employers are required to make either matching or nonelective contributions.

Let's recap:

  • SIMPLEs can be established by business owners who had 100 or fewer employees who earned at least $5,000 during the preceding year.
  • Unlike qualified plans, a SIMPLE IRA plan is easy to administer. The start-up and maintenance costs for SIMPLE IRAs are very low compared to qualified plans.
  • Any employer - which includes sole proprietorships, partnerships, corporations and non-profit organizations - may establish a SIMPLE IRA Plan, as long as the employer meets the eligibility requirements.
  • Contributions to SIMPLE IRAs are immediately 100% vested, and the SIMPLE IRA owner (employee) directs the investments.
  • An employer is required to make either dollar-for-dollar matching contributions (not to exceed 3% of the employee's compensation), or 2% nonelective contribution to all eligible employees regardless of whether they make deferral contributions.
  • The tax and penalty treatment applicable to distributions from a SIMPLE IRA is determined by the SIMPLE IRA owner's age at the time of distribution.

Stretch IRAs


An estate planning concept that is applied to extend the financial life of an Individual Retirement Account (IRA) across multiple generations. A stretch IRA strategy allows the original beneficiary of an IRA to distribute assets to a designated second-generation beneficiary, or even a third- or fourth-generation (or more) beneficiary. By using this strategy, the IRA can be passed on from generation to generation while beneficiaries enjoy tax-deferred and/or tax-free growth as long as possible. The term "stretch" does not represent a specific type of IRA; rather it is a financial strategy that allows people to stretch out the life – and therefore the tax advantages – of an IRA.


Stretching out an IRA gives the funds in the IRA more time – potentially decades – to compound tax-deferred. This provides the opportunity to grow the funds significantly for future generations. With a traditional IRA, the owner has to begin taking the required minimum distribution (RMD) by April 1 of the year after turning 70.5. The RMD is calculated by taking the account balance on December 31 of the previous year, and dividing that number by the number of years left in the owner's life expectancy (as listed in the IRS' "Uniform Lifetime" table.) Each year, the RMD is calculated by dividing the account balance by the remaining life expectancy.

Non-spousal heirs of any age, regardless of the type of IRA, must take RMDs based on their life expectancy. The younger the beneficiary, the lower the RMD, which allows more funds to remain in the IRA to stretch the IRA over time.

However, not all IRAs allow the stretch strategy, and investors should check with their provider or financial institution to determine if beneficiaries will be allowed to take distributions over a life-expectancy period.

What is the "stretch IRA" concept?

By Steven Merkel, CFP, ChFC

Answer: The "stretch IRA" is not a new IRA account on the market, or even a new investment concept, it is simply a wealth transfer method that allows you the potential to "stretch" your IRA over several future generations. As an IRA owner, you are typically required to take minimum distributions from your IRA at age 70.5 based on an IRS life expectancy table. If you are fortunate enough to inherit someone else's IRA, you will be required to take minimum distributions each year from the IRA account based on your life expectancy figure - regardless of your age.

IRA accounts at death of the owner pass by contract or beneficiary designation. It is typical practice for most IRA owners to name their spouse as the primary IRA beneficiary and their children as the contingent beneficiaries. While there is nothing wrong with this strategy, it might require the spouse to take more taxable income from the IRA than what he/she really needs when he/she inherits the IRA. If income needs are not an issue for the spouse and children-, then naming younger beneficiaries (such as grandchildren or great-grandchildren) allows you to stretch the value of the IRA out over generations. This is possible because grandchildren are younger and theirrequired minimum distribution (RMD) figure will be much less at a younger age (see example below).

Traditional IRA worth $500,000 on 12/31/2009

Owner: Dave (deceased 12/1/2009); *IRA Inherited by:

  1. Spouse: Mary (Age 73 in 2010)- Mary will have to take an RMD of $20,234 in year 2010
  2. Son: Mike (Age 55 in 2010)- Mike will have to take an RMD of $16,892 in year 2010
  3. Granddaughter: Julia (Age 28 in 2010)- Julia will have to take an RMD of $9,042 in year 2010
  4. Great Grandson: Dallas (Age 6 in 2010)- Dallas will have to take an RMD of $6,519 in year 2010

*Each beneficiary will have to continue to take the RMD each year thereafter based on the new life expectancy figure which must be computed each year from the IRS Publication 590 (IRA's) from the Appendix C- Life Expectancy Tables section.

If Dave is careful in beneficiary selection, the younger the beneficiary the less the RMD payment. This allows the IRA value to continue to grow tax-deferred, thus allowing it to stretch to several generations.

Find out how your beneficiaries can enjoy tax-deferred growth for as long as possible by referring to Want To Leave Money To Your Family? Stretch Your IRA.

Distribution Rules, Alternatives And Taxation - Beneficiary Considerations or Stretch IRAs

Beneficiary Considerations or Stretch IRAs

Beneficiary designations, with respect to both qualified and nonqualified retirement accounts, are an important consideration. Upon the death of a plan participant, a retirement plan beneficiary may be able to stretch out distributions and thus make smaller tax payments, but this may be done only in very specific circumstances.

  • Stretch IRA - Retirement plan assets passed on to a beneficiary and rolled over into an IRA, and distributed over the course of the beneficiary's life expectancy.

In general, IRS regulations favor spousal beneficiaries over non-spousal beneficiaries, when it comes to tax treatment of inherited retirement plan assets. The tax treatment also differs according to whether the plan participant's death is before or after the required beginning date for RMDs.

Death before Required Beginning Date
Spouse as Sole Primary Beneficiary - A spouse who is the sole primary beneficiary of the retirement account, may distribute the assets gradually over their life expectancy, or fully by December 31 of the fifth year following the year the participant dies. If the spouse elects to distribute the assets over their life expectancy, they are required to begin receiving post-death distributions either the year following the death of the participant or the year the participant would have reached age 70.5 - whichever year is later.

Non-spousal Beneficiary or Spouse Who is One of Multiple Beneficiaries A non-spouse beneficiary or a spouse who is one of multiple beneficiaries, may distribute the assets over the life expectancy of the oldest beneficiary or distribute the full balance by December 31 of the fifth year following the year the participant dies.

Non-Spouse Non-Person Beneficiary An individual may choose to designate a non-person, such as the individual's estate or a charity, as the beneficiary of their retirement account. In this case, the non-person beneficiary must distribute the full balance by December 31 of the fifth year following the year the participant dies.

  • Death after Required Beginning Date

    Spouse as Sole Primary Beneficiary
    The spouse beneficiary is required to distribute the assets over either the life expectancy of the spouse or the remaining life expectancy of the deceased, whichever is longer. If the funds are distributed over the life expectancy of the spouse, their life expectancy is re-determined each year. If the funds are distributed over the remaining life expectancy of the deceased, the life-expectancy number is fixed in the year of death and then reduced by one in each subsequent year.

    Non-Spouse Person Beneficiary and/or Spouse among Multiple Beneficiaries
    A non-spouse beneficiary or multiple beneficiaries would be required to distribute the assets over either the remaining life expectancy of the deceased or the life expectancy of the oldest beneficiary, whichever is longer. If the remaining life expectancy of the deceased is used, it is determined in the year in which the participant dies and then one is subtracted each subsequent year. If the life expectancy of the beneficiary is used, then it is determined in the year after the participant dies and one is subtracted each subsequent year.

Non-Spouse Non-Person Beneficiary
If the beneficiary is a non-person, the assets may be distributed over the remaining life expectancy of the deceased, which is determined in the year in which the participant dies and then reduced by one each subsequent year.

In all three cases, distributions must begin by December 31 of the year following the year the participant dies.

Rollover by Surviving Spouse – A surviving spouse may be able to rollover, tax free, all or part of a distribution from a qualified plan. The rollover rules apply as if the surviving spouse were the employee. The rollover may be into another qualified plan or a traditional IRA.

Rollovers by a Non-spouse Beneficiary – Before 2007, a distribution paid to a non-spousal beneficiary was not eligible for a tax-free rollover. Now, a non-spousal designated beneficiary may be eligible for a direct trustee-to-trustee transfer to an IRA set up to receive the distribution. The receiving plan will be treated as an inherited IRA.

Profit-Sharing Plans

DEFINITION of "Profit-Sharing Plan"

A plan that gives employees a share in the profits of the company. Each employee receives a percentage of those profits based on the company's earnings.
Also known as "deferred profit-sharing plan" or "DPSP."

BREAKING DOWN "Profit-Sharing Plan"

This is a great way to give employees a sense of ownership in the company. The company decides what portion of the profit will be shared. And there are typically restrictions as to when and how you can withdraw these funds without penalties.

Can I roll over a profit-sharing plan to an SEP IRA account without suffering any tax penalties and liquidation of current positions held in this account?

By Denise Appleby

Answer: It depends.

If the transaction is processed as a direct rollover to the SEP IRA, then no taxes will be withheld. Through a direct rollover, the assets are made payable to the SEP IRA custodian (or trustee or plan to which the assets are being rolled). If the transaction is processed as an indirect rollover - which means the assets are first distributed to the participant, who must then rollover the assets to the SEP IRA within 60 days - the administrator of the profit-sharing plan will withhold 20% of any portion of the distribution that is rollover eligible.

Check with the SEP IRA custodian to determine their documentation requirements (if any) for processing the direct rollover. The administrator of the profit-sharing plan may also have special documentation that the participant must complete to initiate any distribution, including those processed as a direct rollover to another retirement plan. In addition, some plan administrators require the custodian to provide an acceptance letter verifying the type of account to which the assets will be credited.

Provide the SEP IRA custodian with a copy of the most recent statement issued for the profit-sharing plan and ask that they identify any asset on the statement that cannot be held in their IRAs. If the custodian is able to hold all the assets that are currently being held in the profit-sharing plan, then all the assets may be rolled to the SEP IRA as they are. If the custodian is unable to hold any of the assets, then these cannot be rolled to the SEP IRA, and the participant may need to liquidate these assets to proceed with the rollover to the SEP IRA. Alternatively, the participant may shop around for a custodian that is able to hold all the assets.

Retirement and College Savings Plans - Qualified Employer-Sponsored Retirement Plans

Under a qualified employer-sponsored retirement plan, all contributions grow tax-deferred. Employees are not taxed on income, dividends or capital gains within the plan until they begin taking distributions from it. In addition, an employer may deduct all contributions it makes to the plan on behalf of its employees.

Qualified employer-sponsored retirement plans can be established as either defined-benefit plans or defined-contribution plans.

  • Defined-Benefit Plans: Defined-benefit plans are rare today. A defined-benefit plan is designed to provide the employee with a fixed monthly income at retirement. The monthly amount is calculated according to the employee's length of service, age and annual salary. The employer is responsible for financing the plan and bears all of the investment risk if its assumptions fall short of the mark, as it is obligated to pay the employee's defined benefits no matter how successfully it has financed the plan.
  • Defined-Contribution Plans: Defined-contribution plans have become the norm in the last decade. Employees who contribute to this type of plan bear all of the investment risk. As such, the employee's retirement benefits will depend on the amount that he or she has contributed to the defined-contribution plan and the performance of the chosen investments within the plan account.
  • Let's look at three of the most common defined-contribution plans: 401(k) plans, 403(b) plans and profit-sharing plans.
    • 401(k) Plans: This is the most common defined-contribution plan. The 401(k) plan allows an employee to make before-tax contributions from his or her paycheck into the plan. The employee decides what investment choices to make from a list of possible mutual funds or employer stock; these contributions grow tax-deferred until the employee starts taking distributions from the account. While employees are always fully vested in their own contributions, the employer has the option to establish a vesting schedule for matching contributions within a 401(k) plan. 401(k) plans also contain annual contribution limits: For 2006 through 2008, employees may contribute up to $15,000 to their 401(k) plan. After 2008, the contribution amount is indexed for inflation.
    • 403(b) Plans: 403(b) plans are similar to 401(k) plans, only they are restricted to employees of certain nonprofit organizations with tax-exempt status, such as public schools, state colleges and universities, churches, hospitals and so on. The 403(b) plans are synonymous with tax-sheltered annuity plans (TSAs). TSAs have the same tax advantages and eligibility requirements as 401(k)s.
    • Profit-Sharing Plans: Profit-sharing plans are established to reward employees for their role in making a business profitable. An employer has the option to contribute to the plan, depending on how well the business is doing. In bad years, the employer might not make a contribution to the plan, whereas, in a profitable year, she will contribute a certain percentage, as determined at the plan's inception. For example, the owner of a business has a profitable year and decides to contribute 15% of her receptionist's salary to the plan. If the receptionist makes $35,000 a year, he would receive a contribution of $5,250. Employers may deduct any contributions made up to a maximum of 25% of the employee's salary, or $40,000, per year (indexed for inflation), whichever is less.

Look Out! The main thing to know about the various defined contribution plans is that 403(b) plans are available only to employees of schools, hospitals and certain non-profit organizations. They are analogous to corporate 401(k) plans.

Money-Purchase Pension Plans

DEFINITION of "Money-Purchase Pension Plan"

A pension plan to which employers and employees make contributions based on a percentage of annual earnings, in accordance with the terms of the plan. Upon retirement, the total pool of capital in the member's account can be used to purchase a lifetime annuity. The amount in each money-purchase plan member's account will differ from one member to the next, depending on the level of contributions and investment return earned on such contributions.
Also known as a defined contribution plan.

BREAKING DOWN "Money-Purchase Pension Plan"

In a money-purchase pension plan, the risk of ensuring an adequate level of retirement income rests squarely with the employee. In comparison, with a defined benefit pension plan, the employer has an ongoing obligation to ensure the plan is adequately funded, thus spreading the plan risk between the employer and plan members over time. Employers who have established money-purchase plans for their employees are required to file Form 5500 annually.

DEFINITION of "Money-Purchase Provisions"

The terms of a registered pension plan that detail the specific amounts that an employer and employee contribute to the plan. The amounts may be stated in dollars or percentages. The provisions of the pension plan states the maximum amount of the employee's contribution that can be matched by the employer. Money-purchase provisions for registered plans must fall under the governing requirements outlined by the Government of Canada

BREAKING DOWN "Money-Purchase Provisions"

Aside from the government's requirements that the money-purchase provisions must meet, the company offering the registered pension plan also adds its own terms that an employee must follow to qualify for the employer's matching contributions.

401(a) Plan

A 401(a) plan is a type of money-purchase retirement plan set up by an employer. Just as in the more familiar 401(k) plan, the employee, employer, or a combination of both, make 401(a) plan retirement contributions.

Under a 401(a) plan, employees either make set-dollar amount contributions to the plan, or pay an amount based on a percentage of their wages. If the employer also contributes to the employee’s account, the plan will have a vesting schedule, which spreads the ownership of the employer contributions over a number of years of service.

401(a) plans have some unique characteristics that differ from 401(k) plans. Employers have much more leeway and control in managing 401(a) plans. In fact, an employer can custom design a 401(a) for a specific employee, and use it as an incentive to keep that employee at the organization. This can’t be done with a 401(k) plan.

Typically, the employer sets the contribution amount levels of the 401(a) plan. In addition, some 401(a) plan contributions are mandatory, meaning the employee is required to contribute to the plan, even if he does not want to participate.

Another difference between the 401(a) and 401(k) is that the employer retains much more control over the investments available in the 401(a), so an employee might not have much say in how his retirement savings are invested.

Generally, governmental and non-profit organizations use 401(a) plans, whereas for-profit organizations use 401(k) plans.

Split-Annuity Strategy

DEFINITION of "Split-Funded Annuity"

A type of annuity that uses a portion of the principal to fund immediate monthly payments and then saves the remaining portion to fund a deferred annuity. The two funding methods let the annuity holder receive dependable income and simultaneously save for future needs.

BREAKING DOWN "Split-Funded Annuity"

Using a split-funded annuity means that individuals do not have to wait for the annuity to reach the payout phase, because the stream of income begins immediately. At the same time, the annuity's remaining balance compounds tax deferred.

A New Chapter for Retirement

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1035 Exchanges


1035 refers to a provision in the tax code which allows for the direct transfer of accumulated funds in a life insurance policy, endowment policy or annuity policy to another life insurance policy, endowment policy or annuity policy, without creating a taxable event.

This transfer option is a like-kind exchange in which no tax is due at time of transfer. Typically, when a policy is transferred, the individual is taxed on any gain. However, if the policy is exchanged for another, Section 1035 of the tax code states that no gain or loss will be recognized. Consequently the transaction is not subject to any tax.

  • A life insurance policy for another life insurance policy, endowment policy, or annuity
  • An endowment policy for an annuity
  • An annuity for another annuity


If all the surrender proceeds from the original policy are transferred into the new policy and there are not outstanding loans on the original policy, there will be no tax on the gain in the original policy at the time of exchange. If the policy is surrendered without a 1035 Exchange, the gain from the original life insurance contract will be taxed as ordinary income (not capital gains). Please note that an annuity can NEVER be exchanged for a life insurance policy.

Exchanges for other annuity contracts

Instead of cashing in a variable annuity in order to buy one with better terms (e.g., lower annual fees), and paying tax at that time on any increase over your investment in the contract, you can exchange the contracts in what is called a 1035 exchange (it’s named after the section in the Internal Revenue Code that permits it). The exchange is tax-free as long as the annuitants are the same in both contracts. The insurance companies can provide you with the paperwork to make the exchange.

Planning Options

Analyzing The Best Retirement Plans And Investment Options: Introduction

ByJean Folger

Knowledge is power, and this certainly holds true for retirement planning: the process of determining income and lifestyle goals and the actions you must take to achieve those goals. While retirement planning involves much more than finances - things such as when you will retire, where you will live, and what you will do - most of these factors depend largely on the income you can expect during your retirement years. The more you learn about and understand the various investment options, the better equipped you may be to make effective decisions.

Because of the power of compounding, the earlier you start saving for retirement - through stocks, employer-sponsored plans, mutual funds or a large variety of other investments - the longer your money can work for you, and the more money you might be able to save for the future. In general, younger people are able to take on more risk: they have more years to recover from any losses. Older people, on the other hand, tend to be more conservative in their investments. This can be a bit of a Catch-22: since older investors tend to limit risk, the investments frequently have lower earnings potential. Starting early is one of the best ways to ensure you will have enough money to live comfortably during retirement. That said, it is "never too late" to start saving for retirement, and every little bit helps.

The investments you choose for retirement may change over time in response to your goals, risk tolerance and investment horizon. Asset allocation - or how you apportion the various investments in your portfolio - is viewed by many as more important than the actual securities chosen for the portfolio. The three main asset classes include stocks (equities), bonds (fixed income), and cash and cash equivalents, and each has different levels of risk and return. Finding the balance that is most appropriate for your situation takes time and effort. Here, we provide an introduction to popular investments that may be considered when planning for retirement.

Analyzing The Best Retirement Plans And Investment Options: Annuities

ByJean Folger

  • What they are: Insurance products that provide a source of monthly, quarterly, annual or lump sum income during retirement.
  • Pros: Tax-deferred growth of earnings; no annual contribution limit; steady income source during retirement.
  • Cons: Notoriously high expenses; surrender charges; early withdrawal penalties; payments may be taxed as ordinary income; no additional death benefit.
  • How to invest: Directly through insurance companies or through your broker.

Annuity Basics
An annuity is a contract between you and an insurance company that agrees to make periodic payments for a given period of time, or until a specified event occurs (for example, the death of the person who receives the payments). Whereas life insurance pays a benefit if an insured person dies, an annuity may make payments as long as an insured person lives. In this manner, annuities are often used to provide an income stream during retirement. You can "fund" an annuity all at once - known as a single premium - or you can pay over time. With an immediate annuity (also called an income annuity), fixed payments begin as soon as the investment is made. If you invest in a deferred annuity, the principal you invest grows for a specific period of time until you begin taking withdrawals - typically during retirement.

The owner of the contract is the person who purchases the annuity and who is entitled to make changes to the policy; the annuitant is the insured person; and the beneficiary is the person designated by the owner to receive whatever is left in the annuity after the annuitant dies. In many cases, the owner and the annuitant are the same person, and the beneficiary is a spouse or child. In other cases, the owner and the annuitant may be different people. The annuitant becomes significant if and when the contract is annuitized.

When a contract becomes annuitized, the annuitant receives a fixed monthly income from the insurance company (typically for life), while giving up any claim to receive a "lump sum" payment. The monthly income will be determined by the annuitant’s - and not the owner’s - age and life expectancy. For example, if a 40 year old woman purchases an annuity and designates her 70 year old father as the annuitant, he would qualify for larger monthly payments each month than his daughter would (because the insurance company would expect to make fewer payments to an older person).

Types of Annuities
There are three broad categories of annuities:

With fixed annuities, the insurance company pays a guaranteed (or fixed) rate of interest while the account is growing. Fixed contracts are similar in function to certificates of deposit (CDs). Fixed annuities can be life annuities or term certain annuities. Life annuities pay a set amount each period until the annuitant passes away. Term certain annuities, on the other hand, pay a set amount per period for a fixed term. Once the term has elapsed, the annuity is spent (even if the annuitant is still living).

With indexed annuities, the insurance company agrees to grow your investment by a specified annual interest rate or by a percentage of a particular index’s growth, such as the S&P 500 Composite Stock Price Index - whichever is greater. The indexed annuity’s participation rate determines how much gain in the index will be credited to the annuity. If there is 10% growth in the index, for example, and the participation rate is 80%, the annuity would be credited with 8% (80% of the 10% index growth).

Indexed annuities may also be bound by a cap rate - a limit to the amount of growth that can be credited in any given year. If a 7% cap rate were in effect for the previous example, for instance, the annuity would be credited only 7% instead of the 8% (less any fees).

Variable annuities allow you to invest in a variety of pooled investment accounts, called subaccounts, within a variable annuity. These products are frequently referred to as "mutual funds with an insurance wrapper." Investments range from very conservative (for example, a money-market subaccount) to very aggressive (such as an aggressive growth stock fund subaccount). You decide how to allocate the funds.

For example, if the insurance company offers two bond funds, a money market fund, and two stock funds, you could allocate 20% of the total contribution to each fund. Conversely, you could put the entire contribution into one subaccount; it is up to you. With variable annuities, the account value fluctuates in response to the markets and the particular subaccounts chosen. Variable annuities are considered securities, and are regulated by the Securities and Exchange Commission (SEC).

Note: Annuities are complicated products, and the advantages, disadvantages and tax treatments differ significantly between products. It is recommended that anyone interested in an annuity for retirement planning consult with a qualified professional prior to making any decisions.

Analyzing The Best Retirement Plans And Investment Options: Bonds

ByJean Folger

  • What they are: Debt securities in which you lend money to an issuer (such as a corporation or government) in exchange for interest payments and the future repayment of the bond’s face value.
  • Pros: Certain bonds are risk-free (many are low-risk); predictable income; better returns compared with other short-term investments; certain bonds are tax exempt.
  • Cons: Potential for default; selling before maturity can result in a loss.
  • How to invest: Over-the-counter (OTC) markets including securities firms, banks, brokers and dealers. Some corporate bonds are listed on the New York Stock Exchange. U.S. government bonds can be purchased through a program called Treasury Direct (

Bond Basics
A bond is an IOU issued by a corporation or government in order to finance projects or activities. When you buy a bond, you are extending a loan to the bond issuer for a particular period of time. In exchange for the loan, the issuer agrees to pay you a specified interest rate (the coupon rate) at regular intervals until the bond matures. In general, the higher the interest rate, the higher the risk for a bond. When the bond matures, the issuer repays the loan and you receive the full face value (or par value) of the bond.

As an example, assume you buy a bond that has a face value of $1,000, a coupon of 5%, and a maturity of 10 years. You will receive a total of $50 of interest each year for the next 10 years ($1,000 * 5%). When the bond matures in 10 years, you will be paid the bond’s face value; or $1,000 in this example.

As an alternative, you could sell the bond to another investor before the bond matures. If interest rates are more favorable now than when you bought the bond, you may take a loss and have to sell at a discount. If interest rates are lower, however, you may be able to sell the bond at a premium (since your higher-interest bond is more attractive). The price for the bond in the previous example (with a face value of $1,000, a 5% coupon, and a 10-year maturity) would decrease if bond rates rose to 6% or increase if bond rates fell to 4%. You would still, however, earn the 5% coupon and receive full face value if you decided to hold onto the bond until it matures.

Bond Risk
Bonds expose investors to several types of risk, including default, prepayment and interest rate risk.

Default Risk
The possibility that a bond issuer will not be able to make interest or principal payments when they are due is known as default risk. While many are considered no- or low-risk (such as short-term U.S. government debt securities), certain bonds, including corporate bonds, are subject to varying degrees of default risk. Bond rating agencies, including Fitch, Moody’s and Standard & Poor’s, publish evaluations of the credit quality and default risk for many corporate bonds.

Prepayment Risk
The possibility that a bond issue will be paid off earlier than expected is known as prepayment risk. This often occurs through a call provision. Many firms embed a call feature that allows them to redeem, or call, the bond before its maturity date at a specified call price. This feature provides flexibility to retire the bond early if, for example, interest rates decline. In general, the higher a bond’s interest rate in relation to current rates, the greater the risk of prepayment. If prepayment occurs, the principal is returned early and any remaining future interest payments will not be made. As a result, investors may be forced to reinvest funds in lower-interest rate bonds.

Interest Rate Risk
Interest rate risk is the possibility that interest rates will be different than expected. If interest rates decline significantly, you face the possibility of prepayment as firms exercise call features. If interest rates rise, you risk holding a bond with below-market rates. The longer the time to maturity, the higher the interest rate risk since it is difficult to predict rates farther into the future.

Analyzing The Best Retirement Plans And Investment Options: Cash Investments

ByJean Folger

  • What they are: Low-risk, short-term obligations that provide returns in the form of interest payments.
  • Pros: Low- to no-risk; easily redeemable; often FDIC insured.
  • Cons: Withdrawal penalties may apply; low return.
  • How to invest: Directly through financial institutions; your broker; your local bank or credit union.

Cash investments are easily redeemable, low-risk places to park your cash. Since the money is easy to get to, you can earn a small return while keeping cash available in case of emergencies. Cash investments include CDs, guaranteed investment contracts (GICs), money market deposit accounts, money market funds and savings accounts. Any earnings on these investments are inherently low due to their no-risk nature.

Certificates of Deposit (CDs)
A CD is a type of savings instrument issued by a bank, credit union or broker. They pay a specified rate of interest over a defined period of time, and repay your principal at maturity. If you cash in or redeem your CD before maturity, you may have to pay an early withdrawal penalty. CDs can be issued in any denomination, and maturities typically range from one month to five years or longer. They are FDIC-insured if they are issued by an FDIC-insured bank. If you buy a CD from your broker, the money should be put in a CD account at an FDIC-insured bank. If not, your CD will not be insured by the FDIC.

Guaranteed Investment Contracts (GICs)
GICs are insurance contracts that guarantee the owner a fixed or floating interest rate for a set period of time, plus the repayment of the principal. GICs essentially work like giant CDs but without FDIC insurance. Typically, GIC contracts run from one to seven years. These contracts are a popular investment options for401(k) plans.

Money Market Deposit Accounts (MMDAs)
Money market deposit accounts are a type of savings account that offer a more competitive rate of interest in exchange for larger-than-normal deposits. MMDAs typically have restrictions that limit the number of transactions you can make each month and set a minimum balance in order to receive the more favorable interest rate. Funds in MMDAs are FDIC insured.

Money Market Funds
Money market funds are a type of mutual fund that deal in debt obligations. Unlike money market deposit accounts, money market funds are not federally insured. Money market funds may invest in:

  • U.S. Treasury funds
  • U.S. Government funds
  • General purpose corporate funds
  • Tax-free money market funds that invest in municipal bonds

Savings Accounts
Savings accounts are deposit accounts held at a bank or other financial institution, providing principal security and a modest interest rate. Although savings accounts pay lower interest rates than CDs, they typically offer better rates than checking accounts. There may be restrictions on the number of transactions that can be made each month.

Analyzing The Best Retirement Plans And Investment Options: Direct Reinvestment Plans (DRIPS)

ByJean Folger

  • What they are: Plans offered by corporations that allow you to reinvest cash dividends by purchasing additional shares or factional shares on the dividend payment date.
  • Pros: Convenient means of reinvesting; often commission-free; shares may be purchased at a discount.
  • Cons: You owe taxes on cash dividends even though you never receive the cash.
  • How to invest: Directly through a participating company or its transfer agent.

DRIP Basics
A dividend reinvestment plan, or DRIP, is a plan offered by a company that allows you to automatically reinvest any cash dividends by purchasing additional shares or fractional shares on the dividend payment date. Instead of receiving your quarterly dividend check, the entity managing the DRIP (which could be the company, a transfer agent or a brokerage firm) puts the money, on your behalf, directly towards the purchase of additional shares. Many DRIPs allow you to start with a very small number of shares or low dollar amount (as little as one share or perhaps $10) and support fractional shares. For many investors, DRIPs offer a convenient method of reinvesting, and they are ideal for investors who do not need cash flow from dividends and who want to build their investment over the long term.

Many DRIPs allow you to purchase the additional shares commission-free and even at a discount from the current share price. DRIPs that are operated by the company itself, for example, are commission-free since no broker is involved. Certain DRIPs extend the offer to shareholders to purchase additional shares in cash, directly from the company, at a discount ranging between 1 and 10%. Because of the discount and commission-free structure, the cost basis of shares acquired can be significantly lower than if bought outside of a DRIP.

It is possible to create synthetic DRIPs through your brokerage account. Certain brokers, including Fidelity, Schwab and TD Ameritrade, offer to reinvest any dividends at no additional cost (outside of regular commissions). This can be an advantage if you want to reinvest your dividends from a company that does not offer a dividend reinvestment plan. Currently, about 1,300 companies offer DRIPs.

With DRIPs, the primary disadvantage to shareholders is that they must pay taxes on the cash dividends reinvested in the company even though they never receive any cash. This holds true whether your dividends are reinvested directly through the company or if you set up a synthetic DRIP with a broker. Another concern with DRIP investing is that it often turns out to be a bit of a set-it-and-forget-it strategy. While this can be a good thing, it is not necessarily so if dividends have been slashed and share prices have dropped. As with any investment, it is important to periodically review and assess the performance of a DRIP to ensure it is meeting your investing goals.

If you sell your shares that are held in a DRIP, you must calculate your cost basis: the purchase price plus any commissions and fees, taking into account any stock splits and other adjustments. Determining the cost basis for shares that have been held for a number of years with dividend reinvestment can be tricky; however, new laws require that this information be furnished to investors by brokers that offer DRIPs (this does not apply to investments you purchased before the laws went into effect on January 1, 2012).

Analyzing The Best Retirement Plans And Investment Options: 401(k)s And Company Plans

ByJean Folger

  • What they are: Employer-sponsored plans, including 401(k)s and 403(b)s, that provide employees with automatic savings, tax incentives and (in some cases) matching contributions.
  • Pros: Contributions may be tax deductible; tax-deferred growth; matching contributions; possible to borrow from plan; possible to use funds for "hardship" withdrawals (e.g. to purchase your first home or to pay for the kids’ college).
  • Cons: Early withdrawal penalties; annual limits on contributions
  • How to invest: Connect with your employer’s Human Resources (HR) or Human Capital department.

Plan Basics
401(k)s and other company plans are known as defined-contribution plans. This is because you - as an employee - contribute to the plan, typically through a payroll deduction each pay period. You decide what percentage of your salary will be contributed, and the deduction is automatically taken out of each paycheck. In some cases, your employer may also contribute to the plan in the form of a matching contribution. For example, your employer may contribute 25 cents for each dollar that you contribute, up to a maximum percentage of your salary (such as 3 to 5%). Though the contribution is known, the benefit - how much money you will get at retirement - is unknown.

The types of plans offered by employers depend upon the company’s structure, and include:

  • 401(k)s - offered to corporate employees
  • 403(b)s - for employees of public education and most nonprofits
  • 457s - for state and municipal employees and certain nonprofits
  • Thrift Savings Plans (TSPs) - for federal employees

Contribution Limits
The Internal Revenue Service (IRS) sets limits for contributions. The limits are periodically adjusted upward in response to increases in the cost-of-living index. For tax year 2013, you can contribute up to $17,500 to a 401(k), 403(b), TSPs, and most 457s. In addition to normal contributions, employees who are age 50 and over can make a catch-up contribution of $5,500 to any of these plans.

Even though you and your employer contribute to your plan, you get to decide how the money is invested. The plans typically allow you to choose from a variety of investment choices, such as mutual funds, stocks (including your company’s stock), bonds and guaranteed investment contracts (GICs; similar to certificates of deposit). If you do not like the investment options offered by your employer, you may be able to transfer a percentage of your plan into another retirement account. This is known as a partial rollover.

