Your Parents' Estate Plan Part 2: What You Need to Know (2010-02-22)

by David John Marotta

A thoughtful estate plan can make your heirs' lives easier. But it is your parents' estate planning that will make your life easier.

Not every family has fostered the ability to speak openly in love. But if you have begun that process, here is an outline of what grown children need to know about their parents' affairs. In fact, adults of any age should update their estate plan every year.

Children may wish to ask their parents about their financial status but worry about being overly intrusive. Or they fear their elders may perceive their questions as motivated by self-interest. They may conclude mistakenly that their parents would prefer to keep their finances private.

However, whether it's our parents or ourselves, we are all certainly mortal, so planning for the future is always wise. Estate planning is just as critical when we are young as when we get older. And if you think estate planning information is hard for you to pull together, imagine how challenging it would be for someone else who may have to step in for you during a family crisis.

As a parent, if you are willing to share some of this information with your children--especially if one of them is also the executor of the estate--they'll appreciate having the facts and be more prepared emotionally when the time comes. They will know your wishes ultimately anyway, and good communication will lessen any surprises ahead of time. They will benefit from knowing the answers to the following questions.

Do you have enough saved for a comfortable retirement? We use a safe withdrawal rate by age to make sure clients will still have enough money toward the end of their retirement. Few parents manage to time spending their last dime the day they die, so adult children are justifiably concerned about their parents.

If your spending is under this withdrawal rate, you have more than enough and probably can leave a legacy to your heirs. But if you are over this rate, you may run out of money and have to compromise your standard of living abruptly. It may be uncomfortable, even embarrassing, for parents to share their finances with their children, but grown children often want to know how their parents are doing.

Where are the important documents? The five documents your executor or your children should be able to retrieve quickly are a will, a living will, a power of attorney, a directory of basic information and the latest end-of-year financial statements.

The directory of information should list the assets of your estate along with account or policy numbers and contact phone numbers. It also helps to indicate your intentions for the distribution of each asset, which will help confirm you have the correct titling and beneficiary designations on every portion of your estate.

You may have structured your will to divide your estate equally among your children. But if you have tried to make it easy for one child to access your bank accounts by adding his or her name, you have overridden your estate plan and left that child joint tenancy with complete rights of survivorship.

Titling and beneficiary designations are legal estate planning actions. It's best to review them with your legal advisor. Various types of assets are best designated differently in the estate plan. This is not the occasion for do-it-yourself thrift. It is a rare family that has compiled and reviewed a complete list of estate assets: bank accounts, investment accounts, retirement account, real estate holding, life insurance, health savings accounts and so on.

Are there any special bequeaths? Any promises you want kept should be documented. Your good intentions won't matter if you aren't around to implement them. If you have promised money to a charity and want that obligation kept, document it. If you have promised to loan a child money, document it. If you have promised to help fund your grandchildren's college education, document that. Without documentation, none of these promises can be kept if you aren't around to make the decisions.

Are there plans to remarry? If parents have remarried, intergenerational estate planning is even more critical. Prenuptial agreements and careful estate planning are required in the case of second marriages to avoid disinheriting children or grandchildren from the first marriage. The default is rarely a good option.

Do you have any prepaid funeral arrangements? Do you want to be buried or cremated? Do you have any preferences for a memorial service? Although it may seem macabre to plan your own funeral, a memorial service takes time and thought. It will be that much more special and comforting to your family when it is filled with your favorite music and readings.

Encourage your children's interest in your estate planning. Most of time, their intentions are honorable. They may simply want to understand your values and therefore your wishes.

 

from http://www.emarotta.com/article.php?ID=377

Your Parents' Estate Plan Part 1: Why You Need to Know (2010-02-15)

by David John Marotta

We spend a lot of time helping our clients make sure their estate plans are as comprehensive as possible. I've seen enough estates settled with critical components or provisions missing to be convinced that the effort spent on estate planning is well worth the time it takes to put them in place.

Your estate plan should be carefully crafted to address your specific needs and circumstances. The more tailored your plan, the less room there is for family disagreements. Unfortunately, you won't be around to see the benefits of your care and concern. Your heirs, unless they have seen inadequate estate plans, also may not appreciate the nightmares that can result from a failure to plan. The best estate plans preserve both your values and family harmony.

Your estate plan can make your heirs' lives easier. But it is your parents' estate planning that will make your life easier. You or your siblings will probably have to settle the estate and potentially have to go to court to resolve matters. Good intentions don't count if they aren't documented legally.

Today's generation of seniors are often much more comfortable talking about sexuality than they are talking about money. Finances have become the new family taboo. Any breach of this protocol is seen as distasteful. My own family, however, was refreshingly open about their finances.

As long as I can remember, my father has taken time at each family vacation to review the family's estate plan. And now every January he sends updated financial information. I knew as a very young child who I would live with if my parents were both killed in an accident. And I knew how they had prepared to pay for my college education if they were not around to take care of it themselves.

As an adult I know who will serve as executor and the details of my father's finances. It is a long list that includes account and policy numbers as well as contact addresses and phone numbers. It is signed "Love, Dad," which it is--a loving gift of both trust and peace of mind that parents can give to their children.

None of this fosters an expectation of what I might inherit someday. I hope my father enjoys every dime of his money, and I don't plan on inheriting a cent. Whatever our parents own is completely theirs, to do with as they see fit. They can leave the entire amount to their favorite charity or in trust to take care of their pet cats. But it is always better when parents deliberately choose how they want their money disbursed and act accordingly.

Not planning at all is obviously an option people can choose, but the consequence could be a complete failure of their vision of what they would want to happen. To repeat an essential point: All the promises and good intentions count for little without the paperwork to back them up. Planning, documenting and sharing that vision frankly increases its likelihood of reaching fulfillment as well as leaving a legacy that better reflects your values and the reasoning behind your actions.

Finally, estate planning goes both ways. Many parents want to ensure that their children will be cared for at least until they graduate from college. Now that the children are adults, they want to know their parents have enough to cover a comfortable retirement. When parents share the details of their estate planning with their children, it helps their offspring plan in case they feel the need to supplement their parents' standard of living. I've known children who assumed because of their parents' frugal lifestyle that they would probably be required to assist their elders. They did not realize their parents had a more than adequate retirement plan with money left over in case of an emergency.

Although I encourage these discussions, I know that not every family has developed the ability to speak openly in love. It is a progression that takes a certain spiritual maturity in both parties. If one of your children is also the executor of your estate, however, it is essential to start that process.

 

from http://www.emarotta.com/article.php?ID=376

America, Land of the Mostly Free (2010-02-08)

by David John Marotta

America is officially no longer free. According to the <a href="http://www.heritage.org/" target=_blank>Heritage Foundation</a> Index of Economic Freedom, we have dropped out of the top seven countries and into the second tier of "mostly free" countries.

I've been writing about the correlation between economic freedom and superior investment returns since my "<a href="http://www.emarotta.com/article.php?ID=16" target=_blank>Let Freedom Ka-Ching</a>" articles in 2004. In that series I wrote, "We find the Heritage study useful, both to refute presidential candidates' claims that governmental coercion will make us richer economically, and also to help us find those countries where investment actually would make us richer."

Since 1994, the Heritage Index has systematically measured economic freedom in countries worldwide. The foundation defines economic freedom as "the ability of individuals to control his or her own labor and property. In an economically free society, individuals are free to work, produce, consume, and invest in any way they please, with that freedom both protected by the state and unconstrained by the state."

Five of the top seven countries have easy, convenient ways of investing there. They use country-specific <a href="http://www.ishares.com" target=_blank>iShares</a>, exchange-traded funds (ETFs) that combine the liquidity of individual stocks with the diversification of index funds.

These countries have maintained their economic freedom better than the United States. Along with the symbols for the ETFs, they are Hong Kong (EWH), Singapore (EWS), Australia (EWA), Switzerland (EWL) and Canada (EWC).

The United States is still mostly free. It ranks eighth among over 180 countries rated. You may note the irony that Canada, with its socialized medicine, is freer than the United States. But you should know that choice lowers Canada's score. The United States has taken actions that as a whole are even worse.

The Heritage Foundation explains what has changed. "The U.S. government's interventionist responses to the economic and financial crisis that began in 2008 have significantly undermined economic freedom and long-term prospects for economic growth. Economic freedom has declined in 7 of the 10 categories measured."

This government intervention was not necessary. After Enron went bankrupt, the markets quickly righted themselves. Other better run companies soon filled the void. In this crisis we've tried to bail out the poorest run companies to the detriment of everyone. Another study by the foundation concluded that the amount a country spends with stimulus money has a negative short-term correlation with its gross domestic product (GDP). In other words, stimulus money may even have a slight negative short-term effect as well as a stronger negative longer term effect.

Governments seize on every crisis--even those they cause themselves--to posture as redeemer and promote extending their own influence as a political solution. Unfortunately, government, more often than not, is part of the problem.

The Troubled Asset Relief Program (TARP) did little to let weak banks fail and give the country strong banks. The cash for clunkers scheme destroyed perfectly good automobiles. Plus it handed money to government- and union-owned failing car manufacturers. Government mandates required lenders to approve mortgages for people who couldn't afford them and caused the subprime meltdown. And government regulations require health insurance companies to charge the young with punitive rates. This intervention encourages many who are unwilling to subsidize older and wealthier patients to simply forgo insurance. All the while government regulation has been purposefully preventing insurance in one state from being offered in other states.

