Bridging the gap…between the business of medicine and the practice of medicine.
- New Law Extends Federal Deposit Insurance
- Investing in Energy Companies May Be a Good Bet Now
- Crucial Reason to Review Retirement Plan Beneficiaries
- Include Reinvestments to Reduce Capital Gains
- New Tax Law Gives Couples a $10 Million Exemption
- Corporate Issues May Beat Government Bonds
- New Tax Savings on Equipment for Medical Practices
- Expert Advice, Other Reasons to Choose Managed Accounts
- Why Consider Dividend-paying Stocks?
- The Appeal of Target Date Funds
- Now May Be the Time to Buy a Home
- Why Convert to a Roth IRA?
- Why You Should Consider Tax-free Gifts in 2010
- Income Shifting an Option as Tax Rates Rise
- Options for a ‘Sideways’ Stock Market
- Understanding Municipal Bonds Risks
- Buy Near-campus Housing to Cut College Costs
- Why Waiting Can Increase Your Social Security Benefits
- Why You Should Consider Switching to Roth IRAs Now
- Better Deals on PLUS Loans
- Greater Tax Deductions for Medical Equipment
- Take a Longer Look at Short Sales
- How to Pay an Advisor
- Be Flexible With Portfolio Withdrawals
- How to Get Higher Yields on Your Cash Reserves
- Coping with Disappointing Life Insurance Values
- Are Hedge-like Mutual Funds Right for You?
- When Prepaid Plans Make Sense
- Understanding New Tax Credits for Home Buyers
- What’s the Right Strategy for You?
- Investing: Physicians’ Best Bet
- Taxes: Special Rule Can Help Pay for College
- Retirement Planning: New Option for High-income Physicians
- Real Estate: Time to Buy Investment Property
New Law Extends Federal Deposit Insurance
The federal government has made permanent its Federal Deposit Insurance Corporation (FDIC) coverage of a maximum $250,000 per depositor per bank. Congress included the permanent increase in the Dodd–Frank Wall Street Reform and Consumer Protection Act, which President Obama signed into law last year. That amount had been increased from $100,000 during the financial chaos of 2008 and was scheduled to return to the $100,000 limit in 2014.
If you use the new permanent status in your planning, keep the following in mind:
- If you’re married, you and your spouse can each have an insured deposit of up to $250,000 at your local bank.
- Even if you and your spouse each have $250,000 of individual deposits at that bank, you also can maintain a joint account and receive additional FDIC coverage up to $250,000 per co-owner. For example if you and your spouse have a joint account containing $250,000, it’s insured for up to $250,000“what’s in the account. However, you and your spouse can have a joint account insured up to $500,000: $250,000 per co-owner.
- Retirement accounts get separate coverage. Besides all the accounts mentioned above, you can have federal insurance up to $250,000 for an IRA at the same bank, as long as it’s a bank deposit (this includes CDs and money market deposit accounts as well as checking and savings accounts) rather than an investment account (such as a mutual fund, stocks, life insurance policies, annuities or municipal securities, even if these investments are purchased at an insured bank).
CDs in six-month increments over three to five years,” says Connie Stone, founder of Stepping Stone Financial in Chagrin Falls, Ohio. When interest rates rise from current levels, money from maturing CDs can be reinvested at higher yields.Following through: Learn how to use simple revocable trust accounts for still more federal deposit insurance at http://www.fdic.gov/deposit/deposits/insured/ownership4.html.
Investing in Energy Companies May Be a Good Bet Now
Investors looking for buy-low opportunities“ often a good investment strategy“might consider energy companies and funds that hold energy stocks.
In the past three years through 2010, the “equity energy” category of mutual funds was near the bottom in performance, losing around 6% per year. But that will likely turn around if oil prices continue to climb. As of this writing, the crisis in Egypt has generated a surge in oil prices; but the key to sustained performance among energy stocks would be growth in the global and domestic economies. “When they show signs of turning around, oil prices and energy investments probably will move up as well,” says Robert Wherry, a mutual fund analyst at Morningstar.
Already the U.S. economy has been posting encouraging growth numbers. Overseas, emerging markets such as China are growing rapidly. When investors expect superior growth in emerging markets, they anticipate more demand for energy, which lifts energy investments.
During the last period of worldwide expansion from 2003 to 2007, oil prices rose and equity energy funds enjoyed five consecutive years of double-digit growth. Those five years included four years with average returns ranging from 32% to 46%. A comparable performance can’t be expected, but energy investments are likely to prosper in the next upward leg of the business cycle.
Following through: To see one list of “6 Energy Funds for Inflation Protection,” go to www.smartmoney.com/investing/mutual-funds/6-energyfunds- for-inflation-protection/.
Crucial Reason to Review Retirement Plan Beneficiaries
Whether you save for retirement in a 401(k), an IRA, or some other type of plan, it’s crucial to review your beneficiary selections periodically. The beneficiaries you name will inherit that account regardless of what’s in your will.
“Many people don’t realize that a beneficiary designation overrides a will,” says James J. Holtzman, a financial advisor with Legend Financial Advisors, Pittsburgh.
To see what might happen, take the real-world example of Mr. Kennedy, who worked for a company with a savings- and-investment plan. He named his wife as beneficiary. This couple divorced after a long marriage, and the wife agreed to relinquish her claims to Mr. Kennedy’s company benefits as part of the divorce settlement. However, Mr. Kennedy never changed the beneficiary designation on this plan. He died seven years after the divorce, and the company paid the plan balance“about $400,000“to his ex-wife.
This case was disputed and eventually came before the Supreme Court, which unanimously ruled that the money was properly distributed to the ex-wife. The plan documents “control” the outcome, according to the court.
The take-away message: Be certain that your documents are in order“including the beneficiary designation of your retirement account.
Following through: The Supreme Court’s opinion in Kennedy v. Plan Administrator for Dupont Savings and Investment Plan is at www.law.cornell.edu/supct/html/07- 636.ZO.html.
Include Reinvestments to Reduce Capital Gains
Since stocks had good years in 2009 and 2010 after a disastrous 2008, you may now have taxable gains when you sell stocks or stock funds. If so, be sure to count any reinvestments of dividends or capital gains distributions to avoid paying tax twice on the same income, says Mary Kay Foss, director, Sweeney Kovar, an accounting firm in Danville, Calif.
