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Monday, January 25, 2010

Insurance Tips

When grouped together, the amount of money a family spends on various insurance premiums can easily eat up twenty percent or more of the household budget. Insurance, in general, is one of the most confusing areas of family finances, partly because policies are complex and also because it’s in the insurance company’s best interest to avoid full transparency. Here are my top 5 insurance strategies:

Lower deductibles don’t save you money. Whether its homeowners insurance or automobile insurance, too often I find families using low deductibles thinking they will save money when they have a claim. Not true. Generally you’re better off with higher deductibles of $500, $1,000 or more. Raising the deductible (the amount you are responsible for when there is a claim) can slash your premium 20% or more every year. Over the long term, this will put substantially more money in your pocket. Use the annual savings to start a sinking fund (savings) to cover the increased deductible.
If you have assets, you need an Umbrella Liability Policy. This ‘add-on’ insurance provides $1 million or more insurance against legal claims of a personal nature above the basic liability coverage provided by your auto or homeowners insurance. It’s inexpensive and imperative if your net worth exceeds $100,000.
You don’t have enough life insurance. Pretty consistently, I find families don’t have enough life insurance on the primary income earner. How much is enough? Think logically about your situation. If the income earner died suddenly, how much income, annually, would the family need to continue to pay the bills, save for college and invest for retirement? Add a zero to this annual number and you’ll have the minimum amount of life insurance needed on that income earner. If you want the income to last a lifetime, you’ll need double that amount. For low-cost rates on life insurance, visit the Resource Center at www.welchgroup.com; click on ‘Links’, then ‘Life Insurance Quotes’.
Rethink Long-Term Care Insurance. The cost of healthcare services has risen sharply over the past decade. While healthcare reform may provide some financial relief such as removing the lifetime claim limits, traditional coverage does not cover in-home healthcare. Consider Long-Term Care insurance to fill this gap especially if you are age 65 or older. I recently visited with a husband who is spending over $100,000 per year on in-home care for his wife. At that rate, most people’s money won’t last long. I prefer ‘indemnity’ type policies versus ‘reimbursement’ type policies. Indemnity policies pay you the full daily benefit regardless of the out-of-pocket expenses and allow you to better control the level and cost of care.
Avoid ‘event’ insurance. There’s a lot of insurance being sold that is just a bad deal and should be avoided. Examples include trip insurance, airline insurance, accidental death insurance, guaranteed-issue burial insurance, mortgage insurance, credit insurance as well as excessive riders on your homeowners insurance. You’ve seen the ads on TV and in your mailbox. Most of this is highly overpriced.

Your best bet is to work with an experienced financial advisor or insurance agent that you trust and who can help you navigate and coordinate the coverage you need at prices you can afford.

Tuesday, January 19, 2010

Roth Conversion Strategies - Part II

Last week, I discussed the general rules and who were the best candidates for converting a traditional IRA to a Roth IRA recognizing that beginning in 2010, there are no longer income limitations on who can do a conversion. This week, I’ll show you some little-known strategies you can use to take advantage of the opportunity Roth IRAs offer.

Roth Strategy #1. If you are an individual tax filer with modified adjusted gross income exceeding $120,000 or a joint filer with MAGI exceeding $176,000 in 2009, you’re not eligible to make a Roth contribution. You are eligible, however, to make a non-deductible IRA contribution of up to $5,000 plus an additional $1,000 if you were age 50 before December 31st 2009. Here’s the strategy: prior to the April 15, 2010 deadline, make a maximum contribution to a non-deductable IRA, then convert it to a Roth IRA. Since there is no gain, there will be no tax. Plan on doing this every year as a way to get more money into your Roth account.

Roth Strategy #2. If you have both deductible and non-deductible IRA accounts, you don’t get to ‘cherry pick’ which ones to convert, but rather you must ‘aggregate’ all of your IRA accounts in order to determine your tax liability. For example, say you have a non-deductible IRA where you have contributed $25,000 with no gain plus a deductible IRA that you have contributed $25,000 with no gain. You decide to convert $25,000 to a Roth. What is your reportable gain? The answer is $12,500, or fifty percent of the combined accounts. Here’s the strategy: Many company retirement plans allow you to roll over IRA accounts into the company retirement account such as the 401k plan. You roll over the deductible IRA into the company plan, leaving the non-deductible IRA which you then convert to a Roth. The result is that you have effectively isolated your non-deductible IRA and minimized the tax consequences of conversion. If you’re self-employed and have a Simplified Employee Pension plan (SEP) or other similar plan, you can use this same strategy.

Roth Strategy #3. Do your Roth conversion early in 2010, especially if you believe the stock market will rise this year. If you wait until the end of the year to do the conversion and the market rises, you’ll owe more taxes on your gains. If you convert early and you’re wrong about the market, you get a free ‘look-back’ which allows you to ‘un-convert’ your Roth up until when you file your tax return including extensions. Be sure to keep these annual Roth conversions separate from your other Roth account for ease of un-converting, if needed.

Roth Strategy #4. This is a variation of Strategy #3 above. Consider separating your IRA accounts by investment type and then converting your most aggressive investments to a Roth early in the year. If the investments do well, consider it a good conversion. If the investments do poorly, you can ‘un-convert’.

