Basics of Estate Planning

Estate Planning Is An Essential Need

A carefully prepared estate plan will allow you to achieve many goals. Ensure the financial security of your spouse; determine what should be left to the children and how their inheritances should be handled if they are young; dispose of the family business; minimize the effects of taxes on your estate; empower a reliable executor and trustee to invest and manage the assets in your estate.

The need for planning
By having a will, which is the basic estate planning tool, you can prevent two costly mistakes: lack of experienced management assistance for your family and the possible loss of thousands of dollars through needless taxation on your estate. But effective estate planning often requires more than a will.

Life insurance proceeds, for example, usually are not governed by the terms of a will. Neither are benefits payable from retirement plans. Yet such assets loom large in many estates. Your planning should encompass all the financial resources that can be used to attain your goals.

A sound foundation for your plan
Comprehensive estate planning demands teamwork. With you at the helm, our estate planning specialists can help you and your attorney design a plan to fulfill your objectives. Together we shall go through a series of important steps:

• Obtain the necessary personal data about yourself and your family.
• Help prepare a balance sheet of your assets and liabilities.
• Assist with the review of your will and any existing trusts.
• Evaluate your estate tax options, such as the best method of disposing of your share of community property—taking into account the unlimited marital deduction and the use of tax-sheltered trusts.
• Consider the best way to distribute your retirement plan benefits.
• Compute potential estate, gift and income tax liabilities, advising on the most practical and economic solutions.
• Determine the availability of liquid assets to meet potential estate expenses and taxes.

Strategy for wise decisions
From this analysis a plan will emerge. It may involve changing your will and naming us to settle your estate. It may involve suggestions for tax savings through the use of trusts, an adjustment in life insurance coverage, a program of lifetime giving. It even may result in suggestions for the orderly transition of the family business from one generation to the next.

Effective estate planning requires teamwork. We will work closely with you and your other advisers to help develop the best estate plan for you and your family.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

© 2006 M.A. Co. All rights reserved.
Any developments occurring after January 31, 2006, are not reflected in this article.

Income that the IRS can’t touch

Municipal Bonds

There’s one readily available and legal source of untaxed income that we know of: municipal bonds. These securities are issued by state and local governments, school districts, hospitals and other public agencies to support community projects and services. To permit these worthy endeavors to raise money economically, Uncle Sam exempts the interest that they pay from federal income tax. And state governments usually do the same for bonds issued within their borders.

As a result, these tax-advantaged “munis” only pay about 75%-90% of the interest that you’d earn on a taxable bond of comparable maturity and credit quality. So, depending on your tax bracket, munis actually may give you higher after-tax income. To figure the equivalent taxable yield of a tax-free bond, divide its yield by one minus your tax rate expressed as a decimal. Thus, if your tax bracket for 2006 is 35%, a 5% tax-free yield would be worth 5% divided by 0.65, or 7.69%.

If you live in a high-tax state, this advantage can be even more dramatic. Suppose that you pay an 8% state tax. Because you deduct state tax from your federal income, your effective state tax is 5.20% (8% x .65), and your combined tax rate is 40.20%. So you’d divide that 5% by .598 (1-.402) and get 8.36%. In that case, you’d prefer the 5% muni issued in your state to any comparable taxable bond paying less than 8.36%. The table at the end of this article shows taxable-equivalent yields for each 2006 federal tax bracket. Obviously, the higher your tax bracket, the larger the benefit of tax-advantaged investments.

Types of municipal bonds
According to their issuers and their terms, munis fall into several distinct categories.

General obligation bonds are backed by the full taxing power of the city or state that issues them.

Revenue bonds pay their coupons and repay their principal from the revenues of the projects that they fund, which can be toll bridges, airports or other public facility.

Private activity bonds are issued in support of private projects, such as industrial parks or shopping malls, intended to bring business to the community. Although income from these bonds issued after August 1, 1986, is exempt from income tax, it is hit by the alternative minimum tax when earned by investors subject to the AMT. This threat tends to push the yields of these bonds up a bit, boosting their attraction for investors not affected by the AMT.

Zero-coupon municipal bonds are sold at a large discount from their face value and pay no current interest. The investor instead receives the full face value at maturity, with all the gain tax free.

Prerefunded bonds. With the relatively low interest rates of the last few years, some municipalities have issued bonds to pay for the redemption of older, higher-yielding bonds on their call date. Until that time the money is usually parked in U.S. Treasury securities. As a result, the prerefunded older munis carry an extra measure of safety.

Risk management
As with other fixed-income securities, munis are subject to two distinct types of risk:
Interest rate risk refers to the fact that a bond loses value in the secondary market when interest rates rise. Nobody will pay full price for a 5% bond when new bonds are available that pay 6%. So, if you need to sell a bond in that situation, you’ll have to accept a price that will give the buyer a competitive yield.

On the other hand, if interest rates fall, the value of your bonds will rise. Don’t count your chickens, though. Most munis carry call provisions allowing the issuer to redeem the bonds early at a specified date, usually with the payment of a call premium. Note that any loss that you take on the sale of a muni may be used to offset capital gains plus up to $3,000 of ordinary income. Any gain, however, may be subject to ordinary income tax (not the reduced capital gains rate).

Of course, if you hold a bond to maturity, interest rate risk is not an issue. Credit risk refers to the possibility that the issuer will default on the timely payment of interest and/or principal. Albeit a rare occurrence, we had the 1994 example of Orange County, California, to impress this possibility upon us. Naturally, lower-rated issues carry higher yields, but of late the spread between high-quality and junk bonds has been little more than 1%. So it’s hardly worth accepting the extra risk for the marginal boost in income.