Government intervention continues to do more harm than good. This past year it took a common recession and prolonged it into a more permanent malaise. GDP growth, which has historically averaged 6.5%, is liable to slow to a more European rate of 3% to 4%. Official unemployment numbers will lower but only as people drop out and are no longer counted. Real unemployment is liable to remain high for some time.

Free markets are critical for job creation and GDP growth. Stimulus money may increase government spending, but the growth of government is a negative in the equation of economic prosperity. Real hope and change can only come from letting entrepreneurs in the private sector innovate in the context of free competing markets.

These are not idle claims. Each of the five major free countries has returns far superior to the United States. Their average return for the past five years was 10.41% versus 0.42% for the S&P 500. It may seem remarkable to beat the S&P 500 by 9.99%, but it proves what a steep price we pay for increasing government intervention.

The top five countries have a 10-year average return of 6.86% versus negative 0.95% for the S&P 500. They also beat the MSCI EAFE foreign index by 6.86% over the last five years and 5.69% over the last decade.

But the argument for economic freedom is not ultimately pragmatic. Economic freedom is not something government ought to provide simply as a utilitarian way to gain economic growth. No, economic freedom is a basic human right. And human rights are inalienable. They are God-given natural laws that government can either respect and protect or can abrogate and disregard.

The intention of our constitution was to protect these natural rights by limiting the scope and power of government. All powers not specifically enumerated were reserved for the people.

Slavery was abolished along with indentured servitude because we all have the right to control and direct the fruits of our own labor. This is why those who love liberty oppose the current administration and Congress so vehemently. Efforts to triangulate economic interests fail because even those who struggle financially suffer under the economic malaise of a controlled economy. But more importantly, everyone suffers when the arbitrary exercise of political power violates basic human rights.

 

from http://www.emarotta.com/article.php?ID=375

The TANSTAAFL Principle (2010-02-01)

by David John Marotta

"There ain't no such thing as a free lunch." As early as 1938, this phrase was touted as "economics in nine words." It should be part of a civics course required for high school graduation. And it should be the pledge of service for elected officials. Instead, we get utopian drivel that garners votes at the expense of economic prosperity.

The initiated shorten the phrase "There ain't no such thing as a free lunch" to the acronym TANSTAAFL, pronounced "Tan-staffle." It means that any claims that something is free neglect to take into account the unintended effects and consequences.

It all started in the early 20th century as a marketing ploy. Saloons would offer a free lunch to anyone who bought at least one drink. The lunch didn't cost anything, but the drinks were correspondingly more expensive. TANSTAAFL.

Saloon proprietors were betting that their patrons would continue drinking, not unlike drug dealers who give away the first hit of crack cocaine. They were also counting on their clientele coming back in the evening when the lunches weren't free and the drinking was more liberal.

Even if an immediate cost can't be found, there still is one. Sound economics dictate that the cost usually exceeds the direct cost of the lunch. If the lunch were really worth the price, someone would have already paid for it. Because no one did, there was something people would have done with the money that was worth more than the cost of the lunch.

Ironically, so-called free lunches can cause people to go hungry. Free lunches reduce the supply of quality lunches. They drive down the number of people willing to make lunches for a profit. Soon only those selling alcohol are providing lunches, and those lunches are meager. Ultimately, if you aren't an alcoholic, you have to go hungry.

Robert Heinlein made TANSTAAFL popular in his 1966 book "<a href="http://www.amazon.com/gp/product/0312863551?ie=UTF8&tag=davidjohnmarotta&linkCode=as2&camp=1789&creative=9325&creativeASIN=0312863551">The Moon Is a Harsh Mistress</a>." One of his characters remarks, "Anything free costs twice as much in the long run or turns out worthless." Heinlein's book is a science fiction story about the lunar colony's revolt for independence against the earth. To say that the book delights libertarians is simply to say it is based on sound principles of economics.

The very earliest reference in print to a free lunch comes from a character in a 1919 novel. He describes the frenzy of battle by saying, "The shells and shrapnel was flying round and over our heads thicker than hungry bums around a free lunch counter." Unfortunately, the hungry bums have all gone to Washington and now represent us in Congress.

For example, take the recent round of stimulus money being flung to the crowds. Our current state representative was criticized by his opponent in this last election for voting against amendments that would qualify Virginia for $125 million in stimulus funds. His challenger complained, "It was free money to help people who were losing their jobs."

Such statements are economically incorrect. In retaliation, we should enforce economically correct (EC) speech. If it isn't EC, it is therefore economically bigoted and should be seen as offensive as advocating indentured servitude. Where is the outrage against such non-EC speech?

Our current representative is one of the few politicians who recognizes TANSTAAFL and isn't afraid to take the long view. He opposed taking the supposedly free money and trusted that the voters would be EC enough to reelect him.

He reasoned that accepting the money would require permanent changes to Virginia's unemployment insurance system in exchange for temporary funding. He argued that these changes would remain long after the stimulus money ran out. And expanding unemployment benefits would erode Virginia's attractiveness to businesses.

The changes that Congress was pressuring Virginia to accept are the same liberal unemployment benefits in place in California. Those benefits mean that California has some of the highest payroll taxes in the country, making it hard for the state to compete and driving out businesses. Rather than relaxing the taxes in California, Congress decided to push the same burdens on every other state by bribing them with bailout money.

The idea was to tax everyone and then give the money only to those states willing to accept the same burdensome government that is bankrupting California. It certainly isn't a free lunch. In fact, it is like eating a buffet of parasites.

When people are unemployed, what they really want is a job. Liberal unemployment benefits make it harder for businesses to compete when people are getting paid with no obligation to work. Prolonged unemployment benefits directly compete with struggling businesses trying to hire people at a reasonable salary.

If California's unemployment benefits are supposed to be a model for the rest of the country, they are a prototype for a banquet of indigestion. In the latest unemployment statistics, the state's unemployment rate is 12.4%. Virginia's rate, in stark contrast, is 6.9%. The national average is 10.0%.

Reasoning through the long-term consequences shows that the money isn't "free money" at all. In fact, accepting the money may very well be selling Virginia's long-term competitiveness for a pot of tainted porridge.

All of this well-founded economic thinking was in danger of being lost in the simplistic sound bites offered by my state representative's more liberal challenger. Fortunately, it was not lost on the voters. The "free money" candidate lost 67% to 33%. But a third of the voters still need a lesson in EC.

The media is particularly susceptible to the free lunch ruse. Only the immediate consequences of a policy fit in a headline or a sound bite. Actually explaining the ill effects of unintended consequences evidently is for books and boring documentaries. News organizations provide entertainment rather than information.

People embrace the media as a career because they want to change the world. The idea that market forces can determine where goods and services should go more effectively than centralized planning or thoughtful evaluation ruins the media pundit's hopes of making the news instead of just reporting it. Informing the consumer, an always worthwhile endeavor, is too indirect for today's teleprompter readers.

My column covers public policy issues based on two basic principles. The first responsibility of all citizens is to take care of their own families. And the first responsibility of government is to do no harm through unintended consequences.

We suggest you save 5% of your take-home pay in a taxable account, in addition to saving 10% in a retirement account. After six years you should have your own six-month emergency fund to cover the possibility of unemployment. Unemployment benefits can help a family in financial trouble, but they do not alleviate the fact that you might need to take a lesser paying job.

We want to lighten the burden of families that are having a hard time but not at the expense of struggling businesses. Mandating benefits to be paid through higher business unemployment taxes is a losing proposition. It sound-bites like a free lunch but still gives you a wicked hangover in the morning. And even if the lunch were free, your pockets would still be empty from buying drinks. TANSTAAFL.

 

from http://www.emarotta.com/article.php?ID=374

Start Saving for College the Day They Are Born (2010-01-25)

by David John Marotta and Matthew Illian

My youngest is a first-year student at the University of Virginia. My coauthor Matthew's youngest child was born only a month ago. Matthew is just beginning to think about college funding, and I'm withdrawing from my final 529 plan.

Over their lifetime, college graduates gross $1 million more in earnings than their less educated counterparts. Education helps people both gain and keep wealth. But paying for it can be daunting, especially if you have to pay all at once. For some families the price tag exceeds the cost of their home. Thus starting a savings plan early is critical. Fortunately, compounded savings eases the financial burden.

The State Council of Higher Education for Virginia study reports that the average costs for a year at a public in-state college or university will set you back $15,642. For every dollar you spend at an in-state college, only 36 cents goes toward tuition. Room and board account for 42 cents and the extra 22 cents covers books, supplies, transportation and other costs.

Expect an average price tag of $28,832 if your child enrolls as an out-of-state student or $35,636 if he or she attends a private college. Aid from grants and tax subsidies help reduce the price about 40% on average. However, those families making over $100,000 in income should not expect much help.

Saving for college requires time and money. The more you have of each, the better. Time puts the miracle of compound interest on your side. And the more money that is earning money, the less you need to continue contributing.

There is no such thing as saving too early, even for Matthew's youngest child. Saving early can cut the cost of his college education in half. Imagine he decides to go to the University of Virginia like his parents. Currently four years of tuition costs about $47,000. But by the time Matthew's son is ready to enroll, the price tag will have risen to $98,960. The earlier Matthew and his wife begin saving, the more manageable the monthly amount that should be saved.

Saving early allows you to buy your education at a discount. After saving $225 a month for 18 years, the newborn's college savings account will have grown to $98,960. An astonishing $49,235 of that amount accrued through the magic of compound interest. The great benefit of a 529 plan is that all the growth in the account can be withdrawn tax free.