It is important to consider your risk tolerance and investment time horizon (how long you have until retirement), and to make careful decisions. In general, people are advised to invest more aggressively when they are younger (and are able to recover from losses) and to make more conservative investments as they approach retirement. As such, you may change your allocations over time. Most plans allow you to make changes whenever you want, while other permit changes only once a month or once per quarter.

Any money that you contribute is yours; however, your company’s matching contributions will not be 100% yours until you are fully vested. Typically, these funds vest over time; for example, after the first year of employment you may be 25% vested, after the second year 50% vested, and so forth. After you are fully vested, all the money in the plan (your contributions plus your employer’s) is yours and you can take it with you if you change jobs or retire.

In general, if you make a withdrawal before you are age 59.5, you will have to pay a 10% penalty tax on the distribution. You will not have to pay the penalty, however, if:

  • You suffer a disability
  • You have died and the distribution is made to a beneficiary
  • You have certain medical expenses
  • You buy your first home
  • You need funds to pay for college (for you, your spouse or your children)
  • You need money to avoid foreclosure or eviction
  • You need money for burial or funeral expenses
  • You need money to pay for certain repairs to your home
After you turn 70.5, you will have to make required minimum distributions (RMDs). In general, you have to start withdrawing money by April 1 of the year following the year that you turn 70.5. Your age (and life expectancy) and account value determine the required minimum distribution.

Analyzing The Best Retirement Plans And Investment Options: Exchange Traded Funds (ETFs)

ByJean Folger

  • What they are: Uniquely structured investment funds that track broad-based or sector indexes, commodities and baskets of assets.
  • Pros: Trade like stocks on regulated exchanges; diversity in a single investment; low expense ratios; tax efficient; some trade commission-free through participating brokers.
  • Cons: Certain ETFs subject to contango; bid-ask spreads can be large; certain ETFs are taxed at a higher rate (such as gains on ETFs that hold physical precious metals).
  • How to invest: ETFs trade just like stocks on regulated exchanges. You can trade online using your broker’s online trading platform, or by calling your broker’s trade desk to place orders.

ETF Basics
Exchange traded funds, or ETFs, are uniquely structured investment funds that track broad-based or sector indexes, commodities and baskets of assets. With access to nearly any asset class or sector, ETFs offer exposure to markets that have traditionally been challenging for individual investors to tap into, such as commodities and emerging markets. Since the first exchange traded fund was introduced in 1993, ETFs have become increasingly popular because they:

  • Are tax efficient investments
  • Boast low expense ratios
  • Can be sold short and purchased on margin
  • Maintain inherent liquidity
  • Offer diversity in a single investment
  • Provide intraday trading access
  • Trade just like stocks on regulated exchanges

ETF Structure
Exchanged-traded funds and exchange-traded products (ETPs) use different product structures. When investing in an ETF, it is important to understand the fund’s legal structure and corresponding implications, including financial risks and tax treatment. This information is generally available in the fund’s prospectus. It should be noted that the term "ETF" is frequently used as a catchall for both ETFs and other exchange-traded products. ETNs, for example, are not actually ETFs but are similarly categorized. There are five types of structures for exchange-traded products, including ETFs: open-end fund, unit investment trusts, grantor trusts, limited partnerships and exchange-traded notes.

Open-End Funds
Most ETFs use an open-end structure. These funds must be registered with the Securities and Exchange Commission under its Investment Company Act of 1940, and there are no restrictions on the number of shares that the fund can issue. As long as there is demand, the fund can continue to issue shares. Any dividends are reinvested on the day of receipt and cash distributions are paid to shareholders each quarter.

Unit Investment Trusts (UITs)
The other primary ETF structure is a unit investment trust, or "UIT.” Also regulated by the SEC Investment Company Act of 1940, UITs are required to fully replicate their specific indexes while restricting investments in a single issue to 25% or less. A UIT holds its investments with little or no change for its duration. A UIT makes a "public offering" of a fixed number of units that are tradable on a secondary market. When a UIT is created, an expiration date is established; when the UIT terminates, any remaining securities are sold and any proceeds are paid to investors. Dividends are held until they are paid to shareholders, generally on a quarterly basis.

Grantor Trusts
Grantor trust investment portfolios are fixed and cannot be changed at a later date. Dividends are immediately distributed to shareholders, and investors have the same voting rights as any other shareholder for each company in the trust’s portfolio. Grantor trusts can be tax efficient and investors can control taxes by deciding when to sell their shares. Many grantor trusts hold physical assets and own single commodities, such as the SPDR Gold Shares ETF (NYSE: GLD) and the iShares Silver Trust (NYSE: SLV), while others invest in a portfolio of securities. Dividends are immediately distributed to shareholders.

Limited Partnerships (LPs)
A limited partnership, or an "LP,” is an alternative legal structure that is not an Investment Company within the meaning of the SEC Investment Company Act of 1940. The most well-known limited partnerships are the United States Oil Fund (NYSE: USO) and the United States Natural Gas Fund (NYSEArca: UNG). These funds, which invest through futures contracts, are taxed each year even if you still own the position; capital gains are taxed at the hybrid 60% long-term and 40% short-term rates. Dividends may or may not be reinvested.

Exchange-Traded Notes (ETNs)
Exchange-traded notes, or "ETNs,” are unsecured debt securities that pay a return linked to the performance of an individual commodity, currency or index. ETNs have a specified date of maturity that can be as long as 30 years or more. These investment products are subject to counterparty risk: the creditworthiness of the backing institution can negatively impact the ETN’s value, even if the underlying index performs well. Typically, ETNs do not pay dividends or annual coupons.

Analyzing The Best Retirement Plans And Investment Options: Individual Retirement Accounts (IRAs)

ByJean Folger

  • What they are: An individual savings account with tax incentives.
  • Pros: Tax benefits - investments grow tax-deferred and contributions may be deductible; variety of investment options with wide range of risk/reward characteristics.
  • Cons: Early withdrawal penalties plus you may have to pay income tax on the amount; limits on annual contributions; eligibility restrictions.
  • How to invest: Directly through financial institutions including banks, mutual fund companies and brokerage firms.

IRA Basics
An IRA can be thought of as a savings account that has tax benefits. You open an IRA for yourself - that is why it is called an individual retirement account. If you have a spouse, you will each have a separate IRA. An important distinction to make is that an IRA is not an investment itself; rather, it is an account where you keep investments such as stocks, bonds and mutual funds. You get to choose the investments in the account, and can change the investments if you wish. There are several types of IRAs, including traditional, Roth, SEP and SIMPLE. In many cases, you can have more than one type of IRA as long as you meet certain requirements.

Traditional and Roth IRAs
The primary difference between traditional and Roth IRAs is when you pay taxes on the money that you contribute to the plan. With a traditional IRA, you pay taxes when you withdraw the money during retirement. With a Roth IRA, you pay taxes when you put the money into the account. The money grows tax free while it’s in either a traditional or Roth IRA.

Another difference between traditional and Roth IRAs is who can contribute. With traditional IRAs, almost anyone with earned income can contribute. With Roth IRAs, however, your income may prevent you from contributing. Ordinarily, you are able to contribute to a Roth IRA if your modified adjusted gross income is (current for tax year 2013):

  • Less than $188,000 if you are married, filing jointly
  • Less than $127,000 if you are single, head of household, or married, filing separately (and did not live with your spouse during the previous year)
  • Less than $10,000 if you are married, filing separately and you lived with your spouse at any point during the previous year
For 2013, you can contribute the smaller of $5,500 or your taxable compensation for the year to traditional or Roth IRAs.

Simplified Employee Pension IRAs, or SEP IRAs, are a type of traditional IRA for self-employed individuals and small business owners. You can open a SEP IRA if you are a business owner with one or more employees, or if you are an individual with freelance income. All employees must be included in the SEP if they are at least 21 years old, have worked for your business for three out of the previous five years, and if they have received at least $550 in compensation from your business. Contributions are tax deductible (for the business or individual) and go into a traditional IRA in the employee’s name, and employees are fully vested at all times. For 2013, contributions cannot exceed the lesser of 25% of the employee’s compensation or $51,000. Catch-up contributions are not permitted.

A SIMPLE IRA (Savings Incentive match Plan for Employees) is an IRA set up by a small employer for its employees. Unlike a SEP IRA, employees are allowed to contribute to SIMPLE IRAs. Eligible and participating employees can make salary reduction contributions up to a certain amount; for 2013, the employee can "defer" up to $12,000. In turn, the employer must make either a matching contribution up to 3% of your salary, or a nonelective contribution of 2% of your compensation.

Required Minimum Distributions
Individual retirement accounts, including traditional, Roth, SEP and SIMPLE IRAs, are subject to required minimum distributions (RMDs). In general, you must make withdrawals before April 1 of the year following the year you turn 70.5. For all subsequent years, you must take the RMD before December 31 of each year.

How much you are required to take depends on the account balance and your age. In general, the RMD is calculated by dividing the prior end-of-year balance by a life expectancy factor that is published in Tables in IRS Publication 590, Individual Retirement Arrangements. You will use a different table depending on your situation; for example, you would use the Joint and Last Survivor Table if your sole beneficiary of the account is your spouse, and he or she is more than 10 years younger than you are.

Analyzing The Best Retirement Plans And Investment Options: Mutual Funds

ByJean Folger

  • What they are: A professionally managed pool of stocks, bonds and/or other instruments that is divided into shares and sold to investors.
  • Pros: Diversification; liquidity; simplicity; affordability (low initial purchases); professionally managed.
  • Cons: Fluctuating returns; over-diversification; taxes; high costs; professional management doesn’t guarantee good performance.
  • How to invest: Directly through mutual fund companies; discount and full service brokerage firms; banks; insurance agents.

Mutual Fund Basics
A mutual fund is a company that pools money from many different investors to invest in a set portfolio of stocks, bonds and other securities. The fund’s professional money manager (or team of managers) researches, selects and monitors the performance of the fund’s portfolio. Each investor owns shares of the fund, which represent a portion of the fund’s holdings. The price that you pay for a mutual fund is the fund’s per share net asset value (NAV) plus any shareholder fees imposed by the fund. Most funds calculate their NAV at least once each business day, usually after the close of the major U.S. exchanges. Because mutual fund shares are redeemable, you can sell your shares back to the fund (or to a broker acting on behalf of the fund) on any business day.

There are three ways in which you can make money from mutual funds:

  • Dividend payments. If the fund earns income in the form of dividends and interest on its portfolio’s securities, the fund will pay its shareholders close to all of the income it has earned, less disclosed expenses.
  • Capital gains distributions. If a fund sells a security that has increased in price, the fund will distribute the capital gains, less any capital losses, to investors at the end of the year.
  • Increased NAV. A higher NAV represents an increased value for your mutual fund investment.
Typically, you can decide if you want to receive dividend payments and capital gains distributions, or if you want the money reinvested in the fund to purchase additional shares.

Open-End Vs. Closed-End Funds
Most mutual funds are open-end funds. Open-end funds have no limits regarding the number of shares that the fund can issue and sell. As a result, the growth potential of the fund, in terms of investment dollars, is open-ended (and not limited). Even though there are no limits, a fund manager can decide to close the fund to new investors if the fund would become too large to effectively manage.

Closed-end funds, on the other hand, establish at the outset the number of shares that will be available for sale to the public. After the shares have been sold through an initial public offering (IPO), the fund is closed. New investors can buy into the fund only if there is a willing seller.

Types of Funds
Most mutual funds are money market funds, bond funds (or fixed income or income funds) or stock funds (also called equity funds). As with most investments, the higher the potential returns, the higher the risk.

Money market funds
Money market funds are considered lower risk than other types of mutual funds. By law, they are limited to investing in certain high-quality, short-term investments issued by the U.S. government (such as Treasury bills), U.S. corporations, and state and municipal governments. Returns tend to be twice what you would expect to earn in a savings account, and a bit less than a certificate of deposit (CD). These funds attempt to maintain a NAV at a stable $1 per share, and the fund pays dividends that generally reflect short-term interest rates.

Bond funds
Bond funds have higher risk than money market funds, in part because they seek higher returns. Because there are many different types of bonds, and these funds are not restricted to high-quality, short-term investments (like money market funds are), the funds vary greatly in terms of risks and rewards. Bond funds are exposed to the same risks associated with bonds: credit/default risk, prepayment risk and interest rate risk (discussed in the Bonds section of this tutorial).

Stock funds
Funds that invest in stocks make up the largest category of mutual funds. Stock funds, or equity funds, utilize various strategies. Growth funds, for example, focus on stocks that have the potential for large capital gains. Income funds, on the other hand, invest in stocks that pay regular dividends.

Stock funds are exposed to the same market risk as individual stocks, and prices can fluctuate - at times dramatically - due to a variety of factors, including the overall strength of the economy.

Target Date Funds
Target date funds are structured to adjust allocations based on a target retirement date. From an investor’s standpoint, they offer an easy way to manage investments based on the number of years they have left until retirement. Investors make one decision: select the target date fund that most closely matches the year they expect to retire. For example, if it is 2013 and you expect to retire in 17 years, you might select a target date fund of 2030 or 2035.

As a target fund approaches its target date, it automatically shifts to more conservative investments by moving assets from higher-risk instruments such as equities into low risk holdings such as fixed-income securities. It is important to remember, however, that these funds hold the same risks as other mutual funds; they do not guarantee any type of income stream for retirement.

Analyzing The Best Retirement Plans And Investment Options: Stocks

ByJean Folger

  • What they are: Securities that represent ownership in the corporation that issued the stock. Stocks are also called equities.
  • Pros: Capital appreciation; often outperform other investments; dividend payments; diversity; voting rights.
  • Cons: Prices can fluctuate dramatically (volatility); potential to lose entire investment.
  • How to invest: You can trade online using your broker’s online trading platform, or by calling your broker’s trade desk to place orders. You can also buy stocks through a dividend reinvestment plan (DRIP).

Stock Basics
Stocks represent partial ownership in a corporation. When you purchase a share of stock, or shares or stock, you are essentially buying a piece of the company, albeit a little one. Most individual investors will never own enough stock in a single company to represent a significant ownership stake (to illustrate: Warren Buffett, who will own about 9 million Goldman Sachs (NYSE: GS) shares by October of 2013, will have a stake of about 2%).

Investors purchase stocks for a variety of reasons, including:

  • Growth potential
  • Liquidity (you can close a position if you need cash quickly)
  • Dividend payments (that provide income or that can be reinvested to purchase additional shares)
  • Stocks have consistently outperformed other investments

Companies issue stock to raise money for various purposes, such as paying off debt, launching new products, expanding into new markets and building new facilities. Common stock (what most people are referring to when they talk about stocks) gives shareholders the right to vote at shareholder meetings and to receive dividends. Preferred stockholders do not typically have any voting rights; however, they receive dividend payments before common stockholders and have priority over common stockholders (if its assets are liquidated due to bankruptcy).

While stocks can be traded actively (scalp traders, for example, get in and out of trades in a matter of seconds), a buy and hold strategy is popular for many investors. With a buy and hold strategy, investors seek gains over the long-term, riding out any fluctuations in the market.

If you own stock, you can make money when it appreciates in value and you sell it, and/or through dividend payments.

Types of Stocks
There are a number of ways that stocks can be categorized. One method is the size of the company - known as its market capitalization or, simply, market cap. A corporation’s market cap is the total dollar market value of all its outstanding shares, calculated by multiplying its shares outstanding by the current market price of one share. For example, if a company has 1 million shares outstanding, and the current market share price is $50, the company’s market cap would be $50 million (1,000,000 * $50 per share). While there is no universal "cut off" for different caps, the approximate categories are:

  • Mega cap: $200 billion +
  • Large cap: $10 billion to $200 billion
  • Mid cap: $2 billion to $10 billion
  • Small cap: $300 million to $2 billion
  • Micro cap: $50 million to $300 million
  • Nano cap: less than $50 million

Stocks can also be classified based on certain performance characteristics:

  • Growth stocks - these stocks have earnings that grow at a faster rate than the market average. Investors typically seek capital appreciation since growth stocks rarely pay dividends.
  • Income stocks - these stocks pay consistent dividends, providing an income for its investors.
  • Value stocks - these stocks have a low price-to-earnings (PE) ratio. Investors purchase value stocks in the hopes that the stock’s price will rebound.
  • Blue-chip stocks - these stocks are from large, well-known and well-established companies with solid growth histories. Blue-chips usually pay dividends.

Taxes on Stocks
There are two ways that you might owe taxes on your stock investment. One is if your stock pays a dividend. If so, they are generally taxed at a rate of up to 15% at the end of each year, even if you never received the cash dividend (e.g. the dividends were automatically reinvested through a DRIP). In addition, if you sell the stock you will have to pay a capital gains tax if you held the stock for more than one year (long-term capital gains), or the gains will be taxed as ordinary income if you held it for less than a year (short-term capital gains).

Analyzing The Best Retirement Plans And Investment Options: Conclusion

ByJean Folger

The Bottom Line
Planning for a comfortable retirement is a long-term process that requires time, effort and carefully considered decisions. Understanding the various retirement investments - from annuities to stocks and everything in between - is an important part of the process. Here, we examined many of the popular investments that you might consider as part of your retirement plan. As with all investments, it is important to consider an investment’s advantages, disadvantages, risks and rewards before making any decisions. If you have questions about a particular investment or about your retirement plan in general, a qualified investment professional can be consulted.

Social Security Income

DEFINITION of "Social Security Benefits"

The monetary benefits received by retired workers who have paid in to the Social Security system during their working years. Social Security benefits are paid out on a monthly basis to retired workers and their surviving spouses. They are also paid to those who are permanently and totally disabled according to the strict criteria set forth by the Social Security Administration.

BREAKING DOWN "Social Security Benefits"

Social Security benefits may be taxable depending on the taxpayer's level of income. Single taxpayers who have income above $25,000 per year and married couples filing jointly with more than $32,000 of income may have a portion of their Social Security benefits taxed. Social Security disability payments are usually tax-free.

Are Social Security benefits taxable after age 62?

By Greg DePersio

Answer: Eligibility to collect Social Security benefits begins at age 62. Many seniors, to collect larger benefit amounts, wait until a later age. Whether Social Security benefits are taxable by the Internal Revenue Service (IRS) depends on how much additional income the person filing taxes receives. Some states, though not many, assess taxes on benefits.

How to Determine If Social Security Benefits are Taxable

A senior whose only source of income is Social Security does not have to pay federal income taxes on his benefits. If he receives other sources of income, including tax-exempt interest income, he must add one-half of his annual Social Security benefits to his other income and then compare the result to a threshold set by the IRS. If the total is more than the IRS threshold, some of his Social Security benefits are taxable.

As of 2015, the threshold amount is $25,000 for singles and $32,000 for married couples filing jointly. Married couples who live together but file separately have a threshold of $0 and must pay taxes on Social Security benefits regardless of other income earned.

States That Tax Social Security Benefits

Most states do not tax Social Security benefits, but 13 do under certain circumstances. The states that tax Social Security benefits are Montana, Utah, Colorado, New Mexico, Kansas, Missouri, North Dakota, Nebraska, Minnesota, West Virginia, Connecticut, Rhode Island and Vermont. Iowa used to assess taxes on benefits until it phased the taxes out completely in 2014, while New Mexico exempts beneficiaries age 65 and over.

Are Social Security benefits adjusted for inflation?

By Greg DePersio

Answer: Social Security benefits are adjusted for inflation. This adjustment is known as the cost of living adjustment (COLA). For the program's initial nearly four decades, benefit amounts did not increase based on higher living costs. The inflation of the 1970s, which was particularly hard on seniors with fixed incomes, prompted the Social Security Administration (SSA) to modify the program so inflation would trigger increases in benefit amounts.

How the COLA Began
The SSA enacted the cost of living adjustment in 1972. The removal of the dollar from the gold standard, rising oil prices, supply shocks and other factors had triggered unprecedented inflation that would plague the remainder of the decade. While workers received some relief from rising prices, since their wages also climbed, seniors on fixed incomes struggled badly. The COLA was a necessary addition to Social Security to ensure that beneficiaries with no other sources of income could still make a living.

How the COLA Is Determined
The COLA is based on the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). This index measures what workers with modest incomes pay on average for retail goods. When the CPI-W increases by more than 0.1% from one year to the next, the SSA makes a COLA to the Social Security program accordingly. During years when the CPI-W increase is nominal or negative, Social Security recipients receive no COLA.

On Jan. 1, 2015, recipients received a cost of living adjustment of 1.7% over their 2014 benefit amounts.

Retirement Plan Distributions

An Overview Of Retirement Plan RMDs

By Denise Appleby | Updated July 11, 2013

Retirement account owners who can finance their retirement years without using their retirement assets may prefer to enjoy the tax-deferred growth offered to retirement plan assets forever. This, however, is not possible, as the IRS eventually wants the deferred taxes on these balances. If you own a Traditional IRA, SEP IRA, SIMPLE IRA, qualified plan account, 403(b) account and/or governmental 457(b) account, and you are age 70.5 or older by the end of the year, you must withdraw a minimum amount from your balance by December 31 of each year. This amount is referred to as a required minimum distribution (RMD).

The Required Beginning Date
Recognizing that the retirement account owner may need some time to adjust to this requirement, the IRS provides a reprieve to individuals in their first RMD year. If you reached age 70.5 in 2013, you have, instead of the December 31st deadline, until April 1, 2014, to distribute the 2013 RMD amount from your retirement account. The date of April 1st of the year following the one in which you attain age 70.5 is referred to as the required beginning date (RBD). If your balance is in a qualified plan, 403(b) or 457(b), your employer may allow you to defer the start of your RMD until after you retire even if that occurs after age 70.5. Check with your employer or plan administrator regarding the rules that apply to the plan.

Calculating Your RMD
Calculating the current year's RMD amount for your retirement account is relatively easy. All you need is the value of your retirement account for the previous year-end (your year-end fair market value) and your distribution period, which you can obtain from the IRS-issued life expectancy tables. Your previous year-end FMV is divided by your distribution period to arrive at your RMD amount for the year. For your IRAs, your custodian is required to calculate and notify you of the amount, either proactively or upon you request, provided they had your IRA as of December 31 of the previous year. For qualified plans, your plan administrator should provide the calculation and facilitate the distribution.

Caution: Have your financial professional double check the previous year-end fair market value for your IRA, as there are circumstances under which it may need to be recomputed.

Determining Your Distribution Period
The IRS provides three life expectancy tables (Appendix C),: (1) single life expectancy (table l), (2) joint and last survivor expectancy (table ll) and (3) uniform lifetime (table lll). Table 1 is used only by beneficiaries, and table ll is used by a retirement account owner who has designated a spouse who is more than 10 years his or her junior as the sole primary beneficiary of the account. In all other cases, including those in which there is either no designated beneficiary or a non-person beneficiary, such as a charity, table lll is used to determine the distribution period.

To determine your applicable distribution period, use your age and your beneficiary's age, if applicable, for the year the calculation is being done. For example, if you were born in 1942, your age for 2013 is 71. Unless the sole beneficiary of your IRA is your spouse and he or she is more than 10 years your junior, your distribution period for 2013 is 26.5. This is determined as follows: locate your age on table lll, and the corresponding figure to the right of your age is your distribution period.

Alternatively, assume that your sole primary beneficiary is your 50-year-old spouse. Your distribution period is then determined as follows: locate your spouse's age on the horizontal top bar of table ll (Appendix C), then locate your age on the first vertical bar. Your distribution period is where the two ages meet at right angles within the chart. In this example, it is 35.0.

What Happens If You Miss Your RMD Deadline
If the RMD amount is not distributed by the deadline, then the IRS assesses a 50% excise tax on the amount not withdrawn. This is referred to as an excess-accumulation penalty. If you withdraw only a portion of the RMD amount, the penalty is assessed on the balance. For example, say your calculated RMD amount for the year is $10,000 and you withdrew $5,000. You will be assessed a 50% excise tax on $5,000.

All Is Not Lost... Maybe
Should you find yourself in the unfortunate predicament of having to pay this excise tax due to an error, you may request a waiver from the IRS. Generally, to consider the waiver, the IRS requires that you submit a letter of explanation asking for a waiver with your income tax return. The excise tax is reported on IRS Form 5329, which may be obtained at You may need the assistance of a retirement plan consultant or tax professional with requesting the waiver.

Multiple Retirement Accounts

  1. IRAs
    The IRS permits individuals with multiple IRAs to total the RMD for all the IRAs and distribute the total from any one. As a word of caution, these amounts should be calculated separately for each IRA, as different rules could apply to each. For example, if you have two IRAs, one with your spouse who is more than 10 years your junior as the sole primary beneficiary and the other with your daughter as the primary beneficiary, different tables would be used to calculate the RMD for each IRA.
  2. Qualified Plans
    If you own assets under multiple qualified plans, RMD amounts for each plan must be distributed from each plan. Unlike distributions from multiple IRAs, these amounts cannot be combined.
  3. 403(b)s
    Similar to RMDs from IRAs, RMDs for multiple 403(b) accounts must be calculated separately, but may be combined and withdrawn from one 403(b) account.
  4. Roth IRAs
    For Roth IRAs, the RMD rules do not apply to the Roth IRA owner. A different set of RMD rules apply to Roth and Traditional IRA beneficiaries.
To ensure that your RMD amounts are calculated properly and that you adhere to the general rules, be sure to consult with a competent retirement or tax professional or your financial institution. Taking precautionary steps will help to ensure that you avoid any associated penalties. Also, try to avoid waiting until the last minute to request your RMD, as doing so could result in you missing the deadline by which the amount must be withdrawn in order to avoid penalties.

Distribution Rules For Inherited Retirement Plan Assets

By Denise Appleby | December 02, 2003

If you've recently inherited retirement plan assets, you may confused about your options. Can you distribute the funds? What about rolling them to your own IRA? In fact, the situation is complicated, because the distribution options available to a retirement plan beneficiary are determined by several factors. These include whether the retirement account owner (referred to herein after as "participant") dies before the required beginning date (RBD), whether the beneficiary is the spouse of the deceased, and the age of the beneficiary in relation to the age of the deceased at the time of death. Read on for an in-depth look at how inherited retirement plan assets are distributed.

Death Before the Required Beginning Date If the participant dies before the plan's RBD, the options available to the beneficiary depend on who the beneficiary is and whether he or she is one of multiple beneficiaries:

  • Spouse as Sole Primary Beneficiary
    A spouse who is the sole primary beneficiary of the retirement account may distribute the assets over his or her life expectancy, or distribute the entire amount by December 31 of the fifth year following the year the participant dies. If the spouse elects to distribute the assets over his or her life expectancy, he or she is required to begin receiving post-death distributions either the year following the year the participant dies or the year the participant would have reached age 70.5 - whichever year is later.

    For the purposes of calculating post-death RMDs, the spouse's life expectancy is determined by using the "Single Life Expectancy Table in Appendix C" of IRS Publication 590. This table must be referred to for each year the spouse needs to calculate the post-death RMD. For instance, if the spouse is required to begin distributions in 2010, he or she will consult the table to determine the life expectancy period for 2010. In 2011, he or she must use the table to determine the life expectancy for 2011.

    The spouse also has the option of moving the assets to his or her own IRA.
  • Non-Spouse Person and/or Spouse Who Is One of Multiple Beneficiaries

    A non-spouse beneficiary or a spouse who is one of multiple beneficiaries may distribute the assets over the life expectancy of the oldest beneficiary or distribute the full balance by December 31 of the fifth year following the year the participant dies. The spouse beneficiary also has the option to distribute and roll over his or her portion to his or her own IRA.

    Like the life expectancy of the spouse sole beneficiary, the life expectancy is determined by using the "Single Life Expectancy Table in Appendix C" of IRS Publication 590. In this case, however, the table is not referred to each year. Instead, the life expectancy for the year following the year in which the participant dies - and for each subsequent year - is determined by subtracting 1 from the previous year's life expectancy. If the beneficiaries elect to have the assets distributed over the life expectancy of the beneficiary, then distributions must begin by December 31 of the year following the year the participant dies.

    For both the spouse and the non-spouse beneficiary, the life expectancy option is the default option if no election is made.
  • Non-Spouse Non-Person Beneficiary
    An individual may choose to designate a non-person, such as the individual's estate or a charity as the beneficiary of the retirement account. In this case, the non-person beneficiary must distribute the full balance by December 31 of the fifth year following the year the participant dies.

Death after the Required Beginning Date
If the participant dies after the RBD, these are the options available to the different types of beneficiaries:

  1. Spouse as Sole Primary Beneficiary
    A spouse who is the sole primary beneficiary of the retirement account may distribute the assets over his or her life expectancy, or distribute the entire amount by December 31 of the fifth year following the year the participant dies. If the spouse elects to distribute the assets over his or her life expectancy, he or she is required to begin receiving post-death distributions either the year following the year the participant dies or the year the participant would have reached age 70.5 - whichever year is later.

    For the purposes of calculating post-death RMDs, the spouse's life expectancy is determined by using the "Single Life Expectancy Table in Appendix C" of IRS Publication 590 IRS Publication 590. This table must be referred to for each year the spouse needs to calculate the post-death RMD. For instance, if the spouse is required to begin distributions in 2010, he or she will consult the table to determine the life expectancy period for 2010. In 2011, he or she must use the table to determine the life expectancy for 2011.

    The spouse also has the option of moving the assets to his or her own IRA.
  2. Non-Spouse Person and/or Spouse Who Is One of Multiple Beneficiaries
    A non-spouse beneficiary or a spouse who is one of multiple beneficiaries may distribute the assets over the life expectancy of the oldest beneficiary or distribute the full balance by December 31 of the fifth year following the year the participant dies. The spouse beneficiary also has the option to distribute and roll over his or her portion to his or her own IRA.

    Like the life expectancy of the spouse sole beneficiary, the life expectancy is determined by using the "Single Life Expectancy Table in Appendix C" of IRS Publication 590. In this case, however, the table is not referred to each year. Instead, the life expectancy for the year following the year in which the participant dies - and for each subsequent year - is determined by subtracting 1 from the previous year's life expectancy. If the beneficiaries elect to have the assets distributed over the life expectancy of the beneficiary, then distributions must begin by December 31 of the year following the year the participant dies.

    For both the spouse and the non-spouse beneficiary, the life expectancy option is the default option if no election is made.
  3. Non-Spouse Non-Person Beneficiary
    An individual may choose to designate a non-person, such as the individual's estate or a charity as the beneficiary of the retirement account. In this case, the non-person beneficiary must distribute the full balance by December 31 of the fifth year following the year the participant dies.

Death after the Required Beginning Date
If the participant dies after the RBD, these are the options available to the different types of beneficiaries:

  1. Spouse as Sole Primary Beneficiary
    The spouse beneficiary is required to distribute the assets over either the life expectancy of the spouse or the remaining life expectancy of the deceased, whichever is longer. If the funds are distributed over the life expectancy of the spouse, his or her life expectancy is recalculated each year. If the funds are distributed over the remaining life expectancy of the deceased, the life expectancy number is fixed in the year of death and then reduced by 1 in each subsequent year.

Example - Distribution According to the Single Life Expectancy Table
Let\'s assume that a participant died at age 80, and the spouse beneficiary is 75 years old the following year. According to the "Single Life Expectancy Table", the participant\'s life expectancy would be 10.2 and the beneficiary\'s life expectancy would be 13.4. The spouse beneficiary would use 13.4, which is the longer of the two life expectancies. If the ages were reversed and the longer of the two life expectancies was that of the deceased, the spouse would subtract 1 each subsequent year to determine the applicable life expectancy.

  1. Non-Spouse Person Beneficiary and/or Spouse among Multiple Beneficiaries
    A non-spouse beneficiary or multiple beneficiaries would be required to distribute the assets over either the remaining life expectancy of the deceased or the life expectancy of the oldest beneficiary, whichever is longer. If the remaining life expectancy of the deceased is used, it is determined in the year in which the participant dies and then 1 is subtracted each subsequent year. If the life expectancy of the beneficiary is used, then it is determined in the year after the year in which the participant dies and 1 is subtracted each subsequent year.
  2. Non-Spouse Non-Person Beneficiary
    If the beneficiary is a non-person, the assets may be distributed over the remaining life expectancy of the deceased, which is determined in the year in which the participant dies and then reduced by 1 each subsequent year. In all three cases, distributions must begin by December 31 of the year following the year the participant dies.

Roth IRA Beneficiary Options
The RMD rules do not apply to the owner of the Roth IRA; however, the post death RMD rules (beneficiary options) do apply to those inheriting a Roth IRA. The options for Roth IRA beneficiaries are the same as those that apply to the Traditional IRA beneficiary if the owner dies before the RBD.

