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Summer 2001 Newsletter
IN THIS ISSUE...
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YOU STILL NEED ESTATE
PLANNING
The Economic Growth and Tax Relief Reconciliation Act of
2001, signed into law on June 7, 2001, provides for the repeal of the estate and
generation-skipping transfer tax in the year 2010. Until that time, the estate
tax exclusion will increase from the current $675,000 to $1,000,000 in 2002,
$1,500,000 in 2004, $2,000,000 in 2006, and $3,500,000 in 2009. In addition, the
maximum estate and gift tax rates will be reduced from the current 55% to 50% in
2002, 49% in 2003, 48% in 2004, 47% in 2005, 46% in 2006, 45% in 2007, and to
the top individual income tax rate in 2010 (for gift taxes only). The rule
providing that inherited assets receive a step-up in basis to the market value
at the date of the decedent’s death will be repealed when the estate tax is
repealed. At that time, inherited property will generally have a basis equal to
the lesser of the decedent’s adjusted basis or the property’s fair market value
at the date of the decedent’s death.
Even though the estate tax will be repealed in 2010, the
gift tax on gifts made during your lifetime will remain. The lifetime gift
exemption will increase to $1,000,000 in 2002 and will remain at that level.
Since the estate tax won’t be eliminated for over eight
years, you probably don’t want to undo any strategies already in place. In fact,
your estate plan will need to consider strategies to deal with estate taxes in
the event you die before 2010. Additionally, the Act contains a "sunset"
provision stating that for tax years after 2010, the 2001 tax law will come back
into effect unless further congressional action is taken.
While reducing estate taxes is a major estate planning
goal, keep in mind that you also want to ensure that your estate is distributed
to your chosen heirs. Keep these points in mind:
 | You still need a will to provide for the distribution of
your estate and to name guardians for minor children. Also consider a durable
power of attorney and a health care proxy. A durable power of attorney
designates an individual to control your financial affairs if you become
incapacitated, while a health care proxy delegates health care decisions to
another person when you are unable to make these decisions. |
| Continue an annual gift program, since it does not
result in the payment of any gift taxes. You may gift up to $10,000 per year
($20,000 if the gift is split with your spouse) to an individual federal gift
tax free. This amount is adjusted annually for inflation, in $1,000
increments. You can make gifts to any number of individuals, even those not
related to you. Over a number of years, an annual gifting program can remove a
substantial amount of assets from your estate. In additions, any future
appreciation or income generated on those gifts is removed from your estate. |
| Consider using your lifetime gift tax exclusion during
your life. The amount is currently $675,000 for 2001, but is scheduled to
increase to $1,000,000 in 2002. This strategy does not result in the payment
of any gift taxes and reduces your taxable estate in the event that you die
before 2010. |
| When making gifts, look for opportunities to transfer
assets that have the potential to appreciate in value, but have not already
done so. |
| Investigate trusts that will accomplish other estate
planning goals. While many trusts are designed to help reduce estate taxes,
there are other reasons to set up trusts, including to control asset
distribution, to make gifts to charities, to provide for the possible
incapacity of the creator, to protect heirs from others or themselves, to
avoid probate, to allow a professional to manage assets, and to ensure that
provisions are made for minors. |
The eventual repeal of the estate tax has not eliminated
the need for estate planning. For a more detailed discussion of these issues or
if you’d like help, please call us at (800) 878-4036.
NEW SIMPLIFIED
DISTRIBUTION RULES
In January 2001, the Treasury Department released new
proposed regulations concerning required minimum distributions from individual
retirement accounts (IRAs) and employer-sponsored 401(k), 403(b), and 457
deferred-compensation plans. Although the rules are scheduled to become
effective on January 1, 2002, the Treasury Department has indicated that they
can be used retroactively to the beginning of 2001. However, if you prefer, you
can still use the old rules for distributions made in 2001.
The new rules simplify the calculation of required minimum
distributions and give account owners more flexibility. To understand the
significance of the new rules, you need to remember a couple of basic points
about the old rules. Under the old rules, you needed to decide two things by
April 1 of the year after you turned 70 ½ – who your beneficiary was and which
of three methods you were going to use to calculate distributions. These two
decisions significantly impacted the amount you were required to withdraw each
year and, once made, were irrevocable.