For example, suppose Dr. Martin invested $20,000 in a stock fund in late 2002, at the bottom of the bear market triggered by the tech stock crash of 2000. Dr. Martin held onto her shares until recently, when she sold them for $30,000.
At first glance, Dr. Martin has a $10,000 capital gain: bought at $20,000 and sold at $30,000. However, when she first invested, she instructed the fund company to reinvest all of her dividends and capital gain distributions. Over the years, Dr. Martin has reinvested a total of $4,000 in this manner, paying tax each year even though she never received any cash.
On a sale, Dr. Martin should increase her “basis” in the fund (her cost, for tax purposes) from $20,000 to $24,000, reflecting her reinvestments. Therefore, a sale for $30,000 results in a $6,000 taxable gain instead of $10,000. If Dr. Martin pays tax on a $10,000 gain, she effectively is paying tax twice on $4,000 worth of reinvestments.
Following through: For a discussion of adjusted basis, see IRS Publication 550, “Investment Income and Expenses,” page 43, at www.irs.gov/pub/irs-pdf/p550.pdf.
New Tax Law Gives Couples a $10 Million Exemption
At the end of 2010, Congress passed a mammoth tax law that kept income taxes mostly at 2010 levels but dramatically changed estate taxes.
Under the new law, the federal estate tax exclusion is $5 million: that’s the amount you can leave, tax-free. What’s more, this $5 million exclusion is “portable” between spouses. Any exclusion not used by the first spouse to die passes to the surviving spouse.
Here’s an example: Dr. Clark dies and leaves $6 million to his wife Kim. There’s no estate tax on bequests to a spouse who is an American citizen, no matter how much money is transferred. Dr. Clark also leaves $2 million to the couple’s children, sheltered from tax by the $5 million exclusion. Because Dr. Clark used only $2 million of his exclusion, the other $3 million passes to Kim. If Kim dies in a year with a $5 million estate tax exclusion for each decedent, she will have a total exclusion of $8 million.Therefore, married couples effectively have a $10 million exclusion.
Because of this policy, some couples will be able to forgo complicated estate tax planning strategies. However, the new rules are in effect only for 2011 and 2012; and it’s unclear what will happen after that. Many reasons remain for sophisticated estate planning.
“Trusts may be especially valuable if you live in a state with its own estate tax,” says Blanche Lark Christerson, managing director, Deutsche Bank Private Wealth Management in New York. “They also can offer creditor protection, an important consideration for physicians in our litigious society.” The bottom line is that this is an ideal time to review your estate plan with a professional advisor.
Following through: For a summary of the new estate tax rules, go to https://guidance.fidelity.com/viewpoints/newestate- tax-laws.
Corporate Issues May Beat Government Bonds
In these times of low yields, there is another option worth a look: corporate bonds.
Low yields are by no means limited to bank accounts and money market funds these days. Government bond funds yield only around 2.5% now, on average. In the wake of a worldwide financial crisis, the demand for U.S. Treasuries has spiked, sending up prices. Higher bond prices, in turn, mean lower yields.
However, on the whole, U.S. corporations have high cash balances, high cash flow, and low debt. Many are reporting record earnings. “Corporate balance sheets generally are in better shape than personal or government balance sheets,” says Jason Brady, a managing director with Thornburg Investment Management, Santa Fe, N.M. Given relatively strong balance sheets, corporations are likely to be able to make promised interest payments to bondholders and redeem their bonds at maturity.
Mr. Brady is upbeat on corporate bonds in the lower levels of investment grade or those that just miss investment grade. Those types of bonds will probably give you a higher yield than a top-rated bond. A BBB-rated corporate bond might yield two percentage points more than Treasuries while an AAA-rated bond might yield only 0.50%-0.75% over Treasuries.
Funds with large allocations to corporate bonds with similar ratings might yield close to 6% now. If you are interested in a bond fund, go online to check the credit quality of its holdings.
Following through: To see a list of the “Top 5 Highestyielding Corporate Bond Funds,” go to www.zacks.com/stock/news/33183/Top+5+Highest+Yielding+ Corporate+Bond+Funds.
New Tax Savings on Equipment for Medical Practices
Your practice should review your equipment purchases in view of new tax breaks that are part of the Small Business Jobs Act, which President Obama signed into law last September. Here’s what may affect your practice:
- Business equipment. The new law increases the limit of first-year deductions for equipment purchases to $500,000 for both 2010 and 2011, an increase from $250,000 under prior law. Moreover, leasehold improvements up to $250,000 may qualify for this tax benefit.
- Depreciation. There’s a special 50% first-year “bonus depreciation” for equipment that doesn’t qualify for first-year deductions and is usually depreciated over many years. Now you can deduct half the remaining cost this year, says Mark Luscombe, JD, CPA, principal federal tax analyst at CCH Inc., a provider of tax and audit services in Riverwoods, Ill. “This provision is limited to 2010, so you may want to accelerate equipment purchases before year-end,” he recommends.
Here’s how it works: Suppose your medical office buys $600,000 of equipment in 2010. You may deduct the first $500,000 right away. Normally, the remaining $100,000 would have to be depreciated over several years, spreading out the tax deductions. Under bonus depreciation, $50,000 (50% of the excess $100,000) can also be deducted in 2010. Only $50,000 has to be depreciated as per IRS tables, with deductions over several years.
- Cellphones. The law removes a provision that has required anyone receiving an employer-provided cellphone to keep records of calls and pay tax on personal use. As a result, your medical practice can now provide employees with cellphones and similar devices without the paperwork headaches.
Following through: Find a summary of the new law’s key tax provisions at http://tax.cchgroup.com/legislation/Small-Business-Jobs-Act-7-23-10.pdf.
Expert Advice, Other Reasons to Choose Managed Accounts
Why are managed accounts so popular? According to the Money Management Institute, nearly $1.8 trillion is currently invested in various types of managed accounts. From mid-2009 to mid-2010, that number increased by more than 27%. Here’s why:
- They’re fee based. Investors usually pay around 1% of assets each year: $1,000 for each $100,000 under management. (The percentage may be higher for small accounts and lower for large accounts.) There are no extra transaction fees.
- They’re professionally managed. A registered investment advisor or a licensed securities broker is responsible for seeing that your investments match your goals and risk tolerance.