The Bottom Line
It is important to note that retirement plans are not required to allow the options provided in the RMD regulations. For instance, as discussed above, RMD regulations provide that a non-spouse beneficiary of a participant who dies before the RBD may distribute the assets over the beneficiary's life expectancy or within five years after the participant dies. Despite these provisions, an IRA agreement or qualified plan may require the beneficiary to distribute the assets in a much shorter period, for instance immediately after the participant dies. If you inherit retirement assets, be sure to check with your plan provider about your available options.

Traditional IRAs

Traditional IRAs: Introduction

By Denise Appleby

There is no question that the world of retirement and retirement plans is a confusing one. With so many options to choose from, how does an individual know which one is best for his or her situation? This tutorial looks at the Traditional Individual Retirement Account - otherwise known as the Traditional IRA. We will go through how it works, how to set one up and even how distributions are taxed. Why Establish a Traditional IRA?

A Traditional IRA is an excellent supplement to an individual's retirement income. Making contributions is discretionary, so individuals can choose when they want to fund their Traditional IRA.

Contributions to a Traditional IRA may be tax deductible, and the earnings grow on a tax-deferred basis. This means that assets in the Traditional IRA are not taxed until they are withdrawn, allowing the owner to defer paying taxes until retirement, when he or she may be in a lower tax bracket, depending on his or her income and the tax rate that applies. Contributions are subject to statutory limits.

What is a 'Traditional IRA'

An individual retirement account (IRA) that allows individuals to direct pretax income, up to specific annual limits, toward investments that can grow tax-deferred (no capital gains or dividend income is taxed). Individual taxpayers are allowed to contribute 100% of compensation up to a specified maximum dollar amount to their Traditional IRA. Contributions to the Traditional IRA may be tax-deductible depending on the taxpayer's income, tax-filing status and other factors.


Traditional IRAs are held by custodians, such as commercial banks and retail brokers, and investors can place IRA funds into stocks, bonds, funds, and other financial assets deemed fit by the custodian. Assets, such as real estate come with heavy restrictions from the IRS, and may be taxed differently.

When the individual begins to receive distributions from a Traditional IRA, the income is treated as ordinary income and may be subjected to income tax. This differs from the Roth IRA, which can offer tax-free distributions. For people over the age of 50, higher annual contribution limits may apply if the IRA has been recently created or under-funded in previous tax years. Distributions are required to come out of the account by the time the owner reaches age 70.5.

401(k) Rollover: Pick Roth IRA or Traditional IRA

By Barbara E. Weltman

When you leave your job or receive a distribution from a 401(k) plan under a qualified domestic relations order (QDRO) or you are a beneficiary who inherits a 401(k) plan account, you can roll over the account to a personal Roth IRA or a traditional IRA. Which option is better? Here are some factors to consider.

Current Tax vs. Future Tax Savings

The choice is between paying tax now or later. If you make a rollover from your 401(k) account to a traditional IRA, you pay no current tax. (Special rules apply to rollovers of designated Roth accounts, explained later).

The best way to make a rollover to a traditional IRA is to have the plan administrator transfer the funds directly into your IRA. This way there won’t be any automatic withholding on the transferred amount. If you take a distribution, 20% will be withheld, requiring you to ante up that withheld amount if you then decide to make a full rollover within 60 days to avoid tax on the distribution. (You’ll recoup the withholding when you file your income tax return for the year of the distribution.)

However, if you make a rollover to a traditional IRA, you’ll have to start taking taxable distributions at age 70½ (or earlier if you were not the employee who had the 401(k)). Tax deferral won’t last forever.

In contrast, if you opt for a Roth IRA rollover, you must treat the entire account as taxable income immediately. You’ll pay tax now on this amount (federal income tax as well as state income taxes if applicable). What’s more, you’ll need the funds to pay the tax and may have to increase withholding or pay estimated taxes to account for the liability. However, assuming you maintain the Roth IRA for at least five years and meet other requirements, then all of the funds – your after-tax contribution plus earnings on them – are tax free.

There are no lifetime distribution requirements for Roth IRAs, so funds can stay in the account and continue to grow on a tax-free basis. You can leave this tax-free nest egg to your heirs (although they have to draw down the account over their life expectancy).

Personal Factors to Consider

Where are you financially now versus where you think you’ll be when you tap into the funds? Answering this question may help you decide on which rollover option to use. If you’re in a high tax bracket now and expect to need the funds before five years, a Roth IRA may not make sense. You’ll pay a high tax bill up front and then lose the anticipated benefit from tax-free growth that won’t materialize. Conversely, if you’re in a modest tax bracket now but expect to be in a higher tax bracket in the future, the tax cost now may be small compared with the tax savings in the future (assuming you can afford to pay taxes on the rollover now).

Will you need money before your golden years? If you may need funds, all withdrawals from a traditional IRA are subject to regular income tax, plus a penalty if you’re under age 59½ and don’t qualify for a penalty exception. In contrast, withdrawals from a Roth IRA of after-tax contributions (the transferred funds you already paid taxes on) are never taxed. You’ll only be taxed if you withdraw earnings on the contributions; these may be subject to a 10% penalty as well if you’re under age 59½ and don’t qualify for a penalty exception.

Did you obtain the account through inheritance? If so, you can make a direct rollover to either account, but you’ll have to start distributions immediately (regardless of your age). For most beneficiaries, paying tax on the account up front to use a Roth IRA only to have to begin drawing it down works against this option.

It’s Not All or Nothing

You can split your distribution between a traditional and Roth IRA (assuming the 401(k) plan administrator permits this). You can choose any split that works for you (e.g., 75% to a traditional IRA and 25% to a Roth IRA).

Don’t Roll Over Employer Stock

If you hold this investment in your account, it may make sense not to roll it over (you can roll over the balance of the account minus the stock). The reason is net unrealized appreciation (NUA). NUA is the difference between the value of the stock when it went into your account and its value when you take the distribution. You’re only taxed on the NUA when you take a distribution of the stock and opt not to defer the NUA. By paying tax on the NUA now, it becomes your tax basis in the stock, so when you sell it – immediately or in the future – your taxable gain is the increase over this amount. Any increase in value over the NUA becomes capital gain. You can even sell the stock immediately and get capital gain treatment (the usual more-than-one year holding period requirement for capital gain treatment does not apply if you don’t defer tax on the NUA when the stock is distributed to you).

In contrast, if you roll over the stock to a traditional IRA, you won’t pay tax on the NUA now, but all of the stock’s value to date, plus appreciation, will be treated as ordinary income when distributions are taken.

Special Rules for Designated Roth Accounts

If your 401(k) plan had this feature, contributions in these designated Roth accounts can only be rolled over to a Roth IRA. This makes sense since you already paid tax on the funds contributed to the designated Roth account. You don’t pay any tax on the rollover to the Roth IRA.

The Bottom Line

Before making any rollover decision, consider whether to keep your account with your former employer, transfer it to a plan of a new employer or simply take the distribution and pay tax now. (For more on this, read Best Ways to Roll Over Your 401(k).) Keeping your account where it is makes sense if you like the investment options offered through the 401(k) plan. Similarly, transferring funds to a new employer is advisable if you like the investment options in the new plan and that plan allows a rollover. Taking a distribution usually isn’t advisable because you lose the future retirement savings. But if the amount is small and you have a pressing need for it now, the lost savings won’t be significant. If you do decide to make a rollover to a traditional or Roth IRA so you gain maximum control over your retirement savings, work with a knowledgeable tax advisor to decide which rollover option is better for you.

Save Now or Save Late

Is it easier to save for retirement if you start earlier in life? Can I make up for what I don't save now by contributing more later on?

By Chris Gallant

In general, the earlier you start saving for retirement, the easier it will be to afford, given the number of financial obligations that tend to be incurred at that later period in your life. A closer look at the interesting aspects of compounding will illustrate how, in the retirement game, the early bird really does get the worm.

Consider two hypothetical twins, Earl and Lance. They are both 25 years old, fresh out of college and ready to start building their retirement nest eggs.

Lance decides that he'd rather enjoy a comfortable lifestyle right away, rather than scrimping and saving like he did in college. Lance reasons that he will be able to save a large chunk of money in his middle-age, because he expects to be earning much more by then. He decides not to contribute to his nest egg for the first 10 years of his career, and then contributes $3,000 per year for the next 20 years of his life.

Earl decides to start saving for his retirement immediately. Earl can only afford to contribute $1,000 to his nest egg each year. Ten years later, when Earl is 35, he decides that he can't afford to fund his nest egg any further.

Let's assume that Earl and Lance both invest their savings into an open-end mutual fund with a 15% annual return.

This table tracks each investor's nest egg at the end of every year until they are 55 years old. Keep in mind that Earl has only saved a total of $10,000. Lance has saved three times as much for twice as long for a total of $60,000.

Age Earl Lance
25 $1,150.00 $0.00
26 $2,322.50 $0.00
27 $3,670.88 $0.00
28 $5,221.51 $0.00
29 $7,004.73 $0.00
30 $9,055.44 $0.00
31 $11,413.76 $0.00
32 $14,125.82 $0.00
33 $17,244.70 $0.00
34 $20,831.40 $0.00
35 $23,956.11 $3,450.00
36 $27,549.53 $6,967.50
37 $31,681.95 $11,012.63
38 $36,434.25 $15,664.52
39 $41,899.39 $21,014.2
40 $48,184.29 $27,166.33
41 $55,411.94 $34,241.27
42 $63,723.73 $42,377.47
43 $73,282.29 $51,734.09
44 $84,274.63 $62,494.20
45 $96,915.82 $74,868.33
46 $111,453.20 $89,098.58
47 $128,171.18 $105,463.36
48 $147,396.85 $124,282.87
49 $169,506.38 $145,925.30
50 $194,932.34 $170,814.10
51 $224,172.19 $199,436.21
52 $257,798.02 $232,351.64
53 $296,467.72 $270,204.39
54 $340,937.88 $313,735.05

Earl's $10,000 has turned into a nest egg of more than $340,000, while Lance's $60,000 has grown to just under $314,000. This occurs because Earl is better able to make use of compounding than Lance. Notice that Earl's savings grow to more than $20,000 after 10 years, when Lance begins saving $3,000 per year. This may not seem like a big difference, but unfortunately for Lance it most definitely is. Even though Lance saves three times as much money as Earl and for twice as long, he is still not able to save as much money. In fact, the longer this time line continues, assuming a 15% return each year, the more Lance will fall behind.

Put another way, the dollars that you save in your youth are actually worth much more than the dollars you save near your retirement. The earlier you can contribute savings to your nest egg, the more time they will have to grow. When it comes to paying for a comfortable retirement, therefore, one of the biggest allies you have is time, provided that you start early. If you wait too long, time can become your enemy.

Estate Tax

What is a "Estate Tax"

A estate tax is a tax levied on an heir's inherited portion of an estate if the value of the estate exceeds an exclusion limit set by law. The estate tax is mostly imposed on assets left to heirs, but it does not apply to the transfer of assets to a surviving spouse. The right of spouses to leave any amount to one another is known as the "unlimited marital deduction."


When the surviving spouse who inherited an estate dies, the beneficiaries may then owe estate taxes if the estate exceeds the exclusion limit. Because the estate tax can be quite high, careful estate planning is advisable.

In 1997, a change in U.S. laws increased the value of assets that a beneficiary may exclude from federal estate taxes - though many states have their own estate taxes. With this change of laws, small business owners became able to pass on farms and other qualifying businesses to their heirs.

Taxation Issues - Estate and Gift Taxes

Unified Estate and Gift Tax
The total of all taxable gifts given during a person's lifetime plus taxable amounts transferred upon death are subject to a unified estate and gift tax. Estate taxes and gift taxes are interrelated, since the federal government applies the Unified Estate and Gift Tax Credit (also known as the Unified Credit) to both types of transfers of property.

Because this area of tax law is complex, clients with large estates should be advised to work with an estate planning specialist to create an estate plan that minimizes potential taxes.

While income taxes are paid by the person who receives the income, gift and estate taxes are paid by the person or entity that transfers the money. Gift taxes are paid by the donor, and estate taxes are paid by the estate. These taxes are progressive, meaning the tax rate increases with the size of the gift or estate.

Unified Estate and Gift Tax Credit
This amount has changed significantly over the years and is scheduled for additional changes in the future.

  • The Unified Credit stayed at $600,000 for many years, until a tax-law change set it to increase to $1 million over a period of years.
  • Another tax-law change in 2001 made a significant change to the schedule. Essentially, it dramatically increases the amount of an estate that is excluded from taxation from 2001 through 2009, and then it entirely repeals the tax in 2010.
  • However, due to budget pressures, this entire schedule is effectively repealed in 2011! Unless additional legislation passes before then, the Unified Credit amount will revert to the amount under the original schedule for 2001. This makes estate planning for the wealthy client quite a challenge.
  • See the following page for a table displaying current exclusion limits.

Gift tax exclusion
The gift tax exclusion allows individuals to give away assets up to a certain value without being subject to the gift tax. For 2007, the limit is $12,000. Individuals can gift up to this amount each year to an unlimited number of people. This is one way for wealthy people to reduce their estate prior to death. A married couple can gift $24,000 per year per beneficiary.

Look Out!
This gift limit is indexed for inflation. It had been at $10,000 for many years before an indexing factor was permitted. As a result, the exam refers to the gift tax exclusion as "$10,000 indexed for inflation annually."

Gifts in excess of this annual amount may still be given free of tax. However, a gift tax return must be filed, showing the amount of the gift and the amount of the Unified Credit that is being taken. The maximum amount of lifetime gifts that can be given tax-free under the Unified Credit is $1 million. This is a lower amount than the basic Unified Credit.

Marital deduction
Not all transfers upon death are taxable. There is an unlimited marital deduction that applies to direct transfers or certain transfers in trust to the surviving spouse. Such amounts would then be subject to estate tax when the second spouse dies, unless they were gifted away or spent prior to the surviving spouse's death. The unlimited marital exclusion also applies to lifetime gifts.

4 Ways To Minimize Estate Taxes

By Joseph Nguyen | March 06, 2011

Estate planning is a very important process in maintaining and efficiently transferring the wealth you've accumulated throughout your life. A large part of that process involves finding ways to transfer your assets to the next generation in the most tax-efficient manner possible. This task is complex, and often overwhelming to do alone, which is why many individuals seek professional assistance. This article doesn't attempt to give you advice on creating an estate plan, nor should you take it as legal advice. It is simply intended to help you identify common issues that many people face and the strategies used to deal with them so that you can proactively focus your attention in those key areas.

Estate Planning Basics

1.Generation Skipping
Generation skipping is exactly as it sounds. In countries that allow it, many people will often choose to transfer a portion of their estate assets to their grandchildren rather than transferring the full estate directly to their immediate children. This strategy skips the second generation, and transfers the assets straight to the third generation, which saves the assets from being eventually taxed twice. Normally the assets would be taxed once when transferred from you to your children (second generation) and again when your children transfer it eventually to your grandchildren (third generation).

Quite often, the most balanced strategy is to transfer enough of your assets to your children that you think they will need, and the excess over that amount would be transferred to your grandchildren. This strategy both covers the needs of your children and secures the future for your grandchildren in a tax-efficient way. However, it is important to note that some countries discourage the use of this strategy by applying a generation skipping tax, so its effectiveness will vary.

2. Spousal Exemptions
In some countries, such as the United Kingdom, certain tax exclusions exist that allow the transfer of smaller estates without an inheritance tax being levied upon the assets. For example, the tax exclusion in the U.K., as of 2009, amounted to £312,000 worth of assets that could be transferred tax free upon the death of a spouse.

For couples, this means that they have two exclusions available to them: One when the first spouse passes away, and the second when the remaining spouse dies. Thus, when the first spouse dies, it is often most beneficial to transfer £312,000 from the estate to a third-party if you eventually intend to bequest the assets to them anyway, and the rest to the surviving spouse. The tax benefits of this tax exclusion would be wasted if the entire estate is transferred over to the spouse upon death.

For example, consider Jim and Sally Smith who have estate assets worth £1,000,000. If Jim passes away, £312,000 of their assets can be transferred out of the estate to a third-party with zero inheritance tax. Sally would then be left with assets worth £688,000. Now, when Sally passes away, the tax exclusion can be applied again to transfer another £312,000 out of the estate, leaving only £376,000 that would be subject to inheritance tax.

The less tax-efficient alternative would have been to transfer the entire £1,000,000 to Sally when Jim died, which results in only one tax exclusion available to be used upon Sally's death. This alternative leaves £688,000 of assets subject to inheritance tax versus £376,000 in the previous example. Assuming a 40% inheritance tax rate, the difference in taxes paid would have been £275,200 compared to the lower £150,400. So using this less efficient strategy would have decreased the value of the Smiths' estate by £124,800.

3. Valuation Discounts
Valuation discounts can be an area where you can find significant tax savings if you own a business or assets that are difficult to value. In general, when assets are transferred, a tax will be applied to the fair market value of the assets, but if the fair market values of your assets are hard to determine, there may be certain discounts that can be applied to reduce the taxable value of your transferring assets.

For example, if shares in a privately run family business are going to be transferred, a discount for lack of liquidity and a discount for having a minority interest may be applicable. The valuation process for a privately held company normally involves the use of a valuation model to determine the intrinsic value of the shares, and once that is determined, a valuation discount is usually applied to account for the lack of liquidity of the shares not being traded on a public exchange. The value of this discount can vary depending on the situation, but it can usually range from 10-35%. This means that if the intrinsic value of your shares were estimated at $1 million, then after applying a discount for lack of liquidity, the transfer value would range from $650,000 to $900,000.

In addition, if you are planning to transfer shares in a privately owned company in which you are only a minority shareholder, then a discount to account for this lack of control may also be applicable. This discount for a minority interest can also be large, potentially ranging up to 40%.

By applying these discounts to your assets, you reduce the asset's taxable basis, and thus the total taxes you pay. A common strategy in some countries is for individuals to create a family limited partnership (FLP) and put their assets into an FLP to artificially create conditions that may justify using illiquidity and minority discounts. Instead of giving out the assets directly, minority interests in the FLP are given to each individual, and this may make it eligible for valuation discounts. However, simply putting cash and cash equivalents into a FLP will typically get you very little or no discounts.

4. Charitable Gratuitous Transfers
In many estate plans, individuals will often set aside assets to give to a charity upon their death. But is it better to donate assets to charity when you die or while you are still alive? Often, in many cases, it is most advantageous to the charity to donate during your lifetime. This is because most countries do not levy gift taxes on charitable donations, and second, you can get an income tax deduction for your donation. In addition, if the organization you are donating to is exempt from paying investment taxes, the earlier you donate, the more the value of your donation can compound tax-free.

Estate taxes and wealth transfer taxes are complicated topics, and many of these strategies may work in some but not all countries. This article simply introduced some of the more common strategies used so that you are aware of them and can allow you to make a broad plan for your estate. It is always advisable, however, to have a lawyer or tax specialist help you with setting up a plan for the transfer of your estate assets.

Gift Tax

What Are Gift Taxes?

By Marc L. Ross, CFP, CPA®, CLU® | April 09, 2012

Estate planning is the process of transferring wealth to subsequent generations. Techniques involve planning for transfers at death and during life. One such mechanism is thegift, or right to transfer assets to another person while the donor is still alive, with the goal of reducing one's taxable estate. In certain instances when all available exemptions, exclusions and thresholds have been met, these transfers are subject to a gift tax.

Gift Primer

A gift occurs when a voluntary transfer for less than full consideration or compensation occurs from a donor to a donee. A valid gift must satisfy the following criteria, to wit:

  • The donor intends to make the voluntary transfer.
  • He or she is competent to do so.
  • The donee is able to receive the gift and has to take delivery.
  • The donor cedes all control over the property given.

Types of gifts include:

  • Direct: the donor transfers cash or property directly to the donee.
  • Indirect: the donor makes a transfer for the donee's benefit. Troy pays his girlfriend's credit card balance, as an example.
  • Complete: in making a transfer to the donee, the donor gives up all right and dominion over the property.
  • Incomplete: in making a transfer to the donee, the donor fails to give up all control over the property. If Helmut places money into a revocable trust, then he has made an incomplete gift as he retains the right to control the ultimate disposition of what is in the trust. By contrast, should the trust become irrevocable, then its contents constitute a completed gift.
  • Reversionary Interest: gifts that the donor transfers to the donee which revert back to the donor. Their worth to the donee is their present value rather than fair market value. An example would be when a donor places money in a trust for a specific time period for the donee's benefit. At the end of the term, the money or property reverts back to the donor. The value of the gift is less than the value of the property in this instance.
  • Net Gift: whereas in most instances the donor is responsible for any gift tax, in the case of a net gift, the donee would be.

Gift Valuation

For gift tax purposes, the value of the gift is its fair market value on the date of its transfer to the donee. Real estate and collectibles would require an appraisal. A bond would be valued as the present value of its future payments. The value of publicly traded shares would be the average of the high and low share price for the day on which they are gifted. An opinion of a qualified valuation specialist would be required for privately held shares (e.g., private equity), taking into consideration potential restrictions on marketability, control and liquidity. For certain property types, the United States Treasury has issued guidelines. Gifting appreciated assets would make more sense to the donor as he or she would remove a larger sum from his or her estate. One needs to consider the totality of one's tax planning needs and consult a professional.

When Does the Gift Tax Apply?

Once one has determined a transfer to be a gift, the next step is to determine at what point the gift tax will apply to that transfer.

Types of Exemptive Relief

The Annual Exclusion
Gifts up to a certain value per donee per year are subject to an annual exclusion. For 2012, the amount is $13,000. Spouses may split gifts. This means that each may give the $13,000 amount or $26,000. For it to be available, the gift must be of a present, rather than future interest. This means that the recipient is not subject to any restrictions on the right to use the property immediately. Gifts of a future interest, which allow the recipient unfettered access only at a later date, are not eligible for the annual exclusion and are fully taxable. Exceptions would be UTMA/UGMA accounts where money is held in trust for minors who are the beneficial owners of the account and the trustee who is the nominal owner may distribute proceeds for the minor's benefit; a Crummey provision giving a trustee powers of appointment to withdraw money at a future date and gifts to minors in trust ((2503(b) or 2503(c)).

The Applicable Unified Credit Amount There is a lifetime of unified gift and estate tax credit amounts which may be used to shelter up to $5.12 million in taxable transfers from the gift tax in 2012. This is the gift tax exemption.

Transfers not Subject to Gift Tax

Certain types of gifts are exempt from gift tax.

  • Qualified Transfers: Payments made directly to a qualified academic institution or medical care provider on behalf of the donee escape any gift tax.
  • Payments for Support: Legal obligations for children or other dependents may be exempt from gift tax. An example would be payments for higher education and room and board.
  • Payments Pursuant to a Divorce Settlement: Alimony is not a gift, but rather taxable income to the recipient (payee) and a tax deductible contribution to the payor. Property transfers within a year of a marriage's termination and related to that termination is deemed pursuant to a divorce decree and not a gift.
  • Transfers to Political Organizations: Exempt, too, from gift tax are gifts made to political organizations. These are broadly defined as those advocating the selection, nomination or appointment of any individual to federal, state or local public office.
  • Business Transfers: Transfers in a business setting are typically deemed compensation. De minimis gifts such as those to reward years of service or commemorate one's retirement are not subject to the gift tax.
  • Spousal Gifts: Transfers between husband and wife are exempt from gift tax so long as the donee spouse is a U.S. citizen. Should he or she be a non-citizen, there is a limit on the tax-exempt transfer.
  • Charitable Gifts: Gift tax charitable deductions are unlimited so long as the recipient is a federal, state or local government for public use, a 501(c)(3) corporation for educational, religious, charitable or scientific purposes; or a 501(c) fraternal or veteran organization.

The Bottom Line

One must file a gift tax return ((IRS Form 709 United States Gift (and Generation-Skipping Transfer) Tax Return)) if one gives gifts that exceed the annual exclusion, are of a future interest or exceed the unified credit amount. When determining whether or not one owes gift tax, one needs to determine what gifts he or she gave for the year, whether or not they are exempt from gift tax or within the annual exclusion amount and to what extent they may be offset by the unified credit amount for the year in question. Above all, one should consult a tax professional when undertaking any tax planning decisions.

Gifting - Gift Tax Filing Requirements

Gift Tax Filing Requirements Generally, you must file a gift tax return on Form 709 if any of the following apply:

  • You gave gifts to at least one person (other than your spouse) more than the annual exclusion for the year.
  • You and your spouse are splitting a gift (see below).
  • You gave someone (other than your spouse) a gift of a future interest that he or she cannot actually possess, enjoy or receive income from until some time in the future.
  • You gave your spouse an interest in property that will be ended by some future event.

The short formula for computing gift taxes for the current year is:
Tentative tax – (Prior year gifts x Current gift rates) – unified credit, where:

  • Tentative tax is the gift rate applied to adjusted taxable gifts for the current or preceding years.
  • Adjusted taxable gifts for current or preceding years represent the total of gifts (at FMV), in excess of exclusions and deductions. The tentative gift tax is reduced by the product of the prior years' adjusted taxable gifts and the current year rates.
  • Current gift rates are the same unified transfer tax rates as used for computing estate taxes.
  • Unified credit is a base amount of $1,730,800, the equivalent estate or gift tax on the first $5,340,000 of taxable transfer (in 2014) reduced by the amounts allowed as credits for all preceding years.

Charitable Trust Tax Benefits

Estate Planning: Charitable Trusts

by Cathy Pareto, CFP®, AIF® (Contact Author | Biography)

Philanthropy through charitable contributions generates not only goodwill, but also has significant income and estate tax benefits for donors. For wealthy individuals, this may translate into hundreds of thousands of dollars in estate and income tax savings. A great way to accomplish this goal is through the use of charitable trusts.

A charitable trust is not tax exempt, and its unexpired interests are usually devoted to one or more charitable purposes. A charitable trust is allowed a charitable contribution deduction and is usually considered organized as of the first day on which it is funded with amounts for which a deduction was allowed.

Charitable Trust Terminology You Need to Know


Corpus is the Latin word for "body". In the case of a trust, the trust corpus is the assets with which the trust was funded. It does not include gains, income, etc. produced by the trust assets.

The person donating the assets to the charity.

Why Consider Leaving Assets to a Charity?

As a general rule, outright gifts to charity at death are deductible without limit and reduce the taxable estate.

The Charitable Remainder Trust

A charitable remainder trust (CRT) is an incredibly effective estate planning tool available to anyone holding appreciated assets with low basis, like stocks or real estate. Funding this trust with appreciated assets allows the donor to sell the assets without incurring a capital gain. CRTs provide investors with an efficient way to transfer appreciated property, benefit from the charitable income tax deduction and reduce estate taxes while still reaping the benefits of the underlying assets for income purposes.

There are two sets of beneficiaries: income beneficiaries, typically you and your spouse, and the charities that you choose to name in the trust. As the grantor, you will generally receive income from the trust during your lifetime or for a fixed number of years. If you are married and either you or your spouse dies, the surviving spouse continues to receive income. Provisions can also be made to continue making income payments to successor beneficiaries, and the charities will receive the residual principal of the trust when all the other beneficiaries die.

The following are two types of CRT than can be considered:

Charitable Remainder Annuity Trust
A charitable remainder annuity trust (CRAT) is used in situations where the donor wishes to provide a non-charitable beneficiary with a stream of income to last for a specific time period (i.e., for the life of the recipient or for a fixed number of years). If a term of years is used, it cannot surpass more than 20 years. The income stream must represent at least 5% of the corpus each year.

In this type of arrangement, the recipient receives an income tax deduction from the present value of the remainder interest. At the time the period ends, the remainder interest in the property passes to a qualified charity, or it can also remain in trust for the charity. However, the remainder interest is required to be at least 10% of the contributed amount. It should be noted that the donor can make only one initial transfer of property to the corpus and there can be no additions or increases to the corpus in later years.

Charitable Remainder Unit Trust
The charitable remainder unit trust (CRUT) is similar to CRAT with the difference that in the CRUT the donor can make more than one transfer to the trust. The other difference is that once the trust is established, the corpus must pay out a specific amount of income each year, as a fixed percentage of at least 5%. Depending on how the trust is set up, the payments will continue for a fixed period of time or until the death of the beneficiary.

Charitable Lead Trusts

The purpose of a charitable lead trust (CLT) is to reduce the donor's current taxable income. The way this type of trust works is that a portion of the trust's income is first donated to a charity, and after a specified period of time (usually until all taxes are reduced), it transfers the remainder of the trust to the trust beneficiaries. By doing this the beneficiaries will face lower gift taxes and estate taxes. The federal tax deduction you receive from this type of trust will be equal to the estimated value of the annual trust payments to the charity.

You can get a lot of help in setting up these types of trusts from different charities, universities and other organizations that would be interested in getting the income for a few years. A charitable lead trust works best for wealthier, estate tax-conscious individuals, as long as those individuals are willing to defer receiving substantial income and own highly appreciating assets.

Withdrawing Before Age 59.5

Early Withdrawal

DEFINITION of "Early Withdrawal"

The removal of funds from a fixed-term investment before the maturity date, or the removal of funds from a tax-deferred investment account or retirement savings account, such as an IRA or 401(k) before a prescribed time. Early withdrawal could be anything earlier than the account owner's attainment of a prescribed minimum age requirement, or the maturity of a fixed-term investment, such as a certificate of deposit (CD).

BREAKING DOWN "Early Withdrawal"

When an early withdrawal is made, the investor usually incurs an early withdrawal fee, which acts as a deterrent to frequent withdrawals before the end of the early withdrawal period. As such, an investor would usually only opt for early withdrawals if there were pressing financial concerns that warranted it, or if he or she had a markedly better use for the funds.

What are the penalties for withdrawing from my Traditional IRA less than a year after acquisition?

By Denise Appleby

Withdrawals from your Traditional IRA will be treated as ordinary income, and if you are under age 59.5 when the distribution occurs, the amount will be subject to an early-withdrawal penalty of 10% (of the amount withdrawn). The amount will be exempted from the early-withdrawal penalty if you meet one of the following exceptions:

  • You plan to use the distribution towards the purchase or rebuilding of a first home for yourself or a qualified family member (limited to $10,000 per lifetime).
  • You become disabled before the distribution occurs.
  • Your beneficiary receives the assets after your death.
  • You use the assets for medical expenses for which you were not reimbursed.*
  • Your distribution is part of a SEPP program.
  • You use the assets for higher-education expenses.*
  • You use the assets to pay for medical insurance after you lose your job.*
  • The assets are distributed as a result of an IRS levy.
  • The amount distributed is a return on non-deductible contributions.

    * Limitations apply

How do you calculate penalties on an IRA or Roth IRA early withdrawal?

By Claire Boyte-White

With a few exceptions, early withdrawals from traditional or Roth IRAs generally incur a tax penalty equal to 10% of the taxable amount. To calculate the penalty on an early withdrawal, simply multiply the taxable distribution amount by 10%. An early distribution of $10,000, for example, would incur a $1,000 tax penalty.

Qualified Distributions

A qualified distribution is any withdrawal from an IRA made after the account owner has reached age 59.5. Withdrawals made before this age are considered early distributions and may be subject to the 10% penalty.

Taxable Income

Although the IRS imposes the 10% early withdrawal penalty to dissuade IRA participants from using their savings before retirement, this penalty is only applied to the withdrawal of taxable funds. If you withdraw funds that are not subject to income tax, there is no penalty for distributions taken at any time. The key factor in determining the amount of your early withdrawal penalty is the type of IRA you own.

Traditional IRAs

Early distributions from traditional IRAs are the most likely to incur heavy penalties. Contributions to this type of account are made with pretax dollars. Any money you defer from your paycheck is subtracted from your taxable income for that pay period, effectively reducing the amount of income tax you pay throughout the year. However, the IRS eventually collects taxes on all income, so income tax is assessed on your traditional IRA funds upon withdrawal.

In general, this means that the entirety of your traditional IRA account balance is comprised of taxable income. If you withdraw funds before age 59.5, the 10% penalty likely applies to the full amount of the distribution. After accounting for the impact of taxes and penalties, an early distribution from a traditional IRA is rarely an efficient use of funds.

Roth IRAs

Contributions to Roth accounts are made with after-tax dollars; you pay income tax on all your contributions in the year when you earned them. As a result, withdrawals of Roth contributions are not subject to income tax, as this would be double taxation. If you withdraw only the amount of your Roth contributions, the distribution is not considered taxable income and is not subject to penalty, regardless of your age.