Those with the money upfront could deposit $26,500 and let compound interest generate the remaining $72,460. Buying a college education for a 73% discount while receiving several years of tax deductions is a deal those with money should not pass up!

My daughter's 529 plan was first funded at the end of 2002 and has experienced a time-weighted return of 88.3%, or 9.4% annualized, since then. Yes, it was once up 121.6%, or 17.7% annualized, but it has still earned over $30,000 and saved us a tremendous amount of money.

If you cannot invest a large sum now, save a little every day. Started young enough, even a few dollars a day will pay the tuition at many public schools. By investing in a college savings plan, your money can grow faster than the inflation rate of higher education. These costs have been rising at a rate of 5%, and over the past 10 years, tuition at public schools has gone up more than 50%. If you are not saving for college, you are falling behind.

Saving for college is a critical part of financial planning. But saving for retirement is even more essential. You can borrow money for college but not for retirement. So prioritize your savings plan based on your specific situation.

For many of our clients it is the grandparents who are secure enough financially to be able to fund their grandchildren's education. The added benefit of having a grandparent own a 529 plan is that these funds are not counted in the formula for financial aid.

Higher education is critical in uncertain economic times. Although official unemployment is more than 10%, unemployment for those with a college education is only about 5%. And for people who did not finish high school, the unemployment rate is 15.3%. These are the official rates that do not count any workers who have been unemployed awhile and presumably have given up. Jobs that do not require a college education continue to move overseas into the emerging market countries.

Virginia has two of the best 529 plans in the country. For more information on the College America and the Virginia Education Savings Trust (VEST) plans, visit www.va529.org. Saving for college should be part of comprehensive wealth management. Only a fiduciary has a legal obligation to sit on your side of the table and put your interests first. The National Association of Personal Financial Advisors website (www.napfa.org) lists fee-only advisors in your area.

 

from http://www.emarotta.com/article.php?ID=373

Reflecting on 2009 Returns Provides Lessons Going Forward (2010-01-18)

by David John Marotta and Matthew Illian

Many are breathing a sigh of relief after participating in the largest stock market roller coaster since the Great Depression. Others bailed out at the wrong time and are unsure whether they will ever recover their nest egg. A valuable exercise in January is to review your investment returns in light of what occurred in the broader asset classes.

The unwinding of the highly leveraged real estate bubble continued throughout 2009. But flooding the markets with credit and currency commitments from central banks around the globe staved off further asset price atrophy.

In 2009 we were reminded that sometimes the greater the fall, the bigger the bounce. After hitting a low on March 6, the markets started a fierce climb. Those with nerves of steel were rewarded.

Standard deviation (SD) is a statistical measure of volatility. Although most market movement occurs within 1 SD, 2009 saw a six-month (March through September) S&P 500 growth period of 40.5%, a 3 SD event. Also called "three sigma" events, under normal conditions they are only predicted to appear once every 56 years. Although rare, stock market returns are capricious by nature and regularly exceed the statistical norms for such wild events.

Money flows from equity mutual funds suggest that investors were pulling their money out in record amounts as the market neared the bottom. Many investors were selling at the bottom! In contrast, disciplined investors stick to an established plan to rein in their emotions. Those who regularly rebalance their portfolios used the sharp decline in the markets to acquire stock investments at half the price they were going for only six months prior.

The S&P 500, which represents the largest American-based companies, finished the year up 26.46%. Smaller companies, represented by the Russell 2000, slightly outperformed, ending up 27.17%. This confirmed a long-term trend that suggests small companies tend to average higher returns than their larger counterparts.

Value stocks historically outperform growth stocks. They didn't last year, however. Both small- and large-cap growth stocks were the winners. The Russell 2000 Growth Index was up 34.47% compared to the Russell 2000 Value Index, up 20.58%. One year of outperformance, even by such a wide margin, did not reverse the long-term trend. The Value Index has a 10-year average annual return of 8.27%. But the Growth Index is still in the red at -1.37%.

Weakness in the U.S. dollar (USD) was another strong theme for 2009. Flooding the world with newly printed greenbacks and growing deficits is causing unease across international markets. Many believe the days of holding dollars as the international reserve currency are numbered.

It is difficult for U.S. investors to comprehend the effect of a devalued USD. International investors saw quite clearly the effect of a weakening dollar. Developed international investments as measured by the Europe, Australasia and Far East (EAFE) Index finished up 31.78%. A foreign investment has two moving parts. The first is the stock price, which fluctuates based on the performance of companies in their own currencies. The second part is the currency exchange. If you could strip away the currency exchange, the EAFE Index return would have only been 24.72% with the remaining 7.06% coming from a weakening U.S. dollar.

Investing in countries with a strong currency and healthy balance sheet showed particular strengths. Australian markets finished the year up 66.16% for U.S. investors but only 36.78% if measured in Australian dollars. Investors gained an additional 29.38% from the U.S. dollar weakening against the Aussie dollar.

The largest growth came from the emerging markets. They were up 78.51% in USD, triple the return of developed foreign or domestic indices. Brazil led the pack, finishing the year up 128.06% in USD and 70.48% in local currency. India, Russia and China all had superior performance.

Natural resource stocks, also called hard asset stocks, were up 37.54%. Hard assets include companies that own and produce an underlying natural resource. These include oil, natural gas, precious metals (particularly gold and silver), base metals such as copper and nickel and other resources such as diamonds, coal, lumber and even water. These stocks are unique in that they have a low correlation with other stocks and bonds and they appreciate with inflation.

Those who moved their investments to the supposed safety of Treasury bond investments were deeply disappointed. The Barclays Capital U.S. 1-3 Year Treasury Bond Index finished the year with a meager gain of 0.8%. The Barclay Capital U.S. Aggregate Bond Index (including corporate bonds) finished the year up 5.93%. Foreign bond performance was even better due largely to currency exchange.

Take the time to compute your 2009 returns and review your asset allocation and investment selection. Too many American investors have most of their investments tied up domestically. We suggest you expand your investment mix to include foreign bonds, foreign stocks and hard asset stocks. Adding these to a diversified portfolio of U.S. stocks and bonds will reduce the average volatility of your portfolio while boosting returns over a full market cycle.

 

 

from http://www.emarotta.com/article.php?ID=372

Last Chance for a Segregated Roth Conversion (2010-01-11)

by David John Marotta

A tax tsunami is coming at the end of this year. The higher your adjusted gross income (AGI), the closer you live to the coast where the tsunami will hit. This is the last chance you will have to put your assets in a lifeboat and avoid getting swamped with taxes.

At the end of 2010, the Bush tax cuts will expire. The Obama administration is not expected to alter the rates significantly before then. They don't want to be held accountable for raising taxes before the midterm elections. And they would rather blame the previous administration for a crazy expiring tax law.

Right now, tax rates are at a historic low. But after 2010, counting all the tax changes, top marginal tax rates may rise from 44.6% to 62.4%. Thus you will only have to pay a maximum of 44.6% on income you can take before 2011, but after that you may have to pay 17.8% more in tax.

If you have an income over $100,000, this is the first year you can take money from your traditional IRA, pay tax as though that money is ordinary income and convert it to a Roth IRA. This procedure is called a "Roth conversion."

Roth IRA accounts are to your advantage if your tax rate will be higher in retirement when you withdraw the money than it was when you contributed. With a Roth IRA, you pay tax on the acorn. With a traditional IRA, you get a bigger acorn to start with, but you pay tax on the oak. Many families have actually lost money by investing in their traditional IRA when they were young and in a lower tax bracket, only to find themselves in a much higher bracket during their retirement. A year from now, we will all be in a higher tax bracket.

If you execute a Roth conversion this month, January 2010, you do not have to pay the tax on that conversion until April 15, 2011. You also may change your mind. If you decide the conversion wasn't worth it, you can move the money from the Roth account back to a traditional IRA account. This is called a "Roth recharacterization."

Recharacterizing a Roth conversion can be done any time before you file your taxes, including the filing extension. So if you file an extension you can change your mind any time before October 15, 2011. And you can decide to recharacterize part or all of what you converted.

The upside is that you can use all these laws and changes to maximize your after-tax investments. During the next few years, tax planning and management will be a significant part of wealth management. But it needs to be put together as part of a larger plan.

Here's the timeline of how to use a Roth conversion to maximize your investments. Now is the time to do five Roth conversions of equal amounts into five separate accounts. You aren't going to keep them all, so you can convert five times as much as you want to end up keeping and actually paying tax on. Invest each Roth account in a different asset class (e.g., large-cap U.S. stock, small-cap U.S. stock, foreign stock, emerging markets and hard asset stocks).

The five accounts will appreciate differently, but the entire portfolio will be fairly well balanced. Before April 15, 2011, decide if you will be keeping only one account or more than one. If more than one has appreciated significantly, you may want to keep more than one account's conversion. Compute your tax liability for the year and pay the tax, but instead of filing your return, file an extension.

Before the October 15, 2011, extension deadline, decide which of the five accounts you are going to keep. By now, nearly a year and three quarters has elapsed. You can easily determine which account has appreciated the most. Keep that one, and recharacterize the other four. Because you only have to pay taxes on the amount you originally converted, it's like betting on the horse race after the winner has already been determined. After recharacterizing the accounts, file your tax return before October 15.

If all of the accounts decrease in value, recharacterize them all and pay no tax. Financially, you are none the worse for having filled out a stack of paperwork. If only one account appreciates significantly, you only keep one conversion. But you have increased the odds of your Roth account appreciating by five times.