Monday, January 11, 2010

Should I Convert my Traditional IRA to a Roth IRA? Part I

Roth IRAs have a couple of significant advantages over traditional IRAs. First, while contributions to a Roth are not tax deductible, withdrawals during retirement are tax free versus taxable withdrawals from traditional IRAs. Second, unlike traditional IRAs, Roth IRAs do not require that you take minimum withdrawals beginning at age 70 ½. Unfortunately, prior tax law has prevented high income earners from accessing Roth IRA plans…until now. Let’s take a quick look at the rules and how they have changed as well as some strategies you can use to your advantage:

The ability to contribute to a Roth IRA is phased out for joint tax filers whose modified adjusted gross income (MAGI) in 2009 was between $166,000 and $176,000 ($167,000 and $177,000 for 2010) or individual filers with MAGI between $105,000 and $120,000.
If you wanted to convert an existing IRA to a Roth in 2009, you could do so only if your MAGI was less than $100,000. This limitation has been removed for 2010, creating a potential opportunity for roughly 16 million Americans.
If you do convert your traditional IRA to a Roth, you must report as income all of the proceeds less any non-deductible contributions. The law allows you to pay the taxes either in 2010 or you can delay the reporting and show half of the proceeds in 2011 and half in 2012 and pay taxes based on the tax rates in effect in those years. Note that tax rates are set to rise in 2011 so any decision to postpone reporting should be done with the advice of your tax advisor.
You can do an ‘in-kind’ conversion, meaning you’re not required to sell securities; rather you can simply transfer securities from your IRA account to your Roth account.

So now that everyone is eligible to play the conversion game, should you? The answer will be dependant upon your personal facts but here are some guidelines to get you started:

If you are considering converting part or all of your IRA to a Roth, you’ll want to be certain that you can pay the taxes due from funds outside your IRA account otherwise you’ll basically defeat the purpose. If you were to pay taxes from the IRA account, that withdrawal would be reportable as ordinary income plus if you are under age 59 ½, you’d also be subject to a federal 10% penalty.
The more time you have before you’ll need to tap your retirement accounts, the more advantageous is the conversion to a Roth. This is because money has more time to grow tax free and offset the upfront taxes you paid upon conversion.
If you believe that your tax bracket when you withdraw funds during retirement is likely to be much higher than now, the more advantageous it is to convert now.
If you believe that there is a good chance you’ll not need your IRA account for retirement income, converting to a Roth will both avoid Required Minimum Distributions (RMDs) beginning at age 70 ½ and allow your heirs to take tax free withdrawals regardless of their tax bracket.

Next week, I’ll discuss little-known strategies that you can use to take advantage of Roth conversions.

Wednesday, January 6, 2010

Today's Low Interest Rates Create Opportunities

Low Interest Rates Create Unique Opportunities

Over the past decade, millions of Americans have built up massive debt in the form of home loans, consumer loans and credit card debt. In order to help catapult America out of the current recession, our government has orchestrated artificially low interest rates. Herein lies a time-sensitive opportunity. If you are a parent or grandparent who is willing to help a child or grandchild out by making a loan, there may never be a better opportunity than now. The federal government requires that you charge a minimum interest rate on loans between family members. Right now those rates are at historical lows but I don’t expect them to stay there for long. My guess is that interest rates will begin to rise sometime in the second half of this year as the Federal Reserve begins to address the problem of rising inflation. The current minimum rates, called Applicable Federal Rate (AFR) are as follows:

For loans of three years or less: 0.57%
For loans exceeding three years up to nine years: 2.45%
For loans exceeding nine years: 4.11%

Let’s look at a couple of strategies for taking advantage of the current situation:

Slash children’s cost of debt. You could loan your child money to pay off existing high interest rate debt. Interest being charged on many credit cards has soared in recent months as credit card companies attempt to reduce losses on rising defaults. Consumer loans, likewise, typically carry relatively high interest rates. Your loan could allow your child to either substantially lower monthly payments or conversely, increase the speed of pay-off under the same payment schedule. For example, if your daughter had credit card debt of $10,000 at 18.9% interest rate, interest costs would be $1,890. If you loaned her $10,000 to pay off the credit card using a three year note at the current AFR, her interest would be just $57. The difference in interest amount, $1,833, could be applied to principal reduction and significantly accelerate the payoff of the debt.

Create an investment advantage for your children. While the stock market has had a meteoric rise over the past ten months, it’s still about 40% below its high in 2007. Many stock market prognosticators believe the market will do well in 2010 as the economy continues to recover. Consider this strategy: Make a three-year interest only loan to your child using the 0.57% AFR and have your child invest in a basket of blue chip dividend-paying stocks yielding 3.5% to 4.5%. The dividends will provide cash flow to make interest payments with plenty left over for either reinvestment, savings or additional personal cash flow that can be used to pay on other debts or expenses. Three years should be plenty of time for the stock market to move higher, reaping capital appreciation as well. At the end of three years, you could have your child repay you from a partial sale of the stocks or you could renew the loan at the then Applicable Federal Rate. Wealthy families could use this strategy to make large transfers free of estate taxes since the gains will accrue in your child’s name, not yours. Business owners can use this strategy to sell business interests to children with loan repayments made from company profits.