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A Monthly Newsletter Source of Financial Sources •
Divorce Trumps Estate Planning: • Before You Sell Any Real Estate, Look at Strategies for Managing Tax Liabilities: • Technical Analysis Keeps Investors from Falling Victim to Emotion. • Data is a Better Indicator than Fundamentals: • Advanced Financial Planning Can Help You Recover from the Impact of a Natural Disaster. • Give Your Financial Advisor the Ability to Advise You: • Kids and Credit Cards: It's essential to expose teens to the good, bad and ugly realities of credit. Divorce Trumps Estate Planning: Every woman getting a divorce, particularly high net worth women need to have their divorce agreements evaluated by their own financial advisor before the agreement is finalized. The attorney’s job is to come to a satisfactory division of the fair market value of the financial resources of the divorcing couple. What may not get attention is the impact of the division of assets. In many cases, the less financially astute spouse winds up with massive tax consequences from capital gains on the assets she accepted at face value. Or, all of her assets are in one sector (real estate, high technology, energy, etc.) In addition and perhaps more important is that it is not the attorney’s job to make sure the terms of the divorce agreement are met by both parties. For high net worth women, an area that often receives less attention than it should is making certain that insurance policies stay in force (usually they insure the husband to benefit the ex-wife should he become unable to pay alimony, child support or college costs.) The question becomes, how does the ex-wife get copies of her enforced insurance interest. The divorce lawyer thinks he’s done when the agreement is signed. Wives should insist on having the insurance policy put in a trust with a separate irrevocable trustee who is forced to pay the bill to keep the insurance in force. The wife, of course, is the beneficiary. Certainly, the ex-wife can sue her ex-husband’s estate executor if her ex-spouse dies before alimony expires and the insurance policy intended to replace this income for the ex-wife was not kept in force. The difficulty is that the divorce decree and the will and trust are often in conflict. Second wives should make certain that their husbands honor their insurance obligations to create an income stream for their ex-wives if their husband dies. What many do not realize is that divorce may trump estate planning. Creditors may win out over beneficiaries. The second wife will lose significant assets if her husband has not honored his divorce agreement and kept insurance in force to meet his obligations to his ex-wife. The ex-wife can and should go after the estate to be made whole according to the terms of the divorce agreement. Michael S. Finer, CPA, CFP, Major League Investments, Salem, Mass., provides family office services to athletes and celebrities. He is one of only 900 National Football League Registered Player Financial Advisors certified to provide full service financial advice to National Football League players. He can be reached at michael.finer@majorleagueinvest.com, or 978-740-1011 x 10.
Before You Sell Real Estate, Look at Strategies to Manage Tax Liabilities: John and Joan Wheeler, both age 65, want to sell a rental house on Cape Cod currently valued at $1 million. In addition to the rental house, the Wheelers have a personal residence, also worth $1 million, a $500,000 IRA, and $500,000 in a taxable portfolio of mutual funds and bonds. All tallied, the Wheelers have a current estate of $3 million. The Wheelers are very tired of managing a summer rental property, and they need to increase their retirement income, and to provide peace of mind, they want to create a cache of funds to pay for long term care concerns. Fortunately the Wheelers have read that there are strategies to defer capital gains taxes on the sale of the rental property. They sought a financial advisor skilled at complex family financial planning to find out if this was the case. The advisor focused on teaching the Wheelers what they did not know, so they could apply what they learned. In this case study, the financial advisor was able to recommend a number of linked strategies used by advisors providing family office services that allowed the Wheelers to increase their retirement income. In addition, they can create a charitable foundation that hypothetically will pay out more than $6 million to non-profit endeavors of the family’s choice, and allow John and Joan’s son and daughter, Bill and Jean, and their grandchildren Max, Nancy and Jane, to receive $5,356.350 in tax free stretch IRA payments over their two-generation life expectancy. Taxes on an outright sale of their rental property (state and federal) would equal $250,000. Here are the options the financial advisor suggested to prevent the loss of the family’s equity and to position assets for the future benefit of the next two generations of their family. The Wheelers deeded their rental house to a Charitable Remainder Trust (CRT). Putting the house in this trust means that no capital gains tax will be paid at the time of the sale. The existence of the CRT also