Though any earnings withdrawn before age 59.5 are generally considered taxable income, there is yet another loophole for earnings on Roth contributions. If you withdraw only the amount of your contributions made within the current tax year, including any earnings on those contributions, then they are treated as if they were never made. If you contribute $5,000 in the current year and those funds generate $500 in earnings, you can withdraw the full $5,500 tax-free and penalty-free as long as the distribution is taken prior to your tax filing due date.

Tax-Advantaged Investments

DEFINITION of "Tax-Advantaged"

Any type of investment, account or plan that is either exempt from taxation, tax-deferred or offers other types of tax benefits. Examples of Tax-Advantaged investments are municipal bonds, partnerships, UITs and annuities. Tax-advantaged plans include IRAs and qualified plans.

BREAKING DOWN "Tax-Advantaged"

Tax-advantaged investments and accounts are used by a wide variety of investors and employees in various financial situations. High-income taxpayers seek tax-free municipal bond income, while employees save for retirement with IRAs and employer-sponsored retirement plans. Selecting the proper type of tax-advantaged accounts or investments depends on an investor's financial situation.

Tax Deductions

Tax Deductions You May Be Missing

By Mark P. Cussen, CFP®, CMFC, AFC

When it comes to filing taxes, getting the best returns is not about skill – it's about what you know. Unfortunately, many taxpayers miss out on deductions and credits simply because they just aren't aware of them. Several of the most overlooked deductions pertain to health and medical expenses, and insurance premiums. Are you paying more tax than you need to? Read on for some insurance-based deductions you may be missing.

Tips for Individual Filers

Disability Insurance
Disability insurance is probably the most common type of premium that is overlooked as a tax deduction. These premiums are always deductible by self-employed taxpayers as a business expense. However, if you deduct the premium, any benefits paid from the policy will be considered taxable income. By contrast, policy benefits will not be taxable if you do not deduct the premium, and some taxpayers use this arrangement so that they can receive tax-free benefits if they become disabled. (The Disability Insurance Policy: Now In English will show

Health Savings Accounts
Another insurance–related tax perk that people without access to traditional group health coverage should be aware of is health savings accounts, which combine a tax-advantaged savings element with a high-deductible health insurance policy. All HSA contributions, up to the maximum permitted by law, are tax-deductible, even for those who do not itemize, and earnings accumulate tax-free. All proceeds withdrawn from the account are tax-free, provided they are used to pay for qualified medical expenses. (See Health-y Savings Accounts for further explanation of how HSAs work.)

Timing Medical Expenses
The only medical expenses that are deductible are those that are more than 10% of adjusted gross income (if you or your spouse are 65 or older, the threshold is 7.5% until Dec. 31, 2016). This means that few taxpayers accumulate enough unreimbursed bills in one year to qualify for the deduction. If you have substantial medical bills pending, you can boost your deduction by scheduling other medical procedures or expenses in the same year.

For example, someone with annual adjusted gross income of $40,000 would be able to deduct any medical expenses not covered by health insurance in excess of $4,000. The deduction might include $17,000 of a $20,000 operation not covered by insurance, plus any other unreimbursed expenses incurred in the same year, such as routine medical checkups, dental procedures, chiropractic treatments and even contact lenses and prescription drugs.

However, if you get a check the following year from your insurance company, you will have to declare the amount of the deduction that was reimbursed as income the following year. For example, if you deducted $17,000 for a surgery this year and your insurance company sent you a $10,000 check for the surgery the next year, that amount would have to be declared as income in the year the check arrives. If there's a chance you may get medical expenses covered by your insurance company in the future, do not declare this deduction until you know whether the insurance company will reimburse you. You can always submit an amended return for the year you would have received the deduction if your insurance claim is denied.

Receipt of Unemployment or Workers' Compensation Insurance Benefits
It is important to distinguish unemployment benefits from a state unemployment agency from workers' compensation, which is awarded to workers who cannot perform their duties as a result of injury. Unemployment benefits are always taxable, as they are considered a replacement of regular earned income and should be reported on IRS Form 1040. Workers' compensation is never declarable as income.

Deductions for Businesses and Self-Employed Taxpayers
Self-employed taxpayers and other business entities can deduct business-related insurance premiums of any kind, including health, disability and dental insurance premiums, as well as legal and liability coverage. Vehicle insurance can also be deducted if the taxpayer elected to report actual expenses and is not taking the standard mileage rate.

Life Insurance
Life insurance premiums are deductible as a business-related expense, and the death benefit is generally tax-free for individual policy owners. Although death benefits for business-related beneficiaries are often tax-free as well, there are certain situations in which the death benefit for corporate-owned life insurance can be taxable. However, employers offering group-term life coverage to employees can deduct the first $50,000 of premiums that they pay, and amounts up to this limit are not counted as income to the employees. Life insurance premiums can also often be deducted for most types of non-qualified plans, such asdeferred compensation or executive bonuses. Usually, the premiums are considered compensation for key executives under the rules of these plans. However, in some cases the deduction cannot be taken until the employee constructively receives the benefit.

Other Qualifying Plans
Nonqualified plans aren't the only type of retirement savings vehicle that can be funded with tax-deductible premiums: 412(i) plans are qualified, defined-benefit plans that can provide substantial deductions for small-business owners looking to catch up on their retirement savings and receive a guaranteed income stream. These plans are funded solely with insurance products such as cash value life insurance or fixed annuity contracts, and the plan owner can often deduct hundreds of thousands of dollars in contributions to these plans each year.

Finally, participants in standard qualified plans, such as 401(k) plans, can purchase a limited amount of either term or permanent coverage subject to specific restrictions. But the coverage must be considered "incidental" according to IRS regulations. In any type of qualified defined-contribution plan, the cost of whole life premiums for each participant must be less than 50% of the employer's contribution amount, plus forfeitures.

For term and universal coverage, the limit is 25%. This is the only instance where individuals can purchase life insurance on a tax-deductible-basis (assuming the plan is a traditional plan and not a Roth plan.) Life insurance death benefits paid out of qualified plans also retain their tax-free status, and this insurance can be used to pay the taxes on the plan proceeds that must be distributed when the participant dies.

The Bottom Line

This article only mentions a few of the more commonly overlooked deductions and tax benefits related to insurance for which business and individual taxpayers are eligible. Other deductions relating to compensation, production, depreciation of buildings and equipment are listed on the IRS website in various downloadable instruction manuals. For more information, visit or consult your tax advisor.

Tax Strategies for Retirement Plans

Top Tax Strategies for Retirement Planning

By Barbara A. Friedberg | September 10, 2015

As retirement approaches, your job is not to gift the IRS but to give what is owed—and not a penny more. In retirement, a sound understanding of the tax code will help you find the best strategy to keep taxes low and optimize income.

Let's explore Social Security tax issues and consider several ways to keep taxes as low as possible, while exploring various retirement income scenarios. (For more, see: Build a Retirement Portfolio for a Different World.)

Understand the Tax Issues

Social Security is typically the largest portion of your retirement income. To keep the most of this important annuity, you should understand how the proceeds may be taxed. As with most government programs, the Social Security tax calculations are complex. This overview will give you a basic understanding of what types of income is taxed and at what levels.

Eighty five percent is the maximum taxable portion of Social Security benefits. Regardless of your income level, 15% of your Social Security benefits are tax-free. The taxable amount of your Social Security benefit is determined by your total income. Publication 915 spells out the details with worksheets to complete the calculation.

Social Security Tax Calculation Tutorial

Use this equation to start:

Adjusted gross income from IRS Form 1040 (This includes wages, self-employment income, dividends, interest, capital gains, pension payments, rental income, and retired minimum distributions, etc.) (For more, see: How Is Social Security Tax Calculated?) + Nontaxable interest

+ ½ of Social Security benefits

= Combined Income

Once you have your income, then you can determine if and how much of that income is taxable. For example, Ricardo is single with a combined income between $25,000 and $34,000. Up to 50% of his Social Security benefits are taxable.

Olivia and Robert are married and filing jointly. If their combined income falls between $32,000 and $44,000, they may also be taxed on a maximum of 50% of their Social Security benefits. If their income is greater than $44,000, up to 85% of their Social Security benefits are taxable.

Regardless of whether your Social Security benefits are taxable or not, you may want to consider delaying them until age 70, when the benefits reach the highest level. (For related reading, see: Social Security 'Start, Stop, Start' Strategy Explained.)

Best Retirement Tax Strategies

Take a look at these guidelines for minimizing taxes in retirement:

Consider spending down IRA funds before taking Social Security benefits

If you’ve built up one or more IRAs during your working years, then you may want to consider this strategy. Waiting longer to claim Social Security benefits yields an increase each year that you wait after the full retirement age.

If you live a long life you may receive greater lifetime benefits by waiting to claim until the maximum Social Security payment tops out at age 70. Also, with lower IRA balances at age 70.5, when the required minimum distribution(RMD) kicks in, you’ll be required to withdraw a smaller amount from your IRA. This may decrease or eliminate potential taxes on the Social Security benefits. Another advantage of taking the IRA withdrawals before Social Security is that it may yield greater total spendable retirement income.

The choice to delay Social Security is only beneficial if you live long enough to recoup the funds sacrificed by waiting to start your benefits until age 70. Also, if you spend down a Roth IRA, which has no RMD, you’ll forgo the possibility of passing this asset on to your heirs.

Convert traditional IRAs into Roth IRAs

There are several advantages to this strategy. Since Roth IRAs have already been taxed, their withdrawal doesn’t add to your combined income and won’t count toward Social Security tax calculations if you do choose to use the Roth IRA funds in retirement.

Additionally, there are no RMDs for Roth IRAs. In fact, your heirs can enjoy your Roth IRA, allowing it to grow and compound for many years.

The biggest drawback to this approach is that when you convert a traditional IRA to a Roth IRA, you need to pay tax on the untaxed funds. This immediate tax hit may surpass the potential long-term tax benefit of having the Roth IRA account.

Use Roth IRA funds in high tax years

If you are having a relatively high income year, you may wish to tap a Roth IRA for additional funds. Since you’ve already paid tax on the Roth IRA contributions, withdrawals are tax-free. This money can reduce potential taxes on Social Security benefits and also minimize the withdrawal amount needed from the traditional IRA.

Of course, traditional IRA withdrawals can only be minimized once the RMD limit is met. A simple underestimate of the RMD from a traditional retirement account costs you a 50% penalty, on top of the taxes owed.

The Bottom Line

When it comes to taxes, Social Security distributions, and retirement planning, you may save some money by meeting with a qualified financial advisor. The decisions around these retirement aspects can have long term financial effects. A financial advisor and/or a tax professional, abreast of the laws, can save you money and help you minimize taxes and maximize income in retirement. (For more, see: Are You Getting the Best Retirement Advice?)

Mutual Fund Profits

What is a "Mutual Fund"

mutual fund is an investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.

One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital. Each shareholder participates proportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and can typically be purchased or redeemed as needed at the fund's current net asset value (NAV) per share, which is sometimes expressed as NAVPS.

Do mutual funds invest only in stocks?

By Greg DePersio

Mutual funds invest in stocks, but certain types also invest in government and corporate bonds. Stocks are subject to the whims of the market and thus offer a higher return potential than bonds, but they also present more risk. Bonds, by contrast, provide a fixed return that is usually much lower than what an investor gets from stocks. The advantage of bonds is they are low risk. Only in an extreme situation, such as the complete failure of a corporation, does an investor not receive the return he was promised from a bond security. A mutual fund's investment profile depends on the type of fund. There are three main types: equity funds, fixed-income funds and balanced funds.

Equity Funds

Equity funds are mutual funds that invest only in common stock. They offer the biggest returns but also the highest risk. An equity fund, however, still presents a lower risk than investing in individual stocks. The reason is an equity fund is a bundle of hundreds or even thousands of stocks. It is diversified by its nature. If one company in the bundle tanks, the investor's exposure is very limited since his money is spread across hundreds of companies.

Fixed-Income Funds

Fixed-income funds invest only in government or corporate bonds that offer fixed returns. These mutual funds are much less risky since they provide the same return whether in a bull market or a bear market. However, investors who choose fixed-income funds because of lower risk must also accept, in most cases, lower returns.

Balanced Funds

Balanced funds feature a mix of equity and fixed-income investments. Their return potentials and risk levels fall between that of equity funds and fixed-income funds. Balanced funds occupy a broad gamut. Some are stock-heavy, while others are comprised of mostly bonds and feature only a smattering of equities. Plenty of balanced funds exist from which to choose; diligent investors can almost always find one whose makeup corresponds with their risk tolerance and desired return potential.

Bond Ladders

DEFINITION of “Bond Ladder”

A portfolio of fixed-income securities in which each security has a significantly different maturity date. The purpose of purchasing several smaller bonds with different maturity dates rather than one large bond with a single maturity date is to minimize interest-rate risk and to increase liquidity. In a bond ladder, the bonds' maturity dates are evenly spaced across several months or several years so that the bonds are maturing and the proceeds are being reinvested at regular intervals. The more liquidity an investor needs, the closer together his bond maturities should be.


If an investor had one $20,000 bond that matured in five years and earned 2.5% interest per year, the investor would not have access to that $20,000 for five years. Also, if interest rates increased to 3.5%, he would be stuck earning the lower, 2.5% rate until the bond matured.

On the other hand, if the investor had five bonds worth $4,000 each that were laddered so that one bond matured each year, he only have to wait a few months to start earning a higher interest rate on a portion of his investment if interest rates increased.

At the same time, if interest rates fell from 2.5% to 1.5%, the investor would not be faced with putting $20,000 into a lower-earning investment all at once. Interest rates might go back up by the time the other bonds reached their maturity dates.

Bond Ladders: A Bad Idea for Retirees?

By Daniel Kurt | January 20, 2016

Bonds should be a key ingredient in just about every retirement account, and particularly in those of older, more conservative investors. But when you invest in these fixed-income instruments, it’s important to understand something called interest rate risk.

Let’s say you buy a $5,000 U.S. Treasury Note that matures in 10 years and pays 2% interest. If interest rates go up in the meantime, you’re forgoing the opportunity to invest that $5,000 in higher-yielding notes. Should you sell the bond before its maturity date, you’ll almost certainly do so at a loss, because bond prices fall when rates increase: Why should someone buy a bond offering 2%, when 3% is the going yield?

The Ladder Strategy

A lot of folks choose to build a bond “ladder” as a way to manage this risk. Instead of putting the entire $5,000 in a single, long-term bond, they purchase separate securities with different maturities. In this example, rather than putting the entire $5,000 into one T-bond, an investor might buy a $1,000 note that matures in two years, another that matures in four years, and so on.

In a rising interest rate environment, this individual no longer has to wait 10 years to take advantage of the improved yields. Every two years, he or she can take the $1,000 returned from the maturing bond and reinvest it in one that pays a higher rate. If the market’s moving in the other direction when it's time to reinvest, the investor experiences less of a hit: He or she only has to turn over 20% of the portfolio's bond allocation into lower-yielding instruments.

A Shaky Ladder

It’s hard to argue with the logic in diversifying your maturity dates. The problem is that most investors construct a ladder with individual bonds rather than bond funds. And that has a number of drawbacks:

  • Reduced liquidity: In a rising interest rate environment, you’ll want to hold onto your bonds until they reach maturity – otherwise you’ll be forced to sell them at a loss. But what if you need extra cash now? Because of the fluid nature of bond funds, which regularly buy and sell issues, you may not take such a drastic hit. That’s because the fund has likely been purchasing higher-yielding bonds since prices dropped. And the value of your shares reflects that extra interest income.
  • Higher default risk: A typical investor might own two dozen separate bonds – perhaps fewer. If even one of the issuers defaults, you’re taking a big hit. By contrast, bond funds own a large number of bond issues. Therefore, they can absorb the impact of one or two defaults with relatively little damage.
  • Increased costs: Whenever you buy or sell a small number of bonds, you’re not going to get a favorable price. Fund managers, on the other hand, have more leverage because they’re dealing with large quantities. It’s like buying one roll of paper towels rather than going to a wholesale store and getting a giant pack – you’re going to spend a lot more per unit. On top of that, you may have to pay a commission to the broker who puts the order in for you – and that can easily tack on another 2% to the deal. One exception is a U. S. Treasury bond or note, which you can buy yourself from the government, at

Fund-Buying Strategies

Overall, most individuals – particularly those with smaller portfolios – will get more flexibility and better pricing when they purchase funds rather than individual bonds. That doesn’t mean throwing out all the principles of laddering, however.

In order to mitigate interest rate risk, you still want to scatter your maturity dates. You can do this in a few different ways. For example, you can select a diverse-term bond fund, like one that tracks the Barclays U.S. Aggregate Bond Index.

Conversely, you could buy a few different funds that, as a whole, offer a mix of durations. You might invest in one that focus on short-term notes (for specifics here are Some Short-Term Bond Funds Worth Your Attention), one that seeks out intermediate bonds and one that targets long-term issues.

Here’s yet another approach. iShares offers a series of ETFs that are grouped by maturity date, so you can actually “ladder” with funds instead of individual bonds. What’s makes their iBonds particularly attractive are the lowexpense ratios and focus on investment-grade securities. (See our Special Feature: Exchange-Traded Funds for everything you need to know about ETFs.)

The Bottom Line

Using a ladder approach may sound like a wise idea, but purchasing individual bonds has inherent disadvantages, especially for retirees. Most investors will want to stick with bond funds, which offer lower costs and greaterliquidity. And the laddering technique can to some extent be applied to funds, so investors can have the best of both worlds.

Exchange-Traded Funds

What is an "Exchange-Traded Fund (ETF)"

An exchange-traded fund (ETF) is a marketable security that tracks an index, a commodity, bonds, or a basket of assets like an index fund. Unlike mutual funds, an ETF trades like a common stock on a stock exchange. ETFs experience price changes throughout the day as they are bought and sold. ETFs typically have higher daily liquidity and lower fees than mutual fund shares, making them an attractive alternative for individual investors.

Because it trades like a stock, an ETF does not have its net asset value (NAV) calculated once at the end of every day like a mutual fund does.

Growth Stocks vs. Value Stocks

By Mark P. Cussen, CFP®, CMFC, AFC

Most investors know that common stocks are one of only two asset classes that have grown faster than the rate of inflation over long periods of time. This, of course, is why so many people invest in them, either directly or through mutual funds, exchange-traded funds (ETFs) or other vehicles. But stocks can be subdivided into two main categories. Growth stocks are considered stocks that have the potential to outperform the overall markets over time because of their future potential, while value stocks are classified as stocks that are currently trading below what they are really worth and will therefore provide a superior return due to their discounted price. But which category of stocks is better? The comparative historical performance of these two subsectors yields some surprising results.

Growth vs. Value

The concept of a growth stock versus one that is considered to be undervalued generally comes from fundamental stock analysis. Growth stocks are considered by analysts to have the potential to outperform either the overall markets or else a specific sub-segment of them for a period of time. Growth stocks can be found in small-, mid- and large-cap sectors and can only retain this status until analysts feel that they have achieve their potential. Growth companies are considered to have a good chance for considerable expansion over the next few years, either because they have a product or line of products that is expected to sell well or because they appear to be run better than many of their competitors and are thus predicted to gain an edge on them in their market. Value stocks are usually larger, more well-established companies that are trading below the price that analysts feel the stock is worth, depending upon the financial ratio or benchmark that it is being compared to. For example, the book value of a company’s stock may be $25 a share, based on the number of shares outstanding divided by the company’s capitalization. Therefore, if it is trading for $20 a share at the moment, then many analysts would consider this to be a good value play.

Stocks can become undervalued for many reasons. In some cases, public perception will push the price down, such as if a major figure in the company is caught in a personal scandal or the company is caught doing something unethical. But if the company’s financials are still relatively solid, then value seekers will often jump in at this point, because they know that they public will soon forget about whatever happened and the price will rise to where it should be. Value stocks will typically trade at a discount to either the price to earnings, book value or cash flow ratios. Of course, neither outlook is always correct, and some stocks can be classified as a blend of these two categories, where they are considered to be undervalued but also have some potential above and beyond this, therefore classifies all of the equities and equity funds that it ranks into either a growth, value or blended category.

Which is Better?

When it comes to comparing the historical performances of the two respective subsectors of stocks, any results that can be seen must be evaluated in terms of time horizon and the amount of volatility, and thus risk that was endured in order to achieve them. Value stocks are at least theoretically considered to have a lower level of risk and volatility associated with them because they are usually found among larger, more established companies. And even if they don’t return to the target price that analysts or the investor predicts, they may still offer some capital growth, and these stocks also often pay dividends as well. Growth stocks, on the other hand, seldom pay dividends and the chances of loss can be higher, especially if the company hits a real snag in its development. For example, a highly-touted growth company with a new product that is supposed to solve some major problem may see its stock price plummet if a serious defect is found in this product. And investors may sustain heavy losses if this issue is not able to be readily fixed. However, growth stocks that pan out are at least traditionally viewed as having the highest potential for the greatest returns over time.

Historical Performance

Although the above paragraph suggests that growth stocks would post the best numbers over longer periods, the opposite has actually been true. Research analyst John Dowdee published a report on the Seeking Alpha website where he broke stocks down into six categories that reflected both the risk and returns for growth and value stocks in the small, mid and large cap sectors respectively. The study reveals that from July of 2000 until 2013 when the study was conducted, value stocks outperformed growth stocks on a risk-adjusted basis for all three levels of capitalization – even though they were clearly more volatile than their growth counterparts. However, this was not the case for shorter periods of time. From 2007 to 2013, growth stocks posted higher returns in each cap class. The author was forced to ultimately conclude that the study provided no real answer to whether one type of stock was truly superior to the other on a risk-adjusted basis. He stated that the winner in each scenario came down to the time period during which they were held. (For more, see: Steady Growth Stocks Win the Race.)

However, Craig Israelsen published a different study in Financial Planning magazine in 2015 that showed the performance of growth and value stocks in all three cap sizes over a 25-year period from the beginning of 1990 to the end of 2014. The returns on this chart show that large-cap value stocks provided an average annual return that exceeded that of large-cap growth stocks by about three-quarters of a percent. The difference was even larger for mid- and small-cap stocks, based on the performance of their respective benchmark indices, with the value sectors again coming out the winners. But the study also showed that over every rolling five-year period during that time, large-cap growth and value were almost evenly split in terms of superior returns. Small-cap value beat its growth counterpart about three-quarters of the time over those periods, but when growth prevailed, the difference between the two was often much larger than when value won. However, small-cap value beat growth almost 90% of the time over rolling 10-year periods, and mid-cap value also beat its growth counterpart. (For more, see: What's the Value in Value Investing?)

The Bottom Line

Unfortunately, the answer to the growth versus value debate is ultimately dependent upon the investor’s risk tolerance, investment objective and time horizon as well as the current state of the market. It should also be noted that over shorter periods, the performance of either subsector will depend in large part upon the point in the cycle that the market happens to be in. For example, value stocks tend to do better during recessions, while growth stocks will often outperform during strong periods of expansion. This factor should therefore be taken into account by shorter-term investors or those seeking to time the markets.


What is Stock?

Plain and simple, stock is a share in the ownership of a company. Stock represents a claim on the company's assets and earnings. As you acquire more stock, your ownership stake in the company becomes greater. Whether you say shares, equity, or stock, it all means the same thing.

Being an Owner

Holding a company's stock means that you are one of the many owners (shareholders) of a company and, as such, you have a claim to everything the company owns. Yes, this means that technically you own a tiny sliver of every piece of furniture, every trademark, and every contract of the company. As an owner, you are entitled to your share of the company's earnings as well as any voting rights attached to the stock.

A stock is represented by a stock certificate. This is a fancy piece of paper that is proof of your ownership. In today's computer age, you won't actually get to see this document because your brokerage keeps these records electronically, which is also known as holding shares "in street name". This is done to make the shares easier to trade. In the past, when a person wanted to sell his or her shares, that person physically took the certificates down to the brokerage. Now, trading with a click of the mouse or a phone call makes life easier for everybody.

Being a shareholder of a public company does not mean you have a say in the day-to-day running of the business. Instead, one vote per share to elect the board of directors at annual meetings is the extent to which you have a say in the company. For instance, being a Microsoft shareholder doesn't mean you can call up Bill Gates and tell him how you think the company should be run!

The management of the company is supposed to increase the value of the firm for shareholders. If this doesn't happen, the shareholders can vote to have the management removed, at least in theory. In reality, individual investors like you and I don't own enough shares to have a material influence on the company. It's really the big boys like large institutional investors and billionaire entrepreneurs who make the decisions.

For ordinary shareholders, not being able to manage the company isn't such a big deal. After all, the idea is that you don't want to have to work to make money, right? The importance of being a shareholder is that you are entitled to a portion of the company's profits and have a claim on assets. Profits are sometimes paid out in the form of dividends. The more shares you own, the larger the portion of the profits you get. Your claim on assets is only relevant if a company goes bankrupt. In case of liquidation, you'll receive what's left after all the creditors have been paid. This last point is worth repeating: the importance of stock ownership is your claim on assets and earnings. Without this, the stock wouldn't be worth the paper it's printed on.

Another extremely important feature of stock is its limited liability, which means that, as an owner of a stock, you are not personally liable if the company is not able to pay its debts. Other companies such as partnerships are set up so that if the partnership goes bankrupt the creditors can come after the partners (shareholders) personally and sell off their house, car, furniture, etc. Owning stock means that, no matter what, the maximum value you can lose is the value of your investment. Even if a company of which you are a shareholder goes bankrupt, you can never lose your personal assets.

Debt vs. Equity

Why does a company issue stock? Why would the founders share the profits with thousands of people when they could keep profits to themselves? The reason is that at some point every company needs to raise money. To do this, companies can either borrow it from somebody or raise it by selling part of the company, which is known as issuing stock. A company can borrow by taking a loan from a bank or by issuing bonds. Both methods fit under the umbrella of debt financing. On the other hand, issuing stock is called equity financing. Issuing stock is advantageous for the company because it does not require the company to pay back the money or make interest payments along the way. All that the shareholders get in return for their money is the hope that the shares will someday be worth more than what they paid for them. The first sale of a stock, which is issued by the private company itself, is called the initial public offering (IPO).

It is important that you understand the distinction between a company financing through debt and financing through equity. When you buy a debt investment such as a bond, you are guaranteed the return of your money (the principal) along with promised interest payments. This isn't the case with an equity investment. By becoming an owner, you assume the risk of the company not being successful - just as a small business owner isn't guaranteed a return, neither is a shareholder. As an owner, your claim on assets is less than that of creditors. This means that if a company goes bankrupt and liquidates, you, as a shareholder, don't get any money until the banks and bondholders have been paid out; we call this absolute priority. Shareholders earn a lot if a company is successful, but they also stand to lose their entire investment if the company isn't successful.


It must be emphasized that there are no guarantees when it comes to individual stocks. Some companies pay out dividends, but many others do not. And there is no obligation to pay out dividends even for those firms that have traditionally given them. Without dividends, an investor can make money on a stock only through its appreciation in the open market. On the downside, any stock may go bankrupt, in which case your investment is worth nothing.

Although risk might sound all negative, there is also a bright side. Taking on greater risk demands a greater return on your investment. This is the reason why stocks have historically outperformed other investments such as bonds or savings accounts. Over the long term, an investment in stocks has historically had an average return of around 10-12%.


What is "Diversification"

Diversification is a risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.

Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.

BREAKING DOWN "Diversification"

Studies and mathematical models have shown that maintaining a well-diversified portfolio of 25 to 30 stocks will yield the most cost-effective level of risk reduction. Investing in more securities will still yield further diversification benefits, albeit at a drastically smaller rate.

Further diversification benefits can be gained by investing in foreign securities because they tend be less closely correlated with domestic investments. For example, an economic downturn in the U.S. economy may not affect Japan's economy in the same way; therefore, having Japanese investments would allow an investor to have a small cushion of protection against losses due to an American economic downturn.

Most non-institutional investors have a limited investment budget, and may find it difficult to create an adequately diversified portfolio. This fact alone can explain why mutual funds have been increasing in popularity. Buying shares in a mutual fund can provide investors with an inexpensive source of diversification.

The Importance Of Diversification

Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event. Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk. Here, we look at why this is true, and how to accomplish diversification in your portfolio.

Risk and Diversification

Different Types of Risk
Investors confront two main types of risk when investing:

  • Undiversifiable - Also known as "systematic" or "market risk," undiversifiable risk is associated with every company. Causes are things like inflation rates, exchange rates, political instability, war and interest rates. This type of risk is not specific to a particular company or industry, and it cannot be eliminated, or reduced, through diversification; it is just a risk that investors must accept.
  • Diversifiable - This risk is also known as "unsystematic risk," and it is specific to a company, industry, market, economy or country; it can be reduced through diversification. The most common sources of unsystematic risk are business risk and financial risk. Thus, the aim is to invest in various assets so that they will not all be affected the same way by market events.

Why You Should Diversify
Let's say you have a portfolio of only airline stocks. If it is publicly announced that airline pilots are going on an indefinite strike, and that all flights are canceled, share prices of airline stocks will drop. Your portfolio will experience a noticeable drop in value. If, however, you counterbalanced the airline industry stocks with a couple of railway stocks, only part of your portfolio would be affected. In fact, there is a good chance that the railway stock prices would climb, as passengers turn to trains as an alternative form of transportation.

But, you could diversify even further because there are many risks that affect both rail and air, because each is involved in transportation. An event that reduces any form of travel hurts both types of companies - statisticians would say that rail and air stocks have a strong correlation. Therefore, to achieve superior diversification, you would want to diversify across the board, not only different types of companies but also different types of industries. The more uncorrelated your stocks are, the better.

It's also important that you diversify among different asset classes. Different assets - such as bonds and stocks - will not react in the same way to adverse events. A combination of asset classes will reduce your portfolio's sensitivity to market swings. Generally, the bond and equity markets move in opposite directions, so, if your portfolio is diversified across both areas, unpleasant movements in one will be offset by positive results in another.

There are additional types of diversification, and many synthetic investment products have been created to accommodate investors' risk tolerance levels; however, these products can be very complicated and are not meant to be created by beginner or small investors. For those who have less investment experience, and do not have the financial backing to enter into hedging activities, bonds are the most popular way to diversify against the stock market.

Unfortunately, even the best analysis of a company and its financial statements cannot guarantee that it won't be a losing investment. Diversification won't prevent a loss, but it can reduce the impact of fraud and bad information on your portfolio.

How Many Stocks You Should Have
Obviously owning five stocks is better than owning one, but there comes a point when adding more stocks to your portfolio ceases to make a difference. There is a debate over how many stocks are needed to reduce risk while maintaining a high return. The most conventional view argues that an investor can achieve optimal diversification with only 15 to 20 stocks spread across various industries.

Diversification can help an investor manage risk and reduce the volatility of an asset's price movements. Remember though, that no matter how diversified your portfolio is, risk can never be eliminated completely. You can reduce risk associated with individual stocks, but general market risks affect nearly every stock, so it is important to diversify also among different asset classes. The key is to find a medium between risk and return; this ensures that you achieve your financial goals while still getting a good night's rest.


What is a "Bond"

A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.


Bonds are commonly referred to as fixed-income securities and are one of the three main generic asset classes, along with stocks (equities) and cash equivalents. Many corporate and government bonds are publicly traded on exchanges, while others are traded only over-the-counter (OTC).

How Bonds Work

When companies or other entities need to raise money to finance new projects, maintain ongoing operations, or refinance existing other debts, they may issue bonds directly to investors instead of obtaining loans from a bank. The indebted entity (issuer) issues a bond that contractually states the interest rate (coupon) that will be paid and the time at which the loaned funds (bond principal) must be returned (maturity date).

The issuance price of a bond is typically set at par, usually $100 or $1,000 face value per individual bond. The actual market price of a bond depends on a number of factors including the credit quality of the issuer, the length of time until expiration, and the coupon rate compared to the general interest rate environment at the time.


Because fixed-rate coupon bonds will pay the same percentage of its face value over time, the market price of the bond will fluctuate as that coupon becomes desirable or undesirable given prevailing interest rates at a given moment in time.

For example if a bond is issued when prevailing interest rates are 5% at $1,000 par value with a 5% annual coupon, it will generate $50 of cash flows per year to the bondholder. The bondholder would be indifferent to purchasing the bond or saving the same money at the prevailing interest rate.

If interest rates drop to 4%, the bond will continue paying out at 5%, making it a more attractive option. Investors will purchase these bonds, bidding the price up to a premium until the effective rate on the bond equals 4%. On the other hand, if interest rates rise to 6%, the 5% coupon is no longer attractive and the bond price will decrease, selling at a discount until it's effective rate is 6%.

Because of this mechanism, bond prices move inversely with interest rates.

