Articles

Is your investment portfolio “off-balance”?

Throughout its history, the investment market obviously has experienced volatile years, going in both positive and negative directions. Such dramatic swings in stock returns typically provide invaluable lessons-and also raise a question all investors should answer every year: Do I need to rebalance my portfolio?

Rebalancing a portfolio involves periodically readjusting its mix of assets. Smart investors start by establishing an initial asset allocation, assigning percentages of the portfolio to assets such as stocks, bonds and cash, and perhaps other types of investments, such as real estate and commodities. The allocations are further broken down by subcategories, such as different types of stocks and bonds.

The target allocations should be appropriate for that investor’s investment goals and financial circumstances as well as comfort level with certain types of investments. Investors also may readjust target allocations to reflect major changes in their personal financial circumstances.

Why rebalance just because a portfolio no longer matches its original allocation? Why not just let it ride-especially if the market’s going up? If you don’t, you increase the risk that you may not achieve your investment goals.

Let’s put it into perspective. Consider your portfolio in a market scenario in which a mix of stocks across various asset classes, sectors and markets (large-cap, technology and international, for example) collectively bring about strong returns. Meanwhile, much of the bond market suffers a significant setback. What impact would these major market changes have on your portfolio? Would they alter your original asset allocation? How much would they alter the mix, and should some of the investments be rebalanced?

How much to allow a specific asset category to shift before readjustment is up to you, but a common guideline is 5 percent. To rebalance, consider directing future investment funds into those underrepresented categories until it’s back in balance. You can also readjust by selling off some of the over-represented assets (the winners) and buying the underrepresented (the losers)-selling high and buying low. It is usually better to execute this strategy within tax-favored accounts to avoid taxes on gains, but if you need to rebalance taxable accounts, don’t let tax concerns necessarily derail you.

Contact us for more information about rebalancing your portfolio-it could take some weight off of your mind.

The “Power” in a Power of Attorney

Lawyers are continually asked by clients whether they need a Power of Attorney. There is no universal answer to this question, as everyone’s financial situation and relationship with others is different. A meaningful response requires that the client understand what a Power of Attorney (commonly referred to as a “POA”) is and what it can and cannot do.

In general, we recommend that our clients execute Powers of Attorney, but only after discussion of several considerations, outlined below. The utility of a POA can be best described by the old saying, “Never has so little done so much for so many.” We will explore the benefits of a POA later in this article, but we will begin with a basic understanding of what a POA is.

Definition

A POA creates an agency relationship between the person who signs the POA, known as the principal, and the person who is appointed as POA, known as the agent. Only the principal is required to sign the POA. The agent has authority under the POA only for so long as the principal is alive or at any time before the principal revokes the POA.

A POA can allow the agent to perform an unlimited number and range of functions on behalf of the principal. A POA can also limit the functions an agent can perform.

A POA should be durable - meaning that the principal intends to allow his agent to (continue to) act on his behalf in the event of the principal’s incapacity. A POA is durable if it contains language that expressly states that the POA will remain in effect regardless of the principal’s subsequent incapacity. Without such a statement, the POA lapses if the principal later becomes incapacitated – something almost always not intended when drafting POA’s for estate planning purposes.

Once a durable POA is signed by the principal, the agent is allowed to act on the principal’s behalf – the agent can perform any of the functions allowed under the POA immediately. However, some people want to execute a POA so that in the event of their incapacity at some point in the future, someone will be able to pay bills, write checks, etc. on their behalf. A Springing Power of Attorney can grant the same authority that a (non-Springing) Power of attorney allows, but does not go into effect until some later triggering event.

For instance, Mrs. Smith may be perfectly capable of managing her own affairs now, but may be concerned that as she ages her abilities may decline. She may want to ensure that someone she trusts will be able to help her out in the future should she need it. With a Springing POA, Mrs. Smith can name someone as her agent, but her agent will not have authority to act on her behalf (access bank accounts, etc.) until some point in the future when Mrs. Smith is no longer capable of managing her affairs on her own.



Choosing an Agent



This scenario leads to a discussion on choosing an appropriate agent. Whether a person should grant a POA to another depends entirely on whether the person has full, total, and complete trust in another person. If there is no one in whom a person has such trust, then she should not execute a POA – Springing or otherwise.

Using our example above, if Mrs. Smith required her agent to sign an affidavit and attach a certification by a licensed physician attesting to her incapacity, she clearly does not have full, total, and complete trust in her agent. We have found in our practice that roughly 60% of our clients use the Springing POA and the rest opt for a non-Springing POA.



Limitations and Other Express Powers 

In financial planning and Medicaid planning contexts, it is best to give a POA that conveys the broadest possible authority, limited only by the principal’s concerns. Statutory POA and Springing POA forms convey thirteen separate powers, including “all other matters.” Although this sounds fairly inclusive, it is not.

The most harmful limitation is that the statutory forms may not expressly give an agent the ability to make gifts of the principal’s assets. One’s incapacity does not lessen the need to reduce the gross taxable estate for estate tax reduction purposes or to remove assets out of one’s name for Medicaid eligibility purposes. Without an express gift-making provision, it will be very difficult to transfer the principal’s assets to her beneficiaries even though this is what the principal would have wanted. Even so, gift-making provisions should not be automatically included in all POA’s without first considering the need and ramifications of such a power. If gift-making is to be included, then the principal should also address to whom and to what extent gifts may be made. To her spouse only? Unlimited gifts? To children? Must gifts to children be of equal value?

Other powers that we expressly add to our POA forms after discussion with our clients include dealing with the state of residence, the I.R.S. and D.R.S. on all tax matters (income and gift, including gift splitting, sales and use tax), accessing safe deposit boxes, changing domicile, creating/funding/requesting distributions from trusts, and changing beneficiary designations on life insurance, annuities and retirement plans. Although some of these powers are arguably included in the statutory form, it is wise to explicitly express them in the POA for enforceability purpose.

Acceptability of a Power of Attorney by Third Parties



You may take all the appropriate steps to execute your POA, but your agent may encounter difficulty trying to use the POA at some point in the future. Although the POA you sign is effective until you revoke it and so long as you are alive, some financial institutions and banks have internal policies whereby employees are instructed to only honor POA’s that are dated recently (in some cases, within six months). Some companies may request that the principal sign a statement that the POA has not been revoked – but what if the principal is now incapable of signing such a statement? These internal policies will frustrate your agent’s ability to act on your behalf.

Your advisor can add language to the POA stating that unless the third party (bank, life insurance company, etc.) has actual notice of revocation, they may rely on the agent’s authority. Your advisor can also include hold harmless or indemnification language to assuage the third party’s concerns. Whatever the method, your advisor should add whatever language possible to make the POA acceptable to the outside world.