The new rules simplify distributions as follows:
| Once you reach age 70 ½, your minimum required
distribution is calculated by taking your account balance as of the end of the
preceding year divided by your distribution period (as noted in the following
table): |
|
Age |
Divisor |
Age |
Divisor |
|
70 |
26.2 |
93 |
8.8 |
|
71 |
25.3 |
94 |
8.3 |
|
72 |
24.4 |
95 |
7.8 |
|
73 |
23.5 |
96 |
7.3 |
|
74 |
22.7 |
97 |
6.9 |
|
75 |
21.8 |
98 |
6.5 |
|
76 |
20.9 |
99 |
6.1 |
|
77 |
20.1 |
100 |
5.7 |
|
78 |
19.2 |
101 |
5.3 |
|
79 |
18.4 |
102 |
5.0 |
|
80 |
17.6 |
103 |
4.7 |
|
81 |
16.8 |
104 |
4.4 |
|
82 |
16.0 |
105 |
4.1 |
|
83 |
15.3 |
106 |
3.8 |
|
84 |
14.5 |
107 |
3.6 |
|
85 |
13.8 |
108 |
3.3 |
|
86 |
13.1 |
109 |
3.1 |
|
87 |
12.4 |
110 |
2.8 |
|
88 |
11.8 |
111 |
2.6 |
|
89 |
11.1 |
112 |
2.4 |
|
90 |
10.5 |
113 |
2.2 |
|
91 |
9.9 |
114 |
2.0 |
|
92 |
9.4 |
115+ |
1.8 |
This table is used regardless of who your beneficiary is
(one exception is noted in the next paragraph). These new distribution rules are
expected to reduce the required minimum distribution amount for the vast
majority of taxpayers.
| If your spouse is your sole beneficiary and is more than
ten years younger than you, you can use either the above table or a table
based on the actual joint life expectancy of you and your spouse. |
| You can change beneficiaries at any time, with no impact
on your minimum required distribution amount. For purposes of determining who
receives your account balance after your death, you have until the end of the
year following your death to make that determination. This could be
accomplished by instructions you leave or by beneficiaries disclaiming their
right to the balance. |
| After your death, your beneficiary can make withdrawals
based on his/her remaining life expectancy. This rule applies regardless of
whether you died before or after your required distribution date. If you do
not have a designated beneficiary and you die after you start making required
minimum distributions, the balance is distributed over your remaining life
expectancy at the time of your death. If you die without a designated
beneficiary and before your required minimum distribution date, the balance
must be paid out within five years of your death. |
| Your IRA custodian must now report what your required
minimum distribution should be each year to both you and the IRS. This makes
it easier for the IRS to monitor whether you have withdrawn at least the
minimum amount required. If you do not, you will owe the IRS a tax of 50% of
the amount that should have been withdrawn. |
WHAT HAPPENED TO SAVINGS?
For years, we have heard that our personal savings rate is
dismally low. And in fact, as the graph below shows, the personal savings rate
as a percentage of disposable income has been significantly declining since
1992, actually turning slightly negative in 2000. How concerned should we be by
this trend?
While this measure of savings is the most widely quoted, it
is often criticized since it reports the percentage of disposable income set
aside for saving. It does not record any increases or decreases in total wealth,
such as gains in investments and real estate.
Yet even studies that have attempted to take capital gains
into account have shown significant declines in the personal savings rate. One
study found that the personal savings rate, including capital gains, decreased
from a little over 12% in 1993 to approximately 7% in 2000 (Source: AARP
Research Study, March 2000).
So why has personal savings decreased so significantly?
Several possible causes have been suggested:
| Steep increases in many services, such as medical
services, education, recreation, and housing, have caused consumers to
significantly increase their expenditures. |
| Government transfer payments, such as Social Security,
Medicare, and Medicaid benefits, act as a disincentive for individuals to
save. Individuals realize that they can count on these benefits from the
government, so feel less need to save on their own. |
| The easy availability of credit has caused many
consumers to borrow aggressively rather than to save. |
| Significant increases in the stock market mean that many
individuals have significant gains. Since consumers base their ability to make
purchases on both their income and wealth, these gains have led them to
increase their purchases and decrease savings. |
Whatever the cause, this long-term trend is distributing
since the baby boomer generation is the first generation that will have to
finance a significant portion of its own retirement. Two major trends will cause
this generation to need more in the way of personal savings:
| REDUCED THIRD-PARTY SUPPORT.
Generous pensions and Social Security benefits will probably not be as readily
available to the baby boomer generation. While the Social Security system is
expected to survive, changes are widely anticipated. The trend in
company-sponsored pension plans has been a significant increase in
defined-contribution plans, where employees make contributions from their
earnings, at the expense of defined-benefit plans, where the employer funds
benefits. |
| INCREASED LONGEVITY.
