LISTEN: SOCIAL SECURITY: You Might Still Get It –If You Live Long Enough (mp3audio) (5:48 min)

With all the political rhetoric about the economy, notice there isn’t much noise about Social Security. In the midst of the toughest economic stretch since the Great Depression, you’d think a national insurance and pension plan that is tottering toward a financial breakdown would generate some strong political discussion. Why so little dialog? Here are some thoughts.

First, the summary review: Social Security provides pension and insurance benefits for qualified recipients by collecting a payroll tax on all wage-earners. In the past, the number of wage-earners far exceeded those receiving benefits. However, increased longevity and the arrival of the Baby Boom generation on the threshold of retirement has skewed the math: At current tax rates, the Social Security Administration will not collect enough from those who are working to provide benefits to those eligible for benefits. In a word, the plan is broken.

Sifting through all the political posturing, there are only four possible real-world solutions to fix Social Security.

1. Increase taxes.
2. Decrease benefits.
3. Change the eligibility requirements.
4. Scrap the plan.

From a rational perspective, getting rid of something that isn’t working is an obvious choice. But the question that follows is “what do we do for a replacement?” Change is fraught with unknowns, both for citizens and leaders, and even good ideas can be scared away by “what might happen.” For three decades, the standard political response has been to defer making a decision, leaving the responsibility in someone else’s hands. And as long as the checks keep coming, there’s little call for change from the populace as well. The hope is “I get mine before the well runs out.”

With a sluggish economy and growing sentiment that the national government has already spent irresponsibly, the idea of raising payroll taxes for all citizens doesn’t have much popular appeal. While government leaders certainly look to squeeze every bit of revenue from the populace, politicians only rule if they get elected. Raising taxes is not a popular plank on the reelection platform this year.

20th century British scholar C. N. Parkinson observed that a “luxury once enjoyed soon becomes a necessity.” Adapting this thought to Social Security, it’s fair to say that what was once supposed to be supplementary income in old age has become a critical retirement component for many Americans. As such, it’s hard to imagine a politician seeing much to be gained by threatening to decrease benefits.

That leaves changing the eligibility requirements. In mid-July, 2010, members of Congress from both parties mentioned two possible changes. The first is to raise the Social Security retirement age to 70 for people who are 50 or younger today. The second proposal up for serious consideration is to include a means-test for benefits; those with more assets would receive smaller benefits.

Raising the retirement age is a logical response to the increased longevity of Americans since Social Security was established in the 1930s. As Patrice Hill of the Washington Post noted in a July 13, 2010 article “with people living longer and enjoying better health in their senior years, the nation simply can’t afford any longer to be paying out benefits for as long as 30 years after retirement.”

The rationale for implementing a means-test to qualify for benefits is simple economics. In the words of Ohio Congressman John Boehner: “If you have substantial non-Social Security income while you’re retired, why are we paying you at a time when we’re broke?” he said. “We just need to be honest with people.”

A means-test would represent a fundamental change to Social Security. With benefits indexed to income or assets, it is possible that some affluent workers will never receive benefits even though they will make a lifetime of payments into the plan. While this approach won’t result in an across-the-board decrease in benefits, making Social Security a clearly defined wealth transfer program has some political risk.

Twenty years ago, retirement planning was often pictured as a three-legged stool, with the legs being Social Security, the company pension, and personal savings. Today, the pension leg is rapidly vanishing from the financial landscape, personal savings have been pounded by the economy, and Social Security (if it survives) looks like it will come into play later in life. This turn of events leaves many Americans wondering if they will have a leg to stand on in retirement.

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LISTEN: Whole Life Insurance: Complex, Ingenious (mp3audio) (11:47 min)

What is whole life insurance? A simple answer, one you might find on a financial information website, might describe whole life insurance as a combination of life insurance and cash value. But once you get past this basic definition, the details and workings of a whole life policy can be quite sophisticated, maybe even confusing. Writing in the January 11, 2009 Palm Beach Daily News, life insurance expert R. Marshall Jones said that:

“Until recently, permanent life insurance was arguably the financial industry’s most complex instrument…”

As with many other complex financial products, whole life insurance is the result of the integration of several basic financial ideas. The starting point for whole life is an understanding of some of the shortcomings with a simple financial instrument, term insurance.

Here’s the big issue with term insurance: As you get older, it gets more expensive. Because statistics show older people are more likely to die than younger people, insurance companies price the coverage accordingly. To illustrate, here are 50 years of scheduled premiums from a reputable life insurer for a healthy 35 year-old male non-smoker to secure $500,000 of life insurance on a yearly renewable basis.

This pricing, while accurately representing the risks assumed by insurance companies as people get older, creates a dilemma for consumers. As they live longer, and pay increasingly expensive premiums, the cost of insurance becomes prohibitive. Thus, when they are most likely to die, they may not be able to afford the insurance. From a financial perspective, the only way to “win” in this transaction is to die “young,” before the insurance gets too expensive. Given the aversion most of us have to dying, the most likely outcome of yearly term insurance is paying premiums for a period of time, then lapsing the coverage. Even though the consumer may have a real need to provide the financial protection of life insurance, the yearly renewable premium schedule creates a financial incentive to drop the protection as soon as possible – or simply forgo life insurance altogether. This is a lose-lose proposition, for the consumer and the insurance company.

Integrated Solution, Step One
One response to increasing yearly renewable premiums is leveling the premium. Instead of increasing the cost every year, the insurer determines a flat rate for a specified number of years, i.e., for a term. A typical term may be 10, 15, 20 or 30 years. The level term arrangement results in a policyowner overpaying (relative to the true annual cost of insurance) during the early years of the term, then underpaying at the end. For the 35-year-old in the above example, the 30-year level term premium is $490/yr. Compared to yearly renewable term, the level premium is more expensive for the first 10 years, then less expensive for the next 20.

To accurately price level term insurance, the insurance company must make some assumptions about the time value of money, because the “additional” premiums they collect in the first 10 years will be invested to subsidize the cost of insurance for the following two decades.

A level term premium schedule significantly resolves the problem of the cost of insurance becoming progressively more expensive in later years – at least during the term. But when the term expires, the problem returns. In our example, the cost to renew $500,000 of life insurance at age 65 is $5,025/yr. – providing the individual can prove excellent health by passing a new physical examination. Even if he is healthy, the new term is limited to 20 years (age 85). And what happens if this man lives to age 86? The scheduled renewal premium is now $207, 990! For one year!

While level term premiums help consumers afford life insurance longer, the same end-of-life problem remains: Just when you are most likely to collect on the life insurance, you may not be able to pay for it. Level term insurance is certainly a win for the insurance company because policyholders pay more premiums longer, but the financial outcome is less clear for most consumers using term insurance – they still are not likely to have an insurance benefit in force at death.

Integrated Solution, Step Two
A lifetime term policy with level premiums would solve the problem. But fairly pricing term for one’s entire lifespan creates a new problem: As illustrated by the yearly renewable table, the cost of insurance rises steeply after age 60. So even with a long time to “overpay” at the beginning, a policy guaranteed to be in-force at age 100 requires a sizable annual premium. In the case of our healthy 35-year-old non-smoker, the lifetime annual premium is $6,165/yr., more than 12 times the annual premium for the 30-year term policy. Unless the consumer has money to burn, the idea of overpaying $5,600 each year (the difference between the whole life and level term premium) for the next 30 years just to keep the premiums affordable in old age probably won’t set well. There’s just too much overpayment for too long to convince most consumers to set aside that much money for an event that may be 50 years in the future.