As mentioned above, pre-refunding can enhance the safety of a bond. More common, however, is the use of insurance to upgrade an issue’s quality. Issuers purchase private insurance that guarantees payment of interest and principal in the event of a default. Bonds thus covered automatically gain an S&P rating of AAA.

Another way to protect a tax-advantaged portfolio is diversification. Bonds of different types, from widespread issuers, and of varying maturities cushion the effect of trouble in any one sector. Because most munis are issued in multiples of $5,000 or $25,000, such diversification is not possible for most individual investors. For a tax-advantaged portfolio of less than $500,000 or so, experts recommend investing in either tax-advantaged money managers or unit investment trusts.

If tax-advantaged income at the yields available currently fits your financial needs, we’re ready to help you build a working portfolio.

Taxable equivalent yields
Equivalent Taxable Yield* by Tax Bracket in 2006
Muni Yield 10% 15% 25% 28% 33% 35%
3.00% 3.33% 3.53% 4.00% 4.17% 4.48% 4.62%
3.50% 3.89% 4.12% 4.67% 4.86% 5.22% 5.38%
4.00% 4.44% 4.71% 5.33% 5.56% 5.97% 6.15%
4.50% 5.00% 5.29% 6.00% 6.25% 6.72% 6.92%
5.00% 5.56% 5.88% 6.67% 6.94% 7.46% 7.69%
5.50% 6.11% 6.47% 7.33% 7.64% 8.21% 8.46%
6.00% 6.67% 7.06% 8.00% 8.33% 8.96% 9.23%
*Federal tax only. If an investor is subject to state and local income taxes, equivalent yields would be higher.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

© 2006 M.A. Co. All rights reserved.
Any developments occurring after January 31, 2006, are not reflected in this article.

Tax Records: What do I Keep?

How Long To Keep Tax Records

You’ve just finished filing this year’s tax return. With a sense of relief, you set aside a copy of your return and your supporting documents. But what do you do with them then? Of course, the first step is to keep your tax records in a safe, convenient place. You may need to refer to them for any number of reasons—for example, for future filings or when you are seeking credit. Then, too, you’ll need easy access if you face an audit from the IRS. The following suggestions will help you compile the best and most complete records.

What to keep
First, there are the basic records that you will want to have on hand. Records of your income: Form(s) W-2, Form(s) 1099 and bank statements. Expense records should include sales slips, invoices, receipts, cancelled checks or other proofs of payment.
Among the investment records that you’ll want to keep are the following: brokerage statements, mutual fund statements, Form(s) 1099 and Form(s) 2439 (Notice to Shareholder of Undistributed Capital Gains). Keep year-end account summaries and deposit receipts for any IRA or Keogh contributions.

Your records should enable you to determine your basis in an investment and whether you have a gain or loss. Records should show the purchase price, sales price and commissions paid. They also may show any reinvested dividends, stock splits and dividends, load charges and original-issue discounts. If you have real estate investments, you’ll need to keep copies of all the regular and extraordinary expenses associated with the properties.

How long to keep it
According to the Tax Code, you are required to keep copies of your tax return and all support as long as they may be needed for the administration of any provision in the law. Typically, that means for as long as the IRS has the right to assess additional tax on your return, or you have the right to amend your return to claim a credit or refund (“the period of limitations”).

There are several periods of limitations. One is a three-year period that applies generally. Another is a six-year period that applies when you don’t report income that you should and that income is more than 25% of the gross income shown on your return. If the return is fraudulent, or you fail to file a required return, there is no limit as to when the IRS can require you to provide it with information.

Recordkeeping for homeowners
Determining your basis (cost) in your home will be extremely important in order to figure the gain or loss when you sell your home (or to calculate depreciation if you use part of your home for business purposes). Therefore, your records should enable you to determine your basis as well as any adjustments to your basis. Your records should show the original purchase price of your home and settlement or closing costs. They also may show any casualty losses incurred, insurance reimbursements for casualty losses and postponed gain from the sale of a previously owned home.

Be sure to keep a file of bills on what improvements you’ve made to your home each year. Generally, the costs of improvements—changes that add value to your home, prolong its life or adapt it to new uses—may be added to the basis in your home. Repairs and general fix-up costs may not.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

© 2006 M.A. Co. All rights reserved.
Any developments occurring after January 31, 2006, are not reflected in this article.

Managing Risk with a Diversified Portfolio

Diversified Stock Portfolio

Diversification is a fundamental investment concept that most investors have no trouble understanding. If, for example, an investor owns equal dollar amounts of only two stocks, and one suffers a 50% loss, his or her portfolio has gone down in value by 25%. But if the investor owns ten stocks, and one drops by 50%, his or her portfolio has suffered only a 5% loss.

With a diversified stock portfolio, risk may be reduced because different stocks tend to rise and fall independently of each other. On a broader scale, combinations of different investment assets may help balance out each other’s fluctuations in price, lowering, though not eliminating, the overall risk.

Categorizing risk
The ultimate goal in a diversification strategy is to improve investment performance while managing risk. One way to categorize risk is to distinguish between unsystematic risk and systematic risk.

Unsystematic risk is risk that is specific to a company. Often, this risk involves some kind of dramatic event such as a strike, a fire or some natural disaster. A company’s slumping sales also fall within this category. Diversification among the stocks of many companies reduces unsystematic risk because, of course, it’s highly unlikely that every one of the unhappy events listed above will occur in all companies.