An alternative or additional protection to a POA is creating a living or revocable trust. A living trust typically names the principal (client) as trustee and also names at least one successor trustee. The successor trustee will step in to manage the trust if the original trustee becomes incapable or passes away. If the principal transfers or re-titles his assets into the trust, then if he should become incapable, his successor trustee would be able to manage the assets – including paying bills, writing checks, etc. Financial institutions seem to be more accepting of a successor trustee’s authority than the authority of what they deem to be an out-dated POA.

In summary, a POA is a powerful and useful tool for a variety of estate planning needs, both foreseen and unforeseen. Once you sufficiently identify your estate planning or Medicaid planning needs, you should execute a POA as soon as possible to ensure a seamless transition in the management of your finances from you to your agent if you should become incapable of managing your own affairs.

Veterans benefits to help subsidize the cost of Assisted Living

One of the most misunderstood of all Veterans Affairs programs is the veteran’s benefit for a non-service connected disability.  There is a “pension program” available for individuals who are disabled due to the complexities of old age, and need assistance with activities of daily living.  Basic activities of daily living (ADL’s) include:  bathing, dressing, grooming, incontinence care, transfer, ambulation, etc.  Instrumental ADL’s are items such as transportation, laundry, housekeeping and meal preparation.   This VA benefit is also defined as an Aid and Attendance benefit, because an individual requires the regular aid (help) and attendance (presence) of another person in order to avoid the dangers and hazards incident to their daily living environment.

This Aid and Attendance benefit is available to a veteran or a widow or widower of a veteran.  A married veteran can receive up to a maximum of $1,950 per month in benefits, a single veteran $1,644, and a widow or widower can receive up to $1,057 per month for the year 2010.

The program has limitations related to income and assets, however, unreimbursed medical expenses may be used to reduce the applicant’s income.  The cost of an assisted living facility is an allowable medical deduction which will reduce income to a much lower net income, allowing an applicant to qualify for this benefit.  Examples of other medical expenses include:  dentures, eyeglasses, hearing aids, hospital expenses, insulin treatment, wheelchair, prescription drugs, etc.

Here are the basic eligibility requirements:

• Must be at least age 65.
• Physician must declare claimant as housebound and in need of assistance from another individual (this includes services offered by an Assisted Living Facility).
• Must have served 90 days and at least one day during wartime.
• Income & Asset limitations, which allows for the deduction of “unreimbursed medical expenses” (mentioned above).

It is never too early to begin to educate yourself about the benefits that are available to you.  It is also never too early to educate yourself about the assisted living communities in your area, so that you can determine the community that will best meet your needs.

It’s almost the end of the year, so it may be a good time to give some thought to these issues

Many people focus on tax planning at the end of the year which is one important issue.  However, the end of the year is also a good time to give some thought to other planning issues that should be considered.  It may be worthwhile to meet with your lawyer, accountant, investment advisor, insurance agent and similar professionals to consider if your plans need updating in some of the following areas:

Estate planning - periodic review of estate plans are important to be sure changes have not been overlooked in how your estate will be handled, planning complies with current laws or your financial situation has had a dramatic change.

• Are gifting programs for charities and transfers of family wealth in need of review?
• Should intra-family asset shifting, such as the establishment of 529 education plans for children or grandchildren, be considered?
• Are beneficiary designations still correct and as desired?
• Should trust arrangements be established or updated to comply with the best interests of the estate and beneficiaries?
• Are Power of Attorney arrangements in effect and current as to wishes, including medical treatment elections?

Tax planning - year-end tax planning is important to make sure the timing of taxable distributions from retirement plans, tax deductible expenses, sale of capital assets, etc. are done with the consideration of effectively minimizing current and future taxes on income.

• Should consideration be given to selling investments to recognize tax losses, either to offset capital gains or generate a loss to offset against ordinary income based on current tax laws?
• Have Required Minimum Distributions been distributed properly from retirement accounts?
• Does it make sense to make additional contributions before the end of the year, or prepay certain taxes deductible as itemized deductions?
• Are estimated tax payments or withholding adequate to cover anticipated Federal and state income tax obligations?

Investments and financial advisory- while your portfolio and investment strategies, including retirement accounts, should be monitored regularly, many of us often neglect to focus on this during the year.  The end of the year can be an appropriate time to make sure to create a periodic review.  Among the questions you may want to consider include:

• Do I have investments that are no longer performing as planned, or underperforming the market?
• Do I have an asset allocation policy that needs to be adjusted?
• Is my financial advisor providing the services and advice expected?
• Are cash, checking and money market funds invested to provide for planned short-term needs?
• Are after-tax rates of return considered in the evaluation of earnings rates?
• Are asset preservation and transfer planning objectives being met?
• Should mortgage refinancing be considered to take advantage of low mortgage interest rates?
• Taking into consideration the low interest rates available for investments, should funds be used to pay down interest bearing credit cards or mortgages with interest rates higher than the rates on earnings?

Insurance - there are many aspects of insurance, including health insurance, life insurance, long-term care insurance, homeowners insurance and automobile insurance that need periodic review.  The considerations may include:

• Do current life insurance policies provide desired amounts of coverage?
• Are beneficiary elections current?
• Should a life settlement structure be considered in lieu of continuing life insurance policies?
• Have values of real estate and contents changed dramatically enough to warrant a change in coverage values?
• Does the automobile policy accurately reflect the vehicles owned and should adjustments in deductibles and coverage limits be considered?
• Evaluate daily living limits of long-term care policies, as well as other terms and conditions to consider current costs and situations.
• And finally, is an updated list of assets, inventory of financial accounts, real estate and other investments, insurance policies and outstanding debts available and located where the appropriate person can easily locate the document?

Time Is Money: Deciding When to Take Social Security

One of the few things you can control about Social Security is when to start collecting it. Should you take it when you become eligible at age 62, wait until “normal” retirement age (a function of your birth date) or consider delaying your benefits past normal retirement age?

To help you make this decision, consider that, on average, Americans are living longer than ever before. Clearly, the longer you expect to live, the more sense it makes to delay taking Social Security. But of course, each person’s circumstances and needs are different—here’s a look at how timing can affect the benefits you receive.

Early Benefits. The soonest you can collect Social Security is age 62. But taking payments at 62 will result in a permanently reduced benefit, ranging from a 20% reduction for people born in 1937 up to 30% for those born in 1960 or later. You may want to consider early benefits if you need income but prefer to leave your portfolio intact, or if you intend to invest the benefits to try to earn a more competitive return (though there’s no guarantee you will do so).
Full Benefits. Eligibility for full Social Security benefits varies according to the year you were born. Depending on how long you worked and how much you earned over your lifetime, the maximum benefit you could collect at full retirement age of 66 is $2,346 per month in 2010. Consider waiting for full benefits if you plan to work until age 65, if you want to ensure a larger survivor’s benefit for your spouse or if family history and good health may lead to an above-average life expectancy. Refer to the Social Security site (http://www.socialsecurity.gov/OACT/quickcalc/when2retire.html) to calculate your “breakeven” age, when the accumulated value of higher benefits from postponing retirement will start to exceed the value of lower benefits from choosing early retirement.