Characteristics of Bonds

  • Most bonds share some common basic characteristics including:
  • Face value is the money amount the bond will be worth at its maturity, and is also the reference amount the bond issuer uses when calculating interest payments.
  • Coupon rate is the rate of interest the bond issuer will pay on the face value of the bond, expressed as a percentage.
  • Coupon dates are the dates on which the bond issuer will make interest payments. Typical intervals are annual or semi-annual coupon paymets.
  • Maturity date is the date on which the bond will mature and the bond issuer will pay the bond holder the face value of the bond.
  • Issue price is the price at which the bond issuer originally sells the bonds.

Two features of a bond – credit quality and duration – are the principal determinants of a bond's interest rate. If the issuer has a poor credit rating, the risk of default is greater and these bonds will tend to trade a discount. Credit ratings are calculated and issued by credit rating agencies. Bond maturities can range from a day or less to more than 30 years. The longer the bond maturity, or duration, the greater the chances of adverse effects. Longer-dated bonds also tend to have lower liquidity. Because of these attributes, bonds with a longer time to maturity typically command a higher interest rate.

When considering the riskiness of bond portfolios, investors typically consider the duration (price sensitivity to changes in interest rates) and convexity (curvature of duration).

Bond Issuers

There are three main categories of bonds.

  • Corporate bonds are issued by companies.
  • Municipal bonds are issued by states and municipalities. Municipal bonds can offer tax-free coupon income for residents of those municipalities.
  • U.S. Treasury bonds (more than 10 years to maturity), notes (1-10 years maturity) and bills (less than one year to maturity) are collectively referred to as simply "Treasuries."

Varieties of Bonds

  • Zero-coupon bonds do not pay out regular coupon payments, and instead are issued at a discount and their market price eventually converges to face value upon maturity. The discount a zero-coupon bond sells for will be equivalent to the yield of a similar coupon bond.
  • Convertible bonds are debt instruments with an embedded call option that allows bondholders to convert their debt into stock (equity) at some point if the share price rises to a sufficiently high level to make such a conversion attractive.
  • Some corporate bonds are callable, meaning that the company can call back the bonds from debtholders if interest rates drop sufficiently. These bonds typically trade at a premium to non-callable debt due to the risk of beingcalled away and also due to their relative scarcity in today's bond market. Other bonds are putable, meaning that creditors can put the bond back to the issuer if interest rates rise sufficiently.

The majority of corporate bonds in today's market are so-called bullet bonds, with no embedded options whose entire face value is paid at once on the maturity date.

Mutual Funds vs. Stocks

Mutual Funds vs. Stocks: Which is Best for Your Investing Style?

New investors looking to invest for the future are usually faced with two main options - mutual funds or individual stocks. Mutual funds are actively managed baskets of stocks, designed to beat the market with the assistance of a fund manager. Individual stocks can be bought by any investor through a brokerage, and it becomes the responsibility of the individual investor to maintain his or her portfolio. Mutual funds are widely regarded as a passive form of investing, while investing in individual stocks is a more active form. Both carry inherent advantages and risks, and it is important for investors to understand the differences between them.

Mutual Funds

Most beginner investors start with mutual funds, since they are automatically diversified, and present investors with a large variety of flavors - from sector based funds such as tech, financial, retail or energy to commodities to foreign indexes.

Mutual funds generally hold a large number or stocks, with each equity only comprising a small percentage of the portfolio. This is both its strength and weakness.

For example, a tech mutual fund may claim Apple as one of its top holdings, but a rally in Apple shares may barely move the mutual fund, on account of Apple only comprising 2% of the overall portfolio, and the remaining 98% being comprised of industry laggards such as Cisco. In this same example, however, a crash in Apple shares will also be cushioned by its low portfolio weight and buffered by other less volatile stocks. Although the growth of mutual funds may be limited, the downside is limited as well.

When purchasing mutual funds, investors usually don’t define the exact number of shares to purchase; rather, they will order a set dollar amount from a brokerage, and the brokerage will calculate the shares to be bought based on the day’s closing price. It is also important to remember that the share price of a mutual fund does not fluctuate during the day - it is only reported after the market close based on the closing prices of all of its underlying securities. Investors interested in actively trading mutual funds should invest in ETFs (exchange traded funds), which were designed for that purpose.

Mutual fund investors should allow a longer time frame, in terms of years, to observe slow and steady growth. They should also make regularly scheduled investments, to take advantage of Dollar Cost Averaging. For example, investing $1000 a year in the same mutual fund without regard to the share price will insure moderate growth, by purchasing more shares when the price is low and fewer shares when the price is higher. In addition, investors who do not intend to use the fund’s dividends as income should use an automatic dividend reinvestment plan - which automatically uses the dividends to purchase more shares (or fractional shares) of the same fund, as a form of dollar cost averaging. This not only allows investors to sidestep the capital gains tax on cash dividends, but also the brokerage commission charged for purchasing additional shares.

Each mutual fund has its own set of fees and expenses. These can include, but are not limited to - the fund manager’s fee, a front-end load upon initial purchase, a back-end load upon sale, as well as early redemption charges. It is important to understand the complex fees of mutual funds in the prospectus before purchasing any shares, as the purchase equals a binding agreement to pay these extra charges. For investors who favor mutual funds but want to avoid the fees, index funds, which are passively managed mutual funds which simply mirror a set market index, such as the S&P 500, may be a better lower-cost alternative.

Individual Stocks

For the more adventurous investor who is not satisfied with the lower returns of mutual or index funds, picking individual stocks for a personal portfolio is the favored choice. Purchasing individual stocks can be done directly through any brokerage, with the only fees being the commission paid upon the purchase of shares and the capital gains tax paid upon sale. Investors define exactly the amount of shares to purchase, and the desired price. Dividends from individual stocks can also be reinvested into the company, with the same aforementioned advantages of mutual funds .

Investing in a single company can be a high risk, high reward affair - investing $1000 in a company could either result in a complete loss of the principal or an exponential increase of the investment, something which could not occur in the slow and steady world of mutual funds. To offset this risk, however, most investors will choose a small basket of stocks to counterbalance each other to diversify and minimize risk. As a general rule of thumb, the more stocks in a portfolio, the better it is protected from volatile market movements. Investors in individual stocks should also be well studied in market terminology and be well read in daily financial currents to assess the state of their portfolios, paying careful attention to quarterly earnings, commodity prices, unemployment reports and interest rates, to name a few. Generally, investing in individual stocks is a task best done by investors with more time on their hands. In addition, each share of stock is a piece of the company and counts as a vote during shareholders’ meetings. An investor investing a large amount of capital (in the millions) may hold considerable sway over a company’s operations.

Individual stocks are also a far more emotional affair than mutual funds. Whereas a drop of 10% in a mutual fund may be depressing, a 30% loss in a single stock is hardly out of the ordinary - and while many investors get tempted to sell at the bottom, patient investors know when to use these dips to increase their holdings of undervalued stocks. Likewise, many investors get pulled in by financial hype and buy stocks at all-time highs only to panic later during a pullback. Stocks have no guarantees - a bankrupt company can liquidate all its shares and leave investors with nothing.

If you are unsure about which investment is right for you, consult one of our financial Advisors at Aspen Capital Management -- it is best to fully understand your investment time frame and risk tolerance limits before committing to mutual funds or stocks.

Mutual Funds

What is a "Mutual Fund"

mutual fund is an investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest the fund's capital and attempt to produce capital gains and income for the fund's investors. A mutual fund's portfolio is structured and maintained to match the investment objectives stated in its prospectus.


One of the main advantages of mutual funds is that they give small investors access to professionally managed, diversified portfolios of equities, bonds and other securities, which would be quite difficult (if not impossible) to create with a small amount of capital. Each shareholder participates proportionally in the gain or loss of the fund. Mutual fund units, or shares, are issued and can typically be purchased or redeemed as needed at the fund's current net asset value (NAV) per share, which is sometimes expressed as NAVPS.

Do mutual funds invest only in stocks?

By Greg DePersio

Mutual funds invest in stocks, but certain types also invest in government and corporate bonds. Stocks are subject to the whims of the market and thus offer a higher return potential than bonds, but they also present more risk. Bonds, by contrast, provide a fixed return that is usually much lower than what an investor gets from stocks. The advantage of bonds is they are low risk. Only in an extreme situation, such as the complete failure of a corporation, does an investor not receive the return he was promised from a bond security. A mutual fund's investment profile depends on the type of fund. There are three main types: equity funds, fixed-income funds and balanced funds.

Equity Funds

Equity funds are mutual funds that invest only in common stock. They offer the biggest returns but also the highest risk. An equity fund, however, still presents a lower risk than investing in individual stocks. The reason is an equity fund is a bundle of hundreds or even thousands of stocks. It is diversified by its nature. If one company in the bundle tanks, the investor's exposure is very limited since his money is spread across hundreds of companies.

Fixed-Income Funds

Fixed-income funds invest only in government or corporate bonds that offer fixed returns. These mutual funds are much less risky since they provide the same return whether in a bull market or a bear market. However, investors who choose fixed-income funds because of lower risk must also accept, in most cases, lower returns.

Balanced Funds

Balanced funds feature a mix of equity and fixed-income investments. Their return potentials and risk levels fall between that of equity funds and fixed-income funds. Balanced funds occupy a broad gamut. Some are stock-heavy, while others are comprised of mostly bonds and feature only a smattering of equities. Plenty of balanced funds exist from which to choose; diligent investors can almost always find one whose makeup corresponds with their risk tolerance and desired return potential.

Mutual Fund Loads

What is a "Load Fund"

A load fund is a mutual fund that comes with a sales charge or commission. The fund investor pays the load, which goes to compensate a sales intermediary (broker, financial planner, investment advisor, etc.) for his or her time and expertise in selecting an appropriate fund for the investor. The load is either paid up front at the time of purchase (front-end load), when the shares are sold (back-end load), or as long as the fund is held by the investor (level-load).


If a fund limits its level load to no more than 0.25% (the maximum is 1%), it can call itself a "no-load" fund in its marketing literature.

Front-end and back-end loads are not part of a mutual fund's operating expenses, but level-loads, called 12b-1 fees, are included. The record shows that the performance of load and no-load funds is similar.


What is an "Annuity"

An annuity is a contractual financial product sold by financial institutions that is designed to accept and grow funds from an individual and then, upon annuitization, pay out a stream of payments to the individual at a later point in time. The period of time when an annuity is being funded and before payouts begin is referred to as the accumulation phase. Once payments commence, the contract is in the annuitization phase.


Annuities were designed to be a reliable means of securing a steady cash flow for an individual during their retirement years and to alleviate fears of longevity risk, or outliving one's assets.

Annuities can also be created to turn a substantial lump sum into a steady cash flow, such as for winners of large cash settlements from a lawsuit or from winning the lottery.

Defined benefit pensions and Social Security are two examples of lifetime guaranteed annuities that pay retirees a steady cash flow until they pass.

Types of Annuities

Annuities can be structured according to a wide array of details and factors, such as the duration of time that payments from the annuity can be guaranteed to continue. Annuities can be created so that, upon annuitization, payments will continue so long as either the annuitant or their spouse (if survivorship benefit is elected) is alive. Alternatively, annuities can be structured to pay out funds for a fixed amount of time, such as 20 years, regardless of how long the annuitant lives. Furthermore, annuities can begin immediately upon deposit of a lump sum, or they can be structured as deferred benefits.

Annuities can be structured generally as either fixed or variable. Fixed annuities provide regular periodic payments to the annuitant. Variable annuities allow the owner to receive greater future cash flows if investments of the annuity fund do well and smaller payments if its investments do poorly. This provides for a less stable cash flow than a fixed annuity, but allows the annuitant to reap the benefits of strong returns from their fund's investments.

One criticism of annuities is that they are illiquid. Deposits into annuity contracts are typically locked up for a period of time, known as the surrender period, where the annuitant would incur a penalty if all or part of that money were touched. These surrender periods can last anywhere from 2 to more than 10 years, depending on the particular product. Surrender fees can start out at 10% or more and the penalty typically declines annually over the surrender period.

While variable annuities carry some market risk and the potential to lose principal, riders and features can be added to annuity contracts (usually for some extra cost) which allow them to function as hybrid fixed-variable annuities. Contract owners can benefit from upside portfoliopotential while enjoying the protection of a guaranteed lifetime minimum withdrawal benefit if the portfolio drops in value. Other riders may be purchased to add a death benefit to the contract or accelerate payouts if the annuity holder is diagnosed with a terminal illness. Cost of livingriders are common to adjust the annual base cash flows for inflation based on changes in the CPI.

Who Sells Annuities

Life insurance companies and investment companies are the two sorts of financial institutions offering annuity products. For life insurance companies, annuities are a natural hedge for their insurance products. Life insurance is bought to deal with mortality risk – that is, the risk of dying prematurely. Policyholders pay an annual premium to the insurance company who will pay out a lump sum upon their death. If policyholders die prematurely, the insurer will pay out the death benefit at a net loss to the company. Actuarial science and claims experience allows these insurance companies to price their policies so that on average insurance purchasers will live long enough so that the insurer earns a profit. Annuities, on the other hand, deal with longevity risk, or the risk of outliving ones assets. The risk to the issuer of the annuity is that annuity holders will live outlive their initial investment. Annuity issuers may hedge longevity risk by selling annuities to customers with a higher risk of premature death.

In many cases, the cash value inside of permanent life insurance policies can be exchanged via a 1035 exchange for an annuity product without any tax implications.

Agents or brokers selling annuities need to hold a state-issued life insurance license, and also a securities license in the case of variable annuities. These agents or brokers typically earn a commission based on the notional value of the annuity contract.

Who Buys Annuities

Annuities are appropriate financial products for individuals seeking stable, guaranteed retirement income. Because the lump sum put into the annuity is illiquid and subject to withdrawal penalties, it is not recommended for younger individuals or for those with liquidity needs. Annuity holders cannot outlive their income stream, which hedges longevity risk. So long as the purchaser understands that he or she is trading a liquid lump sum for a guaranteed series of cash flows, the product is appropriate. Some purchasers hope to cash out an annuity in the future at a profit, however this is not the intended use of the product.

Immediate annuities are often purchased by people of any age who have received a large lump sum of money and who prefer to exchange it for cash flows in to the future.

Investment Risks

Managing Investment Risk

We tend to think of "risk" in predominantly negative terms, as something to be avoided or a threat that we hope won't materialize. In the investment world, however, risk is inseparable from performance and, rather than being desirable or undesirable, is simply necessary. Understanding risk is one of the most important parts of a financial education. This article will examine ways that we measure and manage risk in making investment decisions.

Risk - Good, Bad and Necessary

A common definition for investment risk is deviation from an expected outcome. We can express this in absolute terms or relative to something else like a market benchmark. That deviation can be positive or negative, and relates to the idea of "in order to make it you have to risk it" - to achieve higher returns in the long run you have to accept more short-term volatility. How much volatility depends on your risk tolerance - an expression of the capacity to assume volatility based on specific financial circumstances and the propensity to do so, taking into account your psychological comfort with uncertainty and the possibility of incurring large short-term losses. (To learn more, read Determining Risk And The Risk Pyramid and Personalizing Risk Tolerance.)

Absolute Measures of Risk

One of the most commonly used absolute risk metrics is standard deviation, a statistical measure of dispersion around a central tendency. For example, during a 15-year period from August 1, 1992, to July 31, 2007, the average annualized total return of the S&P 500 Stock Index was 10.7%. This number tells you what happened for the whole period, but it doesn't say what happened along the way.

The average standard deviation of the S&P 500 for that same period was 13.5%. Statistical theory tells us that in normal distributions (the familiar bell-shaped curve) any given outcome should fall within one standard deviation of the mean about 67% of the time and within two standard deviations about 95% of the time. Thus, an S&P 500 investor could expect the return at any given point during this time to be 10.7% +/- 13.5% just under 70% of the time and +/- 27.0% 95% of the time.

Influence of Other Factors

If the level of market or systematic risk were the only influencing factor, then a portfolio's return would always be equal to the beta-adjusted market return. Of course, this is not the case - returns vary as a result of a number of factors unrelated to market risk. Investment managers who follow an active strategy take on other risks to achieve excess returns over the market's performance. Active strategies include stock, sector or country selection, fundamental analysis and charting.

Active managers are on the hunt for alpha - the measure of excess return. In our diagram example above, alpha is the amount of portfolio return not explained by beta, represented as the distance between the intersection of the x and y axes and the y axis intercept, which can be positive or negative. In their quest for excess returns, active managers expose investors to alpha risk - the risk that their bets will prove negative rather than positive. For example, a manager may think that the energy sector will outperform the S&P 500 and increase her portfolio's weighting in this sector. If unexpected economic developments cause energy stocks to sharply decline, the manager will likely underperform the benchmark - an example of alpha risk.

A note of caution is in order when analyzing the significance of alpha and beta. There must be some evidence of a linear pattern between the portfolio returns and those of the market, or a reasonably inclusive line of best fit. If the data points are randomly dispersed, then the line of best fit will have little predictive ability and the results for alpha and beta will be statistically insignificant. A general rule is that an r-squared of 0.70 or higher (1.0 being perfect correlation) between the portfolio and the market reasonably validates the significance of alpha, beta and other relative measures.

The Price of Risk

There are economic consequences to the decision between passive and active risk. In general, the more active the investment strategy (the more alpha a fund manager seeks to generate) the more an investor will need to pay for exposure to that strategy. It helps to think in terms of a spectrum from a purely passive approach. For example, a buy and hold investment into a proxy for the S&P 500 - all the way to a highly active approach such as a hedge fund employing complex trading strategies involving high capital commitments and transaction costs. For a purely passive vehicle like an index fund or an exchange trade fund ETF) you might pay 15-20 basis points in annual management fees, while for a high-octane hedge fund you would need to shell out 200 basis points in annual fees plus give 20% of the profits back to the manager. In between these two extremes lie alternative approaches combining active and passive risk management.

The difference in pricing between passive and active strategies (or beta risk and alpha risk respectively) encourages many investors to try and separate these risks: i.e. to pay lower fees for the beta risk assumed and concentrate their more expensive exposures to specifically defined alpha opportunities. This is popularly known as portable alpha, the idea that the alpha component of a total return is separate from the beta component.

For example a fund manager may claim to have an active sector rotation strategy for beating the S&P 500 and show as evidence a track record of beating the index by 1.5% on an average annualized basis. To the investor, that 1.5% of excess return is the manager's value - the alpha - and the investor is willing to pay higher fees to obtain it. The rest of the total return, what the S&P 500 itself earned, arguably has nothing to do with the manager's unique ability, so why pay the same fee? Portable alpha strategies use derivatives and other tools to refine the means by which they obtain and pay for the alpha and beta components of their exposure.


Risk is inseparable from return. Every investment involves some degree of risk, which can be very close to zero in the case of a U.S. Treasury security or very high for something such as concentrated exposure to Sri Lankan equities or real estate in Argentina. Risk is quantifiable both in absolute and in relative terms. A solid understanding of risk in its different forms can help investors to better understand the opportunities, trade-offs and costs involved with different investment approaches.

Asset Allocation

What is "Asset Allocation"

Asset allocation is an investment strategy that aims to balance risk and reward by apportioning a portfolio's assets according to an individual's goals, risk tolerance and investment horizon.

The three main asset classes - equities, fixed-income, and cash and equivalents - have different levels of risk and return, so each will behave differently over time.

BREAKING DOWN "Asset Allocation"

There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, your selection of individual securities is secondary to the way you allocate your investment in stocks, bonds, and cash and equivalents, which will be the principal determinants of your investment results.

Asset-allocation mutual funds, also known as life-cycle, or target-date, funds, are an attempt to provide investors with portfolio structures that address an investor's age, risk appetite and investment objectives with an appropriate apportionment of asset classes. However, critics of this approach point out that arriving at a standardized solution for allocating portfolio assets is problematic because individual investors require individual solutions.

Stock and Bond Alternatives

Alternative Investment

An alternative investment is one that’s not among the three traditional asset types – stocks, bonds or cash.

Consider an investor who has decided to explore alternative investments. She believes they can help diversify her portfolio and manage risk. And she’s right.

She also knows alternative investments tend to act independently of standard assets. That is, how stocks and bonds perform in the market has little impact on alternatives. Many large pensions and private endowments take advantage of this by allocating part of their portfolios to alternatives, such as hedge funds.

The spectrum of alternative investments is always changing, and her options are abundant. They include hedge funds, managed futures, derivatives contracts and real estate. She can also look at commodities such as gold, beef, oil or lumber. And collectible items, like art and antiques or coins and stamps, are options as well.

But that same investor needs to understand the alternatives she chooses. They’re frequently illiquid and face limited regulations. They can be very complex and offer unique risks.

Certain alternative investments could be subject to greater volatility than investments in the traditional market. For example, a hurricane could damage oil refineries in the Gulf Coast region, or a cattle disease could reduce beef production. The risks aren’t always clear. And like all investments, there are no guarantees.

Institutional investors and accredited, high-net-worth individuals hold most of the alternatives investments. Smaller investors can find alternative opportunities in real estate and precious metals.

Alternative Investments - Commodities as Alternative Investments

Commodities are raw materials that are sold in bulk, such as oil, wheat, silver, gold, pork bellies, oranges and cocoa. They are generally raw materials that are eventually used to produce other goods such as oil for gasoline, cocoa for chocolate, wheat for bread, etc. As such, they give an investor the opportunity to invest in the materials that a country (or corporation) produces as well as those that it consumes. Most larger manufacturers buy the commodities they need on the "spot market," where the full cash price is usually paid on the spot. Speculators typically buy and sell commodities with options and futures contracts.

Types of Commodity Investments

A commodity-linked security refers to a security whose return is dependent to a certain extent on the price level of a commodity, such as crude oil, gold, or silver, at maturity. For example, the principal of a commodity-linked bond is indexed to movements of a commodity index such as precious metal or oil.

Commodity derivatives include both exchange-traded and over-the-counter commodity derivatives such as swaps, futures and forwards. They are used to hedge risk and to take advantage of arbitrage opportunities.

Collateralized Commodity Futurespositions involve taking a long position in the futures contract of your choice and then purchasing the amount equal to your futures position in T-bills. The source of return comes from the interest you earn on your T-bill position and the movement of the futures price.

Motivations for Investing in Commodities, Commodity Derivatives, and Commodity-linked Securities
Commodities offer investors a number of benefits:

  • Hedge Against Inflation: Commodity cash prices may benefit from periods of unexpected inflation, whereas stocks and bonds may suffer. Commodities are "real assets", unlike stocks and bonds, which are "financial assets". Commodities, therefore, tend to react to changing economic fundamentals in ways that are different from traditional financial assets, particularly with respect to inflation. Commodity prices usually rise when inflation is accelerating, so investing in commodities can give portfolios a hedge against inflation. Conversely, stocks and bonds tend to perform better when the rate of inflation is stable or slowing. Faster inflation lowers the value of future cash flows paid by stocks and bonds because those future dollars will be able to buy fewer goods and services than they would today.

    However, this inflation advantage is captured more efficiently by direct investment in commodities than, for example, investment in commodity-related equities whose prices also reflect the financial prospects of the issuer or actively managed commodity futures accounts, which tend to reflect the manager's skills at selecting the right commodities.
  • Performance/Return: Investor interest in commodities has soared in recent years as the asset class has outperformed traditional assets such as stocks and bonds. Over the five-year period ended March 31, 2006, the Dow Jones AIG Commodity Index has returned 10.6%, versus 2.6% for the S&P 500. Part of this superior performance is attributable to a rise in commodity prices driven by increased demand from China and other emerging countries.
  • Enhanced Diversification: Portfolio diversification is the primary benefit of holding commodities. The reason for that is the commodity investor is exposed to commodity futures prices. Changes in those prices reflect changing expectations about future supply and demand for commodities. Factors that change expectations - such as a weather event in the Midwest or a strike in a copper mine in Chile - typically don't have anything to do with stock and bond markets.

Forms of Commodity Investing
Investing in commodities comes in two forms: passive and active:

  • Passive investing is a strategy used by investors who are using commodities as a risk diversification tool. For example, when inflation picks up, it tends to hurt fixed income securities and equities to some extent. However, prices of commodities tend to rise during these periods. This helps diversify your portfolio. Commodity investing has long had a reputation for exceptional volatility and risk but there is now a small but growing number of excellent, high-quality index-based commodity funds available that provide a relatively conservative way to invest in commodities. The management attempts to minimize price fluctuations and provide overall risk management in several ways. The selection and weighting of assets in a portfolio are typically reviewed annually or when there is a major change in an industry or even a drastic change in usage of any given commodity. This provides some overall risk reduction in commodity index funds and makes them suitable for investment by investors with limited commodity backgrounds.

    Index funds usually consist of long positions on the contracts. Short positions are usually not taken.
  • Active investing or actively managing a position in the commodities market can provide good performance results. In periods of economic growth, commodities are in strong demand to satisfy production needs. Because commodity or raw material prices tend to move more quickly in reaction to economic fluctuations than do the prices of the related finished goods, an active approach could lead to economic gains if trading activities are closely monitored and managed by the investor.

IRA Assets And Alternative Investments

By Denise Appleby | May 07, 2006

Step aside, stocks and bonds - alternative investments are becoming an increasingly popular choice for those seeking to invest their retirement plan assets. These non-traditional investment vehicles range from the familiar - for example, limited partnership units - to the not so common, such as real estate investments. Regardless of the form these investments take, however, certain rules and regulations remain constant. For IRAs, failure to adhere strictly to these rules and regulations could result in loss of tax-deferred status for the IRA assets. Read on for a high-level overview of these rules, as well as some other points you should keep in mind when considering alternative forms of investment for your IRA assets.

Investment Strategy Case Study: Traditional Vs. Alternatives for 2016

By J.B. Maverick | February 19, 2016

The opening month of 2016 was not kind to traditional stock investors. Many analysts are forecasting that equity markets in 2016 will be characterized by either volatility or an outright slump. The situation has some investors looking at alternative investments, and they're following the lead of fund managers who openly plan to devote a larger portion of their portfolios to alternatives in 2016. Volatility tends to favor alternative investing strategies used by hedge fund managers, such as long/short investing and arbitrage trading.

Alternative Investments

Alternative investments encompass a broad range of investments and investment strategies outside the traditional choices of stocks or bonds. It includes commodity or commodity futures investing, hedge funds, real estate, private equity investments, foreign currency trading and derivatives.

Many alternative investments, such as hedge funds or private equity investments, used to be observed exclusively by institutional investors or high net worth individuals (HNWIs) because of the high minimum investments required. However, the expanded offerings in mutual funds and exchange-traded funds (ETFs) have brought most alternative investments within easy reach of small investors.

An investor may not have the capital necessary to make direct hedge fund or private equity investments, but he can still access such investments through mutual funds or ETFs. To qualify, these alternatives must use hedge fund strategies or invest in private equity, like the IQ Hedge Multi-Strategy Tracker ETF or the Listed Private Equity ETF from Invesco PowerShares.

Performance of Alternatives vs. Traditional Investments

Alternative investments generally correlate negatively to most traditional investments, so they tend to outperform when the overall equity market is volatile or performing poorly. For example, alternatives significantly outperformed traditional investments during the financial crisis from October 2007 to April 2009. During that time, the only traditional investment that registered a positive gain was investment-grade bonds. However, while the overall U.S. stock markets were suffering more 40% losses, some alternative investments, such as managed futures and gold, produced double-digit gains.

However, not all alternative investment strategies turned a profit during the financial crisis. During the same time frame, commodities declined 25% overall, and long/short trading strategies saw an average 17% loss. While negative, those numbers still represent better performances than traditional equities.

The period from 2000 through most of 2002 saw the technology sector bubble burst, providing another example of alternatives outperforming traditional investments. During that time, U.S. stocks were down approximately 35% overall, while global macro strategies often employed by hedge funds were up over 40%, managed futures strategies saw an average 21% return and risk arbitrage gained 11%.

Conversely, alternative investments tend to lag behind traditional investments when the U.S. equity market is performing strongly. From 2010 to 2015, during which stocks experienced a major bull market, the IQ Hedge Multi-Strategy Tracker ETF showed an average annualized gain of only 1.77%, while the Vanguard Total Stock Market ETF had average annualized gains over 8%.

Types of Alternative Investments

Investors should consider integrating alternative investment classes or strategies into their 2016 investment portfolio.

A global macro strategy is often employed in hedge funds. This strategy may involve other alternative elements, such as long and short positions or futures. It selects portfolio holdings based on the fund manager's view of global macroeconomic and political conditions.

Futures are a popular alternative investment class that invest directly in commodities such as oil and gold. Investors can choose from direct futures contract investing, managed futures accounts, or mutual funds and ETFs that hold commodity futures contracts.

Risk arbitrage involves making trades to take advantage of temporary price discrepancies. It includes merger and acquisition arbitrage, pairs trading and liquidation arbitrage.

Long/short equity trading adopts both buy (long) and sell (short) positions to minimize risk or maximize profits. There are several different approaches, such as buying one market sector while selling another, or buying one stock in an industry while short selling another stock in the same industry. Long/short trading also encompasses option trading strategies to hedge overall long or short positions.

Real estate tends to outperform when stocks are performing poorly. Investors can buy REIT stocks or invest in ETFs or mutual funds focused on real estate holdings.

The foreign exchange market (forex) may offer opportunities in a global economic climate of divergent monetary policies. Forex trading is open directly to retail investors, or investors can choose to access this investment class through ETFs or mutual funds. Foreign exchange trading is often one element of a global macro trading strategy employed by a hedge fund.

What Is It?

Broadly speaking, an alternative investment is any investment other than the traditional investments such as publicly-traded stocks, bonds and mutual funds. The actual definition of alternative investment varies among financial institutions and investors, but it generally includes hedge funds, real estate, venture capital and derivatives. Many financial institutions that facilitate these investments conduct frequent reviews and analyses to determine whether they need to increase their list of alternative investment offerings. Therefore, if your financial institution does not allow the type of investment in which you are interested today, you should check back at a later date because things may change.

Gauging the Risk

Limiting Losses
Investment professionals typically limit their recommendations for alternative investments to accredited investors because these investors tend to have a higher risk tolerance. Even so, professionals usually recommend that investments in such assets be limited to no more than 10% of the investor\'s portfolio. This restriction helps to ensure that any losses are limited, while allowing the investor to share in any profits.

Avoiding Prohibited Transactions
This new investing trend has many people looking to invest their retirement assets in their own property, or property in which they have shared ownership. However, the old adage "you can\'t have your cake and eat it too" rings true in most cases involving non-traditional investments for IRAs and other retirement plans, because such practices could result in a prohibited transaction taking place. As such, investors and those who advise them must exercise caution to ensure compliance with applicable rules.

A prohibited transaction occurs when the IRA engages in certain transactions with the IRA owner or another disqualified person. For these purposes, a disqualified person includes the following:

  • the IRA owner
  • the IRA owner\'s spouse
  • the IRA owner\'s ancestor
  • the IRA owner\'s lineal descendant
  • any spouse of the IRA owner\'s lineal descendant(s)
  • investment advisors
  • the IRA custodian or trustee
  • certain entities in which the IRA owner owns at least 50% interest, such as a corporation, partnership or trust

Not all transactions that occur between a disqualified person and the IRA will result in a prohibited transaction. A list is provided in the tax code to ensure that taxpayers are aware of what constitutes a prohibited transaction. The tax code states that a disqualified person is considered to have engaged in a prohibited transaction with an IRA if any of the following occurs:

  • a sale or exchange, or leasing, of any property occurs between the IRA and a disqualified person;
  • there is lending of money or other extension of credit between the IRA and a disqualified person;
  • there is a furnishing of goods, services or facilities between the IRA and a disqualified person;
  • the assets are transferred to - or used by or for the benefit of - a disqualified person;
  • any action by a disqualified person who is a fiduciary whereby the fiduciary deals with the income or assets of the IRA in his or her own interests or for his or her own account; or
  • receipt of any consideration for his or her own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

In some cases, the penalty is limited to the amount invested in the prohibited transaction. These include investing the IRA assets in life insurance and collectibles. For this purpose, collectibles include artworks, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages and certain other tangible personal property.*

*Note: There are exceptions to this rule. Your IRA can invest in one, one-half, one-quarter or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium and platinum bullion (see IRS Publication 590 at the IRS website).

Complex Rules

It can be a complicated process to determine whether an investment could result in a prohibited transaction. Figuring this out usually requires the assistance of a competent tax or ERISA attorney. In fact, there are some instances in which exceptions have been granted by the Department of Labor (DOL): these are referred to as "prohibited transaction class exemptions" (PTCE). On the other hand, there have been cases in which the DOL determined that some investments were prohibited transactions, when tax professionals thought otherwise. To ensure that a proper determination is made regarding such investments, investors should seek the assistance of a tax professional with experience in the field.

