Casey Clay Hall's Finance Blog

Probability of Plan Success

2012-05-15T12:00:00.000-05:00

Two of the most unpredictable variables affecting the success of a retirement plan are life expectancy and investment experience. In retirement plans, we usually simulate these variables based on probabilities of historical results. We first assume a life expectancy by evaluating what percentage of people have lived to certain ages. We then develop a plan that would have been successful in a certain percentage of past investment time periods. When we combine these probabilities of life expectancy and investment return, we may amplify the probability of success for a retirement plan.

Let's consider a plan that assumes a 50% life expectancy, meaning half of people live beyond that age, and a 80% historical success ratio, meaning one-fifth of past time periods had a lower investment return. The plan would fail only if the person lives longer than 50% of people AND if the investment return is worse than 80% of past time periods. Because plan failure depends on both events occurring, the probability of success is amplified. To calculate this, we multiply the probabilities of both events to find their combined probability. [(1-0.50) x (1-0.80) = 0.10] There is a 10% chance both events occur; therefore, the combined probability of success for that scenario is 90%.

We should be cautious regarding how the combination of conservative assumptions for life expectancy and investment experience can magnify the probability of success. Let's consider a plan that assumes a 25% life expectancy and a 88% historical success ratio. The plan would fail only if the person lives longer than 25% of people AND if the investment return is worse than 12% of past time periods. [(1-0.25) x (1-0.12) = 0.03] There is a 3% chance both events occur; therefore, the combined probability of success for that scenario is 97%. These assumptions may cause the plan to be more conservative than was originally intended.

Although we may like retirement plans that have little chance of failure, no person wants to feel constrained due to overly conservative plan assumptions. Most people want to spend what they can before death rather than leave behind a large estate. We must strike a comfortable balance between the amount of spending and the probability of plan success. If the life expectancy and investment returns do not follow the plan projections, spending can usually be modified later in life to compensate. Retirement plans must always adapt to changing variables in order to maintain an acceptable probability of success.

Your Retirement Number

2012-04-18T12:00:00.000-05:00

As you may have noticed by the advertisements, a currently popular trend in retirement planning is to calculate "your number." This refers to the amount of savings you need to have at retirement. From a marketing perspective, "your number" attracts consumers who prefer simplicity and an easily defined goal, but from a financial perspective, "your number" does not address all the dynamic variables of retirement planning. Retirement planning is more complex than just a number.

Retirement planning is a process that continues over your lifetime, not a one-time occurrence. You cannot calculate "your retirement number" now and carry that same number around for years expecting it to remain static until you retire. During your lifetime, "your number" will be affected by many variables that can unexpectedly change, such as incomes, expenses, savings rates, tax rates, inflation rates, asset allocations, and investment performance. Your retirement plan should be updated and modified as these changes occur so that you can adjust the other variables to maintain an acceptable probability of reaching your goals.

Retirement planning allows you to map a course of actions from now until your death. Just knowing "your retirement number" is like having a destination without having directions. You need directions such as how much to save and where to invest in order to reach your goals. You should also recognize that death, not "your number," is the ending destination point in your retirement plan. Even though you might reach "your number" by retirement, you could still run out of money before death if variables such as inflation rates, investment returns, and portfolio withdrawals are different than planned.

The advertising of "your number" has been beneficial for retirement planning awareness, but consumers should recognize that just calculating "your number" is not an adequate substitution for a comprehensive retirement plan. A retirement plan should be developed, implemented, monitored, and modified as needed over your lifetime to help you achieve your goals. If you would like help with this process, please consult with a CFP® professional who provides financial planning services.

Death File

2012-03-14T00:00:00.000-05:00

Imagine you die today and your loved ones are left without instructions for what to do. Thinking about death may be unpleasant, but planning now for that inevitable event will be very helpful to your survivors once you are gone. Many people think their estates will be taken care of after they die as long as they have a last will and testament. While the will is useful for distributing your estate after death, it does not provide adequate directions for your survivors. You can better prepare for your survivors by building a "death file" that includes all the important documents and instructions they may need to manage your estate after you die. You may want to call it something less morbid than "death file," but make sure your trusted loved ones know about the file and how to access it after your death. Let's review some items you should include in the file.