Conversely, some events can affect all companies at the same time. This systematic risk includes such occurrences as inflation, war and fluctuating interest rates—generally, those events that influence the entire economy. Of course, diversification cannot eliminate the likelihood of these events happening. Systematic risk accounts for most of the risk in a diversified portfolio.

A diversified stock portfolio: how much?
One way that academic researchers measure investment risk is by looking at stock price volatility. A classic 1968 study by J.L. Evans and S.H. Archer, “Diversification and the Reduction of Dispersion,” concluded that an investor who owned 15 randomly chosen stocks would have a portfolio no more risky than the market as a whole. This research confirmed earlier advice, coming from instinct and experience, that Benjamin Graham gave to investors in his 1949 book, The Intelligent Investor. Graham recommended owning from ten to 30 stocks to achieve proper diversification.

A study published in 2001 (“Have Individual Stocks Become More Volatile?” by John Campbell, Martin Lettau, Burton Malkiel and Yexiao Xu) suggests that those numbers may be too small. To replicate the risk of the market as a whole, according to the study, the “excess standard deviation” of portfolio returns needs to be brought down to 5%. In the 20 years ending in 1985, an investor could have achieved this goal by owning 20 stocks. But, in the period from 1986 through 1997, the professors concluded that one needed to own 50 stocks to reach the same result!

Choices in diversification
Of course, an investor who invests for income will diversify his or her holdings among different bonds. In this case diversification usually means owing long-, intermediate- and short-term government bonds. Other categories might include, when appropriate, municipal, corporate and, sometimes, high-yield (“junk”) bonds.

It is possible for an entire asset class to do poorly for an extended period of time (as we have seen in recent years). Therefore, it’s a common diversification strategy for investors to spread their money across asset classes—including, for example, stocks, bonds, cash instruments, and real estate—in their portfolios.

Finally, some investors may want to think in global terms. By investing outside of the U.S., investors are addressing the risk of extended bear markets at home. Global investing includes additional risks, however, such as currency fluctuations and political uncertainty.

May we offer our assistance?
Risk always will be a cause for concern. There’s always a fear of the unknown. Still, knowledge and experience can help improve the odds that you’ll achieve success as an investor in the long term.

We’ll be glad to help you develop a strategy that meets your specific needs as an investor. One designed and implemented to take only the risks with which you are most comfortable. We look forward to the opportunity to tell you more.

Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price. Stock investing involves risk including loss of principal. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not ensure against market risk. Past performance is no guarantee of future results.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

© 2006 M.A. Co. All rights reserved.
Any developments occurring after January 31, 2006, are not reflected in this article.

A Valuable Business Tool: Buy-Sell Agreements

How To Prepare For Possible Changes In Your Company

When you own a company, by yourself or together with one or more partners, you pour heart and soul into making it a success. Indeed, the process of bringing a business into existence and then nurturing it and building upon its success is so engrossing and exhilarating that it’s easy to lose sight of one sobering fact: You and each of your co-owners (partners or shareholders) one day will take leave of the company. It may be by retirement, disability or death. Someone may feel the need to move on. A partner may be tempted by a third party’s offer for his or her share of the enterprise.

Potentially, any of these situations can throw a going business and/or the family of a deceased owner into chaos. A family may be forced to sell its share to cover taxes on the estate—if it can find a willing buyer. Remaining partners may not be able to get along with an interloper who comes into the business through purchase or inheritance. In an S corporation, the new shareholder may not be of a class eligible to hold such shares, thus forcing a reorganization.

A versatile tool
Buy-sell agreements provide a powerful business succession tool that owners of small-to-medium-sized companies can use to address any or all of these eventualities. A form of shareholder agreement, the buy-sell agreement is a contract spelling out what will happen to the equity of a departing shareholder when a “triggering” event occurs.
Buy-sell agreements will generally fall into one of two categories:
• In a cross-purchase agreement, the shares or interest of the departing partner are to be bought by the surviving or remaining partners. In a sole proprietorship, the designated purchaser would be the owner’s chosen successor, whether a family member involved in the business or a key employee vital to its continuation.
• In a stock redemption plan, the equity or shares are bought and retired by the corporation or partnership, thereby increasing the remaining shareholders’ share of the company’s equity.

The choice between these options will depend on the company’s structure and the resources available to fund the purchase. Agreements may set varying terms for different triggering events. For example, a lower price may be paid to a partner leaving to set up a competing business. Purchases might be mandatory upon the death or disability of a partner, whereas voluntary or forced withdrawals might give the business only “the right of first refusal”—to match a first legitimate outside offer, if it so chooses.

Funding choices
Often life insurance and, less frequently, disability insurance are used to fund buy-sell agreements. The contractual buyer purchases a policy on the prospective seller’s life. The proceeds are earmarked to purchase the business interest from the heirs of the deceased owner, and the cash value is available to fund purchases in other situations. In cross-purchase agreements each owner needs to have a policy on the life of each of the other owners.

Because this process can be quite cumbersome when there are multiple owners, a stock redemption plan may be more workable. In that case, the business owns and funds a single policy on each owner’s life. Life insurance cash value is carried as an asset on the corporate balance sheet and will not be considered an excess accumulation of earnings if it does not exceed the reasonable needs of the business.

The hard part
Placing a value on a closely held business can be a challenge. Placing a future value is nigh on impossible. For this reason it may be best to specify a reasonable method that will be used to determine the price to be paid, or to recalculate the price periodically.

