Can You Count On Dividend Income?

One of the challenges many older investors face when managing their cash flow pertains to income from dividends. Unfortunately, common stock dividends come with no guarantees. Companies are not required to pay them, and those that do can suspend their dividends at any time as their business needs dictate. Since there are no guarantees for dividends, should you rely on them for planning even a portion of your retirement income? The answer is yes.



First, create a diversified portfolio of different dividend-paying stocks. If your dividends are coming from a single source, you run the risk losing what could be a significant portion of your income should the company decide to discontinue their dividend payments. With a diversified portfolio, your regular dividend income stream could continue, buffered by the on-going payments of the other stocks in your portfolio. Although diversification does not guarantee against the risk of loss in a declining market, it can help to reduce the market volatility risk of your overall portfolio.

Second, when building your dividend-income portfolio, look for high-quality companies in sectors that have historically paid out a steady stream of dividends to shareholders. Finding these stocks can be tricky, but there are a few good places to start. Companies in stable industries or in highly-regulated markets such as electric utilities are typically good candidates for a dividend-income portfolio. These companies usually face fewer threats to their business and fewer interruptions of their cash flow, making it less likely that they would have to discontinue dividend payments.

The Dow Dividend Strategy has been a very good way to mechnically select stocks with sustainable dividends, growth in dividends and growth of capital. When you compare what history has shown regarding growth of dividend income vs. the reliability of fixed income investments (chart below) for income over the long run, the asset allocation decision is simple.

A Steady Income with Tax-deferred Growth

Have low interest rates and an uncertain economy stopped you from making long-term investments? This reluctance to do anything could come at a cost, such as a reduction of income. Immediate and fixed annuities have often been the investments of choice for people who want steady income and tax-deferred growth. And when used together as a ?split-annuity,? these investments could possibly provide a return that might keep pace with prevailing interest rates while not tying up all of your funds.

An immediate annuity will pay you a predictable amount of money each month for a fixed term (or lifetime). Part of your income would be tax-free since it is a return of your investment. Once you make the investment the funds are generally not accessible. On the other hand, a fixed annuity?s income accumulates tax-deferred. And you can withdraw the earnings and a certain percentage of the principal (depending on the issuing company?s guidelines) each year.
The concept of the split-annuity is that by the time your immediate annuity?s term runs out, and the payments stop, your fixed annuity will have grown enough to replace your original investment. Then you can start the process over again at the current interest rates, which could be higher or lower than your prior investment?s.

The calculation to determine what portion of your split-annuity should go into the immediate annuity will depend on the current interest rates and the number of years for the payouts.

Certified Retirement Financial Advsior graduates have offered to provide no cost illustrations of the split annuity.

A 0% Capital Gains Tax Could be in Your Future

The 2003 tax act reduced the long-term capital gains rate to 15% for anyone in the 25% or higher bracket and down to 5% for taxpayers in the 10%-15% brackets.
These rates will remain effective through 2007. In 2008, however, another
change emerges when the capital gains tax falls to 0% for individuals in the 10%-
15% brackets. This presents some money saving opportunities for you if you are
considering giving assets to anyone in a lower tax bracket, such as children or
grandchildren.

For example, suppose you own a mutual fund that you want to use to help
your grandson when he starts college in 2008. If you are in a high tax bracket,
you will have to pay 15% on any gains that you realize on the fund?s sale.
The IRS specifies that when you give an appreciated asset, the donee
receives the gift at your cost basis. Therefore, any untaxed profit is passed on
with the asset and taxed based on the donee?s tax bracket when sold. So if your
grandson sells any of the gifted shares between now and the end of 2007, he will
have to pay at least 5% on the profits.

On the other hand, you could hold off
giving him the fund until 2007 and have him keep the account for at least one
year. As long as he liquidates the fund in 2008, he will have a good chance of
avoiding the capital gains tax. However, based on present law, if he does not
sell out until 2009, he could face a 10% capital gains tax.