- They provide access to top money managers. Some stock and bond pickers require minimum investments of $1 million or more. With managed accounts, the minimums may be much lower.
“Separately managed accounts often have minimums of $250,000 or so,” says Jean Sullivan, managing principal, Dover Financial Research, Westwood, Mass. With those accounts, investors generally hold individual stocks or bonds. Other types of managed accounts offer mutual funds to investors, where minimum investments might be only $25,000.
Many investment firms offer some type of managed account. If you’re interested, ask your financial advisor for details.
Following through: For details on managed accounts, go to http://www.schwab.com/public/schwab/investment_products/managed_
Why Consider Dividend-paying Stocks?
In an investment environment of lower yields and a sluggish economy that may dampen growth stocks, you may want to consider dividendpaying stocks.
Some of these stocks yield around 4% or even more now, which compares favorably with many investment yields. Moreover, dividend payers typically have outperformed other stocks during bear markets.
“One study of the 2000-2002 bear market found that dividend-paying stocks outperformed non-dividend payers by 47% on average,” says Tom Lydon, president of Global Trends Investments, Irvine, Calif. “A study that took a longer perspective, from 1970 to 2000, found that dividend-paying stocks outperformed non-dividend payers during down markets by an average of 1.5% per month.”
Companies that pay dividends generally take in more cash than they need; these sound firms pay out profits to investors. Overall, they tend to have good long-term prospects. In addition, bear markets often go hand-in-hand with recessions, and many dividend payers are in industries like utilities and household products, which tend to retain customers in hard times.
If you’d rather not pick individual dividend-paying stocks, consider mutual funds and exchange-traded funds, many of which invest in such companies.
Following through: Enter a stock’s ticker symbol and see the information on its dividend payments at http://dividendinvestor.com.
The Appeal of Target Date Funds
Target date funds have “soared in popularity,” according to Pensions & Investments magazine. In 2005, only 25% of employers with defined contribution plans (such as 401k’s) offered target date funds. Now over 60% do. According to the SEC, these funds already have accumulated $270 billion in assets.
As the name indicates, these funds set a certain date at which time an investor may expect to retire, essentially putting your asset allocation on autopilot. When the target date is far in the future, these funds invest heavily in stocks because stocks have delivered strong long-term returns. As the target date nears, these funds gradually shift from stocks to bonds, becoming less volatile and more likely to generate investment income. A 35-year-old physician who expects to retire at age 60 might invest in a 2035 target date fund, for example. Younger investors might choose a 2040 fund while those closer to retirement might select a 2020 fund, say, or a 2025 fund.
All target date funds are not the same. “Some funds manage to the target date, when investors may be looking for a lump sum,” says Edward Bernard, vice chairman, T. Rowe Price Group, Baltimore. “Other funds manage through the target date for a retirement that might last 30 years.” Because funds in the latter category generally hold more stocks, they may be riskier and may have the potential for higher returns than those in the former category.
Investment professionals will adjust your target datefund- asset allocation as you grow older. If you’re interested, read the prospectus carefully to see what strategy the fund will be following and whether you’re comfortable with that approach.
Following through: Read the Wall Street Journal’s five questions to ask before investing in a target date fund at "http://online.wsj.com/article/SB1000142405274870346040457524468241
Now May Be the Time to Buy a Home
Physicians with ample income and good credit ratings may find this is a good time to buy a home, especially in areas where there has not been a flood of foreclosed properties While the past few years generally have not been a good time to buy because of declining asset values, home prices seem to be at or near a bottom at the same time that mortgage rates are at record lows.
The National Association of Realtors (NAR) reports that the median sales price of existing single-family homes peaked in 2006 at about $222,000. By 2009, that median price had dropped to around $172,000, a decrease of $50,000, which is more than a 20% decline from the peak. However, new data are encouraging:
- The median price in August 2010 was $178,600, up from $177,200 in August 2009, reports NAR.
- Prices in July 2010 were 3.2% higher than in July 2009, according to the S&P/Case-Shiller 20-City Home Price Index. Ten of the 20 major cities tracked by the index saw year-over-year gains while only Las Vegas hit a new bottom.
Many homes have been foreclosed and are now owned by banks. If the banks decide to flood the market with homes, prices may drop further. However, that may not happen. Some lenders are suspending foreclosures and evictions while regulators review banks’ procedures. Such developments may reduce the flow of properties onto the housing market and thus remove some downward pressure on prices.
“Banks are reluctant to bring too many homes to the market because they won’t gain from continuing weakness in home prices,” says Mark D. Luschini, chief investment strategist, Janney Montgomery Scott LLC, Philadelphia. “It serves the banks holding foreclosed or foreclosing properties no benefit to toss more inventory onto the market. It is likely, however, that this ‘shadow inventory’ will weigh on prices for many months if not years to come.” With the economy slowly recovering and banks cautiously selling the homes they hold in inventory, prices may be flat for a while.
Following through: Find the latest home price data from NAR at http://www.realtor.org/wps/wcm/connect/9218f380440c64c69e08ff34cafa
Why Convert to a Roth IRA?
Converting your traditional IRA to a Roth IRA can be a great idea. After five years and after age 591/2 , all withdrawals will be tax free; with a traditional IRA, withdrawals are mainly or completely taxable.
The catch? You’ll owe income tax on the conversion. For example, converting a $100,000 IRA would cost you $35,000 in tax if you’re in the 35% bracket.
You might find the cash to pay that tax by skipping IRA contributions. “Instead of contributing to an IRA, consider converting part of your traditional IRA to a Roth IRA,” says Joseph R. Brooks, president, Fairhaven Financial Advisory Corp., East Lansing, Mich.
For example, if Dr. Johnson and her husband are both 39 years old, they might be in the habit of contributing $5,000 to their IRAs. Each of them could convert $14,000 of their traditional IRAs to Roth IRAs. If they are in a 35% tax bracket, they would owe $4,900 each: 35% of $14,000. They could use the money that otherwise would be contributed to a traditional IRA to pay the tax on their Roth IRA conversions, putting them on a path towards future tax-free distributions.