Methods that may be appropriate, depending on the nature of the business, can be to: capitalize average earnings over a period of years; calculate the loan amount that the company’s cash flow will support; total the tangible assets on the balance sheet; place a value on the business’ intangible assets (often its customer base); or simply apply an industry rule of thumb. Any method specified in a buy-sell arrangement that represents a true arm’s length valuation will be binding on the IRS for estate tax purposes.

The payoff
A well-structured buy-sell agreement can provide a panoply of benefits:
• ensuring an orderly transfer of business interests, preventing forced liquidation;
• protecting the heirs of minority owners who otherwise might end up with a holding of restricted, non-dividend-paying stock;
• preventing a sale to outsiders or inheritance by someone not active in the business;
• persuading a key employee to remain in the business;
• establishing the value of a deceased owner’s shares for estate tax purposes.

If you run a business, we’re always ready to work with you and your advisers to develop buy-sell agreements and all other financial services available to help your enterprise thrive.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

© 2006 M.A. Co. All rights reserved.
Any developments occurring after January 31, 2006, are not reflected in this article.

Planning For Long-Term Care

Understanding Long-term Care Insurance

As anyone with an elderly relative or friend who is unable to provide for his or her own care can tell you, the cost of that care—whether at home or in a facility—is a major expense. The financial outlay for such care, because of advanced age or chronic illness or injury, may not be an issue for the very rich, with significant personal resources, or the very poor (who qualify for government assistance). But, for the vast majority of people, whether to purchase a long-term care insurance (LTCI) policy is a worthy topic for discussion. Below we provide a few questions and answers that may assist in determining whether you want LTCI coverage.

1. How likely is it that you will need long-term care?
According to the National Council of Insurance Commissioners, one person in three who turned 65 in 1990 will stay in a nursing home, with one in ten staying five years or more. On the other hand, according to recent statistics, over 25 million people in the U.S. between age 65 and age 84 are living independently. Other statistics suggest that those who do spend time in a nursing home usually remain there under a year.

But what about the chances that you will need long-term care? Perhaps one of the best steps that you can take is to evaluate your family’s medical history. You are more likely to need LTCI if there have been instances of early onset of dementia, heart disease or stroke in your family. Longevity may be a factor, too. If your parents, grandparents or their siblings have lived into their 90s or later, it’s not an unrealistic assumption that you will, too—thereby increasing the chances that you will need some kind of professional care or assistance.

2. What does LTCI cover?
Terms differ from policy to policy. Generally, LTCI covers care in a qualified nursing home, in an assisted living facility or in your home. But, often, policies will pay less for care given in the home than in a facility. As is the case with most insurance, coverage offers protection from catastrophic loss of your assets and income should you require assistance. Coverage varies, but the ability to perform a certain number of “activities of daily life” (ADLs) is a common measure of when benefits will be paid. The most common ADLs are: eating, dressing, bathing, transferring in and out of bed, toileting and continence.

3. What kind of LTCI coverage do you need?
LTCI policies offer a wide variety of options. The good news is that you should be able to fashion a policy that closely suits your needs. The not-so-good news is that you are going to have to spend a significant amount of time reviewing different policy options.

Some examples: Based upon your financial circumstances, you may be able to pay for home care and thus need coverage only if you enter a facility. Do you have a relative or a friend who might provide care? Then you’ll want a policy that permits payments to unlicensed caregivers. Again, based upon your resources, you may want to lengthen or shorten the waiting period before coverage begins. You might consider inflation protection, as well.

4. What does it cost?
The cost of LTCI coverage depends upon a variety of factors. Your age at the time that the policy is issued will determine your annual premium. The terms of the policy as well as your health at the time that the policy is issued also will be a factor.

Another consideration is whether your premiums are locked in or may be adjusted in certain circumstances, such as for inflation. Don’t automatically reject a policy that doesn’t lock in your premium rate. It may not necessarily be a good idea: An insurer with insufficient income to meet claims may go bankrupt and, possibly, be unable to pay benefits.

5. Are there any tax breaks available with LTCI?
LTCI premiums are deductible in the same manner as your regular health insurance. Your expenditures are added to your medical expenses, and you may deduct the amount that exceeds 7.5% of your adjusted gross income. The deduction is capped, based upon your age.

Benefits received from LTCI policies may be exempt from federal income tax—if the LTCI policy is “qualified” (i.e., meets government standards). Generally, qualified LTCI policies cannot exclude coverage by type of treatment, medical condition or accident. Pre-existing conditions can be excluded only for the first six months of coverage. And the policies may not be cancelled for reason of nonpayment of premium. Most states now are offering some form of tax incentives for LTCI policyholders as well.

For tax issues involving LTCI in your personal circumstances, contact your tax advisor before taking any action.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

© 2006 M.A. Co. All rights reserved.
Any developments occurring after January 31, 2006, are not reflected in this article.

Planning For Retirement or A Job Change

Changing Jobs or Retiring? Don’t Forget Your Retirement Savings!

Your retirement savings plan offers you several choices when you decide to change jobs or when you retire. This report explains some of the options you may be able to choose from in deciding how you want the money in your plan treated when one of these events occurs.

What Is a Distribution?
A distribution is simply defined as a payout of the amount of money that has accumulated in your retirement savings plan. This may include amounts you have contributed, the “vested” portion of any amounts your employer has contributed, plus any earnings on those contributions.