Proceed at Your Own Risk

Financial institutions that offer alternative investments typically implement policies and procedures to shield themselves from liability. For instance, an investor may be required to sign what is known as an "indemnification and hold harmless agreement", agreeing that the financial institution bears no responsibility for any losses incurred by the investor. The procedure may also require a certification from the investor that he or she has consulted with legal counsel regarding the investments, and that he or she is not a disqualified person. Consequently, any losses that occur as a result of these alternative investments must be fully borne by your IRA.


So, are you one of those investors who is no longer satisfied with waiting for returns on traditional investments such as publicly-traded stocks, bonds and mutual funds? If you want to explore the possibility of putting your retirement funds in alternative investments, then thoroughly researching these investments should be at the top of your investing "to-do" list. In addition to researching which financial institutions allow these investments, you should also get professional assistance to ensure that the investments do not result in penalties and loss of tax-deferred status for the IRA assets.

Cash Management Basics

What is the best cash flow management tool?

By Claire Boyte-White

The concept of cash flow refers to the amount of money coming into a business as well as the amount of money necessary to cover expenditures. Money management is not something that can be done by halves, so a primary concern of any successful business owner is ensuring that the cash on hand at any given point meets or exceeds the need. Because revenue earned but not yet collected can't be used to pay debts, for example, efficiently managing cash flow to maintain optimal liquidity is of paramount importance to businesses of all sizes. As a company grows, however, its budget becomes rapidly more complex.

Cash flow is not simply a synonym for earnings before interest, taxes, depreciation and amortization (EBITDA). Proper cash flow management means keeping track of all assets and expenditures. This includes revenue, securities and secondary income streams, as well as all bills, debts, taxes, overhead and operating expenses, and one-time or infrequent purchases, such as new equipment. Several tools have been developed to help business owners manage their cash flow without hiring full-time accountants.

Some platforms are available for free online or as a part of other software packages. For simple needs, the Microsoft Office suite of products includes money management templates compatible with Microsoft Excel. Google Docs provides a free spreadsheet that can be shared through a Google Apps account. These tools are relatively simple to use and give crucial insight into your business's cash flow, but you are likely to need to do some customization to create the layout that serves you best. These types of templates are likely most useful to new business owners or those whose operations will remain relatively small.

The cash flow management tool included with Intuit's QuickBooks software is often considered the most popular tool on the market. Because it comes with software specifically designed for business finance, it is well-suited to a wide variety of business types with little adjustment needed. QuickBooks is designed to keep track of payroll, among other expenditures. Because different companies have different payroll schedules, QuickBooks' cash flow management tool allows for projections for a variety of time periods. Other platforms are often limited to default weekly or monthly settings.

A number of standalone platforms available allow for a more customized approach. These applications are not incorporated directly into your business's accounting software, so updates must be made manually or transferred from a spreadsheet. Both Pulse and Master PlanGuru have high-quality cash flow management tools. Both offer projections for a number of time frames, as well as multiple charts, graphs and metrics for detailed analysis. However, you need a firm grasp of the basics of corporate finance and you should be familiar with your business's unique cash flow patterns before jumping into more complex platforms. Master PlanGuru, especially, is a highly evolved application that isn't simple to use. A company that requires such an advanced tool is also likely to need a dedicated accountant.

Stashing Your Cash: Mattress Or Market?

By Lisa Smith

When stock markets become volatile, investors get nervous. In many cases, this prompts them to take money out of the market and keep it in cash. Cash can be seen, felt and spent at will, and having money on hand makes many people feel more secure. But how safe is it really? Read on to find out whether your money is safer in the market or under your mattress.

All Hail Cash?

There are definitely some benefits to holding cash. When the stock market is in free fall, holding cash helps you avoid further losses. Even if the stock market doesn't fall on a particular day, there is always the potential that it could have fallen. This possibility is known as systematic risk, and it can be completely avoided by holding cash. Cash is also psychologically soothing. During troubled times, you can see and touch cash. Unlike the rapidly dwindling balance in your brokerage account, cash will still be in your pocket or in your bank account in the morning.

However, while moving to cash might feel good mentally and help you avoid short-term stock market volatility, it is unlikely to be a wise move over the long term.

A Loss Is Not a Loss

When your money is in the stock market and the market is down, you may feel like you've lost money, but you really haven't. At this point, it's a paper loss. A turnaround in the market can put you right back to breakeven and maybe even put a profit in your pocket. If you sell your holdings and move to cash, you lock in your losses. They go from being paper losses to being real losses with no hope of recovery. While paper losses don't feel good, long-term investors accept that the stock market rises and falls. Maintaining your positions when the market is down is the only way that your portfolio will have a chance to benefit when the market rebounds.

Inflation Is a Cash Killer

While having cash in your hand seems like a great way to stem your losses, cash is no defense against inflation. You think your money is safe when it's in cash, but over time, its value erodes. Inflation is less dramatic than a crash, but in some cases it can be more devastating to your portfolio in the long term.

Opportunity Costs Add Up

Opportunity cost is the cost of an alternative that must be forgone in order to pursue a certain action. Put another way, opportunity cost refers to the benefits you could have received by taking an alternative action. In the case of cash, taking your money out of the stock market requires that you compare the growth of your cash portfolio, which will be negative over the long term as inflation erodes your purchasing power, against the potential gains in the stock market. Historically, the stock market has been the better bet.

Time Is Money

When you sell your stocks and put your money in cash, odds are that you will eventually reinvest in the stock market. The question then becomes, "when should you make this move?" Trying to choose the right time to get in or out of the stock market is referred to as market timing. If you were unable to successfully predict the market's peak and sell, it is highly unlikely that you'll be any better at predicting its bottom and buying in just before it rises.

Money Market Funds

DEFINITION of "Money Market Fund"

An investment whose objective is to earn interest for shareholders while maintaining a net asset value (NAV) of $1 per share. A money market fund’s portfolio is comprised of short-term (less than one year) securities representing high-quality, liquid debt and monetary instruments. Investors can purchase shares of money market funds through mutual funds, brokerage firms and banks.

BREAKING DOWN "Money Market Fund"

A money market fund's purpose is to provide investors with a safe place to invest easily accessible, cash-equivalent assets. It is a type of mutual fund characterized as a low-risk, low-return investment. Because money market funds have relatively low returns, investors such as those participating in employer-sponsored retirement plans, might not want to use money market funds as a long-term investment option because they will not see the capital appreciation they require to meet their financial goals.

Unlike stocks, money market fund shares are always worth $1. What changes is the rate of interest those shares earn, called “yield.” Some money market funds also come with limited check-writing privileges.

Aside from being low risk and highly liquid, money market funds may be attractive to investors because they have no loads (fees that some mutual funds charge for entering or exiting the fund). Some money market funds also provide investors with tax-advantaged gains by investing in municipal securities that are tax-exempt at the federal and/or state level. A money-market fund might also hold short-term U.S. Treasury securities (T-bills), certificates of deposit and corporate commercial paper.

A downside of money market funds is that they are not covered by federal deposit insurance. Other investments with comparable returns, such as money market deposit accounts, online savings accounts and certificates of deposit, are covered. Money market funds, however, have historically been extremely safe investments and are regulated under the Investment Company Act of 1940.

ETF’s – Built-in Diversification and Flexibility

Exchange-traded funds (ETFs) are an easy, low cost way to help provide diversification and flexibility to anyone’s portfolio. E*TRADE lets you trade every ETF sold, and provides over 100 commission-free ETFs from leading independent providers. Manage your ETF portfolio yourself, or let the professionals at E*TRADE Capital Management do it for you for instant diversification and flexibility.

Do Money-Market Funds Pay?

By Richard Loth | Updated May 24, 2013

For investors, money market funds are useful vehicles that have a role to play in the management of an investment portfolio. However, you need to understand the nature of these funds in order to recognize how they fit into your investing objective.

What Is a Money Market Fund?
A money market fund is a mutual fund that invests solely in cash/cash equivalent securities, which are also often referred to as money market instruments. These investments are short-term, very liquid investments with highcredit quality.

They generally include:

  • Certificates of deposit (CDs)
  • Commercial paper
  • U.S. Treasuries
  • Bankers' acceptances
  • Repurchase agreements

Securities and Exchange Commission (SEC) rules dictate that the average maturity of money market fund securities must be 90 days.

Just like any other mutual fund, money market funds issue redeemable units (shares) to investors and must follow guidelines set out by the SEC. All the attributes of a mutual fund apply to a money market mutual fund, with one exception that relates to its net asset value (NAV). We'll take an in-depth look at this exception later on.

Money Market Funds Vs. Money Market Accounts
A key difference between money market funds and money market accounts is that the former are sponsored by fund companies and carry no guarantee of principal, while the latter are interest-earning savings accounts offered byFederal Deposit Insurance Corporation (FDIC)-insured financial institutions with limited transaction privileges. In this case, account principal is guaranteed up to $100,000 by the FDIC. Money market accounts usually pay a higher interest rate than a passbook savings account, but generally a slightly lower interest rate than a bank certificate of deposit or the total return of a money market fund. (For more insight, read Money Market Vs. Savings Accounts.)

What's So Special About These Products?
Money market funds are special for three reasons:

  1. Safety
    The securities in which these funds invest are by and large some of the most stable and safe investments. Money market securities provide a fixed return with short maturities. By purchasing debt securities issued by banks, large corporations and the government, money market funds carry a low default risk while still offering a reasonable return.
  2. Low Initial Investment
    Money market securities generally have large minimum purchase requirements, thereby making it difficult for the vast majority of individual investors to buy them. Money market funds, on the other hand, have substantially lower requirements, which are generally even lower than average mutual fund minimum requirements. As such, money market funds allow you to take advantage of the safety related to a money market investment at low investment amounts.
  3. Accessibility
    Money market fund shares can be bought and sold at any time and are not subject to market timing restrictions. Most of these funds provide check-writing privileges. In addition, while most mutual funds have a transaction-day-plus-three (T+3) settlement date, money market funds offer investors a same-day settlement, which is similar to trading money market securities. (For related reading, see What is mutual fund timing, and why is it so bad?)

Taxable Vs. Tax-Free
Money market funds are divided into two categories: taxable and tax-free. If you're buying a taxable fund, any returns from the fund are generally subject to the regular state and federal taxes.

Taxable funds mainly invest in U.S. Treasury securities, government agency securities, repurchase agreements, CDs, commercial paper and bankers' acceptances. Many other types of investments are eligible for taxable money market funds. For instance, if you are partial to the housing sector, you can buy a money market fund that solely invests in Fannie Maes.

Tax-free funds, on the other hand, do not provide as many options. These funds invest in short-term debt obligations issued by federally tax-exempt entities (municipal securities) and have a lower yield. In some areas, you can purchase tax-free funds that exempt you from both state and local taxes; however, these kinds of exemptions are exceptions rather than the norm, so be sure to check out all the details before you decide to purchase one. (For related reading, see Weighing The Tax Benefits Of Municipal Securities.)

Weighing the Costs of Taxes and Lower Returns
If you are deciding between tax and tax-free funds, it is important to calculate whether the tax savings created by the tax-free fund will be enough to make its lower yield worthwhile. Taxable funds generally have higher returns, but, if the tax on those returns is greater than the additional return you receive in comparison to its tax-free counterpart, the more optimal choice for an investor is to purchase the tax-free fund.

Keep in mind that you can't just compare the two yields by themselves - what you need to do is convert the tax-free yield into an equivalent taxable yield. This can be accomplished with the following formula:
Taxable Equivalent Yield = Tax-Free Yield / (1 – Marginal Tax Rate)
Example - Calculating Taxable Equivalent Yield
Let\'s say that you are in the 28% tax bracket and need to choose between the taxable money market fund with a yield of 1.5% and a tax-free fund with a yield of 1.2%. By converting the tax-free yield into a taxable equivalent yield (using the formula above), we get 1.67%, so the choice is obvious: the tax-free money market is the way to go because the tax savings provide a better yield. As you move into higher tax brackets, the better the taxable equivalent yield becomes. (For a more detailed look at the implication of taxable equivalent yield, see Retirees Can\'t Count On Muni Bonds.)

When to Be Cautious Before you jump in to buy a money market fund, you should be aware of three areas of concern to investors:

  • Expense Ratio
    As with regular mutual funds, money market funds also have expenses, and, because the returns are relatively low, a higher-than-average expense ratio is going to eat into these returns. (To learn more, read Stop Paying High Fees.)
  • Investment Objective
    If you are a long-term investor working on building a retirement fund, an overly large position in money market funds is not appropriate. Investment Company Institute statistics indicate that 23% of 401(k) (and other similar) plan investments are in money market funds. While admittedly safe, an allocation of this size in this asset class is unwarranted. The returns on these funds are generally only slightly above the rate of inflation and are not sufficient to produce an adequate nest egg. Instead, money market funds should be used as a portfolio management tool to park money temporarily and/or accumulate funds for an anticipated cash outlay. (For more on this strategy, read Get A Short-Term Advantage In The Money Market.)

Risk Factors Investors in money market funds think of these mutual funds as risk-free, but this is not an absolute given. Since the adoption of money market funds in 1983, only once has such a fund failed to repay an investor's full principal amount. In 1994, the Community Bankers Money Market Fund of Denver got in trouble and paid out only $0.96 on the dollar upon liquidation. This so-called "breaking the buck" (money market investors have come to expect dollar-for-dollar treatment) is generally considered a very remote possibility, but it could happen - there's no guarantee. As such, ask your fund company what's in your money market fund and to stick to funds sponsored by the prime investment companies in the industry - they have a huge stake in maintaining a net asset value of $1 per share.

Conclusion Whether you decide to use money market funds as an investment vehicle or as a temporary place to stash money while waiting for the right security to buy, make sure you know as much as possible about the fund and make certain it's the best one for you.

2016's Most Promising Money Market Funds

By J.B. Maverick | January 26, 2016

Investors entering 2016 who are sensing uncertainty or a possible downturn in the stock market may wish to allocate at least part of their investment portfolio to safer, income-oriented investments. One possible choice is money market funds. Money market funds are not the same as a money market account. Money market accounts are more or less high-yield savings accounts, while money market funds are mutual fund investments made in various debt securities that may include government and corporate debt.

Money market funds are not FDIC-insured and carry a risk level commensurate with the creditworthiness of the debt issuers and the fund's specific debt securities. However, despite some risk, money market funds are still generally considered a very safe investment. Since the Federal Reserve Bank's decision in December 2015 to raise interest rates should boost money market fund returns, the beginning of 2016 may be an opportune time to consider money market funds for your investment portfolio.

The following are five of the top-ranked and most-promising money market funds for 2016. Because of the relatively low returns offered by money market funds, fees are critically important in determining an investor's real return on investment. None of the funds detailed below charge 12b-1 fees or sales loads. Investors should consider the total picture of yield offered, risks and fees when selecting a money market fund.

1) Fidelity Money Market Fund - Premium Class

The Fidelity Money Market Fund - Premium Class was launched in 1989. With $5.6 billion in assets under management (AUM), the fund invests in U.S. dollar-denominated money market securities, both domestic and foreign, as well as repurchase agreements and reverse repurchase agreements. Certificates of deposit and financial company commercial paper make up more than half the portfolio. The fund's expense ratio is 0.28%. The seven-day yield is 0.26% and 10-year total return for the fund is 1.33%.

2) American Century Capital Preservation Fund
American Century launched the Capital Preservation Fund in 1972. The fund has $2.4 billion in assets. With the primary investment goals of maximum safety and liquidity, this fund is almost exclusively invested in U.S. Treasury bills and bonds. The expense ratio is a very low 0.04%. The seven-day yield is 0.01% and 10-year total return is 1.03%.

3) Vanguard Federal Money Market Fund Investor Class
The Vanguard Federal Money Market Fund, with $4.8 billion in portfolio assets, aims for income and capital preservation through a conservative investing strategy of holding short-term U.S. government securities and repurchase agreements. This fund, launched by Vanguard in 1981, has a relatively low expense ratio of 0.11%. The seven-day yield is 0.23% and 10-year return is 1.27%.

4) Fidelity Government Money Market Fund
The Fidelity Government Money Market Fund seeks the highest possible level of income consistent with capital preservation. The fund was launched in 1990 and has $45 billion in total assets. Typically, the fund's assets are at least 99% invested in either U.S. government securities, cash or fully collateralized repurchase agreements. The fund's expense ratio is 0.15%. The seven-day yield is 0.01% and 10-year cumulative return for the fund is 1.21%.

5) Schwab Cash Reserves Fund
The Schwab Cash Reserves Fund, launched in 2004, aims for high current income within the bounds of capital preservation and liquidity. The fund invests its $40 billion in assets under management in high-quality, short-term money market securities, including U.S. Treasury bills, commercial paper, repurchase agreements, certificates of deposit and various other debt securities from both domestic and foreign issuers. The expense ratio for this fund is 0.16%. The seven-day yield is 0.07% and 10-year return is 1.19%.

Managing Cash

Cash Management

What is "Cash Management"
Cash management is the corporate process of collecting, managing and (short-term) investing cash. A key component of ensuring a company's financial stability and solvency. Frequently corporate treasurers or a business manager is responsible for overall cash management.

Successful cash management involves not only avoiding insolvency (and therefore bankruptcy), but also reducing days in account receivables (AR), increasing collection rates, selecting appropriate short-term investment vehicles, and increasing days cash on hand all in order to improve a company's overall financial profitability.

BREAKING DOWN "Cash Management"

Successfully managing cash is an essential skill for small business developers because they typically have less access to affordable credit and have a significant amount of upfront costs they need to manage while waiting for receivables. Wisely managing cash enables a company to meet unexpected expenses in addition to handling regularly-occurring events like payroll.

Why Cash Management Is Key To Business Success

By Poonkulali Thangavelu | April 15, 2015

Cash is the lifeblood of a business and a business needs to generate enough cash from its activities so that it can meet its expenses and have enough left over to repay investors and grow the business. While a company can fudge its earnings, its cash flow provides an idea about its real health.

Cash is King

By generating enough cash, a business can meet its everyday business needs and avoid taking on debt. That way, the business has more control over its activities. In a situation in which a business has to take on debt to meet its expenses, it is likely that its debtors will have a say in how the business is run. If they have contrary opinions to the management’s, that could be an impediment to the way management executes its vision for the business.

Without generating adequate cash to meet its needs, a business will find it difficult to conduct routine activities such as paying suppliers, buying raw materials, and paying its employees, let alone making investments. And it should have sufficient cash to pay dividends and keep its investors happy. Some companies also use their cash to engage in share buybacks to reward investors.

Improving Cash Management

Even if a company is making a profit, by making more revenue than it incurs in expenses, it will have to manage its cash flow correctly to be successful. A company’s cash flow is tied to its operations or business activities, to its investment activities (such as the purchase or the sale of capital equipment), and to its financing activities (such as raising debt or equity funding or repaying such funding). The cash that a company generates from its operations is tied to its core business activities and provides the best opportunities for cash flow management.

Areas that offer possibilities for better cash management include accounts receivable, accounts payable, and inventories. If a company were to grant credit indiscriminately, without ascertaining the credit worthiness of its customers, and not follow up on tardy payments, that would lead to a slower and smaller inflow of cash, as well as unpaid bills. That is why it is important to have a credit policy and follow up on tardy payments. On the other hand, when it comes to accounts payable, it is better cash management to pay suppliers later rather than earlier. As well, it is important not to have too much cash tied up in inventories, but to have on hand just enough inventories for the immediate needs of the business.

Striking the Right Balance

There is a right balance between having too much cash on hand, out of precaution, and having an inadequate supply. If a business has too much cash, it is missing out on opportunities to invest the cash and generate additional earnings. On the other hand, if it doesn’t have an adequate supply of cash, it will have to borrow the money, and pay interest, or sell off its liquid investments to generate the cash it needs. If the business expects to generate a better return on its investments than it pays in interest on its borrowings, it might decide to invest its surplus cash and borrow any additional money it needs for its activities. In analyzing a company’s balance sheet, certain ratios such as a firm’s acid-test ratio, or the ratio of its most liquid current assets (including cash, accounts receivable, and marketable securities) to its current liabilities provide an idea about its cash management. While a ratio of greater than one indicates a healthy current assets situation, a very high ratio could indicate that the firm holds too much cash or other liquid assets.

The Bottom Line

A company has to generate an adequate cash flow from its business in order to survive. In addition to generating cash from its activities, a business also needs to manage its cash situation so that it holds the right amount of cash to meet its immediate and long-term needs.

College Financial Aid

Education Planning - Types of Financial Aid and College Loans

  1. Types of Financial Aid
    • Grants and scholarships - Grants do not have to be paid back and are awarded by federal and state governments and individual institutions. Scholarships are usually based on merit.
      • Pell Grant - A federal grant that provides up to $2,340 a year. Awarded to the neediest students.
      • Supplemental Educational Opportunity Grant - A federal grant program for low-income students. The government distributes funds to individual schools, which are responsible for awarding grants of up to $4,000 per year.
    • Work - Helps pay for books, supplies and personal expenses. Includes Work-Study, a federal program providing part-time employment on campus or in surrounding communities.
    • Loans - Most financial aid comes in the form of loans that must be repaid. Includes both government-sponsored loans and private loans for students and parents.
  2. II. College Loans

    There are a variety of loan programs to assist families with covering higher education expenses. Some are need-based, others are not. Need-based loans usually have better terms and should be considered first.

    • Federal student loans - There are three main types of federal student loans
      • Perkins Loans - Need-based loans awarded to students with the highest need. Features very low interest rate. Student not required to make any loan payments while in school.
      • Subsidized Stafford Loans - Need-based loans, also with very low interest rates. The federal government pays the interest on the loan while child is in school and during six-month grace period following graduation.
      • Unsubsidized Stafford Loans - Not based on financial need. Student is responsible for paying interest on the loan that accrues during in-school period. Student may pay interest while in school or have the interest added to the principal upon graduation.
    • Other student loan options
      • Private student loans - Many lenders offer private education loans to students. These loans are not subsidized and usually carry a higher interest rate than federal need-based loans.
      • College-sponsored loans - Some colleges operate their own loan funds. Interest rates may be lower than federal student loans.
    • Parent loans
      • Federal PLUS Loan - Largest source of parent loans. Parents can borrow up to the full cost of attendance, minus any aid received. Repayment starts 60 days after funds are sent to the school.
      • Private parent loans - Many lenders offer private education loans to parents. They usually come with a higher interest rate than the PLUS Loan.

Consolidation loan - A loan that combines several student loans into one, larger loan from a single lender. The interest rate may be lower than on the underlying loans. The total monthly payment may be lowered by extending the term of the loan. A term extension, however, will increase the total interest paid.

5 Ways to Get Maximum Student Financial Aid

By Daniel Kurt | Updated December 02, 2015

As the price of a college education continues to soar, many American families are counting on significant outside help to foot the bill. Consider that the average cost of an out-of-state public university is now nearly $24,000 per year, according to The College Board. For private schools, tuition and fees average almost $32,500.

For students who haven't earned lucrative scholarships, need-based financial aid can play a vital role. The key to receiving a generous package rests in large part on the Free Application for Federal Student Aid form, better known as the FAFSA. This is the document that schools use to determine federal aid, including Federal Direct Loans and Pell Grants. Many institutions also use it to decide whether students are eligible for any of their own scholarship funds.

Much of the time, parents don’t give the FAFSA much thought before the deadline. By understanding how the form works, however, you’ll have a better chance of meeting the criteria for aid. It’s also important to look beyond the form itself and realize that finding the right school can be just as important to your aid prospects as what you put in the document. Here are some basic steps for ensuring that you get the best combination of grants, loans and work-study programs possible.

1. File Early Perhaps the easiest move you can make is to fill out the FAFSA as early in the year as possible. That’s because many federal loans and grants are awarded on a first-come, first-served basis. Even if the university has a much later deadline, it helps to submit the document as soon after Jan. 1 as possible.

Many parents assume they have to put the FAFSA on hold until they complete their previous year’s tax return. Unfortunately, doing so can put your chances of need-based assistance in serious jeopardy. If need be, fill out the financial aid documents right away using the previous year’s data. Just be sure to amend your figures once you finish your more-recent tax filing. You can do this automatically by using the IRS Data Retrieval Tool on the official FAFSA website, which is available roughly three weeks after you file the form.

2. Minimize Your Taxable Income The FAFSA is the main tool universities rely on to determine the applicant’s “expected family contribution” (EFC) – that is, the estimated amount the student and his or her parents can kick in toward tuition and other expenses. All else being equal, a lower EFC will result in greater need-based aid.

When calculating the family’s portion of expenses, the biggest factor is its income level. Needless to say, it helps to keep the amount of taxable income as low as possible in the base year.

How can a family accomplish this feat without hurting itself in the short term? One way is to postpone the sale of stocks and bonds, if they will generate a profit, as the earnings will count as income. That also means holding off on early withdrawals from your 401(k) or IRA. In addition, ask your employer if you can defer any cash bonuses to when they won’t have a negative impact on your child’s financial aid.

3. Be Careful About Who ‘Owns’ Your Assets If you’ve been putting money away for your children’s college education over the years, you’ll be in much better shape when they graduate from high school. But all that saving does have a small catch – some of that money will be included in your EFC.

One important aspect to realize about the FAFSA is that schools anticipate students will contribute more of their assets toward higher education than parents will. According to the Web site, 20% of the child’s assets are assessed in the needs analysis, as opposed to the maximum rate of 5.64% of the parent’s assets.

Consequently, in most cases, your application will fare much better if any college savings accounts are in a parent’s name. So if you set up a Uniform Gift to Minors Act (UGMA) account for your son or daughter to avoid gift taxes, you could be hurting your chances of need-based aid. Often, you’re better off emptying these accounts and putting the money into a 529 College Savings Plan or a Coverdell Education Savings Account. Under current rules, these are both treated as a parent’s asset, as long as the student is classified as a dependent for tax purposes.

4. Don’t Assume You Won’t Qualify Having a substantial family income doesn’t always mean that financial aid is beyond your reach. It’s important to remember that the needs-analysis formula is complex. According to the U.S. Department of Education, factors such as the number of students attending college and the age of the parents can affect your award. It’s always a good idea to fill out the FAFSA just in case.

Keep in mind, too, that some universities won’t offer their own financial aid, including academic scholarships, if you don’t fill out the FAFSA first. The assumption that the form is only for low- and middle-income families often closes the door to any such opportunities.

5. The FAFSA Isn’t the Whole Picture While the FAFSA is an immensely important tool in determining need-based aid, some families actually put too much emphasis on the document. The fact is, most financial-aid counselors have the authority to use resources as they see fit. The expected family contribution usually plays a big role, but it may not be the only factor they’ll consider.

The more an institution values the student’s skills and experiences, the more likely it is to woo him or her with an attractive aid package. The key is to look for colleges that represent a good fit, and to reach out to the financial aid office about your child’s prospects for grants or federally subsidized loans. This, in addition to its academic reputation, can help families select whether a school is worth pursuing.

The Bottom Line

A generous financial-aid award can take much of the sting out of college tuition costs. The best way to improve your child’s chances of getting one is by filing early and doing whatever you reasonably can to reduce your family’s estimated contribution.

Student Financial Aid Changes: FAFSA 2015-2016

By Amanda C. Haury | Updated November 20, 2015

College application season is in high gear and parents and students preparing to go to college for the first time are gearing up for financial aid applications. Those not graduating this spring need to prepare for next year's applications. Going to college is an expensive venture. From tuition and textbooks to stocking up a dorm room with all the essentials your child will need, most college students could use all the financial assistance that the government could possibly offer.

Whether you are sending your child to college for the first time, or you are a seasoned veteran, you are bound to face some changes when it comes to financial aid in the year ahead. The first step in getting this aid is to fill out the Application for Federal Student Aid (FAFSA), which becomes available in early January each year.

Here is a look at the current requirements for FAFSA and other federal student aid programs in 2015-2016 and how they will affect what you can get.

Federal Student Aid for 2015-2016

You can apply for aid between Jan. 1, 2015 and June 30, 2016; next year's deadlines should be similar. Click here to check. That's why it makes sense to complete the FAFSA as soon as possible each year after it becomes available in early January.

Pell Grants Increased Amount
Pell grants are a federally funded grant that are rewarded to students who are at-need, and meet financial requirements. Pell grants are intended to help lower the out-of-pocket costs of college tuition for financially struggling families in the United States. The maximum Pell Grant amount is $5,775, which is a $45 increase over last year's reward amount. Please note that you may not receive the total reward amount; this is simply the maximum allowed for the 2015-2016 calendar year.

Higher Allowance for Student Earnings
The student earnings allowance – the amount a student can earn before his/her earnings are considered as part of available income for their family contribution – rose to $6,310 per year, from $6260.

Qualification For Automatic Zero EFC
The qualifications for Automatic Zero EFC, or Expected Family Contribution is unchanged from recent years. A student can receive an automatic Zero Expected Family Contribution when his or her family's income is $24,000 or less annually.

IRS Data Retrieval
The FAFSA filing process has changed, and it is recommended that all students use the IRS Data Retrieval tool to obtain their or their parents' federal tax return. Using this tool will eradicate common errors on FAFSA forms, and keep your application for student financial aid running smoothly. Tax information is available through the tool approximately 2-3 weeks after tax return submission, and by now all data should be in and finalized. Also keep in mind that Federal 1040 tax returns are no longer an acceptable form of verification for the FAFSA.

Fees for Federal Direct Loans Slightly Lower
The loan fee for direct educational loans from both subsidized and unsubsidized organizations dropped from 1.073% to 1.068%. If you are a borrower of a Direct PLUS loan, you should be aware that the loan fee also fell slightly, from 4.292% to 4.272%.

The Bottom Line

Similar to other years, 2015-2016 has seen some changes in how to file and receive financial aid. Keep in mind that loan rates, grant rewards and financial requirements regularly change, so it is important that you know the exact requirements prior to filing your FAFSA forms. Also remember that there are updates to the FAFSA website as well, and there are plenty of helpful resources on the FAFSA website such as the FAFSA/IRS Outreach, FAFSA Webinar and more. Prior to filing for financial aid, be sure that you fully understand all the changes and how they can affect your filing status.

Effects of Inflation

What You Should Know About Inflation

By Richard Loth

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase as reported in the Consumer Price Index (CPI), generally prepared on a monthly basis by the U.S. Bureau of Labor Statistics. As inflation rises, purchasing power decreases, fixed-asset values are affected, companies adjust their pricing of goods and services, financial markets react and there is an impact on the composition of investment portfolios.

Inflation, to one degree or another, is a fact of life. Consumers, businesses and investors are impacted by any upward trend in prices. In this article, we'll look at various elements in the investing process affected by inflation and show you what you need to be aware of.

Financial Reporting and Changing Prices
Back in the period from 1979 to 1986, the Financial Accounting Standards Board (FASB) experimented with "inflation accounting," which required that companies include supplemental constant dollar and current cost accounting information (unaudited) in their annual reports. The guidelines for this approach were laid out in Statement of Financial Accounting Standards No. 33, which contended that "inflation causes historical cost financial statements to show illusionary profits and mask erosion of capital."

With little fanfare or protest, SFAS No. 33 was quietly rescinded in 1986. Nevertheless, serious investors should have a reasonable understanding of how changing prices can affect financial statements, market environments and investment returns.

Corporate Financial Statements
In a balance sheet, fixed assets - property, plant and equipment - are valued at their purchase prices (historical cost), which may be significantly understated compared to the assets' present day market values. It's difficult to generalize, but for some firms, this historical/current cost differential could be added to a company's assets, which would boost the company's equity position and improve its debt/equity ratio.

In terms of accounting policies, firms using the last-in, first-out (LIFO) inventory cost valuation are more closely matching costs and prices in an inflationary environment. Without going into all the accounting intricacies, LIFO understates inventory value, overstates the cost of sales, and therefore lowers reported earnings. Financial analysts tend to like the understated or conservative impact on a company's financial position and earnings that are generated by the application of LIFO valuations as opposed to other methods such as first-in, first-out (FIFO) and average cost.

Market Sentiment
Every month, the U.S. Department of Commerce's Bureau of Labor Statistics reports on two key inflation indicators: the Consumer Price Index (CPI) and the Producer Price Index (PPI). These indexes are the two most important measurements of retail and wholesale inflation, respectively. They are closely watched by financial analysts and receive a lot of media attention.

