Financial Abundance Guide

Disability is a risk that many people underestimate.  While most people have life insurance, health insurance and property/casualty insurance, many people fail to carry adequate disability insurance.  Some people believe that the risk of becoming disabled is so small that they can afford to ignore it.  Others believe that they will get enough through Social Security, if they become disabled.  If you believe either of these to be true, you might want to reconsider.

A U.S. worker, under the age of 65, has a considerably higher risk of being fully disabled for over six months than she does of dying.  Why is it that many more workers have life insurance than have disability insurance?  Can you financially afford the consequences if disability occurs?

Perhaps you are planning to rely on Social Security if you become disabled. The Social Security administration states that “you can receive disability benefits after six months if you have a physical or mental impairment that’s expected to prevent you from doing substantial work for a year or more or result in death.”

However, virtually no one begins collecting Social Security benefits before they have been disabled for at least one year.  Combining the long “lead time” to begin collecting from Social Security benefits, with the relatively low monthly payments, is a recipe for financial disaster.  Just as you are not planning on receiving 100% of your retirement benefits from Social Security, you should not depend on Social Security alone to take care of you if you become disabled.

If your employer does not provide you with long term disability coverage, you should seriously consider buying a personal disability policy.  If you pay for the policy, the disability income will be tax free.  Combining the tax free disability payments with Social Security payments will allow you to buy a policy that covers less than your current total income.

There are many decisions to make with a disability policy such as a “noncancelable” policy in which payments never rise versus a “guaranteed renewable” policy where the insurer may increase premiums over time.  Before buying any disability insurance policy, find a trustworthy insurance agent who will explain the costs and benefits of all of the policy options.  Choose the policy with the coverage amount, benefit period and policy options that meets your current financial requirements.

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On October 19, 1987, the Dow fell 508 points. On October 19, 2007, the Dow fell 367 points. The big difference between the two declines is that the 508 point decline in 1987 represented a 23% decline in the Dow. However, the 367 point decline on Friday represented only a 2.64% decline in the value of the Dow.

The question for investors is whether last week, when the Dow declined by 4.1% and the S&P 500 declined by 3.9%, was a mere blip on a continuing bull market or the presager of a coming bear market. While virtually every analyst has an opinion on this, no one knows for sure.

As an investor, the one thing that you can do is to decide whether you believe that the stock market has more upside or more downside risk in the next 12 months. With economic expansion beginning its sixth straight year, oil and other commodity prices at near record levels, the dollar approaching historic lows and gold near historic highs, it may be time to be cautious about your equity (stock market) exposure.

From January 2001 through December 2002, the S&P 500 fell by over 30%. As demonstrated in the story of Mary, Nancy and Joan on page 122 of the Financial Abundance Guide, portfolio allocations can make a large difference in returns, especially in down markets. Mary, with her 80% equity and 20% fixed income portfolio lost almost 23% during this period, while Joan, with a 50% equity and 50% fixed income portfolio lost only 10%.

It is never wise to try to time the stock market or to sell all of your equity investments. However, it is wise to weigh the risk/reward of your asset allocation between stocks, fixed income and cash. If you have become overly weighted in equities during the bull market of the past five years, it may be time to reallocate your assets so that your equity exposure is consistent with your risk tolerance levels.

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A Coverdell Education Savings Account (ESA) is an ideal way for young families to save for their children’s educational expenses.  With a Coverdell ESA, you are able to save $2,000 annually, for each of your children, from the time they are born until they reach age 18.  The Coverdell ESA deposits may be made by anyone, providing a great way for grandparents to help in fund their grandchild’s education.

You may set up a Coverdell ESA account at any institution that offers IRA accounts.  A Coverdell ESA has tax advantages that are similar to a Roth IRA.  While the initial contribution to the account is not deductible, all growth and income from the account escapes taxation, as long as the withdrawn funds are used for education related expenses.  These expenses can include tutoring, computer equipment, room and board and even school uniforms.

Funds from a Coverdell ESA may be used to pay for educational expenses from kindergarten through graduate school.  The longer that the funds are allowed to grow, the greater will be your financial benefit.

Your may fund both a Coverdell ESA and a Section 529 College Savings Plan in the same year.  A Coverdell ESA has Adjusted Gross Income limits for the contributor of $190,000 for couples or $95,000 for individuals.  If your income exceeds that limit, perhaps your parents or even your child’s godparents might be willing to make the contribution.  Remember, you can always gift up to $12,000 to anyone, without any gift tax consequences.

If the funds in a Coverdell ESA are not consumed before the beneficiary reaches age 30, the beneficiary receives the remaining funds and must pay both income taxes and a 10% penalty on the remaining funds.  To avoid this problem, a rollover of the remaining Coverdell ESA assets may be made to a sibling, a niece, a nephew or even the beneficiary’s child.

Start a Coverdell ESA as early as possible in your child’s life to help fund their education.  As Robert and Cindy find in Financial Abundance Guide, the $2,000 per year that they invest for each of their children grows to $54,300 by the time the child is 15, with an 8% annual return on the invested funds.   Tax free income makes the Coverdell ESA  an excellent vehicle for educational savings.