Questions to ask a Retirement Planner

Where can you get qualified financial help in retirement

The needs of people in retirement or about to retiree are different than those of baby boomers. Yet all you see in articles is advice for baby boomers on how to prepare for retirement. What about help for those age 60+ who have already cashed in their chips or about to do so?

Good news. There has been increased education, albeit slowly, for financial advisors to help people in retirement. But be careful about the several designations you may see.

The most widely held senior designation, Certified Senior Advisor (CSA) is not a financial training at all. Although many financial professionals gain this designation, so do nurses, gerontologists, funeral home directors and others dealing with older people. The designation is really a training in communication skills and issues of aging and not in financial issues.

The Certified Retirement Financial Advisor designation (CRFA) is ONLY for financial professionals that have at least 2 years experience in financial services. The enrollees seek to polish their retiree-specific financial knowledge and the course covers every aspect of financial concerns to someone in their retirement years: how to avoid tax on social security income, how to liquidate assets for the lowest or zero capital gains tax, how to utilize section 72 rules for early retirees who need to tap their retirement funds before age 59 ½, IRS sections 1035 and 1031 exchanges for tax deferral, Roth IRA conversions, how to minimize taxes on IRA distributions, how to build retiree portfolios for greater secure income, how to create low risk equity portfolios, training in estate planning and asset protection, long term care planning and related tax issues, trusts, advance directives, integration of your retirement plan and estate plan, asset titling issues, beneficiary selection for retirement accounts and other assets. Fifteen hours of continuing education is required annually to maintain the designation.

The other legitimate designation is Chartered Advisor for Senior Living (CASL). However, of the 5 courses that graduates must complete, 2 of them are general and not retiree specific. Fifteen hours of continuing education is required every 2 years to maintain the designation.

Be cautious of any other designations held by a financial advisor who contends that the designation has prepared him to give appropriate financial advice for people in retirement. There are several designations that have no substance and are programs designed to make a financial sales person look like a professional.

Here are some simple questions you can ask a retirement planner. If the professional cannot answer them easily, then move on:

How can IRS section 1031 help me (it helps people divest real estate without current taxation)
What is the lowest possible rate on capital gains that I could possibly qualify for (5% currently, 0% starting in 2008)
Can anyone convert their IRA to a Roth IRA (their modified adjusted gross income must be under $100,000 currently)
If I want to leave my IRA to my 3 children, do I need to split it into 3 accounts (no, the children can split the IRA after your death into 3 accounts)
Will a living trust help me save taxes (no?the benefits of a living trust that cannot be accomplished otherwise is the avoidance of probate and privacy)
What?s the difference between an annuitant driven and owner driven annuity (all annuities are owner driven?if the owner dies, the owners beneficiary gets the proceeds)
Can I lose money with an equity indexed annuity (yes, if you withdraw funds during the surrender period, the surrender charge could be larger than anything you have earned resulting in a loss)
Why shouldn?t I put my sons name on my accounts as joint tenant so he inherits them directly if I die (you can be deemed to have given a gift which may have tax consequences and you have exposed jointly held assets to your son?s creditors).

To find a retirement planner that has studied all of these issues and much more visit Retirement Planner.

Best CD Rates

by Jason Gluckman


Certificate of deposits with longer maturity periods pay higher rates than those with shorter maturities. It could be said that the best CD rates have the longest maturities. Some investors believe that a certificate of deposit is the best and safest investment. Others invest in a certificate of deposit to supplement their retirement income. Regardless of the reason, all types of investors want to earn the highest CD rates i.e., best CD rates.

In order to achieve best CD rates, investors need to shop around either online, through newspapers, banners on local institutions, or with the help of brokerage firms to find out which banks and credit unions offer best CD rates all the time. Before purchasing CDs that offer best rates, customers need to consider two factors, the length of the maturity period and the current interest rate environment. Investors who lock up their money in long term CDs will earn a better rate of interest than those who buy short term CDs. This is due to the fact that when customers purchase CDs with longer maturity periods, they commit their funds in the investment for the entire maturity period before they can withdraw. The investor foregoes alternative courses of investment. For all these risks that investors experience, banks pay best CD rates on such units. Similarly bulk buying also fetches investors best rate because banks may insist on meeting minimum requirement for offering best rates.