The average return of the S&P 500 is about 11%, but the standard deviation is about 19%. All of the other asset classes have an even higher standard deviation. It is likely, for example, that emerging markets will be either the best or the worst performing asset class over any two-year period. Using this technique you can guarantee that the Roth conversion you keep will have been invested in the best asset class during that year and three quarters.

Segregating each of the five conversions into a separate account allows you to decide to recharacterize or let each account stand separately. The difference in returns between the average and the best account is liable to be 20% or more over the year and a half before you have to choose which accounts to keep. Coupling the 17.8% tax savings and this Roth segregation technique could boost your returns by 30% or more.

In the quite likely event that all five accounts have appreciated significantly, you may decide to keep them all. Once you have reached the maximum tax rate, the top marginal rate does not increase from there. Those most fearful of expectations of higher tax rates soaking the rich after 2010 would be those most likely to benefit from converting everything.

You are a good candidate for a Roth conversion in 2010 if you have the following characteristics. You have an AGI more than $100,000 and so have not been able to convert previously. You have a large IRA that could be converted. You expect your tax bill to be higher in the future. You have sufficient taxable assets to pay the tax. You would like to reduce the value of your gross estate and leave a tax-free asset to your heirs. You are willing to pay estimated taxes and increased tax preparation fees.

Even thought this technique could boost your after-tax returns, be careful. Executing a Roth segregation account requires professional assistance. Such a technique should be just one small part of a larger comprehensive financial plan. And you should seek the guidance of a personal fee-only financial planner and certified public accountant (CPA) who have a legal obligation to act in your best interests. The laws are changing annually, and as a result so is the optimum path.

 

from http://www.emarotta.com/article.php?ID=371

Compute Your Net Worth Once a Year

by David John Marotta

Since the end of last year the markets are up about 25%. You may not have been on track at the beginning of last year, but now you should reevaluate again. The wave has propelled you miles toward your goal, and at least once a year you should measure your progress.

Everything in the financial markets has changed again: energy, financials, real estate, bonds, equities, even the dollar. If you are within 20 years of retirement (age 45 to 65), it's critical to get your retirement planning updated. Computing your net worth annually is like taking a sextant reading to chart your course toward financial security.

Net worth gives you a snapshot of how much money would be left if you converted everything you owned into cash and paid off all your debts. Compute your net worth by creating four lists.

<b>Liquid assets</b>: An asset is something you own that has significant value. A liquid asset can be sold in a matter of days. Include personal bank accounts (checking, savings and money market), certificates of deposit, bonds, mutual funds, stocks and exchange-traded funds. Use values as of December 31 of the previous year so all of your amounts are calculated on the same day.

<b>Nonliquid assets</b>: Nonliquid assets are those things you own that incur a penalty when they are sold. Include the value of your retirement accounts (IRAs, 401ks, 403bs, SEPs, profit-sharing plans and pension plans). Add real estate investments as well as the market value of your home. Use the assessed value.

Other nonliquid assets may include proprietorships, partnerships or company stock in a firm that is not publicly traded. Add the cash value of any life (nonterm) insurance. Some people include jewelry, collectibles, cars and boats in this category. Although these items often have a high retail value, their true worth is often a small fraction of their initial cost. I do not recommend including personal property.

<b>Immediate liabilities</b>: List what you owe to creditors. Immediate liabilities include credit card debt, car loans, student loans, other loans and any bill or debt that must be paid within two years.

<b>Long-term debt</b>: For most people, long-term debt is primarily their home mortgage, but it may encompass other real estate or business loans.

The first time you gather all of this information will be challenging, but it gets much easier each subsequent year. By keeping an annual record of your net worth, you're creating a valuable financial planning tool.

Next compute three additional values. For your <b>total assets</b>, add your liquid and nonliquid categories; for your <b>total liabilities</b>, add your immediate liabilities and long-term debt; and finally, for your <b>net worth</b>, simply subtract your total liabilities from your total assets.

Use these net worth numbers to compute other values useful for reaching your financial goals. For example, your emergency reserve (liquid assets minus immediate liabilities) should be at least half your annual income. Any extra can be invested more aggressively for appreciation. Your debt load ratio (total liabilities divided by total assets) should be under 35%, with your home mortgage comprising most of your debt.

If you are trying hard to pay off your mortgage ahead of schedule instead of making a huge effort to save and invest, your attempts are laudable but mistaken. The quickest path to wealth includes holding a home mortgage you could pay off but you choose not to in order to take advantage of the tax benefits. The rich leverage wisely and invest.

A net worth statement helps you measure your progress toward retirement. At age 65 you can only withdraw 4.36% of your portfolio to maintain your lifestyle. In other words, to keep the same standard of living, you will need about 23 times what you spend annually.

Take your net worth and divide it by your annual take-home pay. The result shows you how many times your annual standard of living you have amassed in savings. If you are younger than 40, the number probably comes to less than five, which is adequate for now.

Progress toward retirement is not linear. This equation, determined by quadratic regression, estimates how much of your current net worth you should have saved given your age. It gives you a benchmark for determining if you are on track to retire by age 65:

Savings should equal 0.0125 x^2 - 0.5746x + 7.4668, where x is your age in years.

The result should be between zero and 23. That number tells you how many times your current annual income you should be worth. The formula is most accurate between ages 45 and 65.

By age 45, you should be worth about seven times your annual spending. More sophisticated retirement planning includes the difference between taxable, tax-deferred and Roth accounts as well as Social Security guesses and defined benefit plans, but the method described here will approximate your progress. This table shows by what age you should have saved different multiples of your annual spending.

If your net worth is higher, congratulations! You may be able to retire earlier than 65. For every 1 unit you are over, you could consider retiring about a year earlier. Conversely, for every 1 unit you are under your age's benchmark, you may have to work an additional year beyond 65.

Between ages 40 and 50, your net worth should increase by 1 unit of your annual spending every two years. That means your current net worth divided by your take-home pay should be 1 unit greater than it was two years ago. And if you are between age 50 and 65, your net worth should have increased this year by 1 times your take-home pay.

Want to retire younger? Try lowering your standard of living. Most retirees spend about 70% of the gross salary they earned while working. If you can live off 50% of your take-home pay, it's not as essential to save as much.

Need to catch up? Save more than 15% of your take-home-pay. Determine how far you are behind and what additional percentage you can save each year. For example, at age 30, you should be worth 1.5 times your annual income. If your numbers don't match that ideal, an additional 0.3 times your annual income will help you get there. You could save an additional 10% of your income (for a total of 25%) for three years. If that's too much, try saving 20% (an additional 5%) for six years.

Money makes money. By the time you reach your 40s, you should have enough investments to be earning about half of your annual spending each year. Early in life what you save is most important for building wealth, but as you approach age 40 what you earn on your investments becomes critical. While you are young, the best advice a professional can offer is to "save." As you amass significant wealth, it is more pressing to "manage" well what you already have.

All financial planning begins with a clear understanding of your net worth. A PDF template on our website (<a href="http://www.emarotta.com/budget" target=_blank>www.emarotta.com/budget</a>) can help you compute and keep track of your net worth each year. Contact us or visit our website to download a free copy.

 

from http://www.emarotta.com/article.php?ID=370

Seven Financial Resolutions for the New Year

by David John Marotta

Financial resolutions usually don't even last until the end of January. Making a permanent change in our behavior requires both time and a steely resolve to keep the practice until it becomes habit and finally character. We can only develop financial character one action at a time. Here are seven practices that will take you from pauper to prince or princess if you add one each year.

Read through the list. If you already practice the resolution, move on to the next one. Find the first one that isn't already a practice, and make it your resolution for this year. Adding one behavioral change is labor enough for the next 12 months. If you can keep it long enough for practice to become habit, you are well on your way to developing a millionaire mindset.

Resolve to set the habit in place and keep it for an entire year. Share your resolution with everyone you meet. You are 10 times more likely to act on a goal that you have articulated to someone else. Don't wait until you have everything perfect to take ownership verbally.

First, and most critical, resolve to be and stay debt free. You are allowed to have a fixed-rate fixed-year traditional mortgage on your house but nothing else. No equity line of credit on your house. No car payments. Certainly no credit card debt. You have to learn to live within your income, which sometimes means going without. Millionaires are frugal. Learn to enjoy it.

Second, automate saving enough to get the entire match that your company's 401(k) plan offers. Usually this translates to saving 5% of your salary while the company contributes a 4% match, which is the fastest way to get an 80% return on your money. Studies show that most Americans forgo this match, believing they need to spend 100% of their salary. Don't be foolish. Learn to think like a millionaire. You can learn to live well on 95% of what you make.

Next, fully fund your Roth IRA, which in 2010 will be $5,000 for the year. If you can't manage the entire amount in January, put in $416 monthly. Saving this amount manually is too difficult. It requires remembering every month. Millionaires have their default set at saving money. They make spending money difficult, requiring a manual override.

Automating deposits in an employer-defined contribution plan is easy. Fortunately, automating saving in a Roth IRA or a taxable savings plan is equally painless. Most brokers offer an automatic money link between your checking account and an investment account. Set your savings on autopilot.

Fourth, save an additional 5% of your salary in a taxable account. Again, set up an automated transfer. If your paycheck gets deposited the first of the month, arrange for a transfer of 5% to your investment account on the second or third. You need taxable savings for a host of financial planning opportunities as well as for a plethora of life's challenges.