Enter the concept of cash value. The overpayment of premium in a whole life policy represents reserve capital the insurance company will use to cover the cost of insurance as the policyholder ages. In the meantime, this reserve capital will be invested to generate more capital. A portion of this excess cash value, and the earnings from it, is credited to a cash account tied directly to the policy. While the policy is in-force, the policyowner has the right to access this cash value, through a variety of transactions (loans, partial surrenders, dividends, etc.).

In a typical whole life policy, this cash value can eventually exceed the total premiums paid, i.e, the policyholder not only owns the insurance benefit, but has received a positive return on the premiums.

This blending of cash value and life insurance is a brilliant example of integrated thinking. A whole life policy with a level premium provides economic certainty for consumers – they know how much insurance they will have, they know how much it will cost, and (as long as premiums are paid) they know the insurance will be in-force at the end of their lives. At the same time, the larger premiums give the insurance company greater financial stability. It has greater resources to meet its contractual obligations. And during the lifetime of the policy, the owner also has access to this stable source of cash value (and its growth) as well.

Complexity begets more complexity – and more opportunities
Besides turning the life insurance benefit into an asset instead of an expense, the cash value component opens the door to other possibilities. Dividends* can be received as income, or used to pay premiums. Additional paid-up insurance may be purchased. Depending on the performance of the cash value account, additional premium requirements may change or be eliminated.

Because the benefit paid at death is now certain, life insurance can do more than provide income replacement protection in the event of a premature death. Among other things, the proceeds can be vital in estate and inheritance planning, serve as a supplement to long-term care, pay creditors and fund charities.

Some might argue that it is hypothetically possible to project similar or greater financial results by choosing to use term insurance alongside other accumulation vehicles. On paper, this is possible. But while two simple stand-alone financial products might appear to out-perform whole life in a narrow set of criteria (such as pre-tax accumulation in a 20-year period), they cannot equal the combination of benefits, guarantees and flexibility that result from using a whole life policy. The integration of level premiums and cash value, and the resulting opportunities make life insurance a win-win for all parties.

Just as whole life is a multi-faceted complex financial instrument, there are many ways to position whole life in one’s financial program. Contact us to find out how whole life might best fit your current circumstances.

*Dividends are not guaranteed, and are generally declared annually by the company’s Board of Directors.

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LISTEN: Should a Second Home Be The Only One You Own? (mp3audio) (10:24 min)

It’s too early to make a definitive statement, but the fallout from the real-estate bubble may result in some fundamental long-lasting changes in Americans’ perspectives on home ownership. Not only is there the chance that fewer Americans will be able to own a house, but even those who are prime candidates for home ownership may find other options more attractive and financially profitable.

A little background:
Before 1940, slightly less than half of all American households owned a home, a percentage that had remained unchanged for more than four decades. Following World War II, the Baby Boom, coupled with government tax breaks and subsidies, rapidly increased the percentage of Americans who owned their house¹. By 1960, more than 60% of Americans were homeowners, and for a period in the late 1990s and early 2000s, the number approached 70%.² Homeownership became a standard fixture in the American Dream.

However, the allure of homeownership has lost much of its luster in the recent financial melt-down, both for homeowners and the financial institutions who initiated the mortgages to make the purchases possible. Where once only a few financial commentators questioned the financial value of owning a home, a tide of commentary is asking if the US economy would be better off with fewer homeowners and more renters. But maybe the problem isn’t how many people own a home, but what type of home they own.

When the housing market was booming through the past two decades, it was assumed that almost every homeowner could expect to cash out with relative ease, either by selling the house or taking a home equity loan. Home equity was seen as a liquid real asset, one that could be accessed at almost any time.

However, as banks have tightened their lending standards to potential homeowners, the market of potential buyers has shrunk, driving prices down. At the same time, more homes are being liquidated at discount in foreclosures and short sales, further depressing the market. In the course of the past three years, current homeowners find their home equity has substantially diminished – and isn’t very liquid.

These changes in the real estate market increasingly make homeownership a much longer term proposition. A decision to buy a home today isn’t easily undone. For those who currently own a home, it may take awhile for values to rebound, and selling the home in the future is no longer a foregone conclusion, even at reduced prices. This fundamental change in perspective regarding homeownership should compel individuals to consider questions like:

• Is there a profitable exit strategy for this house, or should I plan to live here for the rest of my life?
• What happens if an employment change requires a relocation?
• What is the projected market for my property in the future?
• What is the legacy value of my home? Is this an asset my heirs will want to inherit?

In the past half-century, the largest increase in American residential housing has been in suburban communities, and the bulk of the middle-class homeowners own single-residence dwellings in subdivisions. If you are one of these suburban home-owners, how would you answer the questions above? Can you see yourself staying in this house for the next 20 or 30 years, or into retirement? Would someone else want to live in your subdivision? And if your children or other heirs inherit this property, will they see it as a valued asset or a financial albatross?

When you consider the changing demographics of an aging population, a post-Baby Boom contraction in housing demand for single-family homes, and fewer financially-qualified home buyers, it is reasonable to think the long-term prospects for suburban housing won’t be what they have been for the past 50 years. If this is true, a different approach to homeownership might have some appeal.

A different approach.
Instead of a single-family house as the default option for real estate, look at other options. For example, think about renting a primary residence and buying a “second home” – such as a cottage, a vacation or resort property, or a even an income property in a thriving community. Under the right conditions, this strategy could have several advantages.

First, many buyers of a “second home” property could still receive tax advantages that would closely approximate those that come from owning a primary residence. Second, income from rentals (seasonally on resort properties, or year-round in residential locales) may offset many of the costs of ownership. Third, resort and vacation properties can be enjoyed by owners and their families for their recreation and destination value, both now and in the future. Fourth, renting may offer greater flexibility in adjusting to fluctuating living conditions, such as changes in employment or children leaving the nest. Fifth, if it is desirable to make this property a home in retirement, the transition is simple; you stop renting and move into the house. Sixth, a profitable rental or desirable vacation home would likely have ongoing value for heirs; a sale would not be required for them to receive value from the inheritance.

This strategy of buying a “leisure home,” while living in a rental is not a new idea. This pattern was typical of many wealthy individuals during the late 19^th and early 20^th century. They owned an “estate” in the country, and rented a workplace residence. American steel magnate and finance giant Andrew Carnegie (1835-1919) was one of the richest men in history, and he established his fortune quite early in life. When he was in his twenties, Carnegie erected a large estate home on property in Homewood, PA, near his hometown of Pittsburgh. Yet for much of the next 25 years, Carnegie resided in luxury hotels in New York City, returning to his estate during the summers or as a stop on his travels. At various times, other members of Carnegie’s family also lived at the estate, but it was never Carnegie’s exclusive residence. In later life, Carnegie established additional large estates in Massachusetts, Georgia and Scotland.

In several ways, the “titans of industry” during the Industrial Revolution mimic some of the work circumstances of people in the 21^st century Information Age. Carnegie and other businesspeople of his era were establishing continent-spanning businesses that required them to be mobile. Even though some employers may offer telecommuting options, today’s workforce opportunities often require a high level of transience. Today’s worker expects to change jobs more often, and to change their places of residence as well. While any relocation is stressful, it could be argued that renting makes moving easier from a financial perspective – there is no home to sell, no monthly mortgage payment on an empty home, and there is no equity loss to worry about.