In 2010, practicing physicians and their spouses generally can contribute up to $5,000 each to a traditional IRA, or $6,000 if they are at least age 50 by year end. The 2011 contribution limits may be a bit higher due to inflation. For Roth IRAs, the dollar limits are the same; but high-income taxpayers may not be able to make any Roth IRA contributions. As of 2010, because there are no income limits on conversions, high-income physicians may find Roth IRA conversions appealing now.
Following through: Find the answers to frequently asked IRA questions at http://www.irahelp.com/faqs.php.
Why You Should Consider Switching to Roth IRAs Now
Physicians may want to consider converting their traditional IRAs to Roth IRAs this year to avoid a 3.8% surtax on investment income that takes effect in 2013. That hike is part of the new health insurance legislation, which contains higher taxes for upper-income taxpayers—those withincome over $200,000, or over $250,000 for couples filing joint tax returns. Converting your IRA now offers these advantages:
- With a 2010 Roth IRA conversion, you can pay tax at 2010 tax rates, which are lower than expected future income tax rates. After five years and after age 59 1/2, all Roth IRA distributions will be tax-free.
- A 2010 Roth IRA conversion lets you avoid taking taxable distributions from a traditional IRA in the future.
- You can pay the tax on your 2010 Roth IRA conversion from non-IRA funds. This may reduce your taxable portfolio and thus reduce the taxable investment income that will be subject to the 3.8% tax.
“By using non-IRA assets to pay the tax on a Roth IRA conversion, you essentially are moving taxable dollars into a tax-free account with many investment options,” says Marty James, who heads Martin James Investment & Tax Management, LLC, an accounting and investment advisory firm in Mooresville, Indiana.
Following through: Find out more about the 3.8% surtax at http://tax.cchgroup.com/Legislation/Final-Healthcare-Reform-03-10.pdf?pacp-attached=1&pacp-SITESERVER=ID=70e413ad5980c54f9283357f3dd6c50c, p. 4.
Better Deals on PLUS Loans
Medical school students—and their parents—may be able to have easier access to lower federal student loan interest rates because of a change passed as part of the new health insurance legislation. Previously, most colleges and universities participated in the Federal Family Education Loan (FFEL) program, in which federally guaranteed loans came from private lenders. Fewer schools participated in the Direct Loan program, in which the money came straight from Uncle Sam.
But as of July 1, 2010, all federal education loans will come through the Direct Loan program. That may be good news for parents and graduate students who use federal Parent Loans for Undergraduate Students (PLUS) loans for higher education, now called Parent PLUS Loans and Graduate PLUS Loans.
“Parents and graduate students who were formerly borrowing through the FFEL program will now have access to a lower interest rate,” says Deborah Fox, who heads Fox College Funding in San Diego. “Due to a glitch in prior law, FFEL originated PLUS loans had an 8.5% maximum interest rate while the Direct Loan version charged 7.9%.” Starting in July, all new PLUS loans will have the lower 7.9% fixed interest rate.
She notes that because the lending standards of FFEL lenders are tighter than those of the government, PLUS loans may be easier to get than they were in the past once all-government lending begins in July.
Following through: Go to www.fastweb.com/financial-aid/articles/2177-how-will-the-student-loan-bill-affect-students to read how the new legislation will affect student loans.
Greater Tax Deductions for Medical Equipment
You can deduct up to $250,000 spent on equipment for your practice this year, thanks to the Hiring Incentives to Restore Employment Act of 2010. The new law raised this year’s cap from $134,000 for first-year deductions.
“A company—including a medical practice—can take a first-year write-off for up to $250,000 of business equipment, with a phase-out for capital expenditures exceeding $800,000,” says Ed Mendlowitz, partner in the CPA firm WithumSmith+Brown, New Brunswick, New Jersey.
That means that if you buy $900,000 of equipment in 2010, you will be over the $800,000 threshold by $100,000. Thus, your first-year write-off will be cut by $100,000 from the maximum $250,000 down to $150,000. If you buy $900,000 worth of equipment and you take a first-year deduction of $150,000 under section 179 of the tax law, the other $750,000 worth of equipment will be deducted under multi-year depreciation tables.
Following through: See www.section179.org/section_179_faqs.html, for frequently asked questions and answers on section 179.
Take a Longer Look at Short Sales
Whether you’re in the market for a larger residence, a vacation home, or investment property,this is a great time to be a buyer. Prices are down sharply from the peak of a few years ago.
Often you can get a great deal with a “shortsale.” A short sale takes place when the purchase price deal won’t cover the existing mortgage debt. For example, if you bought a house for $400,000 in 2006, with a $380,000 mortgage, and you can sell the house now for only $300,000, this transaction would result in a loss of some $80,000 for the lender.
“Shortsales need the lender’s approval,” says Bob Fornatto, a senior mortgage consultant at Wintrust Mortgage, Downers Grove, Illinois. “If there’s a second mortgage, the holder of that loan also must agree. So short sales don’t always go through.”
Shortsales may be easier to close now because of federal government initiatives such as the Home Affordable Foreclosure Alternatives (HAFA) program, introduced in April 2010, which encourages short sales. This program provides cash incentives to gain approvals from lenders. Under HAFA, mortgage holders must inform homeowners of the lowest price they will accept, then respond to a homeowner’s offer within 10 days.
Following through: HAFA’s main provisions are spelled out at www.realtor.org/government_affairs/short_sales_hafa.
How to Pay an Advisor
In these tumultuous economic times,you may want a professional’s advice on how to manage your money. You’ll pay for that advice, but different advisors have different compensation arrangements.
Commissions. Perhaps the most familiar way to pay for investment advice is to buy a stock or fund that a broker recommends and pay a sales commission. This arrangement may work well if you invest infrequently and hold onto the securities you buy for years, thus minimizing the commissions you pay.
Assets under management. Increasingly,investment advisors are calling themselves “fee-based” or “fee-only.” Typically, you’ll pay a fee around 1% a year for the assets in your portfolio. With a $400,000 portfolio, for example, you might pay the advisor about $4,000 a year no matter how much trading you do, so this arrangement may be suitable if you tend to change your holdings frequently to take tax losses or rebalance your asset allocation. “Some investors like the idea that the advisor’s compensation will go up only if their portfolio value increases,” says Philip Palaveev, president of Fusion Advisor Network, Seattle. “They like being ‘on the sameside of the table’ with their advisor.”