By now you are saving 15% to 20% of your salary and living off the remainder. Learning to live deferring many of your wants until later is a crucial habit that millionaires have cultivated. Money makes money. And the money you need to make money is called "capital." The textbook definition of capital is "deferred consumption." Money now is spent and gone. Money saved and invested works for you, adding income every year.

Fifth, save an additional 10% for charitable giving. Many millionaires might suggest that being generous with a portion of your income should be first on your list, not fifth. But I've found that until you have your own financial security on track, it is difficult to help others don their own oxygen mask.

No matter where you think charity belongs in your priorities, a sensitivity to the truly needy will change your perspective about distinguishing needs and wants. Many millionaires live simply in order that others may simply live.

Save this additional 10% in your taxable account. By now you are saving 15% in a taxable account. For your charitable giving, gift the investments from the account that has appreciated the most.

No matter which worthy organizations you support, you can donate up to 15% more if you give appreciated stock instead of cash. If you sell $1,000 worth of appreciated stock, you will have to pay the capital gains tax of 15%. If most of the stock's value is appreciation, the tax owed approaches $150, leaving only $850 for charitable giving. But if you give the stock directly to the charitable organization, you can take the full $1,000 tax deduction, and the organization will not have to pay any taxes when it sells the stock.

Up until now I expect you have been giving cash to charities. Now that you are developing some taxable savings, run your giving through your taxable investments. For every $1,000 of appreciated investments you donate, use the $1,000 in cash you would have gifted to buy additional investments. Think of this as planting the saplings you will harvest later for future gifting.

After several years, your $1,000 worth of cash should have grown to $2,000 worth of investments. Gifting a $1,000 worth of appreciated investments leaves the original $1,000 to keep increasing in value and fund future giving. This is one reason why frugal supersavers can be much more generous than those whose rich lifestyles preclude saving and investing.

Sixth, save an additional 10% in your taxable account for unknown unknowns. If your response is to ask, "Like what?" you are not understanding what I mean by "unknown." You can't plan for everything. But you can save cash for the unexpected.

Inevitably, families run up against cash flow problems because of unanticipated expenses. If you are living hand to mouth, your budget cannot handle large unplanned outlays such as the car breaking down, the roof leaking or emergency medical bills.

When a financial crisis strikes, you will be glad you have such a fund. Then, after using the money from your emergency fund, see if you could have predicted the expense, and adjust your plan accordingly. My wife and I learned this way to budget each month for the inevitable expense of buying our next car. The more you can foresee these expenses, the more this category can fund discretional big purchases instead of financial emergencies.

At this point you are saving more than 35% of your salary and living on less than 65%. This is the benchmark for a millionaire mindset. As you save and invest, the appreciation on your investments can provide income that replaces your salary, bringing you closer to financial freedom. When you can replace all of your income, you are free to retire or tackle challenges that do not make any money.

Every 25% of your salary you save replaces over 1% of your regular income in retirement. Money makes money, which then gives you the gift of financial freedom.

The seventh and final challenge is to expand this financial engine beyond 35% toward 50%. Living off half of your income requires a frugal lifestyle in comparison to your income. Impossible, you say? Unless you are among the truly needy, there are families out there living comfortably on less than half of what you earn.

And if you are among the genuinely wealthy, the only obstacle standing in your way is being accustomed to an affluent lifestyle. Learn to value financial freedom over opulence. Developing an engine of wealth production takes foresight and self-restraint in addition to time and patience. But the reward is financial peace and contentment.

 

from http://www.emarotta.com/article.php?ID=369

There's Still Time for Charitable Giving (2009-12-21)

by David John Marotta

The markets are up, and yet most nonprofits are still struggling financially. If you are charitably inclined, there's still time for end-of-year giving.

Charities are hit especially hard during tough economic times. They face reduced giving and often greater needs. They must find supporters who will donate more to offset those who will give less.

Charity freely offered is a virtue distinctly more valuable than any government program funded by taxes, which are an obligation and a duty. With no resources of its own, the government can only take the production of others and redistribute it. Political support for government entitlement programs is like being generous with your neighbor's credit card. Those who seek to be charitable must first produce more than they consume to have something to share. Only when you give of your own resources is it truly charity.

Americans are a generous people. But we don't like to pay taxes. Instead of giving cash, there are two additional ways you may be able to give so more of your money goes to charity instead of the IRS.

First, giving appreciated stock allows you to donate more generously. By contributing appreciated stock directly to charity, you can avoid the 15% capital gains tax. For example, if you sell $1,000 worth of appreciated stock, you will have to pay a 15% tax on the gains. If most of the stock's value is appreciation, the tax you owe will approach $150, leaving only $850 for charitable giving.

But if you transfer the stock directly to charity, you can take the full $1,000 tax deduction, and the organization will not have to pay any taxes when it sells the stock. By giving stock, you can save on capital gains taxes and can make a bigger gift.

Second, if you are age 70 1/2 or older, there is another powerful way to give. This year you are allowed to make tax-free qualified charitable distributions (QCDs) directly from your IRA account.

Normally you would be obliged to take the distribution, increase your adjusted gross income (AGI) and then gift to charity as a charitable deduction. The difference may not be obvious, but it's there. Many calculations in the tax code are tied to your AGI. Increase your AGI and you increase your phaseouts and other additional taxes. Take $100,000 from your IRA and give it to charity, and the tax code still punishes you despite your generosity.

The QCD provision allows you to gift directly from your IRA. Although you won't get a deduction, it doesn't matter because it won't count as AGI in the first place. Each account owner may give up to $100,000 in 2009 without having to pay income tax on the distribution. Gifts from IRAs are also an excellent estate-planning tool, if you are interested in making a large gift to reduce the size of your estate. The details are complex, so contact your tax professional or financial planner to make sure you are complying with the IRS rules.

If fear and worry about your own investments are eclipsing your charitable nature, there's help. Find out the state of your own finances, so you are confident you can afford to be a donor rather than a recipient of charity.

Not knowing is sometimes worse than finding out. Fear drives out emotions like kindness and compassion. And such angst may block purposeful giving from the heart. As St. Paul admonishes, "Each man should give what he has decided in his heart to give, not reluctantly or under compulsion, for God loves a cheerful giver" (2 Corinthians 9:7).

With the unemployment rate currently at 10.2%, this is an especially good year to focus on organizations that support families in financial need. Although everyone has been affected, some families have been singularly hurt and are in need of a little extra help.

Contributions this year could also determine the very survival of some nonprofits. Organizations, especially those without endowments, have been especially strapped this past year. Although the fundraising letters of many organizations can often seem desperate and dire, this year they are most likely to be true.

If you want to know if your gifts to charity are being used as well as they could be, you are not alone. Four of five Americans worry that the charities they support are not stewarding donations well. Fortunately, checking up on them is simple.

Because charities don't pay taxes, Form 990 serves only as an informational return. But for the curious donor, it provides a benchmark to compare the relative health of charities. On the form, you'll find data about how much of your donated dollars go to overhead versus program services. The form also includes facts on revenue streams, general expenses, wages paid to key employees, plus a list of board members.

Although charities are required to send you a copy of their 990 upon request, the fastest way to locate a free copy is to go online. GuideStar.org and FoundationCenter.org both provide free access to 990s as well as search tools to find other charities in your state or city.

Management and fundraising is expensive. Do you ever wonder how much of every dollar you donate actually goes to such overhead costs? Form 990 provides a clear breakdown of funds spent on overhead and fundraising compared to expenditures on program services.

When examining a charity's spending, experts suggest that 65 cents (or more) of every dollar should be spent on program activities. However, due to the type of service the charity performs, more or less may be allocated to program services. For example, an art museum typically has higher operating costs because of its specialized facilities and security requirements and may allocate as little as 50% of the overall budget to program services. A food bank, in contrast, might be able to devote more than 90% of gifts to feeding the hungry. The key here is to compare similar charities to each other.

A host of online tools can give you additional insights about the nonprofit in question. Charity Navigator, at <a href="http://www.charitynavigator.org" target=_blank>www.charitynavigator.org</a>, lists ratings for charities based on their financial health. And the Better Business Bureau Wise Giving Alliance measures public charities against its 20 standards for charity accountability. Their analysis of nearly 1,600 national charities can be found at <a href="http://www.give.org" target=_blank>www.give.org</a>.

When you give to charity, you make an investment. By doing a little homework, you can be sure your gift gives you the best possible return on your investment. And although certainly giving is its own reward, giving wisely increases the blessing.



from http://www.emarotta.com/article.php?ID=368

Marley's Ghost Was Haunted by Regret (2009-12-07)

by David John Marotta

"Marley was dead." That's how Charles Dickens's  "A Christmas Carol" begins. Jacob Marley, dead exactly seven years to the day, is the real ghost in the story. We see Ebenezer Scrooge's life in light of his partner's death. Although the way the two men approached their finances may seem identical, when we take a closer look, subtle but important distinctions emerge.

In his book "Why Smart People Do Stupid Things with Money," Bert Whitehead describes different financial personalities. He depicts a "miser" as someone who is strongly motivated by fear but has a natural inclination to save.

Whitehead maps financial personality on two different scales. The first measures people's tendency toward greed or fear. As a miser, Marley is motivated by fear (low risk acceptance), whereas his longtime partner Scrooge tends much more toward greed (high risk acceptance). The second scale measures an individual's tendency to save or spend. Here both Marley and Scrooge are practiced savers.