At the same time, buying an “estate property” offers several tangible and financial benefits, both now and in the future. A well-managed income property has the potential to add revenue to your financial program. A vacation home can be a welcome getaway and a gathering place for families as they grow up and expand. In both instances, the need to sell will be lessened, which allows more time for equity appreciation, and gives owners the upper hand in deciding when and if a sale should take place. If this property stays in the family for several generations, the long-term benefit of buying estate property could be incalculable.As the turmoil from the Great Recession recedes, the fallout is revealing changes in the financial landscape. Those changes may affect the role of homeownership in the American dream. While single-family residences may still occupy a prominent place in the financial lives of many Americans, it doesn’t hurt to consider (and prepare) for other options.

DO YOUR LONG TERM FINANCIAL PLANS INCLUDE “ESTATE PROPERTY?

IF YOU FOUND AN ESTATE PROPERTY OPPORTUNITY, HOW WOULD YOU EXECUTE THE TRANSACTION?

WOULD YOU LIKE TO EXPLORE THESE, OR OTHER IDEAS WITH US?

U.S. Census Bureau:
11989 report, Historical Statistics: Colonial Times to 1970.
2 US Census Report, Homeownership by Area (focusing on homeownership from 1960-2008)

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LISTEN Asset Transfers (mp3audio) (9:57 min)

Perhaps coinciding with the economic fallout from the Great Recession, the past few years have seen some significant adjustments by financial experts in regard to cash value life insurance. Rather than being seen through a black-and-white lens as either “expensive life insurance” or a “poor investment,” there is a groundswell of commentary that recognizes the unique position cash value life insurance holds in the financial universe.

One of the more prominent commentaries on this new perspective toward cash-value life insurance comes from a 2008 report by Richard Weber and Christopher Hause titled Life Insurance as an Asset Class: A Value-Added Component of an Asset Allocation. As part of their findings, Weber and Hause concluded that:

Permanent life insurance can optimize the risk/reward profile of an investment portfolio. That is, a portfolio with both fixed and equity components that includes life insurance intended for a lifetime, may deliver greater legacy and living values in conjunction with the investment portfolio – for a given risk tolerance and reward goal – than the portfolio without the intended life insurance.

In determining how to pay for permanent life insurance, Weber and Hause make another important statement:

…consumers may wish to consider paying premiums from portfolio resources rather than from income resources.

This is the idea of acquiring life insurance through asset transfers. A simple example of asset transfer would be using the earnings (such interest or dividends) from one asset to pay the premiums to establish a new asset (the permanent life insurance policy). In fact, Weber and Hause take seven pages of their 100-page report to conduct an in-depth financial analysis of this asset-transfer approach, using earnings from a bond portfolio.
The end result: greater accumulation, plus increased benefits.

Other methods of asset transfer:
Single Payments — Depending on the makeup of the assets in one’s portfolio, using earnings to fund annual premiums may not be feasible. Perhaps the principal is not large enough to generate the necessary earnings each year. Or maybe the other assets appreciate in value, but do not distribute interest or dividends. Even if the principal is large enough, some assets may be volatile, and market fluctuations could make it hard to rely on them for ongoing premiums. Also, any transfer from a qualified plan may include an ordinary income tax consequence and a tax penalty on the transferred amount.

In any of these circumstances, it might be desirable to transfer the asset into permanent life insurance in one transaction, i.e., a one-time payment instead of a gradual year-by-year series of transfers. This can be done; the challenge is determining how best to make the transfer.

Single-premium life insurance policies can be used for asset transfers. With this type of policy, one premium secures the life insurance benefit, and establishes a cash value account which grows over time as nonguaranteed dividends are credited. However, current tax law on single-premium policies restricts or diminishes some of what Weber and Hause term the “living benefits” of a permanent insurance contract, specifically the tax-favored access to cash values via either partial surrenders or loans. These restrictions apply not only to single-premium policies, but any cash-value life insurance policy classified as a Modified Endowment Contract (MEC). The MEC guidelines are quite complicated, and exist to discourage the manipulation of permanent life insurance policies into artificially tax-favored “investments” instead of true insurance policies. For most individuals who want to include permanent life insurance in their financial portfolio, avoiding the MEC classification is preferred.

Premiums Paid in Advance — To avoid the MEC classification, yet allow policyholders to fund a permanent policy with one payment, some life insurers offer another option: premiums paid in advance. The rules vary with the insurance company, but usually follow this format: After underwriting approval for an insurance policy has been authorized, the insurance company will allow the policy owner to “pre-pay” future premiums to an account with the company. These premiums will be credited with interest, and gradually transferred to pay future policy premiums. Here is an example from a leading life insurance company, reflecting current rates.

Suppose the annual premium for a 10-pay whole life policy is $5,000. Under normal payment methods, the policyowner would pay a total of $50,000 over ten years to fully fund the policy, but not achieve MEC status. In an arrangement to accept the ten years of premium in advance, the insurance company gives a discount to the policyowner reflecting the interest the company will add to the deposit. In this example, the insurance company is crediting a 4.75% annual return for the first 10 years of the agreement. Thus, instead of requiring $50,000 over ten years, the one-time premium-in-advance amount is $40,938. Each year on the policy’s anniversary, $5,000 is transferred from the advance premium account to the policy. At the end of ten years, the advance premium account is empty, and the policy is fully funded. This arrangement allows the policyowner to establish the permanent insurance policy with one payment – with all of the legacy and living benefits – even though the policy will not be fully paid-up for 10 years. Note: ordinary income taxes apply to the interest earned in the premium account.

There are other important details in connection with this advance premium arrangement which will vary by company. Typically, there is a limit on the amount that can be deposited, as well as a limit on how many years can be paid in advance. With this particular agreement, the policyowner cannot withdraw the balance from the premium account without also surrendering the insurance policy. If the policy is surrendered, the company may charge a surrender fee against the advance premium balance. Also, the interest credited to the account will be reported as income, which may or may not result in additional taxes.

Why would someone use the advance premium payment option? Paying insurance premiums from existing portfolio assets on an annual basis usually requires holding some funds in a safe and liquid account. Currently, these types of accounts may not offer annual returns or guarantees as attractive as the crediting rate in the insurance company’s advance premium account. If you already know this money is earmarked for premiums, and when adding permanent life insurance to one’s portfolio is the objective, using the advance premium payment option may be another way to increase returns and benefits, while minimizing financial risk.

Or suppose you just realized a large gain from another asset in your portfolio; a property was sold, a stock position was liquidated. You have a significant gain you want to transfer to a secure asset, such as permanent life insurance. The advance premium account serves as a conduit to affect the transfer in a clean and efficient manner. With one deposit, the life insurance program is either established or secured (the agreement can be used to pay for existing policies, not just new ones).

Of course, whether an advance premium payment option is appropriate depends on your unique circumstances. But if you are currently paying insurance premiums from other existing assets rather than income, you may want to see if this approach could enhance your asset transfer process.

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LISTEN Bugged by Gold (mp3audio) (10:32 min)

It’s baaaack!

The foundation of monetary systems for centuries, gold has been considered an anachronism in modern financial philosophy, something that computers and sophisticated monetary models had made irrelevant. With the exception of a few contrarian “goldbugs” who market a doomsday view of the financial future, gold is now seen as a precious industrial metal, and its value depends on how it is used – in jewelry, dentistry, electronics, glass-making, etc. But as the shake-outs continue from the global financial crisis that began two years ago, gold has resurfaced in the financial arena. Two news items during the same week in May highlighted a return to prominence for an ancient financial asset.

• Beginning May 13, 2010, CBS News and the Wall Street Journal were among several news outlets to report on an ATM in Abu Dhabi that dispenses gold in exchange for paper money. The ATM provides updates of gold prices every 10 minutes, and dispenses both coins and bars of gold in exchange for paper money.
• Later that week, on May 17, a high-profile television stock market guru (known for his loud and animated opinions) weighed in that now was the time for investors to consider gold as an investment. Citing “Six Reasons to Buy Gold Now,” this investment expert was enthusiastically recommending gold as a “buy.”