Delayed Benefits. If you continue working beyond your normal retirement age, you will be eligible to collect a permanently increased Social Security benefit when you do retire. Approximately 8% more per year will be added automatically to the permanent benefit amount for every year you wait. Delaying benefits past age 70 will generally add nothing more to your monthly benefit.

To help assess your situation, refer to your personalized Social Security Statement, which estimates the monthly Social Security benefits you may qualify for (go to http://www.socialsecurity.gov/mystatement for a copy of your statement). You may also wish to contact us to crunch some numbers and determine what sort of timing would best support the retirement you envision.

Financial assumptions for retirement

With so many variables to consider, how can you reasonably assure you will have sufficient funds to last for your retirement years?  Make sure to use conservative assumptions.
Use conservative assumptions
How can you ensure you’ll have sufficient funds to last your entire retirement?
So many of the variables used to calculate this amount seem uncertain. What is a reasonable rate of return for your investments over the long term? How long will you live, knowing life expectancies are increasing? How much can you count on from Social Security and pension plans? If you’re concerned about running out of money during retirement, you need to be very conservative with your assumptions. Some tips to consider include:

• Assume your retirement income needs to be at least 100% of your current income. Most rules of thumb indicate you’ll need between 70% and 100%, but figure on at least 100% to be safe. Nowadays, retirees want to travel, pursue hobbies, and live an active lifestyle, which generally means you’ll need the higher end of these estimates.
• Add a few years to your life expectancy. You should probably plan on living until at least age 85 or 90. If your family has a history of longevity, add a few more years to these figures. While you may find it hard to believe that you’ll live that long, you don’t want to reach age 75 or 80 and find out you’ve run out of money. At that point, you might not be able to return to work.
• Reduce your estimates of Social Security benefits. The Social Security Administration sends benefit statements every year around your birthday, telling you how much to expect in benefits. While Social Security is currently in sound financial condition, that is expected to change after all the baby boomers retire. To be safe, count on benefits that are somewhat less than the Social Security Administration is estimating and don’t plan on adjustments for inflation.
• Cut back on living expenses now. This has a two-fold impact on your retirement. First, it frees up money to set aside for retirement. Second, you get used to a lower standard of living, which should also reduce your expected lifestyle for retirement.
• Reach retirement with no debt. Mortgage and consumer debt payments consume a significant portion of most people’s income. Pay off all those debts by retirement and you significantly reduce your cost of living.
• Forget about early retirement. Saving enough to last from age 65 to age 85 or 90 is a difficult task. Trying to retire at age 55 or 60 is just not practical for most individuals, unless you’re willing to significantly reduce your lifestyle. Working a few more years can go a long way in helping to fund your retirement. Those years are typically your highest earning years, so hopefully you’ll save significant sums during that period. Also, every year you work is one year you don’t have to support yourself with your retirement savings.
• Consider working during retirement. Especially during the early years of retirement, you should consider working at least on a part-time basis. Even modest earnings can help significantly with retirement expenses.
• Plan on taking conservative withdrawals from your retirement assets. Don’t plan on taking out more than 3% to 4% of your balance annually. Your funds should last for decades with that level of withdrawal.

Retirement Funding

Retirement funding can be a challenge, but there are steps that can be taken to reduce the negative impact of these challenges.

Retirement funding challenges and what we can do about them
Optimism, however, should not be an escape from the reality of what we should do to secure the financial future of ourselves and our family. It is perfectly fine to say the glass is half-full as long as that is followed by the quest to find out what needs to be done so that the glass does not break.

The financial realities the aging baby-boomers face are very different from that of the previous generations.  The followings are few of the most important factors that make the financial security of this generation more challenging. After describing each one, I will describe what we can do to reduce the negative impacts of these challenges.

Outsourcing of jobs
Globalization has caused the outsourcing of many well-paid jobs to other countries.  This trend will continue for a long time until the standard of living of the labor force of less developed countries approach that of the United States. The speed of the loss of the loss of jobs is higher than the one experienced in the previous outsourcing waves that targeted manufacturing jobs.  This is because unlike manufacturing jobs, no major capital expenditure is needed for today’s well paying jobs to be transferred abroad.  A low-cost computer, a phone and internet access is all the equipment needed for many of these jobs.  This means that displaced workers have very little time to adjust to the new paradigm.  Even someone who is able to quickly get trained in another field will have a difficult time maintaining the same income.  The resulting drop in the inflation-adjusted income of the baby-boomer is happening around the peak time of their income-producing years (45 to 55 years old).  This further complicates their retirement planning.

Actual rate of inflation experienced
The second financial challenge is the rate of inflation experienced by most Americans, especially those living in high-cost regions like the Bay Area.

The Consumer Price Index (CPI) is a measure of the average change over time in the prices paid by the urban consumers for a market basket of consumer goods and services.  The index lumps all the geographic areas together, so it could underestimate the actual inflation for someone living in the Bay Area. Also, it is based on a basket of goods and services that may not adequately represent the basket used by many consumers. It is also important to remember that the government has a vested interest in reporting a low CPI since billions of dollars of social security benefits are annually adjusted upward according to the CPI.

It is also important to understand that some of the expense categories such as food, energy and health care which have very little elasticity of demand (consumer cannot reduce its demand even when the prices go up) have consistently had price increases higher than CPI.

Reduction in corporate defined benefit retirement plans
The replacement of the defined benefit retirement plans with the defined contribution plans (such as 401K) is a major disadvantage the retirees of the future will face. In defined benefit plans, the benefits the employee receives for life upon retirement are predetermined and fixed. With defined contribution plans, the only thing that is defined is the contributions. This transfers the investment risk from the employer to the employee.

It is crucial to recognize that even if one has adequate funds for retirement, if the investment returns during a long retirement period is lower than the actual rate of inflation the retiree experiences, there is real danger the retire will run out of funds.

Reduction in Social Security and Medicare benefits
Social Security and Medicare benefits are the government sponsored versions of the defined benefit plans just discussed. With the huge budget deficits the country faces, it is likely that the future retirees will receive the same level of benefits as today.

Increase in life expectancy
With the current rate of advancements being made in the medical field, it is likely that future retirees will live longer, thus need larger retirement funds.

The financial world we live in is very complex.  Sometimes it may not be clear that an action has to be taken to improve or protect you and your family financially.  Other times you might be able to make the right decision on your own, or with the help of an unbiased and competent financial professional, if you were aware of all the facts affecting your options.

Now that I have explained what challenges lie ahead, let us explore what the future retiree can do in facing these challenges.

Financial Literacy
The first and most important recommendation is a genuine commitment to increase your financial literacy.  Financial literacy would make you feel better equipped to handle any financial challenges you may face.  This is true even if you are confident that you have the best financial advisor in the world.