The CPI and PPI releases can move markets in either direction. Investors do not seem to mind an upward movement (low or moderating inflation reported) but get very worried when the market drops (high or accelerating inflation reported). The important thing to remember about this data is that it is the trend of both indicators over an extended period of time that is more relevant to investors than any single release. Investors are advised to digest this information slowly and not to overreact to the movements of the market.

Interest Rates
One of the most reported issues in the financial press is what the Federal Reserve does with interest rates. The periodic meetings of the Federal Open Market Committee (FOMC) are a major news event in the investment community. The FOMC uses the federal funds target rate as one of its principal tools for managing inflation and the pace of economic growth. If inflationary pressures are building and economic growth is accelerating, the Fed will raise the fed-funds target rate to increase the cost of borrowing and slow down the economy. If the opposite occurs, the Fed will push its target rate lower.

All of this makes sense to economists, but the stock market is much happier with a low interest rate environment than a high one, which translates into a low to moderate inflationary outlook. A so-called "Goldilocks" - not too high, not too low - inflation rate provides the best of times for stock investors.

Future Purchasing Power
It is generally assumed that stocks, because companies can raise their prices for goods and services, are a better hedge against inflation than fixed-income investments. For bond investors, inflation, whatever its level, eats away at their principal and reduces future purchasing power. Inflation has been fairly tame in recent history; however, it's doubtful that investors can take this circumstance for granted. It would be prudent for even the most conservative investors to maintain a reasonable level of equities in their portfolios to protect themselves against the erosive effects of inflation.

Inflation will always be with us; it's an economic fact of life. It is not intrinsically good or bad, but it certainly does impact the investing environment. Investors need to understand the impacts of inflation and structure their portfolios accordingly. One thing is clear: depending on personal circumstances, investors need to maintain a blend of equity and fixed-income investments with adequate real returns to address inflationary issues.

Property and Casualty Insurance

Property And Casualty Insurance

By Cathy Pareto

Property and casualty insurance is insurance that protects against property losses to your business, home or car and/or against legal liability that may result from injury or damage to the property of others. This type of insurance can protect a person or a business with an interest in the insured physical property against losses. Let's examine some of the things to look for in the different types of property/casualty insurance.

Auto Insurance

  • Coverage: An auto insurance policy typically covers you and your spouse, relatives who live in your home and other licensed drivers to whom you give permission to drive your car. The policy is "package protection", which provides coverage for both bodily injury and property damage liability as well as physical damage to your vehicle. This damage can include both that caused by the collision and damage cause by things "other than collision", such as flood, fire, wind, hail, etc.
  • Common Types of Coverage: Auto insurance typically covers personal injury (PIP), medical payments, uninsured motorist, underinsured motorist, auto rental, emergency road assistance and other damages to your car not caused by a collision such as flood, fire and vandalism. Other coverage is available, too.
  • Deductible: The deductible is the amount that you will pay out of pocket when you file a claim. Typically, the higher the deductible, the lower your premiums.
  • Insurance Rates: How much you pay will depends on many factors, including your driving record, the value of your vehicle, where you drive, how much you drive, your marital status, your desired coverage, your age, sex and even your credit history.
  • Homeowners Insurance: Our homes and their contents are our greatest assets. That is why it is so imperative that we protect their value. Homeowners insurance helps us achieve that goal. Let's break down the different concepts that encompass this area.
  • Coverage: Homeowners insurance typically covers the dwelling (the structure), personal property and contents, and some forms of personal liability. The policy may cover direct and consequential loss resulting forms damage to the property itself, loss or damage to personal property, and liability for unintentional acts arising out of the non-business, non-automobile activities of the insured and members of that insured's household.
  • Types of Insurance: Are you ready to decipher the codes? There are six standard forms of homeowners insurance containing personal property coverage.
    • HO 00 02 (Homeowners 2, Broad Form)
      This form of insurance provides broad form coverage on your dwelling and other structures and insures against loss of use. To be specific, the broad form of coverage insures against windstorm, hail, aircraft, riot, vandalism, vehicles, volcanic, explosion, smoke, fire, lightening and theft , plus rupture of a system, artificially generated electricity, falling objects and freezing of plumbing.
    • HO 00 03 (Homeowners 3, Special Form):
      This "special form" insurance offers coverage for more causes of loss than the HO 00 02.
    • HO 00 04 (Homewoners 4, Contents Broad Form):
      This is a renter's policy. Even if you don't own your home, you should consider having this type of insurance. Your landlord's insurance will not cover damage to your personal property or liability against you. Think about how much it will cost to replace all of your furniture, clothing etc. If you feel this isn't a loss you could bear, consider buying this type of insurance.
    • HO 00 05 (Homeowners 5, Comprehensive Form):
      This type of policy essentially combines the HO 00 03 form with the HO 00 05 endorsement into one comprehensive form to provide open perils coverage on personal property in addition to the dwelling, other structures and loss of use. The HO 00 05 rider can only be combined with an HO 00 03 policy.
    • HO 00 06 (Homeowners 6, Unit Owners Form) :
      This is a condominium policy. This type of policy is different from a homeowners insurance policy in that it is designed for individuals who live in a unit structure owned and insured by a condo association, townhouse association cooperative, homeowner's association, planned community or other similar type of organization. The insurance the association provides only covers the outside dwelling, not the contents of your unit, so it's important to consider purchasing this type of insurance to protect against personal property losses and liability.
    • HO 00 08 (Homeowners 8, Modified Coverage Form):
      This form of insurance settles losses on an actual cash value basis and is usually only used to cover older structures where the cost of replacement far exceeds the value of the structure. This type of insurance is offered when insurers are not willing to offer HO 00 02, 03 or 05 coverage because there may be an incentive to intentionally destroy the structure.Now let's take a look at what is usually not covered under these types of insurance. These are known as "exclusions", but you may be able to get coverage in these areas with a rider or umbrella policy. Your individual policy may exclude more items than listed below, so consult with your agent.
      1. Ordinance or Law: If the dwelling does not comply with local building codes, the insurer will not be liable for the cost of construction to bring the structure up to code.
      2. Earth Movements: This includes two distinct types of earth movements, including shifting earth (landslides) in the foundation of a home and earthquakes. These may be considered two separate coverage areas, so being covered for one may not mean being covered for the other.
      3. Water Damage: This includes flood, water backing up in sewers or drains, water seeping through basement walls etc.
      4. Neglect: This excludes losses resulting from direct or indirect neglect and failure to use reasonable means to protect property.
      5. War: Damage caused by any type of war or nuclear weapons attack.
      6. Nuclear Hazard: This defined as any nuclear reaction, radiation, or radioactive contamination, (whether controlled or uncontrolled). Any loss caused by nuclear hazard as it is defined will not be considered loss caused by fire, explosion, or smoke, even if these perils are specifically named in your policy.
      7. Intentional Loss: Any damage intentionally done to one's own property is excluded for obvious reasons.

As with any type of insurance, it is critical that you read the insurance policy so that you know exactly what it will cover. The amount of coverage you should consider should be based on the replacement cost value of your home or property. Replacement costs on one's dwelling provides that if, at the time of loss, the amount of insurance covers at least 80% of the replacement cost of the dwelling, the loss will be paid on a replacement cost basis. Keep in mind that this still leaves the homeowner on the hook for the remaining 20% in the event of a total loss.

Oftentimes, the bank or institution holding your mortgage will require that you maintain a specific amount of coverage. However, even if your home is paid off, you should still consider having the appropriate amount of insurance protection, which might include coverage for physical damage as well as liability protection for the owners.

Other Considerations
Depending on where you live and given the unpredictability of nature, specifically the weather, you should consider other types of insurance to protect your property. For example:

Flood Insurance
Flood insurance is becoming more and more popular as places that normally would not experience floods are suddenly finding themselves suffering losses as a result of extreme weather. To the surprise of many of these homeowners, their regular homeowners insurance policy did not cover against flood. This is a separate type of coverage that you will have to purchase if you consider flood to be a risk for your business or property.

If you live in a flood-prone area and you have a mortgage, the lender will require you to purchase adequate coverage to insure the property. If you own the property, you can elect to self-insure and not buy insurance, but you have to remember that any damage caused as a result of flooding will be your financial responsibility. The cost of this kind of damage can run from the hundreds to thousands of dollars, so it's worth considering purchasing the insurance to transfer this risk, especially, if you live in a flood zone. If you don't live in a flood-prone area, you may qualify for a discounted rate, which means a lower premium for you.

Windstorm Insurance
Like flood insurance, windstorm insurance is a separate type of coverage that protects your home or business against wind damage. Wind damage may result from items flying and destroying your property as a result of a hurricane, hail, snow, sand or dust.Coverage for windstorm may be limited in states prone to hurricane and tornadoes. If you live in a state like Florida, Louisiana, Texas or the Carolinas, which are frequently barraged by tropical storms or hurricanes, this should be an integral part of your asset protection planning. Consult with your agent or broker for more details on this type of coverage.

Umbrella Liability Policies
Umbrella insurance helps you protect your assets if you are sued. If you are worried that the liability insurance coverage you have through your auto or property policies is still not enough, you can consider adding an umbrella policy. An umbrella policy is basically an additional policy that kicks in when your other insurance policies have reached their limits. The amount of coverage and types of coverage offered by these policies varies, as will their premiums. You can tag on an umbrella policy to your homeowners or auto insurance policy to protect your assets against liability or lawsuits.

Certain exclusions apply, including:

  • Owned or leased aircraft or watercraft
  • Business pursuits
  • Professional services
  • Any act committed by the insured with the intent to cause personal injury or property damage

Umbrella policies are fairly inexpensive to acquire, and coverage ranges from $1 million to $ 5 million or more. You might expect to pay between $200 to $500 for $1 million in coverage. There is no specific "umbrella deductible". Because an umbrella policy is written on top of any auto or personal property coverage you have, the benefit does not kick in until you satisfy the deductible on those policies and have used up the coverage from either the auto or property policy.

Homeowners Tips
Homeowners insurance is a critical component of anyone's risk management planning. There may always be a threat of property loss from fire, theft or bad weather. Having an accurate home inventory of your possessions can make settlement claims a lot easier and faster. Insurance agents suggest that all homeowners keep receipts, descriptions, photos or video of the items they own. Once your list and evidence of ownership is itemized, store this in a safety deposit box or other safe location outside of your home, along with a copy of your policy.

Split-Dollar Life Insurance

Split Dollar Life Insurance: How it Works

By Richard Rosen

Split dollar life insurance isn’t an insurance product or a reason to buy life insurance. Split dollar is a strategy that allows the sharing of the cost and benefit of a permanent life insurance policy. Any kind of permanent life insurance policy that builds a cash value can be used.

What Is Split Dollar?

Most split dollar plans are used in business settings between an employer and employee (or corporation and shareholder). However, plans can also be set up between individuals (sometimes called private split dollar) or by means of an Irrevocable Life Insurance Trust (ILIT). This article primarily discusses arrangements between employers and employees; however, many of the rules are similar for all plans.

In a split dollar plan, an employer and employee execute a written agreement that outlines how they will share the premium cost, cash value and death benefit of a permanent life insurance policy. Split dollar plans are frequently used by employers to provide supplemental benefits for executives and/or to help retain key employees. The agreement outlines what the employee needs to accomplish, how long the plan will stay in effect and how the plan will be terminated. It also includes provisions that restrict or end benefits if the employee decides to terminate employment or does not achieve agreed-upon performance metrics.

Since split dollar plans are not subject to any ERISA rules, there is quite a bit of latitude in how an agreement can be written. However, agreements do need to adhere to specific tax and legal requirements. Thus a qualified attorney and/or tax advisor should be consulted when drawing up the legal documents. Split dollar plans also require record keeping and annual tax reporting. Generally the owner of the policy, with some exceptions, is also the owner for tax purposes.

Limitations also exist on the usefulness of split dollar plans depending on the how the business is structured (for example as an S Corporation, C Corporation, etc.) and whether plan participants are also owners of the business.

History and Regulation

Split dollar plans have been around for many years. In 2003, the IRS published a series of new regulations that govern all split dollar plans. The regulations outlined two different acceptable split dollar arrangements: economic benefit and loan. The new regulations also removed some of the prior tax benefits, but split dollar plans still offer some advantages including:

  • Term insurance, based on Table 2001 rates, which may be at a lower cost than the actual cost of the coverage, particularly if the employee has health issues or is rated.
  • The ability to use corporate dollars to pay for personal life insurance which can leverage the benefit, especially if the corporation is in a lower tax bracket than the employee is.
  • Low interest rates if the Applicable Federal Rate (AFR), when the plan is implemented, is below current market interest rates. Plans with loans can maintain the interest rate in effect when the plan was adopted, even if interest rates rise in the future.
  • The ability to help minimize gift and estate taxes.

Economic Benefit Arrangement

Under the economic benefit arrangement the employer is the owner of the policy, pays the premium and endorses or assigns certain rights and/or benefits to the employee. For example, the employee is allowed to designate beneficiaries who would receive a portion of the policy death benefit. The value of the economic benefit the employee receives is calculated each year. Term insurance is valued using the Table 2001 annual renewable term rates, and the policy cash value is any increase that occurred during the year. The employee must recognize the value of the economic benefit received as taxable income every year. However, if the employee makes a premium payment equal to the value of the term life insurance and/or cash value received, then there is no income tax due.

A non-equity arrangement is when an employee’s only benefit is a portion of the term life insurance. In an equity split dollar plan, the employee receives the term life insurance coverage and also has an interest in the policy cash value. Plans may allow the employee to borrow against or withdraw some portion of cash value.

Loan Arrangement

The loan arrangement is significantly more complicated than is the economic benefit plan. Under the loan arrangement, the employee is the owner of the policy and the employer pays the premium. The employee gives an interest in the policy back to the employer through a collateral assignment. A collateral assignment places a restriction on the policy that limits what the employee can do without the employer’s consent. A typical collateral assignment would be for the employer to recover the loans made upon the employee’s death or at the termination of the agreement.

The premium payments by the employer are treated as a loan to the employee. Technically each year the premium payment is treated as a separate loan. Loans can be structured as term or demand and must have an adequate interest rate based on the AFR. But the rate can be below current market interest rates. The interest rate on the loan varies depending on how the arrangement is drafted and how long it will stay in force.

Terminating Split Dollar Plans

Split dollar plans are terminated at either the employee’s death or a future date included in the agreement (often retirement).

At the premature death of the employee, depending on the arrangement, the employer recovers either the premiums paid, cash value or the amount owed in loans. When the repayment is made, the employer releases any restrictions on the policy and the employee’s named beneficiaries, which can include an ILIT, receive the remainder as a tax-free death benefit.

If the employee fulfills the term and requirements of the agreement then all restrictions are released under the loan arrangement, or ownership of the policy is transferred to the employee under the economic benefit arrangement.

Depending on how the agreement was drafted, the employer may recover all or a portion of the premiums paid or cash value. The employee now owns the insurance policy. The value of the policy is taxed to the employee as compensation and is deductible for the employer.

The Bottom Line

Like many non-qualified plans, split dollar arrangements can be a very useful tool for employers looking to provide additional benefits to key employees.

Last-Survivor Life Insurance

Variable Survivorship Life Insurance

DEFINITION of "Variable Survivorship Life Insurance"
A type of variable life insurance policy that covers two individuals and pays a death benefit to a beneficiary, only after both people have died. Variable Survivorship Life Insurance does not pay any benefit when the first policyholder dies.

Variable survivorship life insurance is also called "survivorship variable life insurance" or "last survivor life insurance."

BREAKING DOWN "Variable Survivorship Life Insurance"
Like any variable life policy, variable survivorship life insurance has a cash value component in which a portion of each premium payment is set aside to be invested by the policyholder, who bears all investment risk. The insurer selects several dozen investment options from which the policyholder may choose. The other portion of the premium goes toward administrative expenses and the policy's death benefit (also called face value). This type of policy is legally considered a security, because of its investment component, and is subject to regulation by the Securities and Exchange Commission.

A more flexible version of variable survivorship life insurance called "variable universal survivorship life insurance" allows the policyholder to adjust the policy's premiums and death benefit during the policy's life.

Universal Life Insurance

A type of flexible permanent life insurance offering the low-cost protection of term life insurance as well as a savings element (like whole life insurance) which is invested to provide a cash value buildup. The death benefit, savings element and premiums can be reviewed and altered as a policyholder's circumstances change. In addition, unlike whole life insurance, universal life insurance allows the policyholder to use the interest from his or her accumulated savings to help pay premiums.

BREAKING DOWN "Universal Life Insurance"

Universal life insurance was created to provide more flexibility than whole life insurance by allowing the policy owner to shift money between the insurance and savings components of the policy. Premiums, which are variable, are broken down by the insurance company into insurance and savings, allowing the policy owner to make adjustments based on their individual circumstances. For example, if the savings portion is earning a low return, it can be used instead of external funds to pay the premiums. Unlike whole life insurance, universal life allows the cash value of investments to grow at a variable rate that is adjusted monthly.

Universal Life Insurance: Hidden Dangers for Retirees

By Tim Parker | February 17, 2016

You might think of life insurance as a product that replaces your income when you pass away, thus providing support to your dependents. But some life insurance policies act more like investments than insurance. They can also provide you with another income stream after you are retired (but still very much alive).

Universal life insurance is one such instrument. A variety of permanent life insurance plan (which doesn't expire, unlike term life insurance), this sort of policy covers your family if you die during your working years, but also has the ability to build savings that can be drawn upon later in life. But is it right for current or soon-to-be retirees? We asked a few experts about the potential pitfalls of holding and using this type of insurance in this way.

Types of Policies

Universal life policies can be broken down into three basic types, according to Jason Silverberg, vice-president of financial planning at Financial Advantage Associates in Rockville, Maryland. With each, your variable premiums go partially towards the insurance coverage, and partially towards the savings. But each invests the savings component of the policy, known as the policy's cash value, differently.

“The first flavor is fixed universal life. This policy has cash values invested in a guaranteed-interest account; some rates [now] are as high as 4%. Think of it like a CD or a money market fund. Your principal is protected and a fixed interest rate is declared.

“The second flavor is variable universal life, Silverberg continues. These policies have cash values invested in ‘sub-accounts,’ which are very similar to mutual funds. The sub-accounts could be invested in aggressive instruments or conservative instruments. Just like a 401(k), it’s advised to create a portfolio of many different sub-accounts that match the overall risk profile of the client, since the funds are subject to market fluctuations.

“Finally, the third flavor is indexed universal life. The cash value in these policies is technically not invested in the market; [instead, it's tied] to an interest rate based on a chosen index. One of the unique features of these products is that these indexes typically have a floor rate and a cap rate, which allows an individual to try to earn more than [he would with] the fixed policy, without the downside risk of a variable policy.”

A Dicey Income Source

How does the cash value translate into income? Technically, you won’t take actual withdrawals from your policy. Instead, you can take loans – only, you never have to pay them back. (You don't pay income taxes on them either.) Any money you withdraw is transferred from your death benefit; the more you withdraw, the more your death benefit shrinks. You are charged interest on the loans; many folks pay that out of the policy's accrued cash value, too.

So far, so good. But what happens if you don’t have enough cash value to cover the interest payments? It’s added to the overall loan balance and, since these are usually compound interest payments, the size of your debt can mushroom quickly.

Don't forget: With universal life plans, the cash value is often being used to pay all or some of the policy premiums. If they happen to rise dramatically – they're variable, remember – and the cash value is insufficient to cover them, you have to pay them out of pocket. If you can't, the policy may not be able to stay in force.

That's exactly what happened with many of the first generation of universal life policies, established some 30 years ago. “You can talk to many universal life policy owners who bought in the ’80s and have seen their polices lapse,” says Brad Cummins, founder of Local Life Agents, a Columbus, Ohio-based firm of independent insurance agents. “This happens when agents and insurance companies use unrealistic rates of return in the illustration [the industry term for the document that explains how a policy works].

“Some illustrations used anywhere from 11% to 15% returns, because that was the going rate at that time.” Cummins explains. “When the rates of return would drop over time [because prevailing interest rates declined], it meant the insured was not paying enough in premiums to sustain the policy. As a result, the premiums were not enough to cover the fees and cost of insurance, and they would take those directly from the cash value account to make sure the policy stayed in force. This would quickly eat into the cash value of the account and eventually lapse a universal life policy.”

When a policy lapses, you lose your death benefit, of course. But that's not all. After a lapse, any previously tax-free loans you took from the policy will be considered gains, and subject to income tax. Owners of lapsed policies who'd borrowed could face quite a hefty bill from the IRS. For more,

Policies with Over Loan Protection

Luckily, “over-illustrating a universal life policy is not as easy to do as it once was,” says Cummins. In June 2015, the National Association of Insurance Commissioners adopted a new actuarial guideline to regulate and standardize illustrations. “The new law AG49 makes sure the illustrated rate of return and its growth is realistic.”

Even so, universal life policyholders might do well to think about something called “over loan protection,” suggests Andrew Carrillo, founder and president of Barnett Capital Advisors, a firm of certified financial planners andwealth management advisors based in Miami. Not unlike overdraft protection for a checking account, “over loan protection protects the policy from lapsing when it has outstanding loans. This is important because a lapsed policy will cause all the previous loans that were taken to be fully taxable, which can be a huge mess. It’s important to check if your policy has this feature before you start taking loans, and if it doesn’t, then it can make sense to switch to one that does.”

The Age Factor

Because the cash value of your policy can be used to pay premiums, universal life can seem to be a money-saver: insurance that pays for itself, so to speak. But be aware that, as you age, the premium rises – sometimes dramatically, as you hit major milestones and start surpassing life expectancy tables. As a result, the nest egg you thought you were building could be eroded quickly. Be sure to evaluate your policy regularly to make sure the cash value portion is generating enough interest to cover premiums and costs.

Conversely, if cash value is performing really well, keep an even closer watch on it. When you die, will the policy have generated enough (in conjunction with your other assets) to trigger state and federal estate taxes? You don't want the bulk of your death benefit to end up in the hands of the IRS, instead of your heirs. If that could be a problem, Eugene Solomon, principal of the Solomon Insurance Agency (El Segundo, Calif.) suggests shifting ownership away from you and into an irrevocable trust. That effectively removes it from your estate which is one of the many reasons to own life insurance in an irrevocable trust.

The Bottom Line

Universal life insurance policies are complicated animals, and some financial advisors feel they may be simply too unpredictable and too full of unforeseen consequences for the average retiree to use as a cash cow. Traditional investments, such as bonds, and other insurance products, like annuities, may offer more stable and straightforward, if less sexy, sources of income in your retirement years.

Variable Life Insurance

What is a "Variable Life Insurance Policy"

A variable life insurance policy is a form of permanent life insurance, Variable life insurance provides permanent protection to the beneficiary upon the death of the policy holder. This type of insurance is generally the most expensive type of cash-value insurance because it allows you to allocate a portion of your premium dollars to a separate account comprised of various instruments and investment funds within the insurance company's portfolio such stocks, bonds, equity funds, money market funds and bond funds. In addition, because of investment risks, variable policies are considered securities contracts and are regulated under the federal securities laws; therefore, they must be sold with a prospectus.

BREAKING DOWN "Variable Life Insurance Policy"

The major advantage to variable policies is that they allow you to participate in various types of investment options while not being taxed on your earnings (until you surrender the policy). You can also apply the interest earned on these investments toward the premiums, potentially lowering the amount you pay. However, due to investment risks, when the invested funds perform poorly, less money is available to pay the premiums, meaning that you may have to pay more than you can afford to keep the policy in force. Poor fund performance also means that the cash and/or death benefit may decline, though never below a defined level. Also, you cannot withdraw from the cash value during your lifetime.

Variable life insurance was first sold in 1976, and variable universal life policies (VUL) were rolled out in the 1980s. However, VUL did not take off in popularity until the 1990s and sales have been up and down as the stock markets have gone through bull and bear cycles. According to LIMRA, in 2014 VUL sales were up, but still only represented about 6% of all life insurance premium sold.

What is VUL?

VUL a permanent life insurance policy that builds cash value, has flexible premiums and allows for loans. VUL also offers the policy owner the potential to earn a higher rate of return. Unlike whole and universal life policies that invest the cash value in a fixed account, VUL allows the policy owner to invest in a selection of mutual fund subaccounts. Mutual fund subaccounts are essentially clones of retail mutual fund shares offered in life insurance and annuity products. With VUL, the policy owner manages the allocation and decides how and when to invest the cash value into the subaccounts or a fixed account. Most policies do place restrictions on transfers in and out of the fixed account (unless it part of an automatic dollar cost averaging program) and limits on frequent transfers between subaccounts. If the investments don’t provide an adequate return, the policy owner may have to make additional premium payments and/or reduce the death benefit to keep the policy from lapsing. If the policy is properly managed, the cash value can grow, and distributions can be taken from the policy as low-cost loans and/or tax-free recovery of premiums paid (cost basis). Distributions may be limited and subject to with drawl or surrender charges.

As long as the policy stays in force any appreciation or income in the subaccounts is not taxed. However, if the policy lapses, any distributions, in excess of the cost basis, would be taxed as ordinary income. Consequently, the policy owner, rather than the insurer, is taking all the investment risk, since there are no guarantees.

How Does VUL Work?

Since VUL offers mutual fund subaccounts, it is sold with a thick prospectus (some are more than 100 pages). The policies have a lot of moving parts and can be difficult to fully understand, even for advisors.

When a premium payment is made, a sales or premium charge, which vary and can be as high as 8-10% is deducted. The premium charge allows the insurer to recover sales costs and pay taxes. VUL is subject to a premium tax that varies by jurisdiction and currently range from 0% to 3.5%. In many policies, the high initial premium charge is reduced in later years. The remaining premium is added to the policy cash value and invested in the selected subaccounts. Each month, the cost of insurance, administrative costs, asset-based charges (in addition to the subaccount management fees) and other expenses are deducted from the policy cash value. These costs vary by product and company.

Premium Payments

The planned premium is calculated based on a variety of factors including the insured’s age, sex and health; assumed rate of return; level or increasing death benefit; additional policy riders, such as a disability waiver of premium. Many policies also offer a no-lapse premium, which if paid guarantees that the policy will stay in force for a certain number of years (in some policies up to 20 years) even if the cash value in the policy dropped to nothing.

Once the policy has been issued, the policy owner can pay whatever amount of premium they want as long as it does exceed a maximum that is governed by federal tax laws and limit premium payments relative to the amount of insurance in the policy. If they exceed the maximum, the policy can become a modified endowment contract.

The appreciation potential of the subaccounts and premium flexibility are reasons why VUL is often used in non-qualified executive benefits plans, such as split-dollar plans. These individuals have typically maximized contributions to qualified plans, and the goal is to build cash value while buying as little insurance as possible.(See also: Can You Fund Nonqualified Deferred Compensation Plans With Life Insurance?)

Managing the Policy

Unlike more traditional, whole and universal life policies, VUL needs to be actively managed. The subaccounts performance needs to be monitored, and the allocation of the cash value should be rebalanced periodically. Also, other strategies, such as paying the premium monthly to dollar cost average into the subaccounts and having the cost of insurance drawn from the fixed account, rather than the variable accounts, can make sense.

The Bottom Line

Due to its flexibility, some advisors call VUL the Swiss army knife of insurance products. And illustrations with soaring cash values based on a hypothetical 8% gross return can be appealing. However, you really need to stop and think about why you are buying insurance and where you want to take investment risk? If you want a guaranteed premium and death benefit, then VUL may not be the best choice.

Insurance Claims

What is an "Insurance Claim"

An insurance claim is a formal request to an insurance company asking for a payment based on the terms of the insurance policy. Insurance claims are reviewed by the company for their validity and then paid out to the insured or requesting party (on behalf of the insured) once approved.

BREAKING DOWN "Insurance Claim"

Insurance claims cover everything from death benefits on life insurance policies to routine health exams at your local doctor. In many cases, claims are filed by third parties on behalf of the insured person, but usually only the person(s) listed on the policy is entitled to claims payment.

Will Filing An Insurance Claim Raise Your Rates?

By Lisa Smith

You buy insurance to protect your home and car from damage, but when an accident happens, is it in your best interest to file a claim? It seems like the answer should be a resounding "yes," but a middling "maybe" is a far better response. Why the ambiguity? The decision to file a claim can have a major impact on your insurance rates, even if the accident was minor or was not your fault.

The Claim Game
Regardless of the scope of the accident or who was at fault, the number of insurance claims you file has a direct impact on your rates. The greater the number of claims filed, the greater the likelihood of a rate hike. File too many claims and the insurance company may not renew your policy. Similarly, if the claim is being filed based on damage that you caused, your rates will almost surely rise.

On the other hand, if you aren't at fault, your rates may or may not remain unchanged. Getting hit from behind when your car is parked or having siding blow off of your house during a storm are clearly not your fault and may not result in rate hikes, but this isn't always the case. Mitigating circumstances, such as the number of previous claims you have filed, the number of speeding tickets you have received, the frequency of natural disasters in your area (earthquakes, hurricanes, floods) and even a low credit rating can all cause your rates to go up even if the latest claim was made for damage that you did not cause.

Most/Least Damaging Claims
When it comes to rate hikes, not all claims are created equal. Dog bites, slip-and-fall personal injury claims, water damage and mold are red flag items to insurers. These items tend to have a negative impact on your rates and on your insurer's willingness to continue providing coverage.

On the other hand, the much dreaded speeding ticket may not cause a rate hike at all. Many companies forgive the first ticket. The same goes for a minor automobile accident or a small claim against your homeowner's insurance policy.

Rate Hikes
Filing a claim often results in a rate hike that could be in the 20-40% range. The increased rates stay in effect for years, although the size and longevity of the hike can vary widely from insurer to insurer. At some firms the increase lasts just two years, while at others it may last for five. If your insurer drops your coverage, you may be forced to purchase high-risk insurance, which can come with extraordinarily expensive premiums.

To File or Not to File?
There are no hard-and-fast rules around rate hikes. What one company forgives, another won't forget. Because any claim at all may pose a risk to your rates, understanding your policy is the first step toward protecting your wallet. If you know that your first accident is forgiven or that a previously filed claim won't count against you after a certain number of years, the decision of whether or not to file a claim can be made with advance knowledge of the impact it will or won't have on your rates. Talking to your agent about the insurance company's policies long before you need to file a claim is also important. Some agents are obligated to report you to the company if you even discuss a potential claim and choose not to file. For this reason, you also don't want to wait until you need to file a claim to inquire about your insurer's policy regarding consultation with your agent.

Regardless of your situation, minimizing the number of claims you file is the key to protecting your insurance rates from a substantial increase. A good rule to follow is to only file a claim in the event of catastrophic loss. If your car gets a dent on the bumper or a few shingles blow off of the roof on your house, you may be better off if you take care of the expense on your own.

If you car is totaled in an accident or the entire roof of your house caves in, filing a claim becomes a much more economically feasible exercise. Just keep in mind that even though you have coverage and have paid your premiums on time for years, your insurance company may decline to renew your coverage when your policy expires.

A Strategy to Save on the Cost of Your Policy
Understanding the logic behind filing a claim only in the event of a large loss also provides insight into how to save a few dollars on your insurance premiums. Because you aren't going to file a claim in the event of a minor loss, having a low deductible on your policy makes no financial sense. If you already plan to pay for the first $500 or $1,000 dollars worth of damage out of your own pocket, set aside that amount in an interest-bearing savings account and raise your insurance deductible to match the number. Increasing your deductible will result in lower insurance rates, and the cash in the bank will cover your out-of-pocket costs in the event of an accident.

The Bottom Line
When you pay your insurance premiums regularly and on time, it may seem like you should be able to file as many legitimate claims as you want. Unfortunately, the industry doesn't work this way. Filing too many claims or certain kinds of claims can have an adverse effect on your insurance rates or even get your policy canceled altogether after the claim has been paid. To avoid unfair rate hikes and unpleasant financial surprises, do your homework and learn about your particular insurer's policies and industry practices long before you ever need to file a claim.

Protecting Your Home

The Beginner's Guide To Homeowners' Insurance

By Marcy Tolkoff | December 20, 2007

Insurance. Do your eyes glaze over just reading the word? It may not be the most thrilling subject, but it's essential for new homebuyers to understand the nuts and bolts of their homeowners insurance. Virtually all mortgage lenders require insurance coverage to protect their investment. If the house you live in is destroyed, the real owners - and in most cases, that's the bank - would suffer a huge monetary loss.

Introduction To Insurance

You don't even have to "own" your home to need homeowners insurance; many landlords require their tenants to have coverage. But whether it's required or not, it's smart to have this kind of protection anyway. We'll take it step by step as we walk you through the basics of this type of policy.