At the same time, there is a proliferation of commercials on radio and television urging consumers to exchange their “unwanted gold” (usually jewelry) for money. So…there’s a group that says “now is the time to buy gold”, and another that says “now is the time to sell”. What to think?

Because of its chameleon-like characteristics and long history, gold holds a unique place in the financial world. It is truly a one-of-a-kind financial asset. And there are numerous ways to view gold in a financial program.

Gold as Money
One of the most common uses for gold through history has been as money. In coins or bars, gold has been a preferred medium of exchange. Historically, several characteristics have made gold well-suited as money. First, gold itself, in any form, has an almost-universal appeal. It is attractive, durable, and malleable. This means gold can be converted from its function as money into another type of asset without an exchange taking place. A person with five gold coins can melt them and recast the metal into a bracelet, or gold thread or a crown for a tooth. Second, gold is a fungible commodity, i.e., one ounce of gold is considered interchangeable with another. Possessing these two traits, almost every society was more than willing to accept gold as payment for any type of transaction. The face or national symbol stamped on the coin might vary, as would the measures of weight, but for most of the past twenty-five centuries, gold has been the universal currency. (In the early years of the United States, all sorts of gold coins circulated as money, from Spanish doubloons to American double eagles.)

While other items (such as shells or animal pelts) have also served as money, the proponents of gold argue that no other item, including all types of paper currency, is a better medium for financial exchange. Because gold is relatively rare (it is hard to extract and hard to refine), and has real value besides serving as money, there’s not enough in circulation for governments, institutions, or individuals to manipulate its value. In contrast, governments and central banks can “re-price” their money in a variety of ways, typically by increasing or decreasing the amount of paper money in circulation.

Currency manipulation is a primary cause of inflation. In the past, countries and banks have so drastically manipulated either their currency or notes of credit that they became worthless. In the 20th century Germany, Argentina and several African countries experienced periods of hyper-inflation such that their paper money systems collapsed. Instead of serving as units of value, the “money” was nothing more than small pieces of printed paper. Because of the possible dangers of paper money, some economists advocate that all paper money be backed by gold, i.e., you can always exchange a paper note for a corresponding amount of gold. Today, no countries operate on this gold standard, but in times of financial unease, gold may become “money” for people who don’t feel secure making transactions with the paper currency of a particular nation.

Gold as an Investment
Since gold has a long history as real money, it is possible to use gold as a gauge of the value of other forms of money, and to make bets as to which forms of money may fluctuate in value. For example, the market price of an ounce of gold in US dollars on May 21, 2005 was $416.27. Five years later, on May 21, 2010, the price was $1,187.80. An individual who bought 100 ounces of gold five years ago for $41,657 and sold it on May 21, would have realized a gain – in US dollars – of $76,889, which equates to an annual rate of return of slightly more than 23.3%. That sounds like a pretty good investment decision. However… If you bought 100 ounces of gold 15 years ago, in May 1995, the price was just under $400/ounce. During the 10-year period, from May 1995 to May 2005, the rate of return on a gold investment – in US dollars – was close to 0 percent. From an even longer perspective, the price of gold compared to US dollars dropped from a high of $850/ounce in January, 1980 to $481.50 two months later, then stayed in a range between $500 and $300/ounce for the next 15 years. This isn’t the type of long-term performance that most investors are seeking.

From an investor’s perspective, gold usually delivers returns when the bet is against the economy. As the TV stock guru put it, gold is for “when the mentality toward the market becomes negative.” But the trend of a nation’s economy, and human activity in general, is not downward. Down cycles are corrections, followed by new growth. This makes investing in gold primarily a timing strategy. You have to believe you know when to get in, and when to get out.
Statistically, most of us, even the experts, are poor market timers, whether the investment is gold or something else. A cynical observation is that the only people who consistently profit from market timing are those who market the idea.

A “Classic” Idea: Gold as “Insurance”
Besides the use of gold as money and as a speculative investment, there is a long financial tradition of gold as a small, permanent fixture in a financial portfolio. In the form of jewelry, coins and other physical forms from works of art to bars, gold has been viewed as another real asset, like real estate, equipment or art. These gold items were not intended to be bought and sold – they were purchased for collections, for artistic and personal reasons, and were intended to be passed on as family heirlooms.
But just in case…there was always the security in knowing that as a last resort, these items could be liquidated in the event of an extreme financial emergency. This was not an investment strategy, like a collector who buys in order to sell later. This was financial “insurance”, because regardless of whatever might happen to the collectible value of coins or jewelry or other gold objects, there was the assurance that the gold gave it some underlying value. In this context, many individuals would routinely acquire some gold or similar precious metals, primarily as things to enjoy, but with a perception of “financial security.”

Ultimately, gold is a real asset. While it is fungible and accepted by almost everyone as being valuable, its value depends on all sorts of other variables. While it can function as money, and be used to speculate on the relative value of other types of money, a case can be made that the classical perspective on gold – small amounts purchased for enjoyment, inheritance and rare financial emergencies – is one that can be most applicable to everyone.

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LISTEN (mp3audio) (20:16 min)

Buzzwords, Trends, and Unintended Consequences
Here are a few financial particulars currently receiving a fair amount of attention in the financial press:

BUZZWORD: PHASED RETIREMENT

The combination of a struggling economy and declining asset values has affected a sea change on older American workers. Instead of anticipating an early retirement filled with leisure and travel, a new set of expectations have appeared. For some, the prospects for retirement have been postponed; for others, the only option appears to continue working as long as one is able.

But even these adjusted objectives face a daunting challenge: The realities of aging. Even if we are healthy and have employment, most of us face the prospect of declining capacity as we get older. As we age, we can’t work as hard or as long as we could when we were age 30 or 40. This reality can put some people in a bind: In their current circumstances, they don’t have enough time to “catch up” for retirement, and they don’t have the physical capacity to earn more to make up the difference.

Enter the idea of “Phased Retirement.” The term can refer to a broad range of scenarios, but all generally revolve around two ideas: (1) the individual continues working, but usually with a reduction in the number of hours on the job. (2) In concert with the decreased workload, the individual supplements his income with previously accumulated retirement assets.

Phased retirement could take many forms. In fact, many individuals that we might currently classify as “semi-retired” are actually implementing a phased retirement strategy. As an example, it could be a person who retires from 40-hour-a-week employment, takes a part-time job, and draws Social Security and/or a small amount from his/her retirement account. In this form, the possible configurations of phased retirement are endless: part-time work, independent consulting, or seasonal employment combined with irregular withdrawals, or period certain annuity payments, etc.

However, some versions of phased retirement may actually require some restructuring of pension and retirement plans. Consider the situation of a long-term employee with a high level of technical skill and experience. The employer may find great benefit in retaining this employee, even on a part-time basis, so a plan where the employee works three days a week and draws a partial retirement might seem ideal for both parties.

But what if most of the employee’s retirement assets are held in the company’s 401(k), or are in the form of a company pension? Many retirement plan rules prohibit active employees from receiving retirement plan distributions while still employed. And if there is a pension plan, how will the employee’s ongoing earnings affect payments they are receiving concurrently?

Even if you think your accumulation plans are on track, there may a phased retirement in your future. Numerous studies have shown that older workers are valued for their experience, knowledge, work habits, commitment to quality, and proven ability to work in a team environment. Regardless of age, good employees are worth retaining, and as the population glut from the baby boom generation recedes, it is becoming harder to find younger replacements. Especially if you are an employee with highly specialized skills and a long tenure with one employer, you might receive an offer that’s too good to refuse.