It is not advisable for the investor to stay with the same bank for more than one year. By sticking with the same bank, investors lose the chance of getting the highest and best CD rates offered by other banks and credit unions. Generally, the interest rates offered by credit unions, which are non-profit organizations, are the best when compared to those offered by commercial banks.

CD Rates provides detailed information about CD rates, CD rate calculators, CD rate comparisons, and more. CD Rates is affiliated with Online Brokerage Firms.

Medicaid Rules Change to Close Loopholes for Seniors

By the time you read this, the President will have signed into law significant restrictions to the Medicaid law. This article describes the opportunity for seniors to take action and protect themselves. These restrictions are intended to stop abuse of the Medicaid system by middle income and even wealthy seniors who think of Medicaid as the last resort for senior insurance. Until now, the Medicaid law has been so liberal, anyone could qualify for Medicaid supported long-term care. For example, a home has been a non-countable asset, so one could own a $10 million home (or an apartment building in which they reside) and still qualify for Medicaid. No more such loopholes in this senior insurance program.

Anyone with more than $500,000 in home equity cannot receive long term care benefits from Medicaid. Additionally, one will be penalized if they have given any type of gift within the last five years (the look-back period was previously three years). The gifts taken into account include college tuition for grandchildren, emergency help for family, Christmas, birthday, wedding and graduation presents, charitable and church donations. In other words, Congress is attempting to insure that the only people who use Medicaid for long term care will be those that normally don't have enough money to give gifts anyway. Use caution making gifts or donations as they will penalize your ability to obtain Medicaid benefits for long term care for the next 5 years. This senior insurance program will no longer be available to many.

The new law starts the penalty period when the senior applies for Medicaid, not when the gift is given. For example, if Mrs. Jones gave a $40,000 donation four years ago (within the five year look-back period) and if Medicaid needs to pay a local long term care facility $4,000 a month, then Medicaid will not make any payments for 10 months. In other words, Medicaid penalizes assistance for the value of the gift. Even if Mrs. Jones is now broke, Medicaid will not provide support until she has been in a long term care facility for 10 months.

Also be aware that nearly every state is tightening their implementation of the general Medicaid rules. Do not automatically assume that an annuity is an exempt asset or that the residence cannot be attached for recovery. These rules are in flux and favor the state, so you must maintain contact with your state agency that administers Medicaid or an Elder Law attorney.
So what should the average senior do? Middle income and wealthy seniors no longer have a substitute for long term care insurance. They cannot rely on the government as their supplier of senior insurance. Of the three choices that have been available for dealing with long term care: a) self-insurance, b) private long term care insurance, c) position assets to collect Medicaid, the list is now down to two options: a) self-insure or b) private long term care insurance. In other words, if you've delayed buying long term care insurance thinking that you had the government as a safety net, that safety net is now gone.

Note that Medicaid was never a good option anyway. Someone with private long term care insurance that can pay ?full fare? for long term care gets a nice sunny private room with big windows. The senior on Medicaid gets shoved in an interior room with two other people, no windows. As much as this is illegal or people want to deny it happens, as stated by the National Senior Citizens Law Center: ?Many common nursing home practices are illegal. For example, although the Federal Nursing Home Reform Law requires that all residents receive high-quality care, many nursing homes provide lesser care to residents whose care is paid through Medicaid.?

Why don't seniors just get private long term care insurance? The most common reason is the expense. But it's a bad excuse because an experienced financial advisor can show you how to keep the cost down or make a one time payment rather than annual payments (using an immediate annuity or a ?combo policy,? its possible to make one single deposit and avoid annual payments). In some states, insurance companies can provide a return-of-premium option. With that option, if you never use the policy, your heirs get all of your premiums returned. But don't delay. One negative comment in your medical records can preclude you from ever getting insured so get the coverage now.

Larry Klein CPA/PFS, CFP(r), CRFA is founder of the Society of Certified Retirement Financial Advisors. To find a trained certified advisor in your area visit Retirement Planner website.