You will want to think carefully before making any decisions about the money in your retirement plan, as some choices may mean you have to pay more in income taxes on your distribution. It’s also a good idea to talk with a tax advisor before picking a distribution election.

Some Distribution Options
Keep Money in Employer’s Plan: Allows continued tax-deferral of any growth.
Make a Direct Rollover: Allows continued contributions and tax- deferral of any growth. Avoids potential taxes and penalty fees.
Take a Cash Distribution: Satisfies immediate need for cash. Substantial taxes and penalty fees may apply.
A Look at Some of Your Choices
You may be able to leave your money in the plan; move it to another retirement savings account, such as an IRA or annuity, or another employer’s retirement savings plan if you’re changing jobs; or take a cash distribution.
• Keep Your Money in the Plan: You can leave your savings in your employer’s retirement savings plan if your account balance was more than $5,000 at any time, depending on your plan’s rules. Minimum distributions must begin after you reach age 70 ½, however. You’ll continue to enjoy tax-deferred compounding of any investment earnings and receive regular financial account statements and performance reports. Although you will no longer be allowed to contribute to the plan, you will still have control over how your money is invested among the plan’s investment options. You also may still be able to obtain information from the professionals who manage and administer your account.

When retiring, you might choose this option if your spouse is still working or if you have other sources of retirement income (such as taxable investment income). If you’re starting your own business when you leave the company, keeping your retirement money in your former company’s plan may help protect your retirement assets from creditors, should your new venture run into unforeseen trouble.

Example: Sue, 58, is retiring from her full-time job. Her husband is retiring and the family receives his pension and Social Security benefits, which will cover most of their current living expenses. Sue plans to work part-time at her church after “retirement” and does not expect to need her retirement savings for several more years. After consulting with a tax advisor, Sue decided that keeping her money in the company’s retirement plan at least until she turns age 59 ½ will provide her with the greatest flexibility in the future.

• Move Your Money to Another Retirement Account: You can move your money into another qualified retirement account, such as an Individual Retirement Account (IRA), or, if you’re changing jobs, your new employer’s retirement savings plan. With a “direct rollover,” the money goes directly from your former employer’s retirement plan to the IRA or new plan, and you never touch your money. With this method, you continue to defer taxes on the full amount of your plan savings.

Example: Bill is taking a new job at a different company. He elects to roll over balances from his existing plan into an IRA rather than transfer his assets into his new employer’s 401(k) plan. This provides Bill with a much broader choice of investment options.

• Take a Cash Distribution: You can choose to have your money paid to you in one lump sum, or in installments of a fixed amount or over a set number of years, depending on your plan’s provisions. However, you may have to pay taxes on a cash distribution and, if you’re under age 55 at the time when you leave your job, you may also have to pay a 10% penalty for early withdrawal.

Retirees Should Consider Tax Consequences
If you’re retiring, you will want to take into consideration whether favorable tax rules apply to your lump-sum distribution. To qualify as a lump-sum distribution, you must receive all the amounts you have in all your retirement plans with a company (including 401(k), profit-sharing, and stock-purchase plans) within a one-year period.

Potentially favorable tax rules that may apply to a lump-sum distribution include the minimum distribution allowance and 10-year forward income averaging if you were born before 1937.

Ten-year forward income averaging: The taxable part of the distribution is taxed at special rates based on levels for single taxpayers in 1986.

Example: Ron, born in 1936, is retiring in three months. He met with a financial advisor to determine which distribution method would result in the greatest benefit after taxes. His advisor showed him that, under some assumptions about inflation and future rates of return, his best course would be to take a lump-sum distribution and use 10-year forward income averaging. Under other assumptions, he would benefit from leaving his money in the company plan or rolling it over directly into an IRA. There may be other distribution options available. Contact your plan administrator for information on all options available under your plan.

Withholding on Cash Payments
If you choose to physically receive part or all of your money (say, $10,000) when you retire or change jobs, this action is considered a cash distribution from your former employer’s retirement account. The cash payment is subject to a mandatory tax withholding of 20%, which the old company must pay to the IRS, and possibly a 10% penalty if you are under age 55 at the time you left the company.

You can avoid paying taxes and any penalties on a cash distribution if you redeposit your retirement plan money within 60 days to an IRA or your new employer’s qualified plan. However, you’ll have to make up the 20% withholding from your own pocket in order to avoid taxes and any penalties on that amount. The 20% withholding will be recognized as taxes paid when you file your regular income tax at year end, and any excess amount will be refunded to you as an IRS refund.

The Potential Cost of a Cash Distribution
Distribution – 20% Tax Withholding = Amount in Your Pocket - 10% Penalty
$10,000 distribution – $2,000 Tax Withholding = $8,000 in Your Pocket - $1,000 Penalty

If you are under age 55 when you separate from service with your employer, and choose to take a cash distribution, be aware of how it can immediately whittle away the money you’ve worked so hard to save. You can take a cash distribution and avoid the 10% penalty so long as you roll over the entire $10,000 within 60 days into an IRA or your new employer’s qualified plan, even though you actually received only $8,000 after paying the 20% tax withholding. In that case, $2,000 will have to come out of your pocket.

As with all retirement and tax planning matters, be sure to consult a qualified tax and financial planning professional to ensure that your planning decisions coincide with your financial goals.