The concepts contained in a phased retirement program also upend some paradigms of conventional retirement planning. It is possible, even likely, that a phased retirement program will experience income ebbs and flows. There may be periods when the need to supplement income from assets is quite high, but these times could be followed by stretches where the individual has excess income and is saving during retirement. This fluctuating state of affairs could greatly impact decisions about where funds should be allocated, and which ones should be distributed. Given these changing dynamics, it may be time for you to consider phased retirement strategies and the types of financial products that meet these objectives.

TREND: “STRATEGIC DEFAULTS”

“Go ahead. Break the chains. Stop paying your mortgage if you owe more than the house is worth. And most important: Don’t feel guilty about it. Don’t think you’re doing something that’s morally wrong.”

As outrageous as it may sound, that’s the lead sentence to Kenneth R. Harney’s November 29, 2009 LA Times article titled “Professor advises underwater homeowners to walk away from mortgages.” The professor in the article is Brent T. White, a law professor at the University of Arizona, and his comments were probably the first to articulate, and justify, a growing trend among homeowners. His opinion is, if the home you own is now worth a lot less than what you owe on your mortgage, walking away from your home and defaulting on the mortgage may look like a prudent financial decision – even if you still have the financial resources to make the payments. Say hello to the “strategic default.”

A strategic default is the decision by a borrower to stop making payments on a debt despite having the financial ability to make the payments. While businesses may regularly implement strategic defaults (typically on mothballed facilities), only recently has the approach taken hold in the personal real estate arena.

Strategic defaults usually occur after a substantial drop in the house’s price so that the debt owed is considerably greater than the value of the property. This results in a negative equity situation where the homeowner is significantly “underwater,” so much so that the prospect of ever returning to a positive equity position is considered unlikely.

Borrowers who strategically default are often called “walkaways,” and statistics indicate their number is increasing. A September, 2009 joint study from Experian and the Oliver Wyman consulting firm estimated that close to a fifth of troubled mortgages in the U.S. involved borrowers who were strategically defaulting. Google the term, and you’ll even find web sites offering “strategic default calculators,” supposedly helping you decide if it’s time for you to walk away.

Ethical? Logical? Practical?
For most people, reneging on a financial obligation is seen as a last resort, something to consider only when all other options have been exhausted. After all, the only reason people and institutions extend credit is because they assume they will be repaid. Individuals who don’t repay their loans ultimately increase the costs of borrowing for everyone. Brian Faith, a spokesperson for Fannie Mae, the government-sponsored mortgage lender, told Harney “there’s a moral dimension to this as homeowners who simply abandon their homes contribute to the destabilization of their neighborhood and community.”

But some commentators would argue there are unique factors at work in the residential marketplace that justify using a strategic default as a pre-emptive financial strike to minimize future financial distress. Some think the moral arguments for repayment go far beyond what is required. In the January 10, 2010 NY Times Magazine, Roger Lowenstein states the general terms of a mortgage, and the consequences of default:

Mortgage holders do sign a promissory note, which is a promise to pay. But the contract explicitly details the penalty for nonpayment – surrender of the property. The borrower isn’t escaping consequences, he’s suffering them.

So you’re not really breaking the contract. The contract remains valid, and the stipulation for nonpayment follows through according to contract.

For some homeowners, the size of their mortgage and the magnitude of decline in their home’s value have resulted in an investment loss that can never be reversed. The only logical financial decision is to cut one’s losses and start over. Feeling some guilt and shame over defaulting might be natural, but that doesn’t mean it isn’t a wise business decision. As Lowenstein says, “The average homeowner is allowed to take a cold business approach as much as anyone is.”

Right now, the cold business approach seems to indicate owning a home doesn’t have the value it used to, either as an investment or a financial priority. In a January 7, 2010 Time.com article, William Clark, a geography professor at UCLA, said the housing mania of the last decade led many buyers to see their homes as speculative investments — “high-flying stocks that happened to come with wine cellars and four-car garages.” Today, “with the sudden run-up in foreclosures, you’re starting to see people ask, is housing a good investment?” he said. “In fact, it probably never was.” Lita Epstein, in a February 6, 2010 article for AOL’s Daily Finance, cited a January 2010 Transunion trend study that found people were maintaining car payments as their first priority, credit cards second, and mortgages last.

Of course, a strategic default isn’t as simple as simply sending your lender a good-bye note and the keys to your house. And the consequences of strategically defaulting aren’t limited to just losing the house. Because of the variations in state laws and lending agreements, most “default experts” recommend obtaining legal representation. Second mortgages, especially those written as lines of credit, may not be released in a walkaway. Epstein’s article notes that credit scores will average a decline of 100 to 125 points as a result of the mortgage default. If there are late payments prior to the default, Professor White cautions the hit to one’s credit history could be as high as 300-400 points. Besides the services of an attorney, you may require tax counsel as well, because some states may assess taxes on forgiven debts after a short sale or foreclosure. And beyond all the financial and legal ramifications, there’s also the issue of finding another place to live, moving one’s belongings, and handling the increased stress that comes from a major lifestyle upheaval.

There are also alternatives to a strategic default, such as loan modifications and short sales. Cristine Gonzalez, an AP reporter writing an article posted January 8, 2010, on creditbloggers.com, notes that an increasingly prevalent form of loan modification is one in which the lender reduces the principal amount. Besides resulting in a lower balance and payment, a loan modification usually does not change one’s credit score.

If nothing else, the surge in strategic mortgage defaults should reinforce the necessity to accurately assess the true financial benefits and costs associated with home ownership. As Professor Clark said, too many people perceived “buying up” (i.e., buying the most expensive home one could afford) as a great investment strategy that came with extra perks like a swimming pool and a great room.

But a strategic default isn’t a wealth-building strategy; at best, it’s a way to hit the financial re-set button – with a damaged credit history and a slim chance of getting a mortgage for the next three to seven years. So while an online calculator may indicate a strategic default may make financial sense, it’s not easy, and not without wide-ranging financial consequences. Better to have made a good housing decision at the beginning rather than hoping to escape a bad one later.

UNINTENDED CONSEQUENCES: ROTH IRA CONVERSIONS = TAX WINDFALL
In an ironic twist, the perception that the US government is about to do something undesirable in the future may reward that same government in the present.

A tax provision enacted in 2006 established that owners of IRA and other tax-deferred retirement accounts would be allowed in 2010 to convert these accounts to Roth IRAs, without limitation. (In previous years, the eligibility to convert to Roth IRAs was limited by income – the more you made, the less you were able to convert.)

Converting to a Roth IRA entails paying any previously deferred taxes now, on both the deposits and gains. In exchange, the Roth format means freedom from future taxes on principal, income and gains, whether distributed to you or your heirs. As Donald L. Luskin, CIO at Trend Macrolytics, stated in an April 15, 2010 Wall Street Journal Opinion essay, “the tax and estate planning benefits are so compelling that the wealthiest Americans are likely to convert in droves.”

Since the middle of 2009, this expanded opportunity to convert to Roth accounts has been featured prominently in the financial media, and the expectation has been that many individuals will take advantage of the provision. But recent events have perhaps provided even more incentive for conversion.

With skyrocketing national deficits and the need to fund the new health-care provisions, the consensus expectation is higher taxes, particularly on America’s most wealthy households. Luskin says the strong possibility of higher tax rates in the future means “the very wealthiest Americans, who control most of the eligible assets, have utterly irresistible tax incentives” to convert in 2010.

Of course every account converted today in the hope of avoiding higher taxes tomorrow means more revenue now for Uncle Sam. How much more?