Financial Review
Next you need to identify in detail the specific weaknesses of your financial situation, as well as how to protect its strengths. It is important to have a realistic view of how much you need to retire so that you can plan your retirement age accordingly. Alternatively it could be said that it is important to have a realistic view of your monthly retirement budget given that you would like to retire at certain age. Either way, the biggest mistakes to avoid is make a highly optimistic estimate of your investment return, and having a high annual withdrawal rate. Be aware that it is not just the average return that matter, but the sequence of returns matters a lot too. If the investment return at the beginning of your retirement period is low or worst if it is negative, and high toward the end, you will have much higher chance of running out of money than if it was the other way around (high return at the beginning and low towards the end). This is true even if the average annual returns of the two scenarios are the same. One way to reduce the negative impact of unfavorable sequence of return is to have sufficient cash or near cash (investment grade short-term fixed income) investments to be used in times of low returns.

One of the most important considerations especially for couples in their sixties is determining when to file for collecting social security benefits. Social security benefits should be viewed as an extremely rare and valuable asset because it has no investment risk (other than cut in benefits due to budget deficits), no inflation risk and no longevity risk. It also has no investment management fee.

Sometime the file-and-suspend strategy might be the best one. A spouse is entitled to her own social security benefit or up to 50% of her spousal benefit (whichever is greater) assuming the other spouse has reached his full retirement age. With this strategy, both spouses file for benefits. Then the higher income spouse will suspend his benefit by filing SSA-521, Request for Withdrawal of Application. He will file again for his benefit when he is 70 (to maximize his benefit). The lower income spouse will receive up to 50% of the higher income spouse without waiting for the higher income spouse to turn seventy. If the lower income spouse is at least 62, but less than her full retirement age, the percentage would be lower than 50%, but the strategy still applies. Maximizing the higher income earner’s benefit can be a valid strategy even if the higher income earner has a short life expectancy. This is true because the strategy will increase the survivor benefit (100% of the deceased spouse or 100% of the survivor’s spouse benefit whichever is larger) for the lower income spouse.

Even if you feel confident in your ability to sort out the financial issues related to your retirement, it may be wise to get a second opinion from an independent (no affiliation with any financial institutions), Certified Financial Planner.

Always be aware of the potential conflict of interest when receiving financial guidance. As an example, if you have investment assets in a brokerage account, it is highly unlikely that the broker or the brokerage house publications will recommend that you take the money out of the account they are holding (thus reducing their revenue) to speed up your mortgage payment.

Probate: What it is and why to avoid it”

Probate is the process by which a Last Will & Testament is declared valid. When an individual passes away the named executor of the Will must file a Petition, along with the original Will, with Surrogates Court in the county where the decedent resided. Included with the Petition, the Executor must satisfy certain requirements. One such requirement is to serve notice upon all lawful heirs of the decedent.

The heirs are asked to sign a Waiver of Process and Consent to Probate. By signing this form, the heir is consenting to the appointment of the Petitioning Executor – but is not forfeiting any rights to their inheritance. The lawful heirs are the closest relatives – starting with the spouse, children and grandchildren and if there are not any surviving then parents, siblings and nieces and nephews.

At the conclusion of the proceeding – after the Petition has been filed with the necessary Waiver and Consent forms – the Judge will appoint the Petitioning Executor as Executor. At this time, the Executor can collect the assets of the estate and distribute them according to the terms of the Will. Typically the process is not too difficult. However, there are situations where it may be important.

Disinheriting a child:
During the probate process in New York, a disinherited child will still be asked to sign a waiver and consent form. Because the child is disinherited, it is unlikely they would sign the form. The attorney for the estate will be required to ask the Judge to serve that individual with a Citation. The citation would put the individual on notice that he has the right to appear in Court at a predetermined time. If the individual does not show up, they forfeit their rights to contest the estate. Because of these requirements, the entire process is extended and can last for over 6-12 months. Avoiding probate for New York residents is important if they are disinheriting a child. It will reduce the liklihood that the disinherited child will contest the Will. It will also make life much easier for the other heirs, saving them months of aggrevation and thousands of dollars in legal fees.

Property in Multiple States:
Sometimes probate only occurs when the decedent owned property in New York and in another state. In fact, many of my clients own their home in Long Island and a winter home on Florida. When this occurs, the heirs are required to probate the estate in New York and Florida. The entire process will easily last for over 1 year. Further, because two probate proceedings are required, two attorneys would have to be hired, one on New York and the other in Florida. The time and costs associated with two probate proceedings are great reasons to speak with an Estate Planning Attorney in New York to discuss ways to avoid probate.

Second Marriages:
Previously, I mentioned that probate proceedings require the inclusion of all lawful heirs. When passing away with a spouse and children, they are all considered lawful heirs. If you are in a second marriage and your will distributes your assets in a way that may upset either your spouse or children from a previous marriage, there is a very good chance that the probate process can be turned into a battleground between the survivors. With proper planning it is possible to avoid probate in these circumstances and make sure that your assets are distributed in accordance with your wishes.

Probate proceedings are not always difficult. However, in certain situations, it is advisable to seek the advice of counsel and learn how you can make life easier for your heirs. Though it is not a great commentary on our society, unfortunately, money changes people. Most family feuds occur when one family member has passed away and their estate needs to be administered. The probate process in New York is important because it requires all family members to be involved. However, this very requirement also makes the process difficult and expensive. If one of your estate planning goals is to ensure a smooth and inexpensive transition of assets upon your demise, it is advisable to avoid probate – especially in the situations described above.

How to Save for College Tax-Free

College tuition and fees are on the rise. Shockingly, the cost for 4-year private schools now tops $36,000 per year on average.  But the investment is well worth it. According to the U.S. Census Bureau, individuals with a bachelor’s degree earn more than double those with just a high school diploma.

The two most popular college savings programs are 529 plans and Coverdell Education Savings Accounts. Whichever you choose, be sure to start when your child is young. The sooner you begin, the less money you will have to put away each year.

Example: Suppose you have one child, age six months, and you estimate that you’ll need $120,000 to finance his college education 18 years from now. If you start putting away money immediately, you’ll need to save $3,500 per year for 18 years (assuming an after-tax return of 7%). On the other hand, if you put off saving until your son is six years old, you’ll have to save almost double that amount every year for twelve years.

How Much Will College Cost?
Based on the survey completed for the 2010 Trends in College Pricing, the average cost for tuition, fees, and room and board for 2010-11 was:

• $16,140 per year for 4-year public (in state) colleges and universities.
This is an increase of 6.1% from 2009-10 findings.
• $36,993 per year for 4-year private colleges and universities.
This is an increase of 4.3% from 2009-10 findings.

It should be noted that, on average, full-time students receive $16,000 of financial aid per year in the form of grants and tax benefits for private 4-year institutions, $6,100/yr for public 4-year institutions, and $3,400/yr for public 2-year institutions.

Saving with 529 Qualified Tuition Plans
Section 529 plans, also known as Qualified Tuition Programs, are the best choice for many families.
Every state now has a program allowing persons to prepay for future higher education, with tax relief. There are two basic plan types, with many variations:

• The Prepaid Education Arrangement. You essentially buy future education at today’s costs, by buying education credits or certificates. This is the older type of program, and it tends to limit the student’s choice of schools within the state.
• Education Savings Accounts. You contribute to an account earmarked for future higher education.