Not only are we now living much longer than in the past, but this trend is
expected to continue at an even faster pace in the future. |
On an individual level, the decline in the personal savings
rate should serve as a wake-up call to assess your progress toward your
retirement goals.
5 TIPS TO INCREASE
YOUR NET WORTH
To achieve your financial goals, you need to find ways to
increase your net worth, which can be accomplished by increasing your assets
and/or decreasing your debts. These five basic tips can help:
| SET EXCITING FINANCIAL GOALS.
Putting money aside for a distant goal,
rather than spending that money now, is a difficult thing for most people to
do. So set exciting goals that will motivate you to achieve them. Then
quantify your ultimate goal as well as interim goals so you’ll have a way to
track your progress. |
| SPEND LESS THAN YOU EARN.
The amount of money left over for saving is a direct result of your lifestyle.
Your lifestyle decisions will impact you now and in the future, since you will
typically want to continue the same lifestyle after retirement. To get a grip
on your spending, take time to analyze your expenses and to set a budget. Try
reducing nonessential expenditures. Another strategy is to find ways to spend
less money for the same things. |
| SAVE IT BEFORE YOU SEE IT.
If you have to find the money for saving every
month, you’ll likely find that there isn’t much left after all the bills are
paid. Typically, a better strategy is to set up an automatic savings program
where money is automatically deducted from your bank account every month and
deposited directly into an investment account. Another good alternative is to
sign up for your company’s 401(k) plan, having funds withdrawn every paycheck.
(Remember that an automatic investing plan,
such as dollar cost averaging, does not assure a profit or protect against a
loss in declining markets. Since such a strategy involves periodic investment,
consider your financial ability and willingness to continue purchases through
periods of low price levels.) |
| DON’T LET DEBT SABOTAGE YOUR GOALS.
If a significant portion of your income is going to pay interest on your
loans, that leaves less available for saving. Strive to eliminate all your
debts except your mortgage. |
| INVEST, DON’T JUST SAVE.
Your ultimate nest egg is basically a function of
two factors — how much you save and how much you earn on those savings. Become
comfortable with various investment alternatives, so that you’ll feel
comfortable investing in more aggressive alternatives that offer potentially
higher rates of return. |
A LOOK AT CONVERTIBLE BONDS
Convertible bonds are a hybrid investment, combining
features of both bonds and stocks. Like all bonds, convertibles pay a fixed
interest rate for the bond’s life, with the principal returned at the end of the
bond’s term. However, convertible bonds can also be exchanged for a specific
number of shares of the issuing company’s common stock.
The bond’s interest payments are typically higher than the
dividends paid on the common stock, although the interest rate is usually lower
than that on nonconvertible bonds. However, the ability to convert to common
shares allows investors to participate in share price increases without as much
exposure to share price decreases. Convertibles do not decline as much as the
common shares because the bond retains a market value equal to comparable bonds
paying the same yield.
When issued, the value of the convertible bonds exceeds the
price of the common shares by an amount known as the conversion premium, which
changes as the stock price changes. If the stock is selling below the conversion
equivalent, there is no financial incentive to convert the bond, so the bond’s
price will be primarily determined by factors affecting bonds. Once the stock’s
price rises enough to provide a profit converting the bond, the stock’s value
will significantly affect the convertible’s market value.
Most convertibles can be called back by the issuer at a
specific price. These call provisions are typically used by the issuer to force
investors to convert the bond to common stock, so that the debt obligation can
be eliminated.
Since they are a hybrid investment, convertible bonds can
be difficult investments to evaluate. You should consider bond and stock
pricing, current interest rates, the probability of a bond call, the
convertible’s yield advantage over common stock, the fixed-income value of the
convertible, and the volatility of the underlying stock. Please call us at (800)
878-4036 if you’d like to discuss convertible bonds in more detail.
GETTING TO KNOW US
You may not be aware of all our services, so
we are including a basic list:
INVESTING
| Fee-based money management |
| Investment review |
| Asset allocation models |
INSURANCE:
| Screening and selection of life, disability, and
long-term health care |
| Insurance needs modeling and projections |
ESTATE PLANNING:
| Helping coordinate trusts, strategies, and insurance |
RETIREMENT PLANNING:
| Retirement modeling and projections |
| Comprehensive financial planning |
BUSINESS:
| Pension plan asset management |
| Employee benefits coordination |
| Buy-sell and other owner issues |
We offer knowledge and experience with the services listed
above. In addition, we would be happy to meet with any of your family, friends,
or colleagues who need help in any of these areas. If you have questions about
any of these services or would like more detailed information, please do not
hesitate to call us at (800) 878-4036.
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