It’s hard to say for sure. Combining data from several sources, Luskin estimates the total amount of funds eligible for conversion is somewhere in the range of $9 trillion. Approx-imately 60% of the $9 trillion, or $5.4 trillion, is in the hands of the wealthiest 10% of American households. If only 10% of those funds are converted ($540 billion), and taxed at 35%, the result is a “$189 billion revenue surprise for the U.S. Treasury.”

But if the political momentum to increase taxes picks up, the conversion response could be larger. In Luskin’s study of a USAA survey, he finds it conceivable that up to 35% of wealthy Americans could make the change to Roth accounts. The resulting tax bonanza would be $662 billion in “bonus” tax revenues, nearly enough to cut the budget deficit in half. That’s big money!

Luskin’s commentary provoked prompt and opposing responses from some financial experts. In a letter to the editor on April 20, 2010, Douglas Geig II, a CPA from Brecksville, Ohio wrote:

If you are young and beginning your career, you may not want to put any of your savings in a tax-deferred account. In other words, pay the taxes on your savings today at relatively small marginal rates. Sadly, if you defer this tax (and if you are successful and responsible), your future tax burden will be tremendous, as effective tax rates skyrocket to fund our nation’s escalating deficits.

Jack McManemin, CFP in Salt Lake City, begged to differ:

Although tax brackets in general may be higher in the future, what matters is a person’s own tax bracket. Many people, after retiring, will find themselves in lower brackets as they live off their portfolio without income from a salary.

Once again, the question of tax deferral comes down to whether it’s best to pay tax on the “seed”, or on the “harvest.” And once again, the final answer will only be revealed at liquidation. You must make a deposit decision today, not knowing what tax consequences will be when it is time to make a withdrawal.

When dealing with tax law, economists regularly discuss the principle of unintended consequences: changes in tax law will almost certainly result in changes in taxpayer behavior, usually to minimize or avoid the tax. But the final twist in this guessing game is that the individual uncertainties about the future will most likely result in more people choosing to pay taxes today. How strange is that?

The government certainly didn’t anticipate this outcome. Luskin says in 2006 the Congressional Budget Office projected only $8 billion in revenue from Roth conversions for 2010 – and never adjusted that number in successive years. That’s a long way from Luskin’s low estimate of $189 billion, and even further from $662 billion that is projected if a large contingent of Americans decide for conversion.

Are You Ready to be Converted?
For most IRA and qualified retirement account owners, the biggest challenge to conversion is determining how to pay the taxes. The ideal arrangement is usually transferring the IRA balance in full, while paying the resulting income taxes from other non-qualified accounts, such as bank savings, life insurance cash values, or investments held outside the retirement plan. Taxes could be paid from the IRA accumulation, but this will decrease the amount converted, and depending on your age and other issues involving your account, may also result in additional penalties for early distribution. With a Roth conversion, the devil is often in the details.

WANT TO REMOVE FUTURE TAX OBLIGATIONS FROM YOUR RETIREMENT ACCOUNTS? THIS YEAR MAY BE YOUR BEST CHANCE!

WANT TO DO IT RIGHT?

THEN GET PROFESSIONAL HELP!

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“Some macroeconomists say if we just study the numbers long enough we’ll be able to design better policy. That’s like the sign in the bar: Free Beer Tomorrow.”

- Russ Roberts, Economics Professor

LISTEN (mp3 audio) (14:12 min)

One of the assumptions of free-market economists is that fully-informed individuals usually act in accordance with their own interests. In other words, they make financial decisions based on what they believe is best for them. However, sometimes people appear to repeatedly act against their best interests; they act irrationally, even when they have accurate information. Why is this?

In January 2008, four economists working for the National Bureau of Economic Research (NBER) published the results of an extensive study regarding retirement decisions. This information caught the attention of financial writer David Adler, who included some of the findings in his book Snap Judgment: When to Trust Your Instincts, When to Ignore Them, and How to Avoid Making Big Mistakes with Your Money (FT Press, 2009).

The primary feature of the NBER study was a pair of simple one-question quizzes given to 1,300 respondents over the age of 50, with each respondent only answering one quiz. A comparison was then made between the two groups. Because you aren’t part of the study, you can take both quizzes – and see the results!

Here’s the setup:
The quiz involves an evaluation of two fictional, identical individuals, in this case named Mr. Red and Mr. Gray (in all, there were seven fictional persons, with names like Mr. Orange, Mr. Green, Mr. Brown).

• Each person made permanent decisions on how to spend a portion of their money in retirement.

• Each has some savings and can spend $1,000 per month from Social Security in addition to the portion of income mentioned in each question.

• They have already set aside money to leave for their children when they die.

The choices are intended to be financially equivalent and based on personal preferences for spending in retirement. You are asked to evaluate which retirement option represents the “better deal.” Read each choice carefully.

Quiz #1
Mr. Red’s option: Mr. Red can spend $650 each month, along with Social Security, for as long as he lives. When he dies, there will be no more payments.
Mr. Gray’s option: Mr. Gray can choose an amount to spend each month in addition to Social Security. How long his money lasts depends on how much he spends. If he spends only $400 per month, he has money for as long as he lives. When he dies, he may leave the remainder to charity. If he spends $650 per month, he has money only until age 85. He could also spend down faster or slower than each of these options.

Quiz #2
Mr. Red’s option: Mr. Red invests $100,000 in an account which earns $650 each month for as long as he lives. He can only withdraw the earnings he receives, not the invested money. When he dies, the earnings will stop and his investment will be worth nothing.
Mr. Gray’s option: Mr. Gray invests $100,000 in an account which earns a 4% interest rate. He can withdraw some or all of the invested money at any time. When he dies, he may leave any remaining money to charity.

Question: Who has made the better choice?
Mr. Red and Mr. Gray selected different options on how to spend their money in retirement. You are asked to evaluate their decisions.

Can you guess which options were seen as the best in each quiz?

In Quiz #1, 72% felt Mr. Red made the better decision.

In Quiz #2, 79% felt Mr. Gray made the better decision.

But there’s a mind-blowing twist to the study: Each quiz presented the same options! Mr. Red’s plan is the same in both scenarios, and so is Mr. Gray’s!

So, if both plans are the same, why did respondents overwhelmingly choose Mr. Red in the first quiz and Mr. Gray in the second? The answer is “framing.” Our interpretation of new information is dependent in part on the context in which we receive it, i.e., what our “frame of reference” is for a particular scenario. As the NBER researchers put it, “experimental findings suggest that choices are not solely based on material consequences, but instead are filtered through the particular frame that individuals use to interpret choices.”

In these two instances, the “frames” made the difference in the decisions. In the first example, the frame was consumption. The focus was on how much could be spent, and for how long. From this perspective, the emphasis on a larger monthly amount available for consumption, with the guarantee of continuing no matter how long one might live, was seen as most attractive.

The second example was framed by investment. While the numbers remained the same in terms of possible monthly income, the quiz also mentioned that Mr. Red would have access only to the earnings from his investment, and nothing left when he died. In contrast, Mr. Gray had access to his original $100,000 principal at any time, and the prospect of leaving any remainder to heirs.

Analyzing this example, Adler summarizes the effects of framing: “Context can be as important as content when it comes to financial decisions, even very important financial decisions.”

But wait, there’s more…

Beyond the “wow, that’s interesting” factor of the results, both Adler and the NBER researchers believe their study has some significant practical applications.

According to Adler:

“The larger point of the experiment is not just that framing has an impact; it is specifically about how retirement planning is ‘framed’ in the U.S. and how we are conditioned to think about it. Should our financial focus be on building wealth for retirement, or on what we can consume after we retire?”