Tip: When approaching state programs, one must distinguish between what the federal tax law allows and what an individual state’s program may impose.

You may open a Section 529 plan in any state. But when buying prepaid tuition credits (less popular than savings accounts), you often need to apply the credits to a specific college or group of colleges.

Unlike certain other tax-favored higher education programs, such as the Hope and Lifetime Learning Credits, federal tax law doesn’t limit the benefit only to tuition. Room, board, lab fees, books, and supplies can be purchased with funds from your 529 Savings Account. (Individual state programs could be narrower.)

The key parties to the program are the Designated Beneficiary, the student-to-be, and the Account Owner, who is entitled to choose and change the beneficiary and who is normally the principal contributor to the program.

There are no income limits on who may be an account owner. There’s only one designated beneficiary per account. Thus, a parent with three college-bound children might set up three accounts. (Some state programs don’t allow the same person to be both beneficiary and account owner.)

Tax Rules Relating to 529 College Savings Plans
Income Tax. Contributions made by the account owner or other contributor are not deductible for federal income tax purposes. Earnings on contributions grow tax-free while in the program.

Distributions from the fund are tax-free to the extent used for qualified higher education expenses. Qualified expenses include tuition, required fees, books, supplies, equipment, and special needs services. For someone who is at least a half-time student, room and board also qualify.

Tip: In 2009, the American Recovery and Reinvestment Act (ARRA) added expenses for computer technology/equipment or Internet access to the list of qualifying expenses. Software designed for sports, games, or hobbies does not qualify, unless it is predominantly educational in nature. In general, however, expenses for computer technology are not qualified expenses for the American Opportunity Credit, Hope Credit, Lifetime Learning Credit, or tuition and fees deduction.

Gift Tax. For gift tax purposes, contributions are treated as completed gifts even though the account owner has the right to withdraw them – thus they qualify for the up-to-$13,000 annual gift tax exclusion. One contributing more than $13,000 may elect to treat the gift as made in equal installments over that year and the following 4 years, so that up to $65,000 can be given tax-free in the first year.

Estate Tax. Funds in the account at the designated beneficiary’s death are included in the beneficiary’s estate – an odd result, since those funds may not be available to pay the tax.

Funds in the account at the account owner’s death are not included in the owner’s estate, except for a portion thereof where the gift tax exclusion installment election is made for gifts over $13,000. For example, if the account owner made the election for a gift of $65,000 in 2011, a part of that gift is included in the estate if he or she dies within 5 years.

Tip: A Section 529 program can be an especially attractive estate-planning move for grandparents. There are no income limits, and the account owner giving up to $65,000 avoids gift tax and estate tax by living 5 years after the gift, yet has the power to change the beneficiary.

State Tax. State tax rules are all over the map. Some reflect the federal rules, some quite different rules. For specifics of each state’s program, see http://www.collegesavings.org.

Saving with Coverdell Education Savings Accounts
The total contributions for the beneficiary of a Coverdell Education Savings Account (ESA) cannot be more than $2,000 in any year, no matter how many accounts have been established. (A beneficiary is someone who is under age 18 or is a special needs beneficiary.)

The beneficiary will not owe tax on the distributions if they are less than a beneficiary’s qualified education expenses at an eligible institution. This benefit applies to higher education expenses as well as to elementary and secondary education expenses.

Here are some things to remember about distributions from Coverdell accounts:

• Distributions are tax-free as long as they are used for qualified education expenses, such as tuition, books, and fees.
• There is no tax on distributions if they are for an eligible educational institution. This includes any public, private, or religious school that provides elementary or secondary education as determined under state law.
• The Hope and Lifetime Learning Credits can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits.
• If the distribution exceeds education expenses, a portion will be taxable to the beneficiary and will be subject to an additional 10% tax. Exceptions to the additional 10% tax include the death or disability of the beneficiary or if the beneficiary receives a qualified scholarship.

Professional Guidance
Considering the wide differences among state plans, federal and state tax issues, and the dollar amounts at stake, please call us before getting started with any type of college savings plan.

Market Noise – What’s Missing?

The great recession ended over two years and yet, economic growth remains sluggish, labor market is still moribund, and consumer confidence has barely budged since June of 2009. So, what’s missing?.

Economics and central bank policy will most likely play second fiddle to the ongoing debt ceiling debate in the United States, the fiscal woes in Europe and the heart of the second quarter earnings reporting season for the S&P 500 companies. Housing data (home-builder’s sentiment, housing starts, building permits, existing and pending home sales) will also be under the microscope. But the key report will be the July reading of the Philadelphia Fed manufacturing index. Overseas data on June consumer spending in Japan and July manufacturing in China will draw the most attention from market participants. Meanwhile, the Central Bank in Brazil, Canada, India, and South Africa are meeting and it appears Brazil is poised to raise rates. Indeed, many overseas Central Banks may now be much closer to the end of their tightening cycles than they were in the early part of 2011.

The great recession ended over two years and yet, economic growth remains sluggish, labor market is still moribund, and consumer confidence has barely budged since June of 2009. So, what’s missing? The answer, of course, is in the question: the recovery is missing growth, and jobs and confidence, but why? Below we briefly examine how we got here (two years into the recovery) and what makes this recovery different from prior economic recoveries. Our answers may surprise you.

In testimony to Congress in mid-July, Federal Reserve Chairman Ben Bernanke noted that although the economy was growing, and expected to continue to grow in the coming quarters, headwinds to growth were prevalent. The headwinds noted by Bernanke included the following:

• Slow growth in consumer spending, even after accounting for the effects of higher food and energy prices
• A continued depressed condition of the housing sector
• Limited access to credit for some household and businesses
• Fiscal tightening at all levels of government

Consumer Spending
In prior public appearances over the past few months, Bernanke, in addition to mentioning contemporary factors — the earthquake and tsunami in Japan and its impact on the global supply chains, severe weather and higher energy prices –has cited as “weakness in the financial sector” and “balance sheet and deleveraging issues” as longer-term issues that may be impacting the recovery. All along, consumers have hung in there. At the beginning of 2011, the slow labor market and ongoing repair of consumer balance sheets (i.e. consumers are paying down debt and saving, along with doing a little spending) has clearly limited the consumers influence on the recovery. For the first seven quarters of the recovery(the second quarter of 2009 to the first quarter of 2011) consumer spending contribution to overall real domestic product, (GDP) growth has been 11 percentage points. While this may sound great, considering that consumer spending accounts were two thirds of GDP, the consumer’s contribution to GDP growth in this recovery pales when compared to the recoveries following the mid-1990-1991 and 2001 recessions, and is not even in the same league with the performance of consumer following the severe 1973-1975 and 1981-1982 recessions.