Flat fees.Some fee-oriented advisors will quote you a fixed rate for their annual services. You’ll know what your outlays will be, and you may receive financial planning advice in addition to investment management.
Following through: Go to www.resourcem.com/dev/documents/rmiller_article_5.pdf for a review of the pros and cons of various compensation arrangements.
Be Flexible With Portfolio Withdrawals
If you have a flexible retirement fund withdrawal strategy, you maybe able to withdraw more than the 4% that is typically recommended.
For example, under a traditional scenario you would withdraw $20,000 from a $500,000 portfolio in the first year. In subsequent years, you’d increase your withdrawal amount by the rate of inflation to maintain your spending power. If you withdraw $20,000 in year one and inflation is 3%, you’d withdraw $20,600 in year two. Going by historic results, your portfolio has a high probability of lasting 30 years or longer.
However, this assumes a worst-case scenario. If your retirement years occur when financial markets are better than a worst case, you’ll have withdrawn less than you could have afforded and lost out on spendable cash.
“We suggest clients start with a 5.5% rate if they’re willing to forgo automatic annual inflationary increases,” says Jonathan Guyton, principal, Cornerstone Wealth Advisors, a financial planning firm in Edina, Minnesota.
With an initial 5.5% withdrawal, you’d take $27,500 from a $500,000 portfolio in the first year. However, if you start at 5.5%, you should be willing to freeze withdrawals or even reduce the withdrawal amount when markets plunge and the size of your portfolio shrinks. Conversely, you can increase withdrawals by more than the inflation rate if your portfolio grows sharply.
Following through: At http://spwfe.fpanet.org:10005,you can read the breakthrough article that introduced the 4% rule.
How to Get Higher Yields on Your Cash Reserves
If you do a little research, you can get better yields for your cash than money market funds and many bank accounts, which pay astonishingly low interest rates these days. Here are three examples from Rich Chambers, founding partner, Investor’s Capital Management LLC, Menlo Park, Calif.
- Schwab Bank’s High-Yield Checking Account. The current yield here is 0.75%. Mr. Chambers says he uses this account and recommends it to his clients not only for the yield but for other advantages, which include easy access to your money and no fees. This account is covered by federal deposit insurance of up to $250,000 per depositor per bank.
- Emigrant Bank’s DollarSavingsDirect.com. The current yield here is 1.5%. This account, which is available online, can be electronically linked to your checking account. You can keep money at DollarSavingsDirect.com, earning the relatively high yield, and transfer funds to your checking account as needed. This account also is covered by federal deposit insurance of up to $250,000 per depositor per bank.
- Ford Interest Advantage. The current yield here is 2.32% to 2.63% depending on the account balance. Mr. Chambers uses this account for some of his own money but not for clients’ cash because of the higher risk: This account is not covered by federal deposit insurance.
Following through: To keep up with high-yielding online savings accounts, go to www.savingsaccounts.com/.
Coping with Disappointing Life Insurance Values
How to Get Higher Yields on Your Cash Reserves The news is grim for those who either bought variable life insurance in the late 1990s and invested in stocks within those policies, or bought universal life and whole life policies hoping that cash values would grow at substantial rates to match bond yields.
Because of the recent severe bear markets, stocks have suffered while bond yields have fallen. Therefore, many life insurance policies have disappointing cash values. Unless the policy is bolstered, there may not be enough cash to keep the policy in force as you grow older.
Here’s what you should do now to re-evaluate and bolster your situation:
1. Request an “in-force ledger.” That will show the policy’s current status.
2. If the policy is underfunded, get a schedule of how much you’ll need to pay to catch up.
3. Explore your other options. You can cancel the policy if it’s no longer needed, reduce your coverage, or exchange your old policy for a new one.
“Policies offered now might be better,” says Terry Quinn, an attorney who has an insurance consulting firm in Atlanta. “Some companies are offering stronger guarantees of cash value and insurance benefits.”
Following through: For insights on how to interpret a life insurance policy illustration, go to http://articles.moneycentral.msn.com/Insurance/AvoidRipoffs/AvoidThe
Are Hedge-like Mutual Funds Right for You?
With only a modest investment of a few thousand dollars, you can now invest in hedge-like mutual funds and take advantage of a hedging strategy that has previously been available only to the very wealthy or to institutions, thanks to the introduction of new mutual funds.
Hedging is a strategy that paid off during the recent economic downturn: Results vary; but Morningstar’s Long-Short category posted a loss of 15.4% in 2008, which was much better than regular stock funds, which posted loses a 37.5% average loss for domestic stock funds in 2008.
In 2009, these funds hedge-like mutual funds were up 10.4%, enabling investors to recoup a good portion of their losses from the 2008 bear market.
Although there are many types of these funds, the basic hedging strategy is to go long—and short. Here’s how it works:
- Hedge funds go long. The funds buy certain stocks, bonds, or other assets and hope to make money if prices rise.
- Hedge funds also go short. They enter into transactions structured to make money if specified assets lose value.
Because of this mix, a skilled hedge fund manager can make money in bull or bear markets. Investors may wind up with superior long-term returns and a smoother ride to get there. Unlike regular hedge funds, many—though not all—hedge-like mutual funds offer lower minimum investments and lower fees as well as easier access to your money.
“You might be able to get into these funds with just a few thousand dollars,” says Nadia Papagiannis, editor of Alternative Investments Observer. “You can sell your shares whenever you want, which generally is not the case with hedge funds; and fees are much lower than what you’d pay for hedge funds.”
Following through: Go to http://www.nytimes.com /2010/01/10/business/mutfund/10hedge.html for a detailed look at why 24 hedge-like mutual funds were launched in 2008 and 2009.
When Prepaid Plans Make Sense
If you’re planning for a child’s college education, you may find prepaid tuition plans a good option.
Unlike the 529 college savings plans, which were hit hard by the 2008 bear market and still have not recovered their losses, contributions to the prepaid plans are guaranteed to grow at the same rate as college tuition increases, regardless of how financial markets perform.
The catch? Most of these plans, which are offered in 18 states, are tied to the state’s financial fortunes. In the recession of 2008-09, many states have increased fees for these plans or adopted other measures to make them less attractive.