means that the Wheelers can claim a $100,000 tax deduction that they can now spread over an allowed six-year period. During each of those next six years, the Wheelers can take $16,666 a year out of their taxable IRA and put it in a Roth IRA. Roth conversions require that the investor pay taxes on the amounts being converted. In this scenario, however, the Wheelers have a large tax deduction from the CRT and can use it “against” the deposits to their new Roth IRA, making the Wheeler’s conversion of $100,000 to a Roth IRA tax free. The Roth IRA has no minimum distributions compared to a regular Roth IRA. The proceeds from the sale of the rental house, inside the CRT, will pay John and Joan income for rest of their lifetime, estimated to be age 90, or 25 years going forward. Because the Wheelers saved the $250,000 in capital gains taxes at the time of the rental sale, and assuming an 8% rate of return on this portion of their investment portfolio, the Wheelers could generate $20,000 more income for their life expectancy of 25 years, or a total of $500,000 of additional taxable income. The Roth IRA requires no minimum distribution. If the Wheelers did not do the Roth, the minimum required distribution from a $100,000 IRA would have been $287,000 over their lifetime. Now it is zero. They can leave the Roth ($100,000) alone, assuming growth at 8%, it could grow to $675,000 tax free. If they want to allocate this $100,000 of their $3 million estate to their grandchildren Max, Nancy and Jane (leaving everything else to Bill and Jean) the grandchildren will be required to take minimum distributions over their lifetime. But Max, Nancy and Jane’s life expectancies from the time of inheritance in their 40s is possibly 45 more years. If John and Joan live 25 years and their grandchildren get to use the Roth for 45 more years, it can provide the family with 65 years of tax-free growth and income from the Roth. The longer it is stretched out, the more advantageous the tax free part of the Roth becomes as a benefit to the Wheeler family, with the Roth (at 8% return) paying more than $5 million in required distributions to Max, Nancy and Jane, during their lifetime. In addition, when the parents die, Bill and Jean will inherit the remaining $400,000 IRA not converted to the Roth, and the $1 million primary residence. Assuming that the house may grow at 5% a year, and in 25 years the house could be worth $3,390,000. Bill and Jean’s inheritance in this instance could be $4,290,000, and the grandchildren’s inheritance, the $675,000, tax free from the Roth. The CRT, originally funded by the sale of the rental for $1 million, can throw off 8% a year for the Wheeler’s to live on, and still be valued at $1 million at their death, going into a charitable foundation. The children, Bill and Jean become trustees, receiving a fee for running the foundation of about 1% a year for 30 years, creating an additional $300,000 or $150,000 each over their life expectancy. The foundation could earn 8% and pay out 5% for 30 years. Growing by 3% a year, during the children’s lifetime, the foundation will pay out to non profits of their choice, $1,827,750 while still growing to $2,437,000. When Bill and Jean die, the grandchildren become trustees of the $2,437,000 foundation. If their compensation for managing the foundation is 1% they would receive $731,100 in management fees over their 30 years. The grandchildren will be able to distribute an additional $4,386,000 to non-profits over 30 years while the foundation grows at 3% to $5,848,000. The Roth that the grandchildren inherited of $675,000, assuming 8% growth over their lifetime, drawing the required minimum distributions, means the grandchildren can receive over $5 million tax free from the Roth and the opportunity to run a $2 million foundation, where their only burden is to distribute assets to non-profits about which they feel passionately. All of this potential for the Wheelers comes from a relatively modest estate of $3 million. Because of their awareness of tax avoidance through deeding their rental property to the CRT, and because of their use of the CRT tax deduction to fund a Roth IRA, and the establishment of a charitable foundation, the Wheeler’s have created a truly meaningful legacy for their children and their grandchildren. Pearson Financial Services, Dennis, MA, is the author of "The Million Dollar Gift: Dynasty Trusts. Why Leave Your Assets Any Other Way", written for his clients, his clients’ families, and his own family. He offers a fully integrated wealth management process, incorporating investment, retirement, financial and estate planning specialists under one roof, serving clients as their family's office, designing and implementing strategies to protect and distribute their wealth and highly appreciated property. Seth Pearson, CFP, 800-385-7925, seth.pearson@verizon.net Data is Better Indicator than Fundamentals: “It is difficult to remain objective when conducting fundamental research,” says Mike Vogelzang, president of Boston Advisors, LLC. A mid-sized Boston-based employee-owned entity, the firm uses a data driven investment philosophy to manage more than $2.3 billion in both institutional and private advisory assets. Vogelzang sees a