TIPS

Low yields from both stocks and bonds have led some income-seeking investors in search of cash-flow-friendly alternatives. TIPS (or Treasury Inflation Protected Securities), which are issued by the federal government, have been popular with income investors since their introduction in 1997 for this very reason. Plus, they offer a safe buffer from the threat of rising prices.

Additionally, some big name corporations are tapping the demand for inflation-protected securities by issuing bonds that are pegged to the consumer price index. These corporate inflation-indexed notes are also proving to be popular with investors. Plus they offer monthly payments that are adjusted immediately to reflect changing prices.
Corporate inflation-indexed notes are suitable for investors looking for immediate cash flow, whereas TIPS are generally suited for people seeking protection from rising prices down the road. That’s because TIPS primarily adjust for inflation by increasing the principal value of the bond. For corporate inflation-indexed notes, however, changes in inflation are applied to the bond’s monthly coupon rate. Therefore, corporate inflation-indexed notes often adjust more quickly to changes in interest rates, which can possibly provide more income over time.
Taxes can be a tricky issue with corporate inflation-indexed notes. Income from these corporate-issued bonds is subject to Federal, state, and local taxes, while income from TIPS are exempt from state and local taxation. Because of this difference, effective after-tax yields for corporate inflation-indexed notes could be lower than those for TIPS (depending upon the investor’s income tax bracket).

On the other hand, corporate inflation-indexed notes avoid a tax trap that often catches TIPS investors. When the TIPS’ principal value is adjusted for inflation, the IRS considers this taxable income. The TIPS holder must pay income taxes on this income when it is realized – in the year that the bond’s value is increased – even though the investor does not actually receive the income until the bond is sold or matures. Because the inflation adjustment for the corporate notes is made on the bond’s coupon rate and the bondholder immediately receives all income that is realized, the “phantom tax” that affects TIPS does not have an impact on holders of the corporate inflation-index notes.

It is important to keep in mind that consumer prices do not always rise but can decrease, as was the case in the United States during the 1930’s and Japan during the 1990’s. Falling prices or “deflation” over a prolonged period would decrease the interest payments received by TIP owners; additionally a TIP investor could experience a loss of principal if the TIP is sold prior to maturity.

Aside from the tax-consequences, keep in mind that corporate notes are subject to higher credit risk than TIPS since they are based on the credit-worthiness of the company issuing the bonds. In contrast, TIPS are backed by the full, faith, and credit of the federal government.

Spending Down Assets

How would you pay for nursing home care or other types of long-term medical care? Many people believe that Medicare will cover the bills. But the fact is Medicare only pays a portion of your long-term care expenses – and that’s only for short-term skilled care and for the first 100 days.[1] With the average nursing home stay lasting 2½[2] years, it is no wonder that many people start out paying for much of their long-term care expenses out of their own pocket.

How will decisions about planning and paying for long-term medical care impact you? Let’s consider some of the issues you could potentially face by looking at a hypothetical couple:
John and Mary are both in their 60’s, happy and healthy, with two grown children. They have sufficient funds to maintain their current standard of living throughout retirement, and intend to leave some of this wealth to their children after John and Mary pass away.

Mary’s parents are still alive, are in their 80’s, and have lived in a nursing home for the past year. All of the money that they had put away is going toward their nursing home expenses. Eventually, they will have spent their entire life savings on long-term health care, and will have to fall back on Medicaid or their own children to pay these bills.
Mary sees what has happened to her parents and doesn’t want the same circumstances to affect her and John’s independence. She realizes that long-term costs for two individuals would possibly jeopardize the wealth they have accumulated, as well as their retirement goals. What options do John and Mary have?
Medicare might cover a small part of their expenses, but John and Mary would bear the responsibility for the remainder. And they might not qualify for Medicaid until they have spent down their assets to the level required by law.[3] This could leave them with little to live on if they no longer needed the special care. Plus it could reduce or eliminate any hope of helping their children.