The file should include your original last will and your trust documents, or at least copies and the noted location of the originals. Your healthcare power of attorney and financial power of attorney should be accessible by a trusted person before your death, but you may also want to store these documents in the file since they are often prepared with your other legal documents. You should include a letter of final instruction that covers any other requests not specifically addressed in your will, including funeral arrangements. Note any advance payments you made regarding your funeral and burial. The letter of final instruction also allows you to request how your beneficiaries manage your estate after you die; although, they are not legally bound to abide.

Your beneficiaries may not know about all of your assets that are not specifically listed in your will, and if so, those unknown assets could go unclaimed. Therefore, your death file should document all of your assets and their details. These include bank accounts, investment accounts, retirement accounts, business interests, life insurance contracts, real estate deeds, vehicle titles, and anything else where you are the registered owner. For each asset, note the account title, account number, location or custodian, and contact information. Also include this information for any mortgages, loans, credit cards, or other liabilities you have. Some debts may be forgiven at your death while others may need to be paid back using assets from your estate.

Do not expect life insurance companies or any other institutions to initiate contact with your beneficiaries after you die. For this reason, include records of all your life insurance policies so you beneficiaries know about the available death benefits they should claim. Also include records of your other insurance policies such as homeowner's insurance, automobile insurance, health insurance, disability insurance, and long-term care insurance. Your survivors may need to contact the insurance providers to cancel your policies or transfer ownership of the policies.

Income you are receiving should terminate at your death, so your survivors may need to contact certain benefit providers to stop those income payments. Include records of any income sources you have such as Social Security benefits, retirement pension benefits, and annuity contract payments. For each, note whether your survivors are entitled to continue receiving your benefits or reduced benefits. If your survivors are not entitled to the benefits, they may be required to return any payments sent after your death.

Expenses you have could extend beyond your death, so you should include records of all bills that you pay. These could include monthly payments such as rents, utilities, and credit cards, as well as annual payments such as real estate taxes, insurance premiums, and membership dues. Your survivors may need contact the service providers to cancel your accounts and settle any outstanding balances. You may want to leave instructions regarding how you manage and pay the bills. Also note deposits that may be refunded at cancellation.

Your file should include your marriage license so your spouse can prove your relationship and exercise any rights he/she has as your survivor. For similar reason, you should include your divorce records in case your ex-spouse attempts to claim property he/she is not entitled to receive. You may want to include birth certificates, and adoption records if applicable, for your children or other decedents who are named in your will. The file is also a good place to store Social Security cards, passports, and other forms of identification.

The list of items reviewed above should not be considered comprehensive. If you have additional documents or instructions you feel will be important to your survivors, include all of those in your death file. No matter how much information you include in the file, your loved ones may still have questions after you are gone. Include a list of professionals you have worked with that could help answer your survivors' questions. These might include your attorney, accountant, and financial advisor.

Once your gather the documents for your death file, store them in a secure place and share the file's location with your trusted loved ones. Be sure more than one trusted person can access the location and retrieve the file because it will serve little purpose if the only access person has also died. Discuss the file with your loved ones now so they can ask questions and learn what to do following your death. Although it will be a difficult time for your survivors, they will greatly appreciate this invaluable resource when that day eventually comes.

Life Expectancy of Couples

2012-02-15T00:00:00.000-06:00

One of the biggest concerns people have in retirement planning is the possibility they will run out of money before they die. People do not know when they will die, so they have to make assumptions about life expectancy in their retirement plans. They often consider life expectancy probabilities of the general population in determing what age to assume they die.

The process is simple for a single person. A woman may want to assume she lives longer than 50% of women her age, so she would observe historical data that shows at what age 50% of women her age have died. If historically, 50% of women her age have died before age 85, she would want to assume a life expectancy to at least age 85 in her retirement plan.

A complication arises when determining the joint life expectancy for a married couple. The couple may want to assume they each live longer than 50% of people their ages, but they should not consider their life expectancies independently. The married couple does not want to run out of money until both have died, so they should calculate the probability of at least one of them living longer than 50% of people their age. The probability that both die before 50% of people thier ages is much lower than 50%.

The probability of multiple independent events, such as the ages of death for two people, can be calculated by multiplying the probabilities of each event. For example, the combined probability that a man dies before 50% of men his age and a woman dies before 50% of women her age equals 25% (0.50 x 0.50 = 0.25). If the a couple wants to plan for at lease one partner living longer than 50% of people their age, they should assume each partner lives longer than 70.7% of people thier age (0.707 x 0.707 = 0.500).