data driven approach as a significant departure from the practices of mutual funds and most money managers. “Meeting a company’s management and kicking the tires is standard practice in the world of fundamental analysis, yet we believe that it can severely bias even the most cynical analyst’s view of the stock,” says Vogelzang. “Given the depth of talent researching corporate America and the changes in the regulatory landscape, it can be tough to add significant value through fundamental research. Relationships with management have a significant impact on what an analyst believes about a company’s prospects. In fact, an analyst becomes less objective the more he or she engages with personalities on a company’s management team or investor relations officer,” Vogelzang says. Following the data creates a discipline that does not try to time the market or decipher which market sector will outperform next, but provides a completely impersonal look at what to do with an investment -- buy, sell or hold. Data helps insulate an investor from the inevitable emotional swings that market participants go through and can smooth out investment results from the market’s ups and downs. A data driven investment philosophy takes advantage of the large volume of data available today, matching it against disciplined screens. The goal is to create a repeatable process, says Vogelzang, regardless of the industry, market conditions, market cycle or whether the investment is small cap, large cap, growth or value, or international. He believes disciplined use of data underlies and enhances good investment practices. One of many examples of how the investment process works was Boston Advisor’s move into housing stocks in the late 1990s. While many investors were skittish buying the volatile sector, the Boston Advisors’ disciplines led to an overweight position across a broad range of client portfolios. However, in mid-2005, when the housing stocks were setting new highs, the BA rankings deteriorated and most housing stocks were sold. Since then, higher interest rates have caused housing stocks to struggle vs. the broader market. Another example is the timely and early investment in the energy patch. Boston Advisors’ disciplines pointed firmly at energy stocks in late 2003, well before many investors realized the fundamental shift in the energy equation. In addition to investment management services to select high net worth clients, the firm’s manages four institutional equity disciplines: large-cap value, large-cap core, small-cap core and all-cap concentrated core. Mike Vogelzang is President and Chief Investment Officer of Boston Advisors, LLC., a Boston-based, employee-owned investment advisory firm with $2.3 billion in assets under management for both private advisory clients and institutional endowments, foundations, and municipal pension plans. Mike can be reached through Beverly Flaxington, Chief Operating Officer, by email: Beverly.Flaxington@bostonadvisors.com, or 617-348-3102. Technical Analysis Keeps Investors From Falling Victim to Emotion Technical analysis keeps us from falling victim to everyday emotion and delusion. When considering technical analysis, remember that things are quite often not always what they seem. Many facts that we learn are not actually true; and what seems to be obvious, sometimes is not. Many people believe water runs out of a bath tub faster as it gets to the end; it doesn’t. Some people may drink like a fish, but fish don’t drink. George Washington neither cut down a cherry tree, nor threw a silver dollar across the Potomac. Dogs don’t sweat through their tongues, Audi automobiles never mysteriously accelerated, and the Battle of Bunker Hill was not fought at Bunker Hill, rather at Breed’s Hill. A good detective will tell you that some of the least reliable information comes from eye witnesses. When people observe an event, it seems their background, education, and other influences color their perception of what occurred. A most important thing that detectives try to do at a crime scene, is to prevent the observers from talking to each other, because most would be influenced by what others say they saw. Another curious human failing becomes a factor when we observe facts. The human mind does not handle large numbers or macro ideas well. That thousands of people die each year from automobile accidents raises scarcely an eyebrow, but one airplane crash killing only a few people, grabs the nation. We are only modestly concerned that ten of thousands of people are infected with AIDS, but we are touched deeply when presented with an innocent child that has been indirectly infected. If a situation is personalized, we can focus on it. We can become deluded by our emotions, and these emotions can affect our perceptions. When our portfolios are plunging, all of the fears that we can imagine are dragged out: recession, debt, war, budget, bank failures, etc. Something is needed to keep us from falling victim to fear and perceptions; that something is technical analysis. Almost all methods of technical analysis generate useful information, which if used for nothing more than uncovering and organizing facts about market behavior, will increase the investor’s understanding of the