“A few state plans shift the risk from the plan to the schools, which is better for parents,” says Joe Hurley, a CPA and president of Savingforcollege.com. He cites Massachusetts and Texas as examples of this shift. “In addition, the Independent 529 plan offers the same approach to funding tuition at over 280 private colleges across the country.”
You probably shouldn’t manage all of your college savings through a prepaid 529 plan, because these plans generally will provide benefits only for tuition and only at specific schools. Nevertheless, you may want to put some money there if you think your child is likely to attend a school covered by the plan.
Following through: Go to http://www.savingforcollege.com/college_savings_201/ to find out whether your state has a prepaid plan.
Understanding New Tax Credits for Home Buyers
If you’ve been putting off buying a first home—or even moving at all—new tax credits may make it more attractive to do so. Congress passed a law late last year that expands the previous law’s tax credit options for home buyers. Here’s what’s new:
Higher income limits. The full tax credit is available to single taxpayers with income up to $125,000 or up to $225,000 for married couples filing a joint return. These amounts have been increased from $75,000 and $150,000 in the prior law from early 2009. Partial credits are available if those income levels rise to $145,000 and $245,000, respectively.
Option for certain previous owners. First-time home buyers can get a tax credit up to $8,000. You qualify if you (and your spouse, if you’re married) haven’t owned a home for three years before the purchase. In addition, if you’ve owned and lived in the same home for five consecutive years during the eight years before the purchase, you may qualify for a $6,500 tax credit depending on your income.
You have to use the home you buy as a principal residence by April 30 of this year. That moves up to no later than June 30 if a binding contract is in place by April 30. “A qualifying purchase in 2010 can be taken on a 2010 or a 2009 tax return,” says Marty Abo, a CPA in Voorhees, N.J. He notes that homes costing over $800,000 are ineligible for either tax credit.
Following through: Go to www.irs.gov/newsroom/article/0,,id=204671,00.html for complete details on the newest version of this tax credit.
What’s the Right Strategy for You?
While financial professionals usually differentiate between strategic and tactical investing, some say a combination of these approaches would work for some investors.
Although the definitions are not etched in stone, here’s a guide:
Strategic investing usually refers to a long-term approach. You might decide to hold 75% of your portfolio in stocks, for example, and 25% in bonds. You’d keep investing, through good times and bad, and hope for superior returns.
Tactical investing usually indicates an attempt to move in and out of stocks at the right time, to avoid the worst of bear markets. You might sell stocks when the market seems pricey, park the proceeds in cash, then reinvest after stocks have tumbled.
“Investors probably should not be fully invested in tactical methods because they may be late getting in and out of the market,” says Bill Crager, president of Envestnet, a wealth management firm based in Chicago. “However, it may be appropriate to use tactical methods for a portion of the portfolio because these methods may help investors become defensive in falling markets.”
Following through: See www.thestreet.com/story/10612765/the-tactical-investor.html for an overview of tactical investing.
Investing: Physicians’ Best Bet
If you’re leery of stocks and looking for similar returns without the turmoil, put some of your money into bonds.
At first glance, Treasury bonds (T-bonds) seem a wise investment choice. If you had bought intermediate-term T-bonds during 1995-2008, your 7%-a-year return would have beaten stocks’ annualized returns of below 7%, according to Morningstar, Inc., an independent investment research company based in Chicago. Of course, if you bought the wrong stocks or tried to time the market, you may not have made any money at all, making that T-bond yield look even better. In addition, because those bonds had only one down year (they lost about 2% in 1999), investors during that period managed to avoid the stress that often accompanies stock market investments.
However, today T-bonds have relatively low yields—about 2.75% for 5-year bonds and 3.80% for 10-year bonds. Instead, physicians are likely to be better off investing in municipal bonds, which yield around 4% and, importantly, are tax-exempt. Tax rates are widely expected to rise, especially for those with six-figure incomes; and higher tax rates would make tax-exempt interest even more appealing.
Marilyn M. Gunther, a partner at the Center for Financial Planning in Southfield, Mich., currently prefers municipal bonds with maturities no longer than 10 years; longer-term bonds may lose value substantially if interest rates rise.
“It has become difficult to find suitable individual shortterm municipal bonds for clients,” Ms. Gunther says. “So we are using more shorter-term ‘muni’ bond funds.” She advises investors to consider the following before investing:
- Overall length of bonds in the portfolio
- Credit quality of the bonds
- Experience and success of the fund manager
Still wary? Consider this: Municipal bond prices are actually somewhat depressed because investors fear the weak economy will trim states’ and cities’ revenues, perhaps leading to defaults. Once the economy recovers and confidence returns, municipal bond prices may move up, which would boost returns to bond fund investors.
Following through: Keep up with current yields on T-bond and municipal bonds at www.bloomberg.com/markets/rates/index.html.
Taxes: Special Rule Can Help Pay for College
If your son or daughter is in graduate school and 24 years of age or older, he or she may be able to take advantage of a special tax rule (in effect through 2010) that makes income shifting especially attractive.
According to this rule, low-income taxpayers get a 0% tax rate on dividend income and longterm capital gains, explains Tom Ochsenschlager, vice president of taxation at the American Institute of Certified Public Accountants.
In 2009, that 0% rate applies as long as taxable income is no more than $33,950 on an individual return, or $67,900 for a married couple filing jointly. Because tax brackets generally expand each year to keep pace with inflation, those numbers probably will be slightly higher in 2010.
To see how your son or daughter might use the 0% rate, suppose that your 24-year-old daughter is in medical school, has minimal taxable income, and you are helping to pay her bills.
Suppose, too, that you have $52,000 worth of stock in a biotech company that you have been holding for many years. Because you paid $20,000 for those shares, you would incur a $32,000 long-term capital gain if you sold them.
“Instead, you can give $26,000 worth of those shares to your daughter—and file a gift tax return—so she can sell them by yearend,” Mr. Ochsenschlager says. If you’re married and have made no other gifts to your daughter this year, gifts up to $26,000 will be gift-tax free, thanks to an annual gift-tax exclusion.
Your daughter will collect $26,000 from the sale and will owe 0% tax, assuming her taxable income (including the gain amount) remains under $33,950 in 2009. Thus shewill have $26,000 to put toward medical school costs. You can repeat the process in 2010 if that 0% tax bracket is still available.