For John and Mary, long-term care insurance could provide a suitable solution. A long-term care policy can possibly be written to address many specific medical concerns they may have, such as a family history of Alzheimer’s or other congenital diseases. Plus, they can review different plans to find a premium that would fit into their retirement budget. Long-term care insurance can be an effective means of remaining independent, preserving your wealth, and avoiding the potential need to spend down your assets under the Medicaid rules.
[1] MyMedicare.gov (2005)
[2] Long Term Care Study, Michigan State (2004)
[3] Centers for Medicare & Medicaid Services (2005)

Don't be so Quick to Sell that Life Insurance Policy

Do you own a life insurance policy that you no longer can afford or want? Perhaps you’re tempted to sell it to an investor who has offered you a way to get money from this relatively illiquid asset. However, before you take the cash, be sure to get all the facts. You just might be better off keeping the life insurance or surrendering it.

Life settlements are frequently directed towards people over age 65 who own life insurance policies with at least a $100,000 face value, have some health problems, and have a life expectancy of 2 to 15 years. When you sell a life insurance policy to a third party, you will no longer be responsible for the premiums. The investor will make all future payments to the insurance company and collect the death benefit after you die.

This concept could be attractive if you think you don’t need the coverage, your beneficiaries have died, or you want the money for other things, such as long-term care insurance. But what is the cost?

These transactions can possibly have high commissions and tax implications to sellers. A study by Deloitte Consulting and the University of Connecticut found that life-settlement companies, on average, paid only 20% of the face value of the policies to the sellers. Whereas the estimated future returns to investors were 64% of the face amount. Therefore, if you want to pass on the maximum amount to your heirs or a charity, you might be better off keeping the policy.
But suppose you need the money? Instead of selling the policy, a better choice could possibly be selling other assets, such as securities. Or you could take a loan from the policy. Another idea is to have your beneficiaries assume the premium payments—after all they’re the ones who will eventually benefit the most.

So how can you determine if a life settlement company is offering a fair price?
Compare it to your other options, such as the policy’s surrender value. Think about this: You most likely bought the life insurance policy when you were healthy. And the insurance company based the future surrender values on your health at that time. These values do not change, regardless of declining health status. Conversely, the life settlement company will use your present medical condition to come up with their offer. Therefore, as the level of your impairment increases, so should the amount of the offer.

Of course don’t forget about the income-tax free death benefit your beneficiaries won’t receive if you get rid of the policy. And in case you’re still not sure what to do, remember that a seasoned, institutional investor wants to buy your policy. Consequently, it must have a significant value. I always advise clients to consult with their own qualified tax and financial advisor prior to making any investment decisions.

Get More from your Assets

Do you own an asset that you wished paid more income, yet you don’t want to sell because you’ll face a hefty capital gains tax? For example, maybe you have a piece of raw land or stocks that don’t pay the dividends you are looking for. In such a case, you might be able to convert them into another investment that provides more income while avoiding the capital gains tax. This could be accomplished through a Charitable Remainder Trust (CRT).

Through a CRT, highly appreciated and/or low-income producing assets are transferred to a trust that will pay you an ongoing income for your life or for a specified time period. Here is a basic summary of how it works:

Your attorney draws up the trust;
You transfer assets that have appreciated significantly to the trust but are producing an income that is lower than your current expectations or needs;
The trust sells the asset and pays no capital gains tax;
The trust then reinvests the proceeds in investments that could possibly pay a higher income (e.g., bonds or preferred stock) Please note that investments in preferred stocks and bonds involve risks, including the possible loss of principal invested.

Some people overlook this technique because they believe that they must leave the trust’s entire principal to the charity. That, however, is not always the case. As a practical matter, the present value of the remainder interest to the charity must equal at least 10% of value of the donor’s income interest. This calculation is largely based upon the age of the income beneficiaries, trust duration, value of the contributed assets and the Applicable Federal Rate (AFR) published by the Treasury Department. Although the trust must be irrevocable, the donor can serve as the trustee of the trust, which can allow you some discretion over the trust investments.
Furthermore, the trust can be designed, in some cases, to provide children and grandchildren with some benefits. In some cases, these trusts have been drafted to provide children, grandchildren, and other relatives with the benefits associated with the income interest. In other cases, the income from these trusts has also been used to fund the premiums of a life insurance policy to support the younger relatives at the donor’s death.