markets. The investor is made painfully aware that technical competence does not ensure competent trading. Speculators who lose money do so not only because of bad analysis, but because of their inability to transform their analysis into sound practice. Bridging the vital gap between analysis and action requires overcoming the threats of fear, greed and hope. It means controlling impatience and the desire to stray away from a sound method to something new during time of temporary adversity. It means having the discipline to believe what you see and to follow the indications from sound methods, even though they contradict what everyone else is saying or what seems to be the correct course of action. Gregory L. Morris is a portfolio manager for PMFM, Inc., managing their PMFM Core Advantage Portfolio Trust mutual fund. Prior to this role, Greg served as a Trustee and Advisor to the MurphyMorris ETF Fund and as Treasurer and Chief Executive Officer of MurphyMorris Money Management Co. Greg has been a technical market analyst for almost 30 years. Greg is also an accomplished author and has written two books on technical market analysis with McGraw-Hill. A third edition to his best-selling (16th printing) “Candlestick Charting Explained” will be released in March, 2006, and his second book, “The Complete Guide to Market Breadth Indicators,” was published in September, 2005. gregm@stockcharts.com, 706-579-1392 Advanced Financial Planning Can Help You Recover from the Impact of a Natural Disaster The Loma Preita earthquake and the major fire in the Oakland Hills have made Californian’s aware of the ongoing worldwide natural disasters. The national mindset has recently focused on Katrina’s impact on Louisiana residents. Disaster preparedness almost always focuses on having adequate emergency supplies, but disaster planning is more than a supply of water, food, batteries and flashlights. Your planning should also ensure that you have a financial recovery plan, including ready access to your critical financial information and adequate insurance coverage. Follow these steps to get and stay financially prepared for disaster. For in-home storage, a fireproof file box or cabinet can keep important documents safe from minor damage. However, in preparation for a major disaster you may want to store records at alternate locations, such as a second home or the home of a family member or trusted friend, or in a safety deposit box. For security purposes, don’t store statements showing your account numbers together with your social security number or passwords unless you are certain of the security and privacy of those files. Review your policies with your insurance agent. In addition, there are a number of sources of information, including government and private websites, where you can learn more about earthquake risks. Flood insurance is required to obtain secured financing to buy, build, or improve structures if the property is located in Special Flood Hazard Area (SFHA). Even if you don’t have a mortgage on your home, but the property is located in a flood zone, we recommend you assess your risks and compare the risks with the cost of flood insurance. Flood hazard areas are established by The Federal Emergency Management Agency (FEMA). For more information visit www.floodsmart.gov. None of us have the power to prevent major disasters, but by being well prepared each of us can minimize the impact on ourselves, our families, and friends. Barry Taylor, CFP® is a principal of Bingham, Osborn & Scarborough LLC (BOS), a San Francisco and Menlo Park, California-based registered investment advisor with approximately $1.5 billion in assets under management. BOS has provided investment management and comprehensive financial planning for individuals and endowments since 1985. All revenues are fee only. BOS has eight principals plus eighteen team members working on behalf of their clients, including seven credentialed portfolio managers with direct client contact and eleven operations, administration, finance, compliance, and systems staff with responsibilities related to client accounts. Barry.Taylor @bosinvest.com. 415-781-8535. Give Your Financial Advisor the Ability to Advise You: You have chosen to meet with a new financial advisor. You also decide to keep silent about a large portfolio of assets you own, but don't want to disclose to your new advisor until you see the results of his first financial plan. It is understandable in some social settings to play it close to your vest about your total net worth, but the one place where you must come clean is with your financial advisor. Look at this scenario that required the advisor to completely reorganize a financial plan that had been put into motion, with only the disclosed assets fully invested. The first few meetings with the new client went as expected. The client was very clear about their investing risk tolerance and goals. They received the plan for the disclosed assets, and approved the suggested asset allocation. The financial planning firm made arrangements to have all disclosed assets invested to meet the client's stated goals and objectives. Two months after the assets were fully invested the client returned to the advisor's office and