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The Pension Protection Act of 2006 (PPA) allows you to roll over up to $100,000 from an individual retirement account (IRA) directly to a qualifying charity.  However, the time to do a charitable rollover from your IRA is rapidly coming to an end.  Unless Congress extends it, the IRA Charitable Rollover will end in 2007.

If you are at least 70 ½ years old, you may give up to $100,000 directly to a charitable organization and exclude the full amount of the gift from your gross income.

Since you may already deduct your charitable gifts from your annual income, you might be wondering why anyone would use this rollover capability.  There are at least three areas where this approach may be beneficial.

1. If you do not itemize your tax deductions on Schedule A of your income taxes, you may want to rollover your IRA “required distribution” amount to a charity.  If you do not need your required distribution to live on, the rollover provides a generous charitable gift and you do not pay taxes on the unneeded required distribution.
2.  You may want to give a large gift to your favorite charity, but the charitable deduction ceiling prevents you from fully deducting the amount that you would like to give.  With the IRA charitable rollover, you may increase the amount of your gift by up to $100,000, with the total gift fully “deductible” in 2007.
3. If you wish to give a large charitable gift and reduce your future IRA “required distributions,” you may reduce your IRA by up to $100,000 and provide a generous gift to your favorite charity.

You cannot do a rollover to a donor advised fund.  If you have a donor advised fund, use your appreciated stocks to fund it and provide a direct IRA rollover to your favorite charities in 2007.

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Congress is looking for ways to raise taxes and your homes are in their line of fire.

On September 27, the Wall Street Journal reported that the House’s Ways and Means Committee has approved a bill under which homeowners facing foreclosure will not get a tax bill, if part of their debt is forgiven by lenders. Presently, forgiven debt is treated as taxable income to the borrower.

To pay for this tax break, the committee decided to eliminate the ability to sell your second home and pay no capital gains taxes on up to $500,000 in profits, when the home is your primary residence for two out of the last five years. A full explanation of this tax break is found on page 106 of the Financial Abundance Guide.

With the proposed tax policy, the capital gains tax break for a second home would be based on the number of years that the house has been your primary residence. The longer your second home has been your primary residence, the larger will be your capital gains tax break when it is sold.

If your second home has been your primary residence for two of the past five years and you are trying to avoid capital gains taxes on its sale, sell it quickly and hope that Congress does not make this change retroactive.

The second way that your home’s tax deductions may come under congressional fire was discussed in a Wall Street Journal editorial on October 6. As part of a tax bill to reduce CO2 emissions, John Dingle, chairman of the House’s Energy and Commerce Committee, is proposing to eliminate the mortgage deduction on homes over 3,000 square feet in size.

While the probability of this measure passing is low, it portends that large, “energy wasting” homes will be a future tax “target” for Congress. If you are in the market for a new home, consider a smaller, “energy efficient” one.

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You recognize that you need help with financial planning and advice on the investments required to meet your financial goals. How do you find an advisor that is right for you?

The way an advisor is compensated can influence the advice that they provide. Let’s look at compensation methods for financial advisors.

Commissioned based advisors – These advisors typically sell both insurance based financial products and load mutual funds. They will often state that their financial planning services are “free” and that you will pay no commissions, as long as you hold the product for a period of five years or more. Always ask the advisor what they will receive in commissions for each product you are offered.  Once you know what their commissions are, you know how much you are really paying for their advice.

Fee based brokerage advisors – To join the popular trend of charging fees instead of commissions, brokerage firms are offering “fee based” accounts. You pay an annual fee, based on a percentage of the assets in the account.  For this fee, you may make unlimited trades without paying any brokerage commissions. Commissions on mutual funds (such as the 12-b1 annual load) and certain proprietary products may also compensate the broker.

Fee only assets based advisors – These advisors provided professional asset management and financial advice and typically offer products that pay no commissions. Their compensation is based on an annual percentage of the assets that you place with them to manage.

Fee only financial planners – Fee only financial planners provide financial planning and investment advice for an hourly fee and/or retainer. They sell no products and receive no commissions.  Since they are advising you on all of your financial resources, there is no incentive to have assets under management.

On the surface, advisors that sell commissioned-based products appear to charge less than fee only advisors.  However, when you “look behind the curtain,” you will often find that the commissions paid are more than you would pay for fee only based advice.

To demonstrate this, ask a commissioned based financial advisor about variable annuities. Then compare their product with a similar product from Schwab, Fidelity or Vanguard (all non-commissioned brokers).  You will always pay more for the variable annuity from a commissioned broker than you do from a non-commissioned brokerage firm.

Financial advisors are legally required to tell you how they are compensated.  Always ask how they will be compensated for financial advice provided. Once you know how they are compensated, you can determine if any conflicts of interest might arise. With this knowledge, you can make an informed decision on the type of financial advisor that is best for you.

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