When two portly gentlemen stop by Scrooge's office soliciting charitable donations, they discover that Marley has been dead for seven years. One comments, "We have no doubt that Marley's liberality is well represented by his surviving partner." The narrative continues, "It certainly was; for they had been two kindred spirits."

Liberality cannot come from someone who is personally fearful. Distrust drives out emotions like tenderness and compassion. Scrooge confirms this condition in Marley as he looks through his ghostly form and remembers ironically that it was said of Marley he had no bowels. Marley had no empathy for others because he was too anxious for himself.

To Americans celebrating a traditional credit card Christmas, the distinction between a scrooge and a miser may seem insignificant. Both types are cold skinflints who don't spend money to make merry at Christmas. Although their tendency toward frugality may match, however, their investment philosophies do not.

"Misers," Whitehead writes, "are champion savers, but they have little to show for it. They are fearful about investments, even straightforward ones that are simple to explain and understand. At the most extreme, these are the people who keep all their money in a mattress or cans buried in the backyard. More commonly, people with miser-like tendencies hoard their money in bank accounts and Treasury bills."

Unlike scrooges, misers are fearful, a trait they share with Whitehead's other personalities, bon vivants and spendthrifts. All three types worry there won't be enough money. Spendthrifts spend it before it's gone; bon vivants spend it, but only on themselves; and misers hoard it in case they need it later. However because risk and return often go together, playing safe generally does not lead to building real wealth. Wealth is not just what you save; genuine wealth grows from what you save and invest.

Marley may have been a good man of business, but Scrooge was such an opportunist that on the day of his partner's death he "solemnised it with an undoubted bargain."

Scrooge lives in Marley's former chambers. But where Marley saw security, Scrooge envisions opportunity. Scrooge stays in three of the rooms and rents out the others, both above and below his quarters, as offices. He even leases the cellar to a wine merchant.

Misers like Marley don't like to take any such chances. They prefer investments that are touted as secure and come with guarantees. For example, fear often motivates misers to buy life insurance as an investment. Salespeople tout the safety of their company and switch fluidly between guaranteed returns and rosier projections or illustrations.

Misers also buy annuities, which they believe are tax shelters or will guarantee an income for life. With immediate annuities, misers can be so enamored by the annual lifetime return of 6%, they fail to notice the guaranteed 100% immediate loss of their principal. They also generally don't factor in the incredible drag of inflation and the devaluing of the dollar.

It can take a while before misers understand the long-term effects of their actions. They can be shocked to find their financial institution bankrupt, their ultimate taxes higher than necessary and their cumulative return less than savings bonds.

Misers may sleep well tonight, but they won't eat well in 20 years. They are relieved not to have been invested over the past 14 months, although balanced portfolios have shown gains. They are especially glad not to be invested in emerging markets, even though that's the asset class with the highest gains. They are content earning less than 2% while the government devalues the dollar with inflationary spending.

Not taking any risks is a recipe for long-term regret. Some risks are worth taking in life, including calculated financial risks. The danger of a miser's long-term regret is easily avoidable. The solution, of course, is financial education.

There are many worthy long-term investments. But misers worry that much of the financial world is just trying to part them from their money. They need someone who sits on their side of the table to teach them. Misers have learned to love saving their money. Now they just need to learn to love investing. And misers can be very quick learners.

A second regret of misers, and the true moral of Dickens's story, is saving money without any purpose. Marley dies having translated very little of his money into anything of value. Dying having spent the smallest amount is even more meaningless than dying with the most. At least Scrooge invested his money. And after seven years he had probably doubled it.

Perhaps one reason why misers are tightfisted is because they haven't learned how to handle investments. They can't share from an abundance of wealth because they've been too cautious in handling their finances to afford such largess.

Neither Scrooge nor Marley ever asked what the money was for. Marley held on to his out of fear of not having enough. In contrast, Scrooge saved and invested, so he was more able to look beyond his counting house when the spirits haunted him. Marley, looking back on his life, was the first to warn Scrooge, "The dealings of my trade were but a drop of water in the comprehensive ocean of my business!"

We might well feel sorry for Marley. He did nothing wrong. He just wanted to be left alone. His sins were of omission, not commission. To paraphrase the words of the Book of Common Prayer, it wasn't that he did the things he ought not to have done. It was that he left undone the things he should have done.

As Jesus preached, Marley was like "the one who received the seed that fell among the thorns . . . who hears the word, but the worries of this life and the deceitfulness of wealth choke it, making it unfruitful" (Matthew 13:22).

Marley wanted to be left alone to deal with his business. But after death he laments, "Mankind was my business. The common welfare was my business: charity, mercy forbearance, and benevolence, were all my business." Marley saved money but never understood why.

Failing to ask what the money was for left Marley in death with "No rest, no peace. Incessant torture of remorse." And time matters for both investments and our lives. In the long run, we all will be gone from this life, so we must make the most of time, both for our investments and for our lives. The two, it turns out, are inexplicably intertwined. Our wealth is just a placeholder for what we value.

Marley tells Scrooge bluntly in the first chapter of the book, "Any Christian spirit working kindly in its little sphere, whatever it may be, will find its mortal life too short for its vast means of usefulness." And in the final chapter, Scrooge has learned the lesson and found the joy it brings. Having found his affections changed, he finds that "everything could yield him pleasure."

Work kindly in whatever sphere God has placed you. Know what the money is for. And remember Marley's admonition: "No space of regret can make amends for one life's opportunities misused!"

 

from http://www.emarotta.com/article.php?ID=366

Best Christmas Presents (2009-11-30)

by David John Marotta

Many people spend more during the holiday season than they can afford. Guilt or shame drives them to put too many big-ticket items under the tree. But the satisfaction is both short-lived and shortsighted. Understanding the economics of gift giving may help you decide when and what to buy for Christmas.

You might take comfort in Wharton School professor Joel Waldfogel's book, "Scroogenomics: Why You Shouldn't Buy Presents for the Holidays." In his economic analysis, people are the most efficient when spending their own money, producing at least a dollar in satisfaction for every dollar they spend. But spending money on those we don't know well results in what Waldfogel calls a "deadweight loss" of about 20%.

A deadweight loss is an economic term signifying a loss by one party (in this case the giver) that is not offset by a corresponding gain by another party (in this case the receiver).

With Christmas spending in the United States at $100 billion, this loss results in "an orgy of wealth destruction" to the tune of about $20 billion.

Waldfogel's study found that givers with infrequent contact were those most likely to give less appreciated gifts. This group includes aunts, uncles and grandparents who live in another town. He compares these gift givers to the loss experienced when some government bureaucrat guesses at what we really need and makes choices for us. According to economists, people are better off when they make their own choices. For this obvious reason, Waldfogel suggests giving money or gift cards instead.

His original 1993 paper, "The Deadweight Loss of Christmas," was perceived as an attack on the holiday. So Waldfogel clarified that his critique is a study of the economic inefficiencies caused by the commercialization of Christmas and gift giving to strangers.

To the criticism that he had taken the joy out of Christmas, he responds that after watching desperate last-minute shoppers, he thinks the joy was taken out of Christmas long before his critique.

Of course railing against the commercialism and waste of Christmas is a cliché. Finding creative ways of showing your love and caring for others is more complex and nuanced. Here are some categories of gift giving and receiving you may find helpful.

First, learn to distinguish between a gift and a present. It's a gift when you give something the other person wants to have. It's a present when you give something you want the other person to have. When we offer a dictator military support, it is a gift. When we give him a copy of the Constitution, it is a present. At Christmas, sometimes we are trying to give gifts; other times we are trying to give presents.

Some gift giving is a social expectation and a test of the relationship. For example, for couples who are dating seriously, the message is much more important than the medium. Give a book the other person despises, and you have revealed how little you pay attention to your loved one's opinions. But a pair of gloves, with a heartfelt note saying, "These will keep your hands warm when I'm not there to hold them" would show your affectionate side. Or perhaps the receiver doesn't like romantic mush, and you are expected to know better.

Parents can help extended family members select gifts for their children by providing specific wish lists to ensure that what they buy will truly be appreciated. If you aren't confident, include a gift receipt. You are guarding against deadweight loss when the recipient can exchange the gift or return it for cash.

Families can help make exchanging a gift more socially acceptable. It doesn't mean that the recipient did not appreciate the gesture or does not love the giver. Sometimes with after-Christmas sales, if you have the receipt you can get the original value back, purchase a different make or model at a discount and still pocket a sizable amount of cash.

And in families where children don't have any spending money, cash may be the best possible gift. Handling cash with all the complexity of choice is an experience that offers irreplaceable life lessons.

Presents are handled differently. A present is when you buy Grandpa an iPod because you know he would never buy it for himself. Or when you give Grandma a computer with a built-in video camera so she can enjoy more contact with her grandchildren. It is a present if you want the recipients to have it more than they realize they want it.

Thoughtful presents may kindle new interests or prove inspiring. For example, they can encourage children to develop their talents or expand their horizons. My favorite Christmas gift idea comes from "The Homecoming," the first movie about the Waltons, in which the father buys John Boy paper and pencils. His gift, which affirms his son's choice of writing as a career, is the emotional climax of the story.

Try asking people, "What Christmas present changed the course of your life the most?" to see how much influence you can have. A pair of binoculars sparks a love of ornithology. A telescope fuels a fascination with astrophysics. A microscope leads to a biology career. An electronic toy prompts your daughter to join a robotics competition.