On average, during the first seven quarters of the economic recovery following the two mild recessions (1990-1991 and 2001), consumer spending contributed around 14 percentage points to growth. In a similar period following the severe recessions of 1973-1975 and 1981-1982, consumer spending contributed around 22 percentage points to growth.

Tepid real income growth, which, in turn, is a result of tepid job growth, takes most of the blame here during the current recovery, along with the aforementioned balance sheet repair. Looking ahead, the consumer-related headwinds are likely to persist, keeping a lid on spending and consumer confidence. Our outlook remains that the consumer will continue to try to hang in there, but will not be the driver of the economic growth as it was during similar stages of prior recoveries.

Housing and Credit
Over the first seven quarters of the current recovery, housing has been a net drag on overall GDP growth, marking for the first time in post-World War II era that housing has not made a contribution to overall economic growth this far into a recovery. On average, during the economic recoveries following mild recessions, housing continues three (3) percentage points to GDP growth, and that figure is closer to seven (7) percentage points in recoveries from severe recessions. As one might expect, the weakness in housing in this recovery had a major impact on employment in the construction industry.

Construction employment has declined at a 3.7% annualized pay since June of 2009, while in the recoveries from the severe recessions in the ’70s and ’80s, construction employment at this point in the cycle has increased by 4%. Looking ahead, housing is likely to continue to bounce along the bottom, not getting any worse, but not getting any better anytime soon.

A large overhang of unsold existing homes – officially around 4M, but there are another 2M or so existing homes in so-called “shadow inventory” (bank owned houses mirrored in the foreclosure pipeline) – continues to be the largest impediment to an improved housing market. Additionally, tighter lending standards are in play as compared to the 2002-2006 boom years, and tepid labor markets are also helping to restrain people from buying homes.

The only plus side we see is that housing affordability and the ability of a family with medium income to afford the payment on a medium priced home is at an all-time high. Banks are just becoming more willing to lend in this sector.

Fiscal Tightening
Since World War II, state and local government spending and employment has been a reliable source of economic growth at virtually all points of the business cycle. In mid-July, Fed Chairman Bernanke stated that state and local governments have been an unprecedented impediment to growth and employment in this recovery.

For the first time since World War II, state and local government spending has not added to the growth over the first seven quarters of the economic recovery. In fact, state and local government spending have subtracted 1.5 percentage points from growth over the past two years, and the state and local government employment has contracted at a 1.5% annualized rate over that time. In contrast, state and local government spending has added around one full percentage point to growth over the first seven quarters of the prior four economic recoveries, while adding jobs at 1.5 annualized rate.

Looking ahead, the best case would be that state and local government’s contribution to GDP growth stabilizes, and that job losses seen in the sector continue at the current pace (around 15,000 to 20,000 per month) for the foreseeable future, as states and municipalities of all sizes continue to struggle with too much spending and not enough revenue.

Of course, the lack of contribution with state and local government and housing, along with historically low contribution from consumers at this stage of the recovery, has left the heavy lifting to the export sector, inventory accumulation, business spending and, of course, federal government spending. Three of the four drivers of growth thus far in the recovery –business capital spending, exports, and inventory accumulation–appear likely to continue, while federal government spending will likely fade as budget cuts at the federal level loom on the horizon.

Estate Tax and Health Care Reforms

Tax reforms seem to be a back-burner issue at this time, but we should be aware of changes that may tax place after 2012. The Federal Appeals Court judges are still in disagreement if the Health Care Reform is really “unconstitutional”, and keeping up-to-date is challenging.

Let us take a look at Estate Tax reforms, if there are any coming up pretty soon. The truth is, nothing lately has been said about its reform. What we know is that after 2012, the $5 million exemption for gift and estate taxes for each spouse is scheduled to go down to $1 million. The maximum tax rate is expected to rise again to 55% (currently it is at 35%). The transfer of the unused exclusion to the surviving spouse is set to expire after 2012. It is also likely that the 35% low tax rate could be extended but that will probably happen after the 2012 elections. The laws are still friendly to the rich, i.e., individuals can give up to $5 million of assets free of gift tax or $10 million for married couples. You and your spouse can still give $26,000 per year to any individual without affecting your lifetime gift tax exemption.

The Federal Appeals Court judges are still in disagreement if the Health Care Reform is really “unconstitutional.”  The mandatory provision in the law that required people to get medical insurance by 2014 or pay a penalty was deemed “unconstitutional” by a Florida Judge, but not the entire health care reform.  Another Judge in another circuit did not find anything “unconstitutional.”  It will take the tortoise Supreme Court to rule on its validity.  By 2014, employers may owe a “tax penalty” of $3,000 dollars per employee who buys health care coverage through an “insurance exchange.”  If Obama loses the election, the Republicans will most likely discard this Health Care Reform that will go down as an unwise use of American tax dollars in legislative exercise.

Someone borrowed funds and used his publicly traded stock as security to obtain a home loan. Yes, he wanted to boost his mortgage interest deduction beyond the mortgage loan limit of $1.1 million dollars. (Total loan was $1.6 million). The IRS disallowed the extra mortgage interest that technically was an “investment interest” even though the loan proceeds was used to buy a home.  Watch out for this loan limit the IRS is very keen about.
A sole owner of an S-Corp. gave his son 95% of his stock and reported the gift to the IRS. The following year, he gave himself “cash distributions” from the S-Corp. in excess of the value of his remaining stock holding that was reduced to 5%. The IRS determined his “cash distribution” was a taxable dividend.  He should have done these two transactions the other way around and in such order to avoid being taxed.  This taxpayer relied on his own discretions without professional help like so many.

The carryback of Net Operating Losses can be waived. The carryback is allowed for two years, and then any remaining loss is carried forward for up to 20 years.  To relinquish the carryback, attach a statement to your timely filed return.  If you failed to, you can still make the election by filing an amended return within 6 months of the due date of the original return.  Some businesses find no need of a carryback since there are already losses in the past two (2) prior years.  The Net Operating Loss is much needed to reduce taxes in the next 20 years.  Our economy has produced strings of net operating losses requiring wise discretions on its use these days.   You be wise folks!

Living Trust 101

There are many kinds of trusts. A living trust (also called an inter vivos trust) is simply a trust you create while you’re alive, rather than one that is created upon your death under the terms of your will. All living trusts are designed to avoid probate. Some also help you save on estate taxes, while others let you set up long-term property management.

A trust, like a corporation, is an entity that exists only on paper but is legally capable of owning property. However, a live person called the trustee must be in charge of the property. Further, you can actually be the trustee of your own living trust, keeping full control over all property legally owned by the trust. Note: Property held in trust that is actually “owned” by the trustees of the trust, subject to the rights of the beneficiaries. The trust itself doesn’t actually own anything.

There are many kinds of trusts. A living trust (also called an inter vivos trust) is simply a trust you create while you’re alive, rather than one that is created upon your death under the terms of your will.

All living trusts are designed to avoid probate. Some also help you save on estate taxes, while others let you set up long-term property management.