Points to Remember
1. A distribution is a payout of realized savings and earnings from a retirement plan. In general, you must begin taking distributions from your account by April 1 of the year following the year in which you turn 70 ½, unless you are still working for your employer.
2. Your distribution options include keeping your money in your plan; enacting a direct rollover; or taking a cash distribution.
3. If you keep your money in your plan you will no longer be able to make contributions, but you still maintain control over the investments and any growth continues to be tax deferred.
4. In a direct rollover, you have your money moved directly to a qualified plan or IRA without physically receiving a cent. If you are under age 55 at the time of separation from service, a direct rollover may be a good option, as it avoids the hefty taxes and penalties associated with a cash distribution.
5. Although a cash distribution is perhaps the most enticing option available, consider that you must pay taxes on the money you receive at then-current rates. And if you are under age 55 when you leave your employer, you may have to pay Uncle Sam 10% of your savings in penalties.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

Copyright © 2008, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.

College Tuition Planning and Wealth Management

Using 529 Plans to Invest for College and Manage Wealth

Paying for a child’s or grandchild’s college education is an expensive proposition, even for many high-net-worth Americans. Today’s elite institutions promise graduates a rewarding future, but at a cost that more often than not extends well into six figures. Enter the 529 plan, a tax-advantaged investment vehicle generally available to families regardless of their income level. For affluent parents and grandparents, a 529 plan offers a variety of potential benefits — including some that go beyond the scope of college planning. A 529 plan may in fact play an integral role in an estate plan.

Named for the section of the Internal Revenue Code that authorized them, 529 plans allow investment earnings to grow sheltered from federal income taxes, and withdrawals used to pay for qualified education expenses are tax free. But for parents or grandparents concerned about estate taxes, 529 plans may be even more valuable, supporting a long-term gifting strategy while still providing significant control over assets that have been removed from a taxable estate.

First and Foremost, a College Savings Tool…
Before you consider the potential role of a 529 plan in your estate plan, it’s important to understand a few basics.

There are two types of 529 plans — prepaid tuition plans, which let you lock in tomorrow’s tuition at today’s rates, and college savings plans, which let you choose from a menu of investments and offer more return potential, as well as risk. Both types of plans are generally sponsored by a state government (although tax law permits certain educational institutions to sponsor prepaid tuition plans) and administered by one or more investment companies.

With a 529 college savings plan, the underlying investment options are typically managed by mutual fund companies. Many plans offer age-based asset allocation portfolios that become more conservative as the beneficiary grows older. Others let account owners choose from individual investment options to create a customized portfolio.

Originally, 529 plans offered the benefit of tax-deferral — taxes on earnings weren’t due until withdrawal and then only at the beneficiary’s rate. But qualified withdrawals are now federally tax free.

Eligibility to contribute to a 529 plan is not limited by age or income. In addition, total plan contribution limits often exceed $200,000.

Withdrawals can be used to pay for undergraduate or graduate school expenses. Withdrawals for purposes not related to paying qualified education expenses are subject to ordinary income taxes and a 10% penalty tax.

Finally, remember that you are not limited to participating in your home state’s 529 plan — you can participate in national plans sponsored by other states as well. Be aware that your home state’s 529 plan may have state income tax consequences. Consult with a tax advisor before investing in a plan.

…But With Valuable Estate Planning Potential
The IRS clearly had college planning in mind when it drafted Section 529 of the Internal Revenue Code. However, it also left the door open to use 529 plans as estate planning tools. That’s because a contribution to a 529 plan is considered a completed gift from the donor to the beneficiary named on the account, even though the account owner, not the beneficiary, maintains control over the money while it’s in the account. Tax rules permit you to give $12,000 (indexed to inflation) to as many individuals as you choose each year, free from federal gift taxes. Couples can give $24,000 without incurring taxes. As a result, one method of reducing a taxable estate is to make scheduled gifts up to the tax-free limits each year. You might give $12,000 to each grandchild on an annual basis, for example.

That’s where 529 plans come in: The first $12,000 you contribute each year per beneficiary won’t come back to bite you, as long as you haven’t made any additional taxable gifts to the beneficiary in that year. You can also accelerate your gifting schedule by electing to make a lump-sum contribution of $60,000 to a 529 plan in the first year of a five-year period ($120,000 for a couple). Of course, you wouldn’t be able to make additional taxable gifts to that beneficiary during the five-year period. And if you use the five-year averaging election and die before the five years are up, a prorated portion of the contribution may be considered part of your taxable estate.

But the wealth transfer potential can be substantial: An individual who has five grandchildren could immediately remove up to $300,000 from his or her taxable estate by contributing the money to five separate 529 plan accounts. Five years later, he or she could do it again.

Smart Shopping: Making the Right Decision
If you decide that a 529 plan deserves further consideration, keep in mind that there are often important differences between the plans offered by each state. For example, lifetime contribution limits can vary widely from state to state. The limits are often based on average college costs within the sponsoring state. In calculating those averages, some states assume that not just undergraduate expenses are incurred, but graduate expenses as well.

Also, some plans offer relatively few investment options, while others may give you a wide range of investment choices managed by specially selected sub-advisors. Evaluate the performance of the investment options offered by specific plans. Compare the fees and expenses each plan charges too. And finally, keep in mind that some states offer in-state residents a tax deduction when they make a 529 plan contribution.

You Stay in Control
It’s worth emphasizing: Although the assets contributed to a 529 plan are no longer considered part of your taxable estate, you still exercise control over the money. You decide how it will be invested — within the confines of the plan’s available investment options — and when it will be withdrawn. You also have the right to change beneficiaries, in the event that the original beneficiary decides not to attend college, for example. And doing so generally won’t trigger tax consequences if you choose a beneficiary who is a member of the original beneficiary’s family. (As spelled out in Section 529, qualified family members include the beneficiary’s brothers or sisters, mother or father, sons or daughters, and nieces or nephews, among others.) If there isn’t another suitable beneficiary, you also have the option of closing the account and taking the money back, although earnings will be subject to income taxes, as well as a 10% penalty.