Not all presents need to be academic. A graphics tablet can lead to a design career. A guitar can inspire your son to form a new band. Or a video camera can lead to a later career choice in filmmaking.

Discovering talent, calling and vocation is never foolproof. Every success will be accompanied by many more failures, but that's what it takes to help children find their passion. Sometimes the risk of giving a present that may or may not be wanted is worth the possible deadweight loss. It is like research and development in the pharmaceutical industry. Most experiments are dead ends, but the whole process is worth the one success. Think of presents as R&D for the course of someone's life.

Presents that expand a child's horizons are a satisfying way to fight the commercialism. Another way is to work toward redefining our expectations for Christmas. That's what Christmas is all about. Their website explains, "It's not about reinventing the holiday. It's about changing the way we look at gift giving and receiving."

At the site you can arrange for gifts to nonprofit organizations in lieu of personal gifts and send gifts in someone else's name to his or her favorite charity. Consider their wise words: "There is no question we are in the midst of difficult financial times. And if it has you feeling unsure or uncomfortable this holiday season, imagine how purely difficult it's becoming for people who already, or are about to, depend on the generosity of others for the things that only a donation can provide."

Finally, some parents who are still unemployed will disappoint their children if they are hoping for expensive gifts this year. I've known a few families who had to tell their children that celebrating a traditional American credit card Christmas would jeopardize the family's financial security. Many parents are experiencing the first economic setback in their adult lives. Being financially cautious doesn't mean you love your children any less. And if you can be positive and reassuring, you needn't try to shelter you children from household economics.

The greatest joy of the holiday season is not bought in a store and does not increase your credit card debt. There is a better way to celebrate that builds long-lasting family ties.

Recognize that serenity during the holidays comes from taking time to celebrate values that don't show up in your net worth statement. Start by asking your family to share their fondest holiday memories. Make a list of all the things you have gotten right in past years and make them annual family traditions. Add a few new ideas each Christmas. The best holiday traditions don't cost a lot of money, and they aren't wrapped and put under the Christmas tree.

 

from http://www.emarotta.com/article.php?ID=365

Fourteen Tax Management Techniques (2009-11-23)

by David John Marotta

No one approaches financial planning with the goal of paying more taxes. Tax management, like all financial planning, is based on the premise that small changes made over time can achieve big goals. Good investment returns are important. But over the next few years, comprehensive tax management may reap even greater gains.

Don't file your taxes in April and then forget about them for the next 10 months. By investing a little time throughout the year, you can create compounded value. The 14 techniques described here may help you lighten your tax burden.

1. Check line 45 on your 2008 IRS form 1040 to see if you paid any alternative minimum tax (AMT) last year. People subject to AMT pay an average of $6,000 more than they would otherwise. AMT turns tax planning upside down. Because conventional wisdom may not apply, be sure to review your financial affairs with a professional.

2. This year offered a spectacular opportunity for realizing capital losses. Realized losses can offset realized gains. They can also be deducted against ordinary income up to $3,000 a year. Any excess above $3,000 is carried forward and can be deducted in future years.

3. You can realize capital losses and still stay fully invested. Sell the security, and then wait 31 days before buying it back. Alternately, double up. Purchase the same number of shares you currently hold. Wait 31 days. Then sell the original shares for a tax loss. Waiting a month between the sale and the buyback avoids a so-called wash sale, which would prevent you from taking the tax loss.

4. Individual stocks offer more opportunities to realize capital losses or gift capital gains. This is useful primarily in larger portfolios. A portfolio of individual stocks collectively may mimic the return of an exchange-traded fund and still provide additional tax savings. For example, although the total return might be 10% for the year, one of the individual stocks has doubled and two others lost 50% of their value. By holding individual stocks instead of the fund, you are able to sell the two stocks that have a 50% negative return and take the loss on your taxes. Holding the stock that has doubled in value postpones paying capital gains.

5. Using appreciated stock for charitable giving can avoid paying capital gains entirely. This allows you to contribute up to 15% more than you could with a cash gift.

6. This year also extended the opportunity to make qualified charitable distributions. If you are 70 1/2 or older, gifts you make directly to charity from your IRA are not counted as income. In this way you can reduce your tax deduction phaseouts for additional savings.

7. Perhaps you are considering funding a 529 college savings plans for your children or grandchildren. Contributions in some states (including Virginia) qualify for a state tax deduction if executed before the end of the year. Up to $4,000 per account can be taken, with the remaining amount carried forward to future years. Account owners over age 70 are allowed to deduct any amount they contribute to a 529 plan in 2009.

8. Keep in mind that if you make your fourth-quarter state estimated tax payment prior to year-end, you can use it as an itemized deduction next year.

9. You may also give $13,000 per person in 2009 to an unlimited number of individuals without gift tax implications. Families interested in maximizing intergenerational wealth transfers should explore with a professional how trusts can minimize their tax burden and maximize estate planning.

10. Putting investments in the correct investment accounts can also generate significant savings. Fixed-income investments belong in traditional IRA accounts. Interest is taxed at ordinary income tax rates, but the entire value of an IRA account is taxed at ordinary income tax rates anyway upon withdrawal. Appreciating assets should be in taxable investment accounts where the growth will be at a 15% capital gains rate, which is likely much lower than your ordinary income tax rate. Additionally, any foreign tax paid on foreign stock investments is tax deductible in a taxable account. Finally, those investments with the greatest potential for growth belong in Roth accounts where no tax will ever be paid. This tax management alone may boost your after-tax returns by as much as 1% annually.

11. Although small business owners shoulder much of the tax burden, they also enjoy more tax-maneuvering flexibility than other taxpayers. Reducing your taxes may be as simple as deferring income until next year or accelerating Section 179 expenses in the current year.

12. If you own a business, consider stashing cash in a retirement fund to reduce your tax liability. With a solo 401(k), you can contribute to the plan both as the employer and as the employee. As the employer, you can contribute either 20% of self-employment income or 25% of compensation income, depending on your company's structure. Plus, as the employee, you can contribute another $16,000 ($22,000 if age 50 or older). Finally, for the employee portion, tax planning can help you choose between a Roth 401(k) or a traditional pretax contribution.

13. Converting traditional IRA assets to Roth IRA accounts offers a chance for additional tax savings. Couples with an adjusted gross income below $100,000 can always consider a Roth conversion. Next year everyone, regardless of their tax bracket, can convert or contribute to a Roth IRA. And because 2010 is also the last year of the Bush tax cuts, you can use the conversion as a way to avoid the coming tax tsunami in 2011. Make plans now to prepare for next year's conversions.

14. Finally, a complex technique called "Roth segregation accounts" could earn your investments even more savings over the next two years. By segregating your Roth conversions in 2010, you can undo (or "recharacterize") those that underperform and keep the winners. This strategy offers you 20 months to determine which accounts to keep. It's as profitable as betting on the horse race after you know the winner.

Although just a small part of a larger comprehensive financial plan, savvy tax management requires professional assistance. Seek the guidance of a personal fee-only financial planner and certified public accountant (CPA), fiduciaries with a legal obligation to act in your best interests. The laws and ensuing complexities are changing annually, and as a result so is the optimum path.



from http://www.emarotta.com/article.php?ID=364

Mindless Spending 2: You'll Get By with a Little Help from Your Friends (2009-11-16)

by David John Marotta

Both mindless eating and mindless spending rely on our subconscious need to follow scripts to pace our consumption. Community plays a huge role in regulating our financial destiny--either a path of savings that builds real wealth or a path of spending that leads to impoverishment.

In one study cited in <a href="http://www.mindlesseating.org/" target=_blank>Brian Wansink</a>'s book "<a href="http://www.amazon.com/gp/product/0553384481?ie=UTF8&tag=davidjohnmarotta&linkCode=as2&camp=1789&creative=9325&creativeASIN=0553384481">Mindless Eating</a>," people were invited several times to a lunch of pizza, cookies and soft drinks. They were watched both eating by themselves as well as in groups of four or eight. When the subjects ate alone, researchers used a baseline that allowed them to categorize people as typically light or heavy eaters. Interestingly, when people dined in the groups, the quantity they ate changed.

Light eaters ate more in a group, and heavy eaters ate less. Both kinds of eaters conformed somewhat to the average pace and quantity of the group's consumption. Mindless spending works the same way.

If you tend to be a conservative spender, shopping in a group can easily entice you to buy more than you would normally. Conversely, if you have trouble saving money, taking along a frugal friend will help you resist. In fact, following the lead of penny-pinching friends or family can help you evaluate your own lifestyle and change the way you view money.

Millionaire couples may have very little in common except that they all answer "yes" to these three questions: "Are you frugal? Were your parents frugal? Is your spouse even more frugal than you are?" A culture of frugality builds a lifestyle of wealth. You subconsciously learn an appropriate lifestyle from those around you.

My wife and I formed our spending habits right out of college. Our first community of friends earned very little. Their lifestyle made even ordering pizza an extravagance. Combined with the example of my parents' depression-era thrift, we started saving and investing early.

In contrast, if your parents golf at Farmington or play tennis at the Boar's Head Country Club, you may struggle to maintain a frugal lifestyle. If your friends live rich, you will too. Your spending scripts will be based on comfort and convenience. You will get the deluxe model with all the features. And you will invariably buy the added service, protection and accessories.

Spending money just to socialize with friends is an especially common trap. Teenagers who work all day for minimum wage and then go out for dinner and a movie can easily end the day having spent more than they earned. Meals out in expensive restaurants with elaborate appetizers, drinks and desserts add both to the bottom line as well as to your waistline. Consider inviting friends over for potluck and a game night, and everyone might afford to send their children to college.