Jeffrey Brown, one of the NBER researchers, contends we have been conditioned to think about retirement as mostly an investment decision, similar to quiz #2. But in Brown’s opinion, retirement is largely a consumption decision. Says Brown,

“The messages that individuals receive when encouraged to save are all about how much you have in your account and your rates of return. But really you should think about how much can you eat each month, how much can you consume.”

And there’s even more…
If you didn’t already know it, Mr. Red’s retirement decision is a simple description of a lifetime annuity. A life annuity is a relatively straight-forward financial transaction: In exchange for a lump sum payment, an insurance company guarantees monthly payments for your lifetime, no matter how long it may be.

The NBER study (titled “Why Don’t People Insure Late Life Consumption? A Framing Explanation of the Under-Annuitization Puzzle”) is an attempt to explain why some people don’t buy annuities despite their significant financial advantages.

Life annuities are not new. They have a long history, but are infrequently selected by consumers. However, as company pension plans steadily disappear and are replaced by personal accumulation accounts, such as IRAs, 401(k)s, etc., retirees are beginning to reconsider annuities in retirement. But because many potential buyers have an “investment” frame of reference; the idea of “losing” any leftover principal at death is perceived as a strong deterrent to purchasing an annuity.

In contrast, most economists, especially those whose “frame” is consumption, see annuities in a very positive light. You don’t have to worry about outliving your money – ever. If you live beyond your life expectancy, there’s a good chance the guaranteed payments will deliver higher returns than what would have come from traditional investments. Once implemented, there are no management decisions required, and no investment risk. As Adler says, “the wildly enthusiastic consensus among most economists, to say nothing of the insurance industry, is that annuities are a great thing.”

Finally, there’s this…
In spite of all the statistical evidence supporting annuities, there’s still a mental snag for many individuals considering a lifetime annuity. When an annuitant with a lifetime annuity dies, the payments stop (unless a refund feature or term certain feature was elected). There are no refunds of “unused principal.” In a worst-case scenario, someone gives the insurance company a big chunk of change to buy a life annuity, then dies within a short period of time. This possibility, framed from an investment perspective, is probably the biggest reason many people reject a lifetime annuity.

But curiously enough, it seems some of the fears of not living long enough to receive full value from an annuity can be alleviated… by buying one.

Steven Levitt and Stephen Dubner are co-authors of the best-sellers Freakanomics and SuperFreakanomics. Both books take a simple economic idea, that incentives matter, and apply it to a variety of unusual financial, environmental and cultural situations. One of their chapters discusses actions which could lead to a longer lifespan. Among the diverse factors: career choices, winning a Nobel Prize, having a woman doctor…and buying an annuity. Yep, you read that right. Here’s the reason:

“People who buy annuities, it turns out, live longer than people who don’t, and not because people who buy annuities are healthier to start with.  The evidence suggests that an annuity’s steady payout provides a little extra incentive to keep chugging along.”

Wow. Based on this evidence, annuities sound like a financial “silver bullet” and a fountain of youth!

But this article really isn’t about annuities…
Whether or not you should buy an annuity depends on your unique circumstances.

A greater issue is who or what is framing your financial decisions, and whether that frame is the most beneficial perspective for you and your future.

A parallel issue, one that may offend some sensibilities, is whether all frames are equally viable. Specifically, are the consumption and investing frames just two approaches to the same objective, or is one better than the other?

While historical and mathematical arguments can be made for either the consumption or investing frame, there is strong psychological support for the consumption paradigm. In March, the Employee Benefits Research Institute (EBRI) released its 20th annual report on retirement confidence. One of their findings: “Nearly half of all workers would opt for a guaranteed income for life.”

Perhaps this inclination toward security is primarily a reaction to the recent financial turmoil. But more likely, it points to the real value of financial security. Maximized consumption isn’t just a framing option. It’s the better choice for financial success and contentment.

DO YOUR FINANCIAL OBJECTIVES INCLUDE A CONSUMPTION FRAME OF REFERENCE?

HOW MUCH OF YOUR FINANCIAL FUTURE IS SECURED?

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LISTEN: mp3 audio (9:44 min)

“Perhaps the most valuable result of all education is the ability to make yourself do the thing you have to do, when it ought to be done, whether you like it or not; it is the first lesson that ought to be learned; and however early a man’s training begins, it is probably the last lesson that he learns thoroughly.” — Thomas H. Huxley, English biologist (1825 – 1895)

Often the biggest challenges most people face in reaching their objectives, financial or otherwise, are not external, but internal. For reasons we can’t entirely comprehend, great plans and good intentions are undone by our poor behavior.

We may blame it on a lack of willpower, a character flaw, or even a psychological condition; regardless the explanation, we find we are our own worst enemy. And even the best among us feel the frustration. Paul the Apostle once wrote:

“For what I am doing, I do not understand; for I am not practicing what I would like to do, but I am doing the very thing I hate.”

At one time or another, we’ve all been there. So if some of the biggest obstacles are internal and psychological, what can be done to fix them?

Hey, this isn’t a Dr. Phil column. There are a bunch of ways to resolve your issues, and a bunch of people to help you. But when it comes to achieving your financial objectives, there is one simple, practical thing anyone can do to improve their chances for success:

“GET IT IN WRITING.”

Seriously. Whether you use a pencil or a word processor, getting things out of your head and onto paper increases your chances of achieving your objectives. As Will Farrell would say in Anchorman, “It’s science.”

First, the physical act of preparing a paper document requires a greater level of engagement. Thoughts and words are vapors that can easily dissipate when new distractions emerge. But getting things in writing usually focuses thought and encourages clarity. And the physical act of writing (or, to a lesser degree, typing) engenders another level of reinforcement – your thoughts take on a visual aspect, and even acquire some “muscle memory.”

Second, getting it in writing leaves a trail, including one that is visible to others. Getting it in writing provides you with a definitive reference point, for the past and the future. You’re saying “on this day, here’s where I was, and there’s where I wanted to be.” And when you put it in writing before a spouse, partner, or advisor, that document becomes a common point of reference. It can be used by others to understand you, help you, remind you, and challenge you.

When it comes to my finances, what should I get in writing?
1. Write (or type) your present financial condition. Most people believe they have a general sense of their financial status. They can tell you if they’re current with their bills, if they’re saving money, and roughly how much they earn in a year. But move beyond the generalities, and you’ll find most people don’t have a good grip on what’s really going on – it’s all sort of fuzzy.
Consequently, it’s difficult to make new financial decisions with any degree of confidence. Are you sure you can afford a new car payment? What about re-financing? If you start a new life insurance program, will you be able to make the premium payments? When you’re not sure, you either make guesses or put off deciding, and neither of those options have a high success rate.

Imagine what could happen if you committed to preparing an accurate cash-flow statement every month. First, just attempting it would improve your financial organization. Checks would be written from the correct account, receipts would be kept – if nothing else, you would begin to have a paper trail.

For some, making an accurate monthly cash-flow statement might be a challenging task. It might take a lot of effort to set up the process and sort through your piles. If you find a cash flow statement requires too much work, start by picking one or two financial categories that need the most attention, like tracking your debt reduction progress, or monitoring the monthly accumulations in your savings and investments. Just collect some accurate information, and write it down.

2. Write (or type) your financial objectives. In general, everybody wants more money. But how much do you want, and for what purpose?
Everyone knows the job of sales and marketing departments is to convince consumers to buy their products. And most people understand that sales and marketing experts use a range of psychological ploys, both blunt and subtle, to compel people to buy. If you’re not clear on what you really want, you are much more susceptible to being sold something else.