Do I need a living trust?

Property you transfer into a living trust before your death doesn’t go through probate. The successor trustee, the person you appointed to handle the trust after your death, simply transfers ownership to the beneficiaries you named in the trust.

In many cases, the whole process takes only a few weeks and there are no attorney or court fees to pay. When the property has all been transferred to the beneficiaries, the living trust ceases to exist.

Is it expensive to create a living trust?

The cost of creating a living trust depends on what you want to achieve. The more complicated a living trust is, the more expensive it will be. Also important to note is that while the fees associated with creating a living will are paid upfront a living trust actually saves you money and time by avoiding probate court.

Is a trust document ever made public, like a will?

A will becomes a matter of public record when it is submitted to a probate court, as do all the other documents associated with probate – inventories of the deceased person’s assets and debts, for example. The terms of a living trust, however, need not be made public.

Does a trust protect property from creditors?

Holding assets in a revocable trust does not shelter those assets from creditors. A creditor who wins a lawsuit against you can go after the trust property just as if you still owned it in your own name.

After your death, however, property in a living trust can be quickly and quietly distributed to the beneficiaries (unlike property that must go through probate). That complicates matters for creditors; by the time they find out about your death, your property may already be dispersed, and the creditors have no way of knowing exactly what you owned (except for real estate, which is always a matter of public record). It may not be worth the creditor’s time and effort to try to track down the property and demand that the new owners use it to pay your debts.

On the other hand, probate can offer a kind of protection from creditors. During probate, known creditors must be notified of the death and given a chance to file claims. If they miss the deadline to file, they’re out of luck forever.
Do I need a trust if I’m young and healthy? 
Probably not. At this stage in your life, your main estate planning goals are probably making sure that in the unlikely event of your premature death, your property is distributed how you want it to be and, if you have young children, that they are cared for. You don’t need a trust to accomplish those ends; writing a will, and perhaps buying some life insurance is sufficient.

Can a living trust save taxes?
A simple probate-avoidance living trust has no effect on either income or estate taxes. More complicated living trusts, however, can greatly reduce your federal estate tax bill if you expect your estate to owe estate tax at your death.

Year End Tax Saving Ideas for Individuals

There are a number of steps you might take by year-end to cut your 2011 tax bill, such as deferring income, accelerating deductions and capital gains planning.

Deferring Income

• If you are planning on selling an investment this year on which you have a gain, it may be best to wait until the following tax year to defer payment of the taxes for another year (subject to estimated tax requirements).
• If you are expecting a bonus at year-end, you may be able to defer receipt of these funds until January. This allows you to defer tax payments (other than the portion normally withheld) until the following year. However, keep in mind that you usually defer taxes on a bonus that is contractually due in 2011.
• If your company grants stock options, it may be wise to wait until next year to exercise the option or sell stock acquired by exercise of an option. Exercise of the option is often but not always a taxable event; sale of the stock is almost always a taxable event.
• If you’re self employed, and can afford the delay in cash inflow, defer sending invoices or bills to clients or customers until the end of December.

Caution: Keep an eye on the estimated tax requirements.

Accelerating Deductions

• Pay a state estimated tax installment in December instead of at the January due date. However, make sure the payment is based on a reasonable estimate of your state tax.
• Pay your entire property tax bill, including installments due in year 2012, by year-end. This does not apply to mortgage escrow accounts.
• Try to bunch “threshold” expenses, such as medical expenses and miscellaneous itemized deductions. Threshold expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income (AGI). By bunching these expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing your deduction.
• For example, you might pay medical bills and dues and subscriptions in whichever year they would do you the most tax good.

Caution: In most cases, credit cards charges are considered paid in the year of the charge regardless of when you pay on the card. This, however, does not apply to store revolving credit cards, so if you charge expenses on a Wal-Mart store credit card, the deduction can not be claimed until the bill is paid.

In cases where tax benefits are phased out over a certain adjusted gross income (AGI) amount, a strategy of deferring income and accelerating deductions may also allow you to claim larger deductions, credits, and other tax breaks for 2011. The latter benefits include Roth IRA contributions, conversions of regular IRAs to Roth IRAs, child credits, higher education tax credits and deductions for student loan interest.

Tip: Deferring income into 2012 is an especially good idea for taxpayers who anticipate being in a lower tax bracket next year, generally because of much-reduced income or much-increased deductible expenses.

Tip: It may pay to accelerate income into 2011 if you think your marginal tax rate will be much lower this year than it will be next year.

Tip: If you know you have a set amount of income coming in this year that is not covered by withholding taxes, increasing your withholding before year-end can avoid or reduce any estimated tax penalty that might otherwise be due.

On the other hand, the penalty could be avoided by covering the extra tax in your final estimated tax payment and computing the penalty using the annualized income method.

If you have any questions about estimated taxes, please call us.

Caution: Alternative Minimum Tax (AMT) no longer just impacts the wealthy! Do not overlook the effect of any year-end planning moves on the AMT for 2011.

Due to tax changes in recent years, AMT impacts many more taxpayers than ever before because the tax is not indexed to inflation. As a result, growing numbers of middle-income taxpayers have been finding themselves subject to this higher tax.

Items that may affect AMT include the deductions for state property taxes and state income taxes, miscellaneous itemized deductions, and personal exemptions.

Note: AMT Exemption Amounts For 2011

• $48,450 for single and head of household fliers;
• $74,450 for married people filing jointly and for qualifying widows or widowers, and
• $37,225 for married people filing separately.

Please call us if you’d like more information or if you’re not sure whether AMT applies to you. We’re happy to assist you.

Residential Energy Tax Credits
If you haven’t taken advantage of energy tax credits for your home, 2011 is your last chance. The credits–10% of cost up to $500 or a specific amount from $50 – $300–expire on December 31, 2011 and only apply to improvements in an existing home that is your principal residence. New construction and rentals do not qualify.

The tax credits are as follows:

• Energy Star window tax credit: up to $200 maximum
• Water heater tax credit (includes electric, natural gas, propane, or oil): up to $300 maximum
• Air conditioner tax credit: up to $300 maximum
• Insulation, doors, and roof credits: up to the $500 cap
• Furnace tax credit (includes natural gas, propane, oil, or hot water): $150 maximum. Efficiency must be 95% (up from 90% before the extension)

Caution: Taxpayer is ineligible for this tax credit if this credit has already been claimed by the taxpayer in an amount of $500 in any previous year.

Make Charitable Contributions
You can donate property as well as money to a charity. You can generally take a deduction for the fair market value of the property; however, for certain property, the deduction is limited to your cost basis. While you can also donate your services to charity, you may not deduct the value of these services. You may also be able to deduct charity-related travel expenses and some out-of-pocket expenses however.

Keep in mind that a written record of charitable contribution is required in order to qualify for a deduction. A donor may not claim a deduction for any contribution of cash, a check or other monetary gift unless the donor maintains a record of the contribution in the form of either a bank record (such as a cancelled check) or written communication from the charity (such as a receipt or a letter) showing the name of the charity, the date of the contribution, and the amount of the contribution.