In addition to the potentially higher income payments, the donor is usually entitled to an income tax deduction, which is tied to the value of the charities’ remainder interest. Also, when the trust is properly created, the assets remaining in the trust at the end of the donor’s life (or predetermined term of years) can pass to the charity free of federal estate taxes. Of course, certain income limitations and deduction restrictions will often apply to the amount and timing of the income-tax deduction. For this reason, careful planning is required to determine the extent of the donor’s income and estate tax benefits. As these benefits are subject to several federal tax rules, professional assistance from an established estate-planning attorney is highly recommended.

Creditors will have a Tougher Time Getting to Your IRAs

No one likes to think about bankruptcy. But it can happen to the best of people. In fact, the Administrative Office of the U.S. Courts reported that for the 12-month period ending March 31, 2005, there were almost 1.6 million bankruptcy filings.[1]

A study by Harvard University showed that medical problems caused half of these individuals to seek protection from creditors.[2] And according to the Congressional Record, seniors (65 and older) are now the fastest growing age group filing for bankruptcy protection.[3] If circumstances force you into bankruptcy, you can take comfort in knowing that some of your assets might now be better protected.

On April 20, 2005, the President signed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. The purpose of this new legislation was to revise existing laws to help make credit more affordable for Americans.[4] Part of the regulations expanded the language regarding retirement plans.
All money that you have in qualified retirement plans, such as 401(k)s and profit sharing plans; and 403(b)s are now exempt from bankruptcy. And your IRAs and Roth IRAs will have a $1 million limitation that is adjusted for inflation. Now you may think that this isn’t a particularly large amount since many investors get big rollovers when they retire. The government took care of you there. The $1 million limitation applies only to your contributions and the associated appreciation. It does not include funds rolled into your IRAs from qualified plans, which have unlimited protection.

For example, suppose that over the last 30 years you had faithfully contributed the maximum into your IRA. Now that account is worth $400,000. What if you still have $800,000 sitting in your former employer’s 401(k) and were afraid to roll it into your IRA because your state had poor bankruptcy protection laws? The new federal law has changed all of that.
For even though the IRA will be worth $1.2 million after the rollover, only the original $400,000 will apply to the $1 million limit. The balance falls into the unlimited protection category. However, this only applies to bankruptcy. Not to judgments awarded in other courts where state creditor protection laws could possibility prevail.

Thanks to the new provisions, your IRAs will have more creditor protection and be there when you need the money. Therefore, you can have greater peace of mind when you roll your qualified plan funds into an IRA. Plus you’ll have the flexibility that an IRA can offer, such as more investment options, less restrictive rules, and tax-savings provisions for your beneficiaries. I strongly recommend all investors consult with their own qualified tax and financial advisors prior to making any investment decisions.
[1] http://www.uscourts.gov/Press_Releases/news61005.html
[2] http://www.hms.harvard.edu/news/releases/2_2Himmelstein.html
[3] http://www.senate.gov/~feingold/statements/05/03/2005415658.html
[4] http://www.whitehouse.gov/news/releases/2005/04/20050420-5.html

Convert to Roth after Retirement?

Should you convert a traditional IRA to a Roth IRA after retirement? With retirees enjoying longer lives these days, a post-retirement conversion to a Roth IRA could have advantages for certain investors.

A Roth IRA can be a good savings vehicle for those still working, thanks to the tax-free treatment of qualified earnings. A Roth IRA conversion can also benefit a retired investor. Because there are no minimum distribution requirements, Roth IRA assets can be invested for a longer period and thus have more time to work for you. For a recent retiree, that could mean your assets could potentially have 10 or 20 years to grow on a tax-free basis.