presented a portfolio of municipal bonds that was half the size of the original sum invested by the advisor on their behalf. Disclosure of the pre-existing assets significantly disrupted the original plan. Confronted with this new reality, the advisor had to adjust the portfolio to take into account this significant portfolio of municipal bonds. The presence of such a high percentage of bonds was at odds with the original risk tolerance and asset allocation. Going forward, the client may have had unreasonable expectations for the performance of his portfolio. The advisor and the client had to reevaluate the financial goals and risk tolerance, essentially starting all over again. The advisor then had to liquidate some of the recent investments in order to rebalance the portfolio in light of the bond portfolio disclosure. The mismatch between the clients’ goals and their actual net worth also happens when clients do not disclose large 401(k) balances or IRAs. Consumer reticence to tell advisors about all of their net worth can result in a financial plan that may be at odds with their investing intentions. It is imperative to give your financial advisor the opportunity to really advise you. Non-disclosure of assets at the beginning is not getting off on the right foot. Even if it is not your intention to have the advisor manage a group of assets, the information needs to be provided so that the advisor has an accurate picture of your financial situation and can craft a meaningful asset allocation. Donald L. McCoy, J.D., CMFC -- Planners Financial Services, Inc., 952-835-9000. Minneapolis, Minnesota. Registered investment adviser and subsidiary company Montgomery Investment Management, specialize in the management of no-load mutual fund portfolios for individuals and retirement plans designed to protect capital by reducing risk.pfs@usinternet.com Kids and Credit Cards: Credit cards can be a lifesaver in a financial emergency, serve as a financial organizational tool, and be a convenient way to consolidate and simplify one’s personal finances. For teens, having a credit card to use in emergencies can literally be a lifesaver. Young drivers, for safety’s sake, should have a credit card in their own name or get a card on a parents’ account where the child may sign for purchases. Of course, this all depends on your willingness to pay bills your child may incur. If you do not believe your child could manage a credit card well, only give it to your children when they are out of town on a sports or drama club trip. Credit cards come with an important learning curve that must be taught: • What constitutes an emergency? Tell your children the kinds of events that may trigger use of the credit card you have entrusted with them. Whether it is a flat tire, or a taxi ride home from a party if a ride has left without him, or has been drinking. • What constitutes unacceptable “emergencies”? Role play and clearly state that finding a favorite band’s CD on sale or an unexpected trip for pizza do not constitute credit card emergencies. • What are the logical consequences of inappropriate purchases? One rule would be to require your child to pay “interest” on the unacceptable purchase. Financial transactions between parents and their minor children are not generally subject to usury limitations. It makes an impression to have a 20% or 25% interest on the item, or a $25 or $50 addition to the cost of the non-emergency item. You will get their attention. Credit card learning is a process. Once your child has shown responsibility with emergency use of a credit card, you can let him start using the card for convenience. Allow him to charge up to the amount of his allowance each month. When the bill comes in, though, he must pay for his purchases in full. If your child cannot pay his charges in full there are a number of strategies to employ that encourage learning and experiencing the logical consequences of credit card debt. • Insist he pay you interest at the highest rate allowed in your state, whether that is the rate on the card or not. • Require him to pay a substantial share of the discretionary portion of his allowance toward the card charges until they are paid. • If he gets behind or takes more than three or four months to pay off credit card charges, “garnish” his allowance. • If he gets so far behind that it will take more than six months to pay you back, take the card away until the debt is paid. • Restrict your child’s activities to those that could not have financial emergencies. The effort is to create consequences for credit card misbehavior and to present them as consequences and not arbitrary punishment. Credit cards, when misused, are a disaster. Help your children learn while they are young how to avoid the problems of credit card debt when they are on their own. Linda Leitz, CFP, Pinnacle Financial Concepts, Inc., Colorado Springs, Colorado, is author of “The Ultimate Parenting Map to Money Smart Kids,” as a book or as a CD. She specializes in helping families and individuals meet their long- term financial goals. She also helps those in the midst of divorce resolve financial issues through her company Divorce Solutions, Inc. She can be reached at 719-260-9800 or Linda@brightleitz.com. |