When choosing a 529 plan, you’ll need to look beyond estate planning considerations. There are dozens of plans available and their features and rules can vary greatly. To help narrow down the choices, consider working with a qualified financial professional. And be sure to consult with an estate planning attorney or tax professional before making any decisions that could affect your tax liability.

Points to Remember
1. State-sponsored Section 529 college savings plans have the potential to double as high-powered estate planning tools. Any assets you contribute to a 529 plan account are removed from your taxable estate and pass into the plan free of federal gift taxes, up to an annual limit of $12,000 ($24,000 per couple.)
2. The IRS will allow you to make five years’ worth of tax-free gifts in one year, but only once every five years. That means you can contribute up to $60,000 at once ($120,000 per couple), helping to finance a beneficiary’s education while simultaneously minimizing potential estate tax obligations.
3. Although the assets gifted to a 529 plan are removed from your estate, you retain control over investment, withdrawal, and beneficiary decisions.
4. 529 plan contributions and investment earnings can be withdrawn tax free as long as the money is used for qualified education expenses. If you make withdrawals for non-education purposes, you must pay ordinary income taxes and a 10% penalty.
5. Shop wisely before selecting a 529 plan. For example, compare fees, investment options, and lifetime contribution limits.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

Copyright © 2008, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.

Charitable Contributions

Bring Charitable Giving Into Your Estate Plan

In addition to the altruistic and goodwill benefits any charitable contribution brings, it can also have significant tax advantages. When deciding your estate-planning strategies, consider a charitable contribution to help the charity of your choice as well as provide you with a steady stream of income and potential tax benefits.

There are different options for setting up a charitable contribution through your estate plan. The easiest is a simple bequest through your will. Remember that charitable contributions are 100% deductible from estate taxes.

Charitable Remainder Trusts
What may be even more beneficial for you than a simple bequest is a charitable remainder trust (CRT). A CRT offers flexibility, an income stream for life or a term of years, and significant tax benefits to you and your heirs.

A CRT is an irrevocable, tax-exempt trust in which you place assets to provide income for you during a specific period of time (i.e., your lifetime or a term not to exceed 20 years). At the end of that period, the remaining assets will be turned over to the charity of your choice. The trust can be funded with a wide assortment of assets, including bonds, mutual funds, stocks, and real estate.

A CRT can offer benefits on a variety of levels. For instance, if you have appreciated assets like stock, you will likely pay a great deal in capital gains taxes when you sell the stock. But if you transfer the stock to a charity through a CRT, the trustee may be able to sell the stock with no gift, estate, or capital gains tax consequences for the donor. The trustee can then set up an investment that will provide an income stream for you, which will be subject to ordinary income taxes and capital gains. Finally, you’ll be able to take a charitable income tax deduction based on the present value of the trust’s remainder interest.

Designing a CRT
A CRT must be designed in the form of either an annuity trust or a unitrust. Both allow flexibility in payment options. The main difference involves income and fair market value of the assets in trust. Income from an annuity trust is a fixed percentage (not less than 5% or more than 50%) of the initial fair market value of the assets. This type of trust is best used with assets that will
be able to generate the required income and do not fluctuate greatly in value (such as bonds). The income to the donor is fixed and will not grow as the asset base grows. Consequently, the income may not keep up with inflation.

A unitrust is a more flexible but risky alternative. In a unitrust, the donor still receives a fixed percentage (not less than 5% or more than 50%) of the value of the assets in the trust, but the assets are valued annually, and the donor receives the fixed percentage of the current fair market value. This allows the donor to benefit from any growth in the investment; of course, there are no guarantees such growth will occur. The unitrust also allows for additional contributions to the trust, whereas the annuity trust does not.

A unitrust has better potential to keep up with inflation because the income payments will increase if the investment grows in value. However, if the value of the assets in the trust falls due to market conditions, the income also will decrease. In an annuity trust, the donor is guaranteed the same income payment regardless of current asset value and thus is protected from a possible market downturn. Ultimately, the choice between an annuity trust and a unitrust will be dictated by a number of factors as best determined by your advisory team.

Benefits of a CRT:
􀁺 In many cases, there are no capital gains taxes on assets transferred to a CRT;
􀁺 Has the potential to generate substantial income for the donor; and
􀁺 Creates income tax deductions for the donor.

Other Considerations for CRTs
A CRT can be a little involved to set up. By establishing the trust, you forever relinquish your rights to the assets you put in the trust. Another consideration is that your heirs will not inherit the assets placed in this trust. Some donors compensate for this by purchasing a life insurance policy with some of the income generated by the CRT or by using the savings incurred by the charitable income tax deduction.

CRTs Must Be Annuity Trusts or Unitrusts
Annuity Trusts
􀁺 flexibility in payment options
􀁺 fixed income payout
􀁺 inflation risk (fixed payout may not keep up with inflation rate)
Unitrusts
􀁺 flexibility in payment options
􀁺 variable income payout
􀁺 market risk (variable payout can rise or fall with changing value of underlying assets)

Options for Charitable Giving
Though a CRT may sound like the ideal choice for your charitable bequests and estate planning needs, you might also consider these other options.