Remember, income shifting doesn’t work for younger children. In those cases, the “kiddie tax” assesses investment income over $1,900 (in 2009) at the parents’ tax rate. Children who aren’t full-time students will no longer be liable for the kiddie tax once they reach age 19. Other rules apply to youngsters whose earned income provides more than half of their own support.
Following through: For more details on the kiddie tax, go to www.fairmark.com/college/kidtax/kiddietax.htm.
Retirement Planning: New Option for High-income Physicians
If you’ve been earning too much to take advantage of Roth individual retirement accounts (Roth IRAs), you may be able to tap into a special rule that takes effect in 2010.
Roth IRAs allow tax-free withdrawals after you’ve had the account for five years if you’re 591/2 or older. In addition, you never face any required distributions, no matter your age.
But most physicians have been shut out of the option. In 2009, for example, a single taxpayer with modified adjusted gross income (MAGI) over $120,000 wasn’t able to contribute anything to a Roth IRA; married couples with MAGI over $176,000 were also barred. To contribute the maximum $5,000 this year ($6,000 if you’re 50 or older), your MAGI must be under $105,000 on a single tax return or $166,000 on a joint return.
If you want to convert your traditional IRA to a Roth IRA, the hurdles are even higher. You must have MAGI no higher than $100,000 this year, on a single or joint tax return. That $100,000 income limit will be abolished after 2009 so you can have a Roth IRA next year, regardless of your income.
Usually, when you convert a traditional IRA to a Roth IRA, you owe tax on any pretax dollars that you’re converting for the year of the conversion. But for 2010 conversions, you can report half the income on your 2011 return and half on your 2012 return, says Ed Slott, a CPA in Rockville Centre, New York, author of Ed Slott’s IRA Advisor, a monthly newsletter; and host of the PBS special, “Stay Rich Forever and Ever.”
He cautions that the tax bill can be steep. Assuming that Dr. Jones has $400,000 of pretax money in his IRA, if he is in a 35% tax bracket, Dr. Jones will owe a total of $140,000 in tax on a full conversion.
If Dr. Jones prefers to pay less tax, he can do a partial conversion. He might convert $100,000 of his IRA in 2010 and defer the taxable income to 2011 (when he’ll report $50,000) and 2012 (when he’ll report the remaining $50,000). Assuming tax rates remain the same in those years, Dr. Jones will pay a total of $35,000 in tax.
“Many people expect future tax rates to be higher because of all the obligations the federal government has assumed,” Mr. Slott says. “If you convert your traditional IRA to a Roth IRA now, you’ll be able to take tax-free distributions and pass the tax-free account to your beneficiaries, even if tax rates shoot up.”
Following through: For answers to your questions about Roth IRAs, go to Mr. Slott’s Website, www.irahelp.com. Click on “IRA Resources” and “Frequently Asked Questions.”
Real Estate: Time to Buy Investment Property
If you are interested in rental property, now may be the time to buy. Housing prices may be as low as they’re going to get while mortgage rates are reasonable for investors with a good credit record and cash for a down payment.
“To get the best mortgage terms, investors probably will need a credit score of 750 or higher as well as enough cash to put at least 30% down,” says Greg McBride, a senior financial analyst at Bankrate.com, North Palm Beach, Fla.
For the best deals, follow these tips:
- Try to buy from a lender after it has foreclosed on a home. These homes are collectively known as REO (“real estate owned” by a bank or other lender). Because banks generally don’t want to be landlords, they may ask low prices in order to get REO homes off their books.
- Ask the bank to verify that you won’t have to deal with others’ claims such as title liens, delinquent taxes, or homeowners’ association fees that are in arrears.
- Be aware that, because REO property usually is sold “as is,” a house may have hidden flaws. “It’s vital that you hire a reputable home inspector before signing a contract,” Mr. McBride says.
- Insist on working through a realtor who represents one or more lenders. This realtor will have easier access to the bank’s properties and probably will have experience in moving the process along.
The days of property “flipping” for quick profits are gone and best forgotten, but rental real estate is likely to deliver solid returns and tax benefits to investors who can hold the property for four years or longer.
Following through: Find local REO properties owned by Bank of America at www.countrywide.com/purchase/f_reo.asp.
About the Author: Donald Jay Korn is a New York-based financial writer with particular expertise in investments, real estate, financial planning, taxes, and insurance. He has authored seven books on financial topics and is a regular contributor to Financial Planning, Black Enterprise, Investor’s Business Daily, and Consumer Reports Money Advisor.
Why You Should Consider Tax-free Gifts in 2010
Now is the time to think about making annual exclusion gifts. Even though the estate tax isn’t in effect for 2010, it’s highly likely that it will return in 2011 and later years as the federal government looks for ways to battle huge budget deficits. Physicians who earn substantial amounts during their careers probably will amass enough net worth to owe estate tax at rates that might be around 50%.
The gift tax exclusion allows you to give up to $13,000 a year each to any number of recipients. For example, Dr. Hall could give a total of $65,000 worth of assets to his two children and his three grandchildren this year, free of gift tax. If Dr. Hall is married, he and his wife could give up to $130,000 to those recipients.
Giving away assets that have lost value, such as stocks and real estate, might be a good idea now, too. “If those assets gain value in the future, those assets as well as any appreciation will be out of your estate and thus avoid estate tax,” says Martin S. Finn, CPA, managing partner of Lavelle & Finn, a law firm in Latham, N.Y.
Following through: Find answers to frequently asked questions about the gift tax from the IRS at http:// www.irs.gov/businesses/small/article/0,,id=108139,00.html.
Income Shifting an Option as Tax Rates Rise
Physicians’ tax rates may rise next year as current tax law changes take effect. Here’s how the rates compare:
- Rates in 2010: 10%, 15%, 25%, 33%, and 35%.
- Rates in 2011 (scheduled): 15%, 28%, 31%, 36%, and 39.6%.
One money-saving strategy is to shift income to low-bracket family members. For example, you may be able to hire your children or retired parents to work in your office. “Relatives might perform jobs such as filing, handling mail, Web design, and updating contact lists,” says Julie A. Welch, CPA, director of the tax department at Meara Welch Browne, an accounting firm in Kansas City, Mo.