Tip: Contributions of appreciated property (i.e. stock) provide an additional benefit because you avoid paying capital gains on any profit.

Investment Gains And Losses
Minimize taxes on investments by judicious matching of gains and losses. Where appropriate, try to avoid short-term gains, which are usually taxed at a much higher tax rate (up to 35%) than long-term gains, which in 2011 and 2012 are taxed at rates of zero and 15 percent depending on your tax bracket. Consider where feasible to reduce all capital gains and generate short-term capital losses up to $3,000 as well.

Tip: If you have a large capital gain this year, consider selling an investment on which you have an accumulated loss. Capital losses up to the amount of your capital gains plus $3,000 per year ($1,500 if married filing separately) can be claimed as a deduction against income.

Tip: After selling securities investment to generate a capital loss, you can repurchase it after 30 days. If you buy it back within 30 days, the loss will be disallowed. Or you can immediately repurchase a similar (but not the same) investment, e.g., another mutual fund with the same objectives as the one you sold.

Tip: If you have losses, you might consider selling securities at a gain and then immediately repurchasing them, since the 30-day rule does not apply to gains. That way, your gain will be tax-free, your original investment is restored and you have a higher cost basis for your new investment (i.e., any future gain will be lower).

Note: The maximum long term capital gains tax rate is currently 15 percent and will expire on December 31, 2012 when it’s set to rise to a maximum of 20 percent. Also of note is that starting in 2013, a 3.8 percent medicare tax may also be applied to long term capital gains. This information is something to think about as you plan your long term investments.

Feel free to call us if you need assistance with any of your long term planning goals.

Mutual Fund Investments
Before investing in a mutual fund, ask whether a dividend is paid at the end of the year or whether a dividend will be paid early in the next year but be deemed paid this year. The year-end dividend could make a substantial difference in the tax you pay.

Example: You invest $20,000 in a mutual fund at the end of 2011. You opt for automatic reinvestment of dividends. In late December of 2011, the fund pays a $1,000 dividend on the shares you bought. The $1,000 is automatically reinvested.
Result: You must pay tax on the $1,000 dividend. You will have to take funds from another source to pay that tax because of the automatic reinvestment feature. The mutual fund’s long-term capital gains pass through to you as capital gains dividends taxed at long-term rates, however long or short your holding period.

The mutual fund’s distributions to you of dividends it receives generally qualify for the same tax relief as long-term capital gains. If the mutual fund passes through its short-term capital gains, these will be reported to you as “ordinary dividends” that don’t qualify for relief.

Tip: Wait until after the dividend to buy the shares because the share net asset value will drop after the dividend is paid. Alternatively, buy the shares in 2011, but opt to take the dividend in cash instead of having it reinvested.
In spite of these tax consequences, it may be a good idea to buy shares right before the fund goes ex-dividend. For instance, the distribution could be relatively small, with only minor tax consequences. Or the market could be moving up, with share prices expected to be higher after the ex-dividend date.

Tip: To find out a fund’s ex-dividend date, call the fund directly.

Call us if you’d like more information on how dividends paid out by mutual funds affect your taxes.

Year-End Giving To Reduce Your Potential Estate Tax
For many, sound estate planning begins with lifetime gifts to family members. in other words, gifts that reduce the donor’s assets subject to future estate tax. Such gifts are often made at year-end, during the holiday season, in ways that qualify for exemption from federal gift tax.

Gifts to a donee are exempt from the gift tax for amounts up to $13,000 a year per donee.
Caution: An unused annual exemption doesn’t carry over to later years. To make use of the exemption for 2011, you must make your gift by December 31.

Husband-wife joint gifts to any third person are exempt from gift tax for amounts up to $26,000 ($13,000 each). Though what’s given may come from either you or your spouse or from both of you, both of you must consent to such “split gifts”.

Gifts of “future interests”, assets that the donee can only enjoy at some future time such as certain gifts in trust, generally don’t qualify for exemption; however, gifts for the benefit of a minor child can be made to qualify.

Tip: If you’re considering adopting a plan of lifetime giving to reduce future estate tax don’t hesitate to call us. We can help you set it up.

Cash or publicly traded securities raise the fewest problems. You may choose to give property you expect to increase substantially in value later. Shifting future appreciation to your heirs keeps that value out of your estate. But this can trigger IRS questions about the gift’s true value when given.

You may choose to give property that has already appreciated. The idea here is that the donee, not you, will realize and pay income tax on future earnings, and built-in gain on sale.

Gift tax returns for 2011 are due the same date as your income tax return. Returns are required for gifts over $13,000 (including husband-wife split gifts totaling more than $13,000) and gifts of future interests. Though you are not required to file if your gifts do not exceed $13,000, you might consider filing anyway as a tactical move to block a future IRS challenge about gifts not “adequately disclosed”.

Tip: Call us if you’re considering making a gift of property whose value isn’t unquestionably less than $13,000.
Income earned on investments you give to children or other family members is generally taxed to them, not to you. In the case of dividends paid on stock given to your children, they may qualify for the reduced 5% dividend rate.

Caution: In 2011, investment income for a child (under age 18 at the end of the tax year or a full-time student under age 24) that is in excess of $1,900 is taxed at the parent’s tax rate.

Other Year-End Moves
Retirement Plan Contributions. Maximize your retirement plan contributions. If you own an incorporated or unincorporated business, consider setting up a retirement plan if you don’t already have one. (It doesn’t need to actually be funded until you pay your taxes, but allowable contributions will be deductible on this year’s return.)
If you are an employee and your employer has a 401(k), contribute the maximum amount ($16,500 for 2011 and $17,000 for 2012, plus an additional catch up contribution of $5,500 if age 50 or over, assuming the plan allows this much and income restrictions don’t apply).

If you are employed or self-employed with no retirement plan, you can make a deductible contribution of up to $5,000 a year to a traditional IRA (deduction is sometimes allowed even if you have a plan). Further, there is also an additional catch up contribution of $1,000 if age 50 or over.

Health Savings Accounts. Consider setting up a health savings account (HSA). You can deduct contributions to the account, investment earnings are tax-deferred until withdrawn, and amounts you withdraw are tax-free when used to pay medical bills.

In effect, medical expenses paid from the account are deductible from the first dollar (unlike the usual rule limiting such deductions to the excess over 7.5% of AGI). For amounts withdrawn at age 65 or later, and not used for medical bills, the HSA functions much like an IRA.

To be eligible, you must have a high-deductible health plan (HDHP), and only such insurance, subject to numerous exceptions, and must not be enrolled in Medicare. For 2011, to qualify for the HSA, your minimum deductible in your HDHP must be at least $1,200 (single coverage) or $2,400 (family). It remains unchanged for 2012.

Summary
These are just a few of the steps you might take. Please contact us for help in implementing these or other year-end planning strategies that might be suitable to your particular situation.