Charitable Lead Trust (CLT)
A CLT is essentially a CRT in reverse. Unlike a CRT, a CLT allows you to place in trust assets that will be left to your heirs; however, you specify a set number of years during which a guaranteed amount of a fixed percentage of the value of the assets in the trust will be paid to a charity. You pay discounted gift taxes on assets transferred to the trust and do not receive a charitable deduction. However, your heirs ultimately will receive trust assets free of estate taxes.

Foundations
Another possibility is setting up a foundation allowing systematic gifts to an area of special importance to you, the founder. Foundations can fund college scholarships, research grants, and the maintenance of collections or real estate, among others. Although foundations fell out of favor with some wealthier individuals after the Tax Reform Act of 1969 eliminated some of the tax advantages, they are still highly utilized to preserve and foster an individual’s or family’s philanthropic legacy.

A Win-Win Proposition
When planning your estate, you should consider making a charitable contribution. In addition to the altruistic benefits of donating to charity, you can also gain significant tax advantages. Though perhaps one of the more popular estate planning tools is the CRT, you might consider the benefits of other options as well. Talk to your financial advisor or legal counsel to determine which option is right for you.

Points to Remember
1. Consider charitable giving as a way to maximize your estate-planning strategies.
2. A CRT offers you flexibility, can provide income during your lifetime, and offers significant tax benefits to you and your
heirs.
3. A CRT must be designed in the form of either an annuity trust or a unitrust.
4. CRTs are irrevocable; therefore, you forgo rights to any assets placed in the trust.
5. Other charitable options include a charitable lead trust and private foundations.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

Copyright © 2008, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.

Are You Ready To Retire?

Retirement Planning

You have done pretty well for yourself with all the work that you’ve put in over the years. The kids are through college and launched on careers of their own. You’ve built up substantial balances in your retirement plans, put aside a good-sized rainy day fund and insured yourself against every conceivable catastrophe.

You have dreams and aspirations for life beyond the daily grind. Now you suspect that you are ready to enter that next phase of your life, but you want to be sure that you have the resources to live it as you intend. Perhaps it is time to do some serious thinking and planning about retirement.

Consider your costs.
You will have to begin with a hardheaded estimate of your retirement expenses. Although many sources tell you that you can maintain your lifestyle with 60% to 80% of your pre-retirement income, the reality can differ greatly with the style of life that you have in mind. If you plan to relocate to a less costly community and spend your days catching up on your reading at the local library, your expenses may be modest. On the other hand, a year of serious globe-trotting or shuttling between summer and winter retreats easily can consume more than your current income.

Will you still be making mortgage payments? Do you plan to help with the expense of a grandchild’s education? Does family history suggest that you will need to contend with chronic illness, or live far beyond your allotted three-score years and ten? Do you intend perchance to do some consulting after retirement? Do you have a philanthropic urge? All factors of this sort should figure into your income requirements. Nor should you forget the income tax that will be due unless that income is derived from tax-exempt municipal bonds, Roth IRA withdrawals, or the nontaxable portion of your Social Security benefit.

Don’t forget inflation.
Then you will have to factor in a presumed rate of inflation throughout your retirement. Even at today’s modest rates, inflation gradually will boost the amount that you will need to finance your intended lifestyle. Retiring today at age 60, you may be looking forward to 30 or more years of retirement. Just 3% inflation will reduce the purchasing power of your dollar by 59 cents over the course of 30 years. The capital that you have available to support your retirement must produce income enough not just to support you at the level of your needs for the first year, but also to increase each year to cover rising costs. The accompanying table shows how long a nest egg can continue providing a stream of income rising by 3% each year under various earnings assumptions.

Ready?
The question is whether your resources will support you through the retirement that you envision with a comfortable margin of safety. It’s not rocket science, but the calculation does call for a number of facts, suppositions and estimates. You could crunch the numbers yourself if you are handy with a spreadsheet or use one of the retirement planning aids provided in financial books and magazines, software programs and Internet sites. On the other hand, if you would like some help with the arithmetic, we would, of course, be happy to provide it.

Either way, you will start by toting up your current and expected assets. Your current balances in retirement accounts, as well as unsheltered savings and investments that you do not intend for more immediate use, form the basis of your nest egg. Factor in your projected Social Security and pension benefits. An expected inheritance or a judgment due you can add to the total. Home equity also can contribute if you intend to move to a less expensive home.

With your projected expenses and available resources, all that is needed to complete the calculation are assumptions as to (1) the rate of inflation, (2) the expected return on your investments, and (3) the number of years that you will spend in retirement. Because you cannot be sure of any of these factors—or of tax rates or the state of your health in the future—it is prudent to be conservative in your estimates.

As our table demonstrates, with large enough returns, withdrawals kept small enough, and a reasonable rate of inflation, a given nest egg may last for a long, long time.

Percentage of nest egg withdrawn in the first year * At these average rates of return, capital will provide withdrawals rising by 3% each year for this number of years . . .
5% 7% 9% 11%
3% 52   
4% 34 72  
5% 25 36  
6% 20 26 44 
7% 17 20 27 
8% 14 17 21 31
9% 12 14 17 22
10% 11 12 14 17

*Total withdrawal made at beginning of the year.
 Money does not diminish.

This is a hypothetical example and is not representative of any specific situation. Your results will vary.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Securities offered through LPL Financial, Member FINRA/SIPC. Advisory services offered through Wealth Enhancement Advisory Services, a registered investment advisor.

© 2006 M.A. Co. All rights reserved.
Any developments occurring after January 31, 2006, are not reflected in this article.