Here’s how it would work: Dr. Smith pays his teenage daughter Alicia $4,000 a year for work on his practice’s information technology system. That reduces Dr. Smith’s taxable income at his own high tax rate. Alicia owes no tax on that income because she can take a standard deduction: $5,700 in 2010. If tax rates rise, the family’s tax savings may be even greater. For this income shifting to be valid, Dr. Smith must pay Alicia a fair wage for work actually performed.
Therefore, if you decide to hire your children or other loved ones for your practice, be sure to keep records and pay the going rate.
Following through: Find tips on how to cut payroll tax as well as income tax when you hire your children at http://www.irs.gov/businesses/small/article/0,, id=97748,00.html.
Options for a ‘Sideways’ Stock Market
The stock market is now trading in the middle of the range it has been in for the last decade. Specifically, the Standard & Poor’s 500 index peaked at over 1,500 in March of 2000, fell as low as 675 in early 2009, and now trades around 1,050. In this “sideways” market you should consider selling what’s known as “covered calls” to boost your investment income, even if stocks aren’t gaining ground. While a regular call is an option to buy a stock at a given price by a set time, a covered call is an option in which the seller owns the underlying stock. Listed options are available on many widely traded stocks.
For example, suppose you own 100 shares of ABC Corp., trading at $55. You might sell an option to buy those shares at $57.50 within six months. If you collect $150 for the call, that’s a 2.7% return in six months, or a 5.4% annualized return on your $5,500 worth of stock. You’d also collect any dividends earned while you still own the shares.
The downside is that you give up any chance of appreciation above $57.50 per share. “If you like the strategy but can’t take the time to implement it, there are several mutual funds that buy stocks and sell covered calls,” says Nadia Papagiannis, alternative investments strategist at Morningstar.
Following through: Find a workshop on covered calls from the Chicago Board Options Exchange at http://www.cboe.com/Strategies/EquityOptions/CoveredCalls /Part1.aspx.
Understanding Municipal Bonds Risks
Although tax-exempt municipal bonds are gaining popularity, be aware of the serious risks before making an investment decision.
Spurring the interest are scheduled income tax rate increases: Under current law, top-bracket investors will pay 39.6% on investment interest income in 2011, up from 35% in 2010. Nevertheless consider these ominous risks:
Short-term risks: The recession that started in 2008 remains a concern. As unemployment increased and real estate values fell, municipal bond issuers have seen income, sales, and property taxes decline. Some issuers may default because of difficulty paying interest and redeeming bonds.
Long-term risks: Some municipal bond issuers have huge obligations, especially pensions. Some day those issuers may have to choose between paying retirees and paying bond holders. Bankruptcy is a possibility, and bond holders could suffer losses. “Pension obligations are senior to bond debt service in most states,” says Josh Gonze, managing director, Thornburg Investment Management and co-portfolio manager for Thornburg Municipal Bond Funds, Santa Fe, N.M. “Defaults could occur in the future.”
To minimize those risks, focus on bonds issued to fund essential services, such as water and sewer bonds. Because of their vital nature, it’s unlikely that these issuers will default. Conversely, be cautious about municipal bonds from issuers with large numbers of public employees and long histories of offering rich pensions. In any case, be sure to read the offering materials before investing so you know where your money is going.
Following through: Find Moody’s detailed study of municipal bond defaults in the last 40 years at http://www.moodys.com/cust/content/Content.ashx? source=StaticContent/Free%20Pages/Regulatory%20 Affairs/Documents/us_municipal_bond_defaults_and_ recoveries_02_10.pdf.
Buy Near-campus Housing to Cut College Costs
If you’re sending a child away from home for multiple years of higher education, one way to reduce your net expenses is to buy housing near campus where your student can live. Here are two options:
Buy a condo. After your child graduates, you can sell the apartment, perhaps to another student. If you break even on the re-sale or even come close, you may save tens of thousands of dollars that you would have spent on dorm fees or apartment rents.
Buy a house. Choose one that’s large enough for several students so that your child can have roommates. Your child can live there while other students are rent-paying tenants.
“Buy a house that doesn’t need a lot of time and money to get ready for occupancy,” says Bert Whitehead, MBA, JD, president, Cambridge Connection Inc., a financial planning firm in Franklin, Mich. “You might spend a few dollars on carpeting, cleaning, painting, basic landscaping, and small repairs. If the house needs a new kitchen or a new roof, don’t buy it.” If your aim is to rent to students, a location near campus is more important than elegance.
With the latter option, cash flow from tenants may cover the costs of owning the property; and you’ll be entitled to the tax breaks from owning investment property, such as depreciation. Besides all the money you save by not paying for your student’s room and board, you may even turn a profit on the deal if the real estate market recovers.
Following through: See how room and board add to the total cost of sending a child to college, as reported in the latest annual report from the College Board at http://www.trends-collegeboard.com/college_pricing/pdf/2009_Trends_College_Pricing.pdf.
Why Waiting Can Increase Your Social Security Benefits
Although Social Security benefits won’t make you rich, don’t ignore them when planning your retirement. Today a physician with high lifetime earnings may collect $28,000 a year from that program. Given a 50% benefit to a spouse with low earnings, a retired couple could receive $42,000 a year from Social Security. That’s like having a $1-million bond portfolio.
But don’t rush to collect. The earliest you can start to receive Social Security benefits is age 62, and the latest is age 70. During that eight-year span your benefit will increase by about 8% for each year that you wait. Consider this example: Dr. Carson could start at age 66, now the “normal retirement age” for Social Security, and receive $28,000 a year. By waiting four years to start, until age 70, Dr. Carson would boost her benefits by 32% to more than $37,000 a year.
“If you are unmarried [and] in poor health, it probably makes sense to start Social Security as soon as possible,” says Michael Kitces, director of research for Pinnacle Advisory Group, a wealth management firm in Columbia, Md. “Otherwise, waiting to start benefits can help to hedge retirement risks such as inflation, poor investment performance, and running short of money as you grow older.”
For married couples, there may be another reason for waiting to start Social Security: If the higher-earning spouse dies first, the surviving spouse will continue to collect the benefit earned by the higher-earning spouse.
Following through: Find the report “How Much Do Households Really Lose by Claiming Social Security at Age 62?” from the Center for Retirement Research at Boston College at http://crr.bc.edu/images/stories/Working _Papers/wp_2009_11.pdf.