Spending money is contagious. If you go to the mall and a friend is hunting for the perfect purchase, it's easy to get caught up in the excitement. If you want your turn in the spotlight, you have to be shopping as well. Even if what you buy is small, the expense still depletes your finances.

And if you don't spend money or you resist going to the fancy restaurant or the full-priced movie, you risk being perceived as cheap. You may even worry that your friends won't invite you because you spoil the party.

By voicing your concerns, however, you may allow others to agree without feeling as uncomfortable. Truth be told, the person most worried about the expense is often the most secure financially. After all, wealth is what you save, not what you spend. And if your friends won't adjust to help you meet your financial goals, maybe you need different friends.

A life of country clubs, facials and galas will obligate you to spend money. If your social life includes such activities, budgeting will be difficult. Your financial stability may ultimately require developing relationships with people who are more fiscally conservative. It's your choice either to live rich or actually be rich.

Spending habits begin very early as we follow the lead modeled by our parents. In many homes, financial matters are a well-kept secret. Children are left to guess and infer from their elders’ actions and cryptic remarks. As a result many children learn habits that threaten their ultimate happiness and success.

<a href="http://www.kinderinstitute.com/" target=_blank>George Kinder</a>, author of "<a href="http://www.amazon.com/gp/product/0440508339?ie=UTF8&tag=davidjohnmarotta&linkCode=as2&camp=1789&creative=9325&creativeASIN=0440508339">The Seven Stages of Money Maturity</a>," asks his clients to write an autobiography that focuses on their relationship to money and the beliefs they have acquired. This exercise can help you examine your ingrained assumptions about money. Belief is powerful. As people think, so they will act.

And if everyone around you is doing something, it seems normal. Consequently, one person in a family can't single-handedly change the family's financial DNA. Deeply entrenched traditions generally will overwhelm any one family member who tries to question them.

So galvanize the whole family behind budget changes. It takes explicit communication. Children as young as four years old can contribute and learn from the process. There's no stigma attached to living within your means. If a budget isn't a team effort, then one family member will end up holding the purse strings and everyone else will be resentful.

Both spouses must start on the same page and with the same degree of humility. Every financially struggling family has one partner who believes he or she is the careful one with money and that any financial problems are the other person's fault. Most of the time, this generalization is untrue. It is relatively easy to be frugal by comparison if you abdicate all the spending decisions to your spouse. That way you can enjoy the results of spending without any of the guilt.

Serving as a role model in the family includes setting the pace and nature of spending. Learn to regulate when and how much money gets spent. Norms are set in the trenches of everyday spending, not in criticizing the number of presents on Christmas morning.

Even the most reclusive among us relies on spending scripts and norms to regulate when to open their wallet and when to refrain. If you are happy with your spending scripts, that's great. But if you are trying to change them, you need a little help from your friends.

Behavioral changes are best reinforced when you ask everyone you know to help you make the change permanent. It takes explicit thought and energy within your social network to overcome mindless spending scripts. And it takes a consistent effort for at least a month or more before new habits begin to take root.

The task is challenging but certainly not impossible. And small behavioral changes can result in building significant long-term wealth. The reward of financial peace and security is worth developing a prudent and thoughtful lifestyle.

 

from http://www.emarotta.com/article.php?ID=363

Mindless Spending: Frequency Matters More Than Height (2009-11-09)

by David John Marotta

Dieting and budgeting face similar hurdles in the American lifestyle. Some of us live to eat; others eat to live. Attempting to reduce our spending is every bit as challenging as trying to slim our waistlines. Some shop to live; others live to shop.

We can better understand mindless spending by looking at some of the psychological studies that <a href="http://www.mindlesseating.org/" target=_blank>Dr. Brian Wansink</a> describes in his book "<a href="http://www.amazon.com/gp/product/0553384481?ie=UTF8&tag=davidjohnmarotta&linkCode=as2&camp=1789&creative=9325&creativeASIN=0553384481">Mindless Eating</a>." He explains, "Everyone--every single one of us--eats how much we eat largely because of what is around us. We overeat not because of hunger but because of family and friends, packages and plates, names and numbers, labels and lights, colors and candles, shapes and smells, distractions and distances, cupboards and containers."

"We all think we are too smart to be tricked," warns Wansink. "That is what makes mindless eating so dangerous."

One study compared the amount people would drink using two differently shaped glasses. One glass was tall and skinny. The other was short and wide. Each glass had the same capacity, but people would drink 25% to 30% more from the short glasses than the tall ones.

Interestingly, our brains focus too much on the height of objects and underestimate the effect of their width. So people with short wide glasses had to fill them more before they believed they had consumed the same amount as those with the tall skinny glasses.

We all think we can't be fooled by something as obvious as the shape of a glass. But our brains are wired that way, without exception. If you want to drink less, you can measure every portion or simply buy tall skinny glasses. Better yet, buy glasses that are very narrow at the bottom or elevated on a stem.

Finances work the same way, and by extension, so does mindless spending. Many families are struggling to get a handle on their savings. They are trying, often in vain, to find ways to cut back. But when we are worried about our expenditures, we tend to look at the dollar amounts more than the frequency of our purchases.

For example, a young woman named Emily inherited a sizable sum of money. She could have used it to make a sizable down payment on her first house. But instead of protecting her windfall, Emily attached a debit card to the account for the convenience of paying for a few items she needed.

In less than two years she had spent most of her inheritance in increments of no more than $35. That doesn't seem like a lot of money because the $35 height is relatively small. Given a width of three times a week, the height isn't even noticeable. The same $105 Emily spent would have seemed like a much larger budget item if it had been in a single purchase. In that case she might have refrained from handing over her debit card so casually.

Other purchases were $50 monthly memberships or $100 a month services. Very few of these purchases were over $100, but when they were added up, Emily had drained her account.

The frequency of a purchase matters even more than its height. But our brains tell us to be more concerned about the height.

Marketing firms use this principle all the time to bypass our defenses when they break annual purchases down into low monthly payments.

An offer I received in the mail recently explained its cost as "Only $4.99 per month with an annual subscription (billed as one payment of $59.88)." The advertised rate only applied if you were willing to purchase the entire year. If you wanted to be billed monthly, the rate was $9.99.

Advertising a $59.88 annual subscription fee as $4.99 per month relies on the fact that consumers are more sensitive about height than breadth. Note that the primary way they advertised the subscription, $4.99 a month, was not one of the options! Even more deceptive would have been making the offer 16.4 cents a day for an annual subscription. Less than a penny an hour!

They even marketed as a feature the service of charging your credit card automatically each year: "All subscribers get the hassle-free advantage of the Unlimited Automatic Renewal Program. At the conclusion of your first term and each subsequent term (one year or one month) we will automatically renew your membership upon expiration for the same period so you get continuous service unless you tell us otherwise."

Madison Avenue takes advantage all the time of the way your brain works. So it's in your best interest to learn to use your brain to your own benefit.

We recommend that every household have a dollar limit that domestic partners agree not to exceed without consulting the other. This way they can avoid budget busters, single items that can wreak havoc on a spending plan. The same caution ought to be put in place for any reoccurring charge, no matter what the price.

Similarly, when people are seeking ways to reduce their spending, they tend to look at big-ticket items or daily needs. A much less painful and more productive alternative is to look at the purchases you don't have to decide about every day (e.g., automatic subscription services).

Consider that the average family spends hundreds of dollars on a host of monthly services such as iPhone, Skype, TiVo, Netflix, Palm Pre, GPS Pet Locator, World of Warcraft, The Sims Online, anime subscriptions, comic subscriptions, health clubs, season tickets, and online file sharing or backup. Average people who can't afford to pay for their own health-care costs pay twice that amount in monthly subscription fees.

And each of these monthly fees is laden with extra features for an additional charge. Before the era of cell phones, I would save my quarters. If I needed to call home, I would stop at a pay phone. In addition to driving safely without the distraction of talking at the same time, which of course is still advisable, my phone expenses for the month were minimal. The latest base cost for an iPhone over two years is about $4,000, which could go a long way toward covering a family's annual health-care costs.

If you can afford a full-featured cell phone, by all means indulge. I assume you've done your retirement planning and are saving more than enough each month. If not, and you only need a cell phone for emergencies, however, buy a single-use cell phone and keep it in your car. You will only pay for the minutes you use, and the money you save will be significant.

If you saved and invested $2,000 a year at market rates of 10% a year, you would have about a million dollars in 40 years. Every young person with an iPhone is missing a million dollars at retirement to fund that trendy subscription.

Cutting back on reoccurring spending is easier because you don't have to decide every day to refrain from spending. Sometimes it is as simple as deciding to eliminate features. Extra charges accrue for voice mail, another for call waiting and still another for unlimited text messaging. If after you have dropped all these subscriptions and features you decide you really miss them, you can always add them back later.

If you are trying to cut back on your spending and save money, review every reoccurring charge on your credit card. Try living without the service or at least eliminating features. Many companies will release you from your contract and cancel your service for reasons of financial hardship. If you need to stop paying immediately, cancel the credit card being charged and get a new one.

Take your savings and set up an automatic transfer to your investment account. You can achieve big goals by making small changes consistently over time, which is the cornerstone of successful financial planning.

And although our brains aren't wired to realize it, frequency matters even more than height.



from http://www.emarotta.com/article.php?ID=362