What a Homeowners' Policy Provides
The elements of a standard homeowners' insurance policy provide that the insurer will cover costs related to:

  • Damage to the interior or exterior of your house - In the event of damage due to fire, hurricanes, lightning, vandalism or other covered disasters, your insurer will compensate you so that your house can be repaired or even completely rebuilt. Damage that is the result of floods, earthquakes and poor home maintenance is generally not covered and you may require separate riders if want that type of protection.
  • Loss or damage to your personal belongings - Clothing, furniture, appliances and most of the other contents of your home are covered if they're destroyed in an insured disaster. You can even get "off-premises" coverage, so you could file a claim for lost jewelry, for example - no matter where in the world you lost it. There may be a limit on the amount your insurer will reimburse you. Even if your Rolex or mink coat is damaged at home, there will be a limit on the coverage for that, too - unless you purchase a separate "floater" policy that insures the item for its full appraised value.

    According to the Insurance Information Institute, most insurance companies will provide coverage for 50-70% of the amount of insurance you have on the structure of your home. If your house is insured for $200,000, there would be up to about $140,000 worth of coverage for your possessions - would this be enough for you? In order to answer this question, you would need to have a list of all your possessions and their value, also called a "home inventory".
  • Personal liability for damage or injuries caused by you or your family - This clause even includes your pets! So, if frisky Fido bites your neighbor Doris, no matter where the bite happens to occur, your insurer will pay her medical bills. Or, if Junior breaks her Oriental vase, you can file a claim to reimburse her. And if Doris slips on the broken vase pieces and successfully sues for pain and suffering or lost wages? You'll be covered for that, too, just as if someone had been injured on the premises of your home or property. While policies start in the range of $100,000 coverage, experts recommend having at least $300,000 worth of coverage according to the Insurance Information Institute. For extra protection, a few hundred dollars more in premium may buy you an extra $1 million or more through "umbrella coverage".
  • Hotel or house rental while your home is being rebuilt or repaired - It's unlikely you'll ever need this protection, but if you do find yourself in this situation, it will undoubtedly be the best coverage you ever purchased. If your house has been completely destroyed or is so damaged that it's uninhabitable, you may need to rent another house or live in a hotel until it's repaired or rebuilt. This portion of homeowners' coverage would reimburse you for the cost of rent, hotel, restaurant meals and other incidental costs because you were unable to live in your house. Before you book a suite at the Ritz-Carlton and order caviar from room service, however, keep in mind that policies impose strict daily and total limits - but, of course, you can expand those daily limits if you're willing to pay more in coverage.

Different Types of Coverage
All insurance is definitely not created equal. The least costly homeowners insurance will likely give you the least amount of coverage, and vice versa.

There are essentially three levels of coverage:

  • Actual cash value - This value covers the house plus the value of your belongings after deducting depreciation (i.e., how much the items are currently worth, not how much you paid for them).
  • Replacement cost - This is the actual cash value without the deduction for depreciation, so you would be able to repair or rebuild your home up to the original value.
  • Guaranteed (or extended) replacement cost - The most comprehensive, this inflation-buffer pays for whatever it costs to repair or build your home - even if it's more than your policy limit! Certain insurers offer extended replacement, meaning it offers more coverage than you purchased, but there is a ceiling; typically, it is 20-25% higher than the limit.

How Much Does It Cost?
The average yearly premium cost for U.S. homeowners insurance in 2008 (as of 2010, the latest year for which data is available) was $791, according the National Association of Insurance Commissioners, but premiums vary widely and depend on multiple factors. First, of course, price will be determined by how much coverage you buy, a decision you can only make after evaluating the market value of your house, completing a household inventory, and deciding how much liability protection you want.

Other variables that need to be considered include your zip code. If you live in a high-crime area, for example, insurance premiums will be higher. Companies also take into account the size of your house, how close it is to a fire hydrant, the condition of your plumbing, heating and electrical systems, how many claims were filed against the home you're seeking to insure, and even details like your credit score that reflect on how responsible a consumer - and, therefore, a homeowner - you are.

No matter what initial price you're quoted, you'll want to do a little comparison shopping. And don't forget there are many other ways to slash costs, such as raising deductible levels, buying multiple policies from the same insurer, getting all available discounts (for security devices, such as burglar alarms, for example), checking for group coverage options through credit or trade unions, employers, or association memberships, and boosting your credit score.

Selecting an Insurance Company
Price is important, but it is not the only or even the most important factor. When it comes to insurance, you want to make sure you are going with a provider that is legitimate and creditworthy. Before you sign on the dotted line, first contact your state's insurance department to make sure the company is licensed, as all insurers are required to be. Second, check its financial strength by going to websites of the top credit agencies (ex. A.M.Best, Moody's, Standard & Poor's) and searching their financials. Finally, consider asking relatives, friends and coworkers for referrals. It always makes sense to benefit from the experiences of others, so ask someone you know who has filed a claim about an insurer's customer service representatives, the speed with which a claim was appraised, processed and paid, in addition to your friend's general level of satisfaction with the insurer.

As with all insurance policies, they are under-appreciated until they are needed, and then they quickly become a godsend. Getting yourself set up with a comprehensive homeowners policy can go a long way toward making your home truly a place of comfort and security.

Assessing Disability Income Insurance

Choosing The Best Disability Insurance

By Steven Merkel, CFP, ChFC | January 11, 2006

When you think of insurance coverage, the two most common types - home and car insurance - are often the first that spring to mind. Because the mortgage company requires the former, and the law requires the latter, you don't have much of a choice when it comes to deciding whether to be insured. However, it's your ability to earn an income that allows you to afford these items. In fact, without earning potential, it would be difficult for many of us to maintain our homes and automobiles while still providing for our families. The solution for supplementing this missing income in the event of a permanent or temporary disability is known as disability insurance. Here we explain why disability insurance should be an integral part of your financial plan and what you'll need to consider when choosing a policy to protect your income.

Social Security and Disability
Many U.S. workers take disability risk management for granted because they assume that the Social Security system will take care of everything should they become disabled. Contrary to popular belief, qualifying for Social Security disability benefits can be quite difficult, and it often takes a long time for the benefits to start. To qualify, you must prove that you are incapable of performing any job, not just your primary occupation. As long as you can be gainfully employed, even if it's working for minimum wage, you won't be able to collect Social Security disability payments.

The Social Security Administration (SSA) will consider a person to be "disabled" if all of the following requirements are met:

  1. He or she lacks the ability to engage in any substantial gainful activity (SGA).
  2. The incapacity is due to one or more medically determinable physical or mental impairments.
  3. The incapacity has lasted or can be expected to last for a continuous period of at least 12 months or to result in death.

In order to meet the requirements for disability coverage under Social Security, applicants must pass a "recent work" test based on their age at the time they became disabled. Passive income activity, such as investments and sick pay would not be considered gainful activity income. However, if you claim disability, are younger than full retirement age and are earning income of more than $1000 a month (in 2011) and are not blind, this could lead to a declined claim because it would be considered substantial gainful activity. Even if you are eligible for benefits, it's highly unlikely that the benefit will meet your financial obligations - the payment for an individual who earned over $95,000 per year before becoming disabled is only $2,224 per month as of 2010.

Protecting Your Family and Income
When reviewing your risk management objectives, you need to take a close look at your emergency reserves and liquidity capabilities. (To learn more, see Build Yourself An Emergency Fund.) If you became disabled and qualified for a maximum SSA monthly payment for your age and income, would this be enough income to support your budget? According to the U.S. Census Bureau, the average median monthly household income was $4,200 in 2010. This data strongly suggests that a supplemental income source would be a necessity for many Americans if they were to become disabled. It's important that you understand the benefits provided by your company, as you may be covered under a short-term or long-term disability policy through your employer benefits plan. When it comes to disability insurance, "short-term" refers to periods of 90 days or less, while "long-term" refers to periods of more than 90 days.

Once you've determined what disability risk management you have in place, you can then make an educated decision as to whether you are fully insured or underinsured. If you lack the appropriate income replacement, you may want to consider buying a personal disability policy. As with most types of insurance, the older you get, the more expensive the coverage will become. Therefore, you may want to acquire a policy now while you are illness and accident free. Whether your benefits are taxable will typically depend on how the premium is paid. In most cases, if you pay the premiums with after-tax dollars, the benefit received will be tax free. However, if your employer pays the policy premiums for you, then the benefit will likely be treated as taxable income when paid to you. (For further reading, see Insight Into Insurance Scoring.)

Here are some questions to consider when looking into disability insurance:

  • How much coverage should you consider?
    You should consider obtaining enough coverage to maintain your family's current standard of living. While gauging your required amount of replacement income, it is best to err on the side of conservatism. However, recognize that you may save on certain living expenses (such as driving to and from work every day) that may reduce the amount of replacement income you will need to maintain your family's lifestyle. In short, be sure to consider both sides of the coin when assessing your coverage needs.
  • What is an "elimination period"?
    The elimination period is the amount of time that you must wait before your benefits kick in. The typical elimination or waiting period for most policies is 90 days, which means you must have your own resources for the first 90 days of your disability. Be sure to incorporate your insurance plan's elimination period into your personal saving requirements.
  • For how long will an individual policy pay a benefit?
    Since there are many different options for this, you can select the period of time for which your benefit will last. The best policy would entail benefits being paid until you reach age 65, at which time retirement benefits should become accessible to you.
  • What is the difference between "own" and "any" occupation?
    If you're looking at policies that allow you to select between "own occupation" or "any occupation," you'll want to consider a plan that defines "disabled" as unable to continue work in your current profession - known as "own occupation." Otherwise, if you choose "any occupation," you'll need to be unable to perform any type of work in order for the policy to pay any benefits.

The Bottom Line
The overall decline in the number of insurance companies writing disability insurance in the past 20 years has resulted in the cost and frequency of disabilities among workers to increase. What would happen to your household income if you became disabled for a long time? Hopefully, you and your family would be taken care of, but if you're not sure that's the case, now might be the time to cover that risk. After all, part of being a savvy investor is making sure that your family is not unduly burdened by risks you can't afford to take.

Types of Health Coverage

Health Plan Categories

DEFINITION of "Health Plan Categories"
Four types of health insurance plans that are differentiated based on the average percentage of health-care expenses that will be paid by the plan. Under the Patient Protection and Affordable Care Act (ACA), the U.S. health reform enacted March 23, 2010, health insurance plans are offered in four actuarial levels: Bronze, Silver, Gold and Platinum. The level defines the amount of expenses each type of plan covers. The higher the actuarial value (i.e. Gold and Platinum), the more the plan will pay, on average, toward health-care expenses; the lower the actuarial value (Bronze and Silver), the less the plan will pay.

BREAKING DOWN "Health Plan Categories"
On average, the actuarial values for the four coverage tiers are:

  • Bronze = 60%
  • Silver = 70%
  • Gold = 80%
  • Platinum = 90%

All plans cover the same set of Essential Health Benefits. Because each plan is different in terms of deductible, copayments and coinsurance amounts, your share of the costs may come in the form of a large deductible with low coinsurance (for example, a $4,000 deductible with 10% coinsurance) or a small deductible with high coinsurance (such as a $1,500 deductible with 30% coinsurance). With all health plans, consumers pay a monthly fee known as a premium whether or not they use health-care services. Premiums are typically higher for plans that pay more of your medical expenses when you get care, such as Gold and Platinum plans. In general, premiums are also higher for plans that have lower deductibles and lower coinsurance amounts.

In addition to the four “metallic” coverage tiers, a catastrophic level is available to people under age 30 and to certain people over age 30 who are granted hardship exemptions based on income and other circumstances that would prevent them from getting a Bronze, Silver, Gold or Platinum plan. There are 12 reasons for which someone may be granted a hardship exemption, including being homeless, having substantial property damage resulting from fire, flood or other disaster, and filing for bankruptcy in the last six months.

Intro To Insurance: Health Insurance

By Cathy Pareto

Health insurance may be the most important type of insurance you can own. Without proper health insurance, an illness or accident can wipe you out financially and put you and your family in debt for years. So what is health insurance and how does it work?

Health insurance is a type of insurance that pays for medical expenses in exchange for premiums. The way it works is that you pay your monthly or annual premium and the insurance policy contracts healthcare providers and hospitals to provide benefits to its members at a discounted rate. This is how hospitals and healthcare providers get listed in your insurance provider booklet. They have agreed to provide you with healthcare at the specified cost. These costs include medical exams, drugs and treatments referred to as "covered services" in your insurance policy.

As with any type of insurance, there are exclusions and limitations. To know what these are, you have to read your policy to find out what is covered and what is not. If you elect to have a medical procedure done that is not covered by your insurance, you will have to pay for that service out of pocket.

The range of coverage for expenses varies depending on the type of plan, as will the restrictions. You can purchase the insurance directly from the insurance company through an agent or through an independent broker but most people get their insurance coverage through employer-sponsored programs.

Additional Costs
Aside from premiums, there are other costs associated with your health insurance coverage. Let's explore what these are and how you would calculate them.

Premiums: This is the amount that you pay for coverage.

Deductible: The amount that you pay out of pocket. Like any other type of insurance, the deductible can range in amount depending on how much you would like to pay out of pocket. Generally, the higher the deductible, the lower the premiums.

Co-insurance: The percentage of covered expenses paid by the medical plan. The co-insurance amount is per family per calendar year. For example, in a co-insurance arrangement, there can be an 80/20 split between the insured and the insurance carrier in which the insured pays 20% of the cost of care up to the deductible, but below the out-of-pocket limit set forth by the policy. This is typically associated with coverage provided by a PPO.

Co-payment: Sometimes referred to "co-pay", this is a set cap amount that you will pay each time you receive medical services. This is typically associated with coverage through an HMO (which will also be discussed a little later). For example, every time you visit your doctor, you may have to pay $20 as a co-payment. These payments usually do not contribute toward out-of-pocket policy maximums. The co-payment and the coinsurance are not one in the same.

Stop-Loss Limit: The cumulative dollar amount of covered expenses in excess of the deductible after which the coinsurance payment stops and the insurer pays 100% of covered expenses. The purpose of to the stop-loss limit is to limit the out-of-pocket costs for the insured individual. The "out-of-pocket max" is the maximum out-of-pocket expense you will incur before your insurance carrier pays 100% of covered services. At this point, all you will have to pay is your premiums.

What's important to remember for out-of-pocket expenses is that not all expenses go toward meeting the out-of-pocket max. Co-payments and premiums do not apply to the out-of-pocket expense maximum. Your deductible and coinsurance do apply toward this amount. It's worth noting that this may not be a standard feature with every policy.

Let's look at an example to clarify what is meant.

Let's say your health insurance plan has the following features:

  • Deductible: $500
  • Coinsurance: 80/20 (you pay the 20%)
  • Out of Pocket Max: $5,000

Now, let's say that you go to the hospital and incur $7,500 worth of medical expenses. How much do you have to pay? Let's do the math.

Let's start by subtracting your deductible from the total expense amount:

$7,500 - $500 = $7,000

Remember that you have to pay the deductible before the insurance kicks in.

Now you have to pay 20% of the $7,000, which would be:

$7,000 x 0.20 = $1,400

All in all, you will have to pay $1,900 out of pocket ($500 deductible + $1,400 of coinsurance).

You will have to continue paying out of pocket until your total out-of-pocket expenses reach the $5,000 max set in your policy. At that point, you will no longer pay the coinsurance or deductible.

With out-of-pocket expenses, co-payments, coinsurance and premiums why get insurance at all? The answer is simple: while these costs certainly do put a pinch in your wallet, their costs are not nearly as painful as those from a long-term illness or emergency.

Types of Plans

Indemnity Plan
An indemnity plan, sometimes called a fee-for-service plan, is a type of insurance that reimburses you according to a schedule for medical expenses, regardless of who provides the service. These plans cover things such as:

  • Hospital stays
  • Surgical expenses
  • Major medical coverage

Under these plans, the insurer pays a specific amount per day for a specific number of days. The amount paid can be calculated either as a percentage (80/20) or for actual expenses.

Health Maintenance Organizations (HMO)
The HMO is the most common type of insurance policy people own and the one most frequently provided by employers. HMOs provide a wide range of comprehensive healthcare services to a group of subscribers in return for a fixed periodic payment. With this type of coverage, you select a primary care physician that acts as the gatekeeper for you to receive virtually all the medical care required during a year. The gatekeeper concept is the health insurer's attempt to control the cost and quality of care by coordinating health services with other providers. Specifically, your primary care physician is responsible for determining what care is required and when a patient should be referred to a specialist.

These policies tend to be the least expensive form of health insurance, but they do come with annoying restrictions. Aside from having a gatekeeper, you can only select doctors and hospitals approved in the insurance carrier's network. This becomes a problem if you already have a great relationship with a doctor who is not in the network. If you use a non-network provider, your HMO will not cover the costs unless it's for an emergency. Other than this, most preventive care services are covered.

Preferred Provider Organization (PPO)
PPOs are a group of healthcare providers that contract with an insurance company, third-party administrators, or others (like employers) to provide medical care services at a reduced fee. There are two major differences between HMOs and PPOs in that:

  1. The healthcare providers in the PPO are generally paid on a fee-for-service basis as their services are needed, much like a traditional doctor's visit.
  2. You are not required to use the PPO's healthcare providers or facilities - you can go outside the network. That said, going outside the network usually means paying a higher co-payment or deductible.

Point of Service (POS) A point of service plan is a hybrid plan that combines aspects of an HMO, PPO and indemnity plan. This type of plan is more flexible in that it allows you to decide at the time you need services to elect to use the POS plan's physician to arrange in-network care (HMO feature), or to go outside the network or hospital and pay a higher portion of the cost.

Additional Liability Coverage

Umbrella Insurance Policy

What is an "Umbrella Insurance Policy"
An umbrella insurance policy is extra liability insurance coverage that goes beyond the limits of the insured's home, auto or watercraft insurance. It provides an additional layer of security to those who are at risk for being sued for damages to other people's property or injuries caused to others in an accident. It also protects against libel, vandalism, slander and invasion of privacy. An umbrella insurance policy is very helpful when the insurance owner is sued and the dollar limit of the original policy has been exhausted. The added coverage provided by liability insurance is most useful to individuals who own a lot of assets or very expensive assets and are at significant risk for being sued.

MBREAKING DOWN "Umbrella Insurance Policy"
The premium for an umbrella insurance policy may be less expensive if the policy is purchased from the same insurer that provided the original auto, home or watercraft insurance. Depending on the provider, the policyholder who wants to add umbrella insurance policy is required to have a base insurance coverage of $150,000 to $250,000 for auto insurance and $250,000 to $300,000 for homeowners insurance.

Long-Term Care Costs

Taking The Surprise Out Of Long-Term Care

By Steven Merkel, CFP, ChFC | November 16, 2004

People tend to think they will never need long-term care; unfortunately, if they do, they are not prepared for the financial burden it may cause. The fact is that more than 50% of Americans are expected to need some form of long-term care at some point in their lives. According to "A Shopper's Guide to Long-Term Care Insurance" (put out by the National Association of Insurance Commissioners), there is a 41% chance that those over 65 will spend an average of 2.5 years in a nursing home. When should you shop around for long-term care insurance? The time may be now.

What Is Long-Term Care?
Long-term care refers to a broad range of supportive medical, personal, and social services needed by people who are unable to meet their basic living needs for an extended period of time. This support, which requires the time and effort of a healthy caregiver, can be supplied at home or in a nursing care facility.

How Much Does It Cost?
Well, at $200/per day, you would spend $73,000 for a full one-year stay in a nursing home. At three years, your nursing-home costs would be well over $200,000. Don't rely on Medicare, which only pays of 100 days of care for recovery - it does not cover indefinite long-term care.

When you are purchasing long-term care insurance, the financial strength, size, and insurance rating of your provider are significant factors to consider. Since the average age for LTC claims is typically in the late 70s, it may be 20 to 30 years before you'll need to cash in on your policy. So you want to be quite sure that your insurer will still be around when you need it

There are many decisions to make when buying long-term care insurance, but the five key factors that will have the largest impact on the cost of your policy include (1) the elimination period, (2) your age, (3) benefit period, (4) daily benefits, and (5) inflation riders

1. Elimination Period - This is the number of days you choose to wait until your benefits begin after you start receiving care. They can begin immediately once your care begins or be delayed 90, 120 or 180 days (or more). The longer your elimination period, the lower your annual premium will be. Many retirees recognize that Medicare pays all or part of the first 100 days, so they structure their policy to fill the gap when Medicare ceases to pay.

2. Your Age - In most cases, the ideal time to buy long-term care insurance is in your early 50s, while you are still in good health. Some professionals will recommend that you buy it in your 30s or 40s to lock in the lower premium costs. Remember, the older you are when you start, the higher your premium will be.

3. Benefit Period - The length of time you want the policy to continue to pay benefits (for example, two, five, eight, or more years) will affect the price of your premiums. If your family has a history of needing years of care, you may want to opt for the longer period. Since the average stay in a nursing home is 2.4 years and it's important to keep premiums affordable, a five-year benefit period is often a popular choice.

4. Daily Benefits - The daily benefits represent the amount that the insurer will pay to cover your daily care. According to the 2009 Metlife Survey of Long-Term Care Costs, a nursing home costs between $200 and $220 per day on average, but these numbers vary depending on your location and the amenities available at the facility. Keep in mind, the costs of at-home care will usually be considerably more than those for a nursing home. If you plan on using your savings to pay for some of the daily costs, you can select a lower daily benefit to keep your premiums down.

5. Inflation Riders - This inflation protection feature allows an annual increase in your daily benefit to help keep pace with the rising costs of inflation. This is one of the most important additional features of an LTC policy. With the elderly population on the rise, the costs of long-term care are estimated to rise by 5% or more per year. At this rate, a 50 year old purchasing a policy today with a $150 daily benefit will need over $390 per day 20 years from now.

Claiming Your Benefits
To be eligible to receive benefits, you must have a qualified physician verify to the insurer that you are unable to meet your basic living needs for an extended period of time. Before paying anything, most policies will require proof you are unable to perform at least two of the daily functions of living. The activities of daily living (ADLs) include eating, bathing, dressing, using the toilet, bladder control and transferring from bed to chair.

Once you are eligible, most policies require you to have a trained professional supply the caregiving - family members, unless they are qualified professionals, no longer count as caregivers. Although many of the policies that at one time required hospitalization are extinct, it's still important to check the policy language to make sure that hospitalization is not required.

A long-term care insurance policy is a viable way to protect your assets. Do your homework first and obtain at least three quotes from highly rated LTC insurers before you sign on the dotted line. The few dollars spent today in premiums could save you hundreds of thousands down the road. For further reading, see Medicaid Versus LTC Insurance.

Long-Term Care: How and Why You Should Plan for It

By Zina Kumok | February 24, 2016

Long-term care can be a pretty easy issue to ignore. It’s difficult for most people to imagine themselves in such a helpless position and many think of the issue as something only other people need to worry about. We all know, deep down, that we’ll eventually age and lose the faculties of youth. Dealing with that reality in the present is a different story.

Ignore the possibility of needing long-term care at your own peril. The likelihood that you’ll need long-term care is higher than most people realize. And with average life expectancies predicted to rise over the next few decades, that likelihood is only going to increase.

Likelihood of Needing Long-Term Care

Long-term care includes nursing homes, in-home care and assisted living facilities. Patients may require extensive care due to a disability, injury or other malady. Common reasons for a senior needing long-term care include dementia, cancer and injuries that significantly restrict mobility. These places assist seniors with basic, everyday activities such as using the restroom, eating and getting dressed. They can also help manage finances, care for pets and make doctors' appointments.

Because women live an average of five years longer than men, they’re likely to need more time in a long-term care facility. The average stay for a woman in a nursing home is about 1.5 years more than it is for a man, according to the U.S. Department of Health and Human Services.

The odds of anyone needing long-term care is high. About 66% percent of 65 year olds will need it and one-fifth will have to be in a facility for more than five years. Currently, men spend an average of 2.2 years in a long-term care facility, while women spend 3.7 years.

The Costs

Some people assume that long-term care will be covered by Medicare, but it won’t. Even Medicaid only pays for a third of those costs, while general health insurance covers less than 3%. If seniors anticipate needing long-term care, they need to buy separate insurance to cover it.

Long-term care can cost up to $250 a day at a nursing home or more than $20,000 for a three-month visit. For those who choose to have in-home help, the average cost is $21 per hour. A daily stay at an adult day care center is about $70. For people who don’t have the ability to pay cash for long-term care, insurance is the next best thing. Unfortunately, it can be pricey as well. The average person pays $3,500 in annual premiums for long-term care insurance. That adds up to almost $300 a month, a huge chunk compared to auto and homeowner’s insurance. With price tags like that, it’s easy to see why people ignore the issue so stubbornly.

Many policies will only pay a portion of the cost, so seniors will still have to pay some out-of-pocket expenses. According to statistics from the National Care Planning Council, seniors paid 25% of nursing homes costs themselves in 2010.

How to Be Prepared

Like any form of insurance, long-term care is not something that anyone wants to actually use - but having it can ease your worries. According to the American Association for Long-Term Care Insurance, 50% of seniors who bought their policy before turning 60 used it during their lifetime. Those are pretty high odds.

Unfortunately, people with certain health conditions may also be ineligible to purchase long-term care insurance. This can include Parkinson's, Alzheimer's, cystic fibrosis and a sizeable list of other conditions. If you’re unable or ineligible to purchase long-term care insurance, make sure to have a well-stocked emergency fund. Even those with insurance should check their policy to see how much they might have to pay out of pocket.

Purchasing a policy when you’re younger can save you thousands in annual premiums over the course of your lifetime. The difference between someone who purchased a policy at 55 versus age 70 is about $1,500 a year. Not all policies are created equal. Many do not cover stays in facilities that last less than 90 days. About 20% of people spend less than 90 days in nursing homes, meaning their coverage will not kick in. Seniors can purchase policies that will cover visits for any length of time, but they will likely pay a higher premium.

The Bottom Line

Like most potential problems, long-term care is an issue that gets scarier the longer you ignore it. But just like those other problems, that fear starts to abate when you spend some time preparing for the worst. Do everything you can to be prepared. Live a healthy lifestyle, get your healthcare ducks in a row and ensure your retirement years will be spent in comfort. Your future self and your family will thank you for it.

Types of Life Insurance

Understanding Different Types of Life Insurance

By Melissa Horton

Individuals utilize life insurance policies to effectively transfer the risk of financial loss to a third party due to death. Life insurance carriers take on the financial obligation to pay a specified death benefit in return for premiums paid by policy owners for a set amount of time as defined by a life insurance contract. Life insurance coverage is used in personal financial planning and estate planning, as well as business protection planning for a myriad of reasons, depending on an individual's specific need for transferring risk. While some may choose to purchase a life insurance policy to replace income, others obtain coverage to secure a lump sum for financial goals that are not yet fully funded, such as a child's education or retirement savings.

Regardless of the reason for coverage, individuals have a plethora of life insurance policy types available to them, each with specific advantages and disadvantages. The two main categories of life insurance are term and permanent insurance, with subcategories of permanent insurance consisting of whole life, universal life, variable life and variable universal life policies.

Term Life

Term life insurance contracts, also known as pure insurance policies, provide life insurance coverage to individuals for a specific period of time, or term, commonly issued with five-, 10-, 15-, 20-, 25- and 30-year terms. Because an expiration date exists, term insurance is considered temporary coverage. Individuals who obtain a term insurance policy enter into a contract with the life insurance carrier that guarantees a specified death benefit in exchange for a specified level premium throughout the term of the contract. Should a policyholder pass away during that term, his beneficiary receives the total death benefit as a tax-free payout.

Term insurance coverage is best-suited for individuals who want coverage for a short-term need, such as replacement of income during working years, funding a child's college education, or protecting the remaining balance of a business or mortgage loan. Young families often choose term insurance as their primary policy type, and business owners select this type of policy during the startup phase to cover key personnel. Because of their temporary nature, term insurance premiums are far less expensive than permanent policies with a comparable death benefit.

Whole Life

Whole life insurance policies fall under the purview of permanent life insurance contracts, which means coverage lasts throughout a policyholder's lifetime, regardless of how long he lives. Also known as cash value life insurance, whole life is the most common type of permanent coverage on the market because of the guarantees it provides to policyholders. An individual who enters into a whole life insurance contract with an insurance carrier agrees to a specified death benefit amount in exchange for a fixed level premium. As long as the premium is paid in accordance with the policy contract, the insured individual's beneficiaries are paid the total tax-free death benefit at the time he passes away.

Permanent life insurance contracts differ from term not only in their duration but also in providing policyholders a benefit that can be used while they are still alive, known as a policy's cash value. With a whole life policy, a portion of premiums paid are siphoned off into the cash value account within the policy, creating a type of savings for the policyholder. Balances within the cash value account of a whole life policy are guaranteed to receive a set rate of return throughout the life of the policy. Funds within a cash value account held in a whole life policy are tax-deferred and may be borrowed against during the policyholder's lifetime. Any unpaid loan balances against the cash value account are withheld from the final death benefit paid out to beneficiaries.

Whole life insurance is far more expensive than term insurance because of the built-in guarantees for the death benefit, the premiums and the interest rate applied to cash value accumulation. Because of the cost associated with whole life insurance coverage and its lifetime guarantees, this type of policy is best-suited for individuals with long-term protection needs, such as retirement income for a spouse.

Universal Life

Universal life insurance coverage also falls under the permanent life insurance category, but differs slightly from whole life. As a form of permanent coverage, universal life policies provide a guaranteed tax-free death benefit to policyholder beneficiaries based on the amount of premiums paid over time. A universal life contract provides access to cash value accumulation like that of a whole life policy; however, cash value within a universal life policy includes a guaranteed minimum interest rate plus an additional interest payment if and when the life insurance carrier experiences higher returns on its own investments.

In addition to the potential for higher earnings on cash value balances, policyholders of universal life contracts have flexibility in terms of the level of total death benefit, premium amounts paid and payment frequency. After the first year of ownership, universal life policyholders have the option to increase, decrease or skip premium payments, so long as the cash value balance is sufficient to cover all policy expenses. Additionally, policyholders of universal life contracts have the option to select a fixed death benefit payout or an increasing death benefit payout for their beneficiaries. The latter is the equivalent of the pure insurance death benefit plus any accumulation in cash value balances.

Universal life policies are less expensive than whole life policies because the guaranteed minimum interest rate is lower for universal contracts, but premiums are more expensive than term policies. Individuals who are in need of coverage for mid- to long-term financial objectives, or those who want more flexibility in premium frequency and amount, may find universal life more fitting than term or whole life coverage.

Variable Life

Another option within the permanent life insurance category is variable life insurance, which provides policyholders the same long-term coverage and cash value benefits as whole and universal life policies. Variable life insurance premiums are fixed like they are with whole life policies, but cash value balances and death benefits fluctuate. This is because variable life insurance cash value balances are invested in various tax-deferred subaccounts provided by the insurance company. Once policy expenses and charges are paid, the remaining premium amount is moved to the cash value account where it is invested based on the policyholder's investment selections. When the subaccounts perform well, a policyholder's cash value and death benefit rise; when they perform poorly, both the death benefit and cash value fall.

Variable life insurance contracts are best-suited for individuals with a long-term need for coverage. The policyholder takes on the risk of the subaccount performance rather than the insurance carrier, creating a policy that is most appropriate for individuals who want to manage their own cash value accounts and risks associated with them. Cash value balances still grow tax-deferred and are available as a policy loan while the insured is still living. Policyholders of variable life pay similar premiums as those who hold universal life contracts.

Variable Universal Life

Variable universal life insurance coverage is a hybrid of universal life and variable life contracts. Under a variable universal life contract, policyholders have numerous investment subaccounts available to them like they do with variable life policies but also have the flexibility in premium payments and frequency offered by universal life policies. Premium amounts above and beyond the total policy charges and expenses are covered first, with the remaining amount deposited into the cash value account based on the policyholder's investment selections. As with other permanent life contracts, the cash value within a variable universal life policy grows tax-deferred and is available through a policy loan while the policyholder is alive.

The combination of universal life and variable life allows an individual to create a custom policy that suits specific insurance needs for the long-term. However, variable universal life policyholders assume the risk of the underlying investments within the cash value portion of the policy, and death benefit and total cash value can rise or fall over time. Because of the flexibility afforded by a variable universal life policy, policyholders pay slightly more in premiums than universal or variable life policyholders but less than whole life policyholders.

Life insurance coverage is an integral aspect of comprehensive financial planning and estate planning, but there is no single type of life insurance that is most appropriate for every individual. Instead, an evaluation of total death benefit needed, time frame of coverage, and willingness to take on risk within the cash value account are necessary to determine which type of coverage is best-suited for an individual's specific needs.