Writing down what you want to accomplish makes it easier to resist the daily bombardment of sales pitches. You’ve embedded your own financial values, which allows you to see which items align with your objectives and which ones don’t. Clearly articulated objectives help you recognize that a flat-screen TV priced 50% off is a great deal – but only if you really want a flat-screen TV.

3. Write (or type) your plan of action. The default option for contemporary American culture is often the tyranny of the urgent; what’s immediately in front of us demands our attention. We deal with one momentary crisis after another, then either collapse in exhaustion or seek some recreational escape. And then we do it all over again the next day.

At some point we may notice the track we thought we were on is really a treadmill, but those moments of recognition are fleeting; there are new items hitting our in-box, and each one seems to be stamped “urgent.” Even if you decide to get off one treadmill – by changing careers, relocating, etc. – you may find yourself on another treadmill, running just as hard, yet still staying in the same place. Taking the time to write down a course of action in order to achieve your financial objectives gets you off the treadmill, first to reflect on, and then to redirect, your activities.

Does getting it in writing really work?
Intuitively, most people know getting it in writing would help them make progress. Of course, there are caveats. Making a direct cause-and-effect connection between writing it down and success is difficult because so many other factors are involved. You may have some financial issues that aren’t going to be resolved by simply writing them down (like back taxes to the IRS), but the very act of deciding to get your financial life in writing means you’re giving it a higher priority and a higher likelihood of success.

Thomas Stanley and William Danko are the co-authors of the Millionaire Next Door. Released in 1996, the book was a comprehensive study of the character traits and actions of American millionaires, particularly those the authors classified as PAWs – prodigious accumulators of wealth. Stanley and Danko found that the most successful millionaires spent a significantly higher percentage of their time reviewing their financial condition and planning their next financial action. Both activities required them to obtain accurate information, and develop clear plans of action – in some fashion, you could say they were “getting it in writing”.

You can find a lot of information about financial recording and goal-setting. Those details may help you, but the basic issue is this: When it comes to your finances, do you have it in writing? If you don’t, you have a simple question to answer: Are you going to get it in writing?

•   HOW MUCH OF YOUR FINANCIAL LIFE IS IN WRITING?

•    DO YOU HAVE A MONTHLY CASH FLOW STATEMENT?

•    DO YOU HAVE A WRITTEN LIST OF FINANCIAL OBJECTIVES?

•    DO THE FINANCIAL PROFESSIONALS YOU WORK WITH HAVE COPIES OF YOUR WRITTEN INFORMATION?

•    OR… WOULD YOU LIKE TO HAVE A FINANCIAL PROFESSIONAL HELP YOU TO GET IT IN WRITING?

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LISTEN: mp3 audio (4:07 min)

IDEAS THAT ENDURE

Ideas matter. The value of every statistic, every calculation, is determined by the ideas and philosophies to which the numbers are applied.

In the past several years, several trade publications have republished a short commentary on the essential elements of life insurance. Originally titled “Just a Life Insurance Policy,” this is a brief yet powerful statement of the timeless ideals that make life insurance a financially relevant product.

The article, probably written at least 50 years ago, was resurrected by Marvin Feldman, a prominent Ohio insurance agent and industry authority, in 2006. Feldman notes in an accompanying commentary that he was unable to identify the original author, and while the article can be found in a number of publications and websites, none of these sources cites an author either. Feldman also acknowledges he had to reword some of the article because the original syntax reflected a different era. Still, the financial and social concepts at the heart of life insurance remain relevant to the challenges and aspiration of today’s world.

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LISTEN: mp3 audio (9:40 min)  

If the early announcements are any indication, 2010 could be the Year of the Roth IRA conversion. How do we know this? Well…  

An August 27, 2009 article from Morningstar (news.morningstar.com) calls the chance to convert to a Roth IRA “the planning opportunity of the decade.”  

In an article for the Detroit Free Press, on November 19, 2009, Susan Tompor reported “the Roth IRA conversion is definitely building buzz.”  

On November 24, 2009 Forbes.com led with “Get ready to be bombarded with information about Roth IRA conversions.”  

Admittedly, three sources by themselves do not make a trend, but they are representative of the general media buzz. What’s the big deal? Here’s the story:  

Roth IRA retirement plans have the following features:  

• Eligibility to make deposits to a Roth IRA is dependent on your income level.
• Deposits receive no tax deduction.
• Once you have held the Roth IRA for at least five years, and are at least age 59 ½, withdrawals are tax-free.
• There are no required minimum distributions from a Roth IRA at any age.
• Roth IRA assets can be left to children or other heirs.

A change in tax law, effective 2010, broadens the ability of owners of Traditional IRA accounts to convert them to Roth accounts. This is what the fuss is all about.  

Beginning in 2010, the income limits on Roth IRAs will be eliminated, so investors of all income levels will be able to convert their Traditional IRA assets to Roth IRA assets. This is significant, because prior to this change, only those with a modified adjusted gross income (MAGI) of $100,000 or less could execute a conversion.  

Reasons to consider a conversion to a Roth IRA
You may pay less in taxes. If you convert your Traditional IRA balance to a Roth IRA, you’ll pay taxes on the amount being converted. But because of recent market volatility, your account balance may be lower than it was when the market was stronger. In effect, you may pay less in taxes.  

If you convert in 2010, you have the option to spread the tax burden over two years. When you convert to a Roth IRA, you will have to pay taxes on any deductible contributions and investment earnings. But, if you make the conversion in 2010, you can pay the taxes in 2010 or you can spread the taxes over the subsequent two year, 2011 and 2012.  

There are no required minimum distributions. Unlike Traditional IRAs, Roth IRAs do not require that you take minimum distributions when you reach age 70½. That means your account can continue to grow tax-free until you – or your heirs – are ready to withdraw the money.  

Reasons to not convert to a Roth IRA
Money. The Roth conversion isn’t a freebie. In order to convert to a Roth IRA, you must pay income taxes on the Traditional IRA as if you had cashed out. If you pay the tax from funds in the IRA account, it will decrease the transfer amount and diminish the tax-free growth that might occur over time. Further, if you use funds from the IRA and are younger than 59 ½, the amount used to pay the tax may be subject to an early withdrawal penalty. “A Roth conversion is expensive. There’s a big up-front cost to doing this,” Tim Steffen told Tompor. Steffen is a financial and estate planning manager for Robert W. Baird & Co. in Milwaukee.  

You think you’ll be in a lower tax bracket in retirement. If your financial situation is such that you anticipate future income will be much lower than it is today, paying the tax now may not make sense.  

You have a short time until you intend to withdraw the funds. Money transferred to a Roth IRA must remain in the account for five years, or it will lose its tax-free withdrawal status.  

 

Another twist:
What might happen to tax rates in the future? In the Detroit Free Press article, Garvey points out that the current federal income tax rates expire at the end of 2010. If Congress takes no action to renew these rates, the highest tax rate would jump to 39.6%, up from 35%. And with the deficit ballooning, it’s not unthinkable that Congress might authorize even higher marginal tax rates.  

The conversion decision is “a little more art than science,” according to John Carl, president and founder of the Retirement Learning Center in Brainerd, Minnesota. “How much [in] taxes are you willing to fund now for a lifetime of tax-free income?”

IRA Help is Everywhere. To assist you in your decision, many financial companies are offering Roth Conversion Calculators on their web sites. But this is a transaction that probably can’t be decided by answering a few questions or entering some numbers in an on-line calculator. A consultation with your tax advisor is a must, as well as the financial professionals who will be handling the conversion paperwork.

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