However, you must weigh the benefit of tax-free treatment against the costs of the conversion (in terms of the federal income taxes paid on the converted amount). Furthermore, a Roth IRA conversion generally works best when an investor has a longer investment time horizon.
Generally, you should only consider a post-retirement Roth conversion when you have assets outside your traditional IRA to pay the taxes on the converted amount. Also, if you would end up paying more taxes on the conversion than you would if you leave the assets in your traditional IRA for withdrawals later in life, then a Roth IRA conversion might not be in your best interest.

Some rules to consider: You are only eligible to convert a traditional IRA to a Roth if your modified adjusted gross income ("MAGI") is below $100,000 and you file a joint return with your spouse or you are single.[1] The good news is that the amount of traditional IRA converted is no longer included in your MAGI to determine your eligibility for a Roth conversion.
Another rule you should be aware of: If you convert to a Roth IRA after age 70½, you must take one last required minimum distribution from your traditional IRA for the year in which you make the conversion. The remaining assets in your IRA are then available for conversion to a Roth.

Although distributions from a Roth IRA typically come out tax-free upon retirement, you must satisfy a five-year holding period requirement to achieve this benefit. Please also note that early distributions prior to age 59 ½ can be subject to ordinary income taxes and a 10% income tax penalty.
[1] IRS Publication 590 (2005)

Probate is the legal process of wrapping up a person's affairs, paying their bills, and distributing their assets. And it is not uncommon for this to take several months to go through the court system. The expenses involved can potentially include property appraisal, executor fees, court costs, plus legal and accounting fees. The amount varies depending on your state and the local practice in your community.

To avoid this burden on their loved ones, seniors frequently transfer assets into joint-tenancy ownership with their intended beneficiaries. Although this strategy can reduce settlement costs by eliminating probate, it could open up another set of problems.

Assets held in joint-tenancy automatically go to the surviving owner when you die. However, while you are alive, the joint owner can legally withdraw part or all of the money in the account without your permission. In addition, if he or she gets into financial or legal trouble, the property could be at risk to creditor claims.

Rather than making a beneficiary a joint owner of your property to simply avoid probate, you might consider another idea.

An individual can own certain assets and list a beneficiary. At the owner’s death, the assets pass to the named beneficiary and avoid probate. While you are alive, your beneficiary does not have access to your account. You can change beneficiaries at anytime, and you might even be allowed to name a contingent beneficiary.

A Payable on Death (P.O.D.) registration applies to bank, savings and loan, and credit union accounts, as well as United States savings bonds. On the other hand, a Transfer on Death (T.O.D.) registration is used for securities such as stocks, bonds, and mutual funds (but only if the securities firm allows it). With both of the above, the beneficiary receives the funds by offering proof of identity and a copy of your death certificate, regardless of the provisions in your will. Please note that the assets will still be included in your estate when you pass away. Estates that exceed $2 million are subject to federal estate taxes.

Which Account Should Your Draw from First

This is a common dilemma for seniors who are retired and have investments in taxable accounts as well as tax-deferred ones, like IRAs. Generally, you would want to take money from your taxable accounts first so as to preserve the tax deferral of the other funds. There may, however, be circumstances where investors should consider alternatives.

When you withdraw funds from a taxable account, your income tax liability is limited to amounts exceeding your cost basis that has not been previously taxed. Whereas all money you take from your IRA is usually taxable. Yet if you let the IRA grow, you’ll pass that tax burden to your beneficiaries.

On the other hand, if you use the IRA funds first, you’ll have the income tax to pay. But then a greater amount of the taxable accounts can remain intact to transfer income tax free to your heirs.

It can be a tough choice to make and everyone’s situation is different. Here are two other solutions that you may want to consider:

Convert to a Roth IRA
You could roll your traditional IRA to a Roth. You’ll have to pay income tax on the amount transferred. But once the funds are rolled over, withdrawals and bequests are income tax free.

Wealth Replacement Trust
Compare your income tax liability of taking money from the taxable account vs. the IRA.
Also how big of a tax bill will your beneficiaries face? You could buy a life insurance policy to pay the income tax for them. And possibly you might finance it each year with the taxes saved by withdrawing funds from your taxable accounts rather than the IRA.

What's the Real Return on a Fixed Annuity

Annuity interest rates can often change in tandem with the rates paid on other fixed interest investments. However, whenever rates drop, the real return on annuities could potentially be higher than other interest-paying assets.

First of all, fixed deferred annuities typically promise a minimum rate of return for the term of the contract. For example, if you select an annuity that locks in current rates for five years, you will earn a competitive rate for the first five contract years. After that, you will receive no less than the minimum rate, regardless of how low market rates might possibly go.

Second, annuities are tax-deferred investments. That means the earnings on your annuity’s principal will compound without you owing current taxes. Other fixed income investments, such as CDs, are taxed as interest is credited (of course, CDs are FDIC insured for up to $100,000 per account). Even if you reinvest the interest, you have to pay income tax. This reduces the effective rate of return on your taxable fixed interest investments.

Please note, however, that annuities are designed for long-term investing and ordinary federal income taxes and a 10% tax penalty could apply to withdrawals taken prior to age 59 ½.
Third, many annuities pay bonuses for the first year. This extra return could boost the yield over the term of the contract. However, early withdrawals from annuities could result in surrender charges that reduce the benefits of these bonuses. Please note that annuities that pay bonuses may have higher fees and charges and longer surrender periods than other annuities that do not offer a bonus.

In some cases, you can also put off taking money out of an annuity and therefore delay paying income taxes. This could allow you to arrange your payments to coincide with time periods when you are in a lower tax bracket. Furthermore, you can sometimes postpone receiving payments from annuities for your lifetime and structure a plan to create additional funds for your heirs. In this case, your heirs will pay income taxes at their respective tax rates. You can’t do that with CDs (of course, annuities and CDs are both subject to estate taxes if the owner’s taxable estate exceeds $2 million). As previously mentioned, annuity benefits and guarantees are based upon the claims-paying ability and financial strength of the underlying insurance company and are not government insured. Additionally, one should remember that annuity surrender charges are often based upon the time the insured has been invested in the annuity and surrender schedules vary from company to company.

Tax Strategies for Retirees

Now that you are either retired or close to retired, preserving your principal while taking a steady income from your investments could be more important than ever. But if you are in a high income tax bracket, the federal government could be waiting to take up to 35% of the income you receive from your investments.[1]

With respect to your IRA money, you could also be at the age (over 70½) where you are required to take minimum distributions (RMD). But each year, do you find yourself sticking the money into a checking account or CD. Although there is something to be said about safety and the FDIC insurance afforded to these investments, it is important to also consider the effects of income taxes and cost of living. In years where inflation is on the rise, you could find that your “after-tax” return is not keeping up with the cost of living.[2]

As a practical matter, municipal bonds could offer an alternative and some tax relief, since the interest is generally received free of federal, state and local income taxes. This could provide more income to help meet retirement needs. Of course, there are exceptions to the favorable income tax treatment for taxpayers that are subject to the Alternative Minimum Tax (ATM) or who have invested in bonds outside of their state of residence. You should remember that these bonds are backed by the credit of the issuing local government, and the principal and yield on these bonds can fluctuate with market conditions.

On another note, if your beneficiaries receive your IRA money, they will have to pay income taxes on their distributions. Assuming that your IRA grows, this means that the potential income tax liability to your love ones will also increase. On the other hand, beneficiaries who receive assets that are owned “outside” the IRA will receive them at the fair market value on your date of death. In other words, you beneficiaries receive a “stepped-up” cost basis on the inherited asset.
To illustrate this principal, you could have mutual fund shares in your IRA that are worth $100,000. When the funds are held inside an IRA or other qualified retirement plan, your beneficiaries will eventually pay income tax on the entire value of the shares at their respective tax rate. However, if you own the shares outside an IRA, your heirs could receive and sell the shares without owing any federal income taxes (although federal estate taxes could apply if the decedent’s estate exceeded $2 million). This is something to consider if you are concerned about the end-result of your estate plan.
[1] 2005 Federal Income Tax Rates
[2] Society of Certified Senior Advisors, Working With Seniors, p. 351 (December 2003)