Life expectancy is just one of many assumptions that must be made in retirement planning. Assuming a long life expectancy will not ensure retirement plan success, but assuming too short of a life expectancy will increase the chance of running out of money before death. People can better prepare for making their money last a lifetime if they give adequate thought to their life expectancy assumptions.

Mutual Fund Cost Basis

2011-12-08T00:00:00.000-06:00

The IRS rules for mutual fund cost basis reporting have changed effective January 1, 2012. Before 2012, investment companies were not required to report cost basis information to investors or the IRS when investors sold mutual fund shares. Investors were solely responsible for reporting their cost basis and capital gains to the IRS when they sold mutual fund shares. Investment companies that historically provided cost basis information did so at their own discretion. Now for the 2012 tax year and beyond, the IRS requires investment companies to report cost basis information to investors and the IRS when investors sell mutual fund shares. The cost basis reporting requirement only applies to mutual fund shares acquired on or after January 1, 2012. Investment companies are still not required to report cost basis information for mutual fund shares that investors acquired before 2012. The cost basis reporting also only applies to shares sold in taxable, non-retirement accounts because realized capital gains in retirement accounts are typically tax-deferred or tax-exempt.

Investors have three options for how their mutual fund cost basis will be reported. The average cost method assumes the cost of shares sold equals the average cost of all shares acquired by the investor. The first-in first-out method stipulates for the shares to be sold in the same order they were acquired by the investor. The specific identification method allows the investor to select which shares are sold regardless of when they were acquired. Investors are free to choose which cost basis method best suits their individual tax situation and even switch between the different methods with one exception. Investors who use or have used the average cost method to report capital gains or losses on mutual fund shares acquired before 2012 must continue to use the average cost method for all shares of that mutual fund acquired before 2012.

When investors sell mutual fund shares acquired before 2012, they are not required to decide on a cost basis method for those shares until they file their income tax returns because investment companies are not reporting the cost basis to the IRS. With that flexibility, investors can choose which cost basis method provides them the lowest tax burden after they have evaluated their entire tax situation for the year. That flexibility does not exist for mutual fund shares acquired in 2012 and beyond. When investors sell mutual fund shares acquired on or after January 1, 2012, they need to select their cost basis method before or at the time of sale so investment companies know which method to report to the IRS. Investors should be motivated to select their own cost basis method because an investment company's default reporting method may not provide the best tax advantage. Ultimately, the new cost basis reporting requirements should benefit investors as well as the IRS. Although more tax planning may now be required, fewer tax reporting errors should occur. Investment companies and investors are now cooperating parties in the calculation of mutual fund capital gains.

Index Fund Advantages

2011-11-09T00:00:00.000-06:00

Mutual funds can be classified as either index funds or active funds. Index funds attempt to replicate the performance of a benchmark index by owning the same securities as the index in the same proportions as the index. Active funds attempt to perform better than a benchmark index by owning specific securities that may or may not be included in the index but are expected to perform better than the index as a whole. Both types of mutual funds have proponents who will argue their advantages. Three advantages of index funds are convenience, consistency, and cost-efficiency.

Index funds are very convenient for investors who prefer not to spend a lot of time and resources trying to determine which mutual funds to buy and sell. Investors decide which segments of the market they want own and then buy and hold index funds that track those segments. This eliminates the need to evaluate all the active fund offerings of multiple companies to select which fund might perform best in a category. Instead of analyzing mutual funds, index fund investors rely on the benefits of diversification and allocation. Diversification within a category is easy to achieve with index funds because they typically own most if not all of the securities that comprise a category. Rather than determining which categories to overweight or underweight, index fund investors can get market performance by simply allocating their portfolios to match the percentages each category represents of the overall market. Risk levels can be easily controlled by adjusting the allocations between stock index funds and bond index funds, and occasionally rebalancing among those index funds will allow investors to maintain their desired allocations.

Index funds consistently provide the average performance of a category because they always own a representative sample of all the securities in a category. The investment return of an index fund will resemble the aggregate return of all the securities that comprise that index. The securities owned by active funds may not fully represent the category, so their returns can be very different and inconsistent from the average returns of the category. When active funds in pursuit of better performance buy securities outside of their benchmark category, this changes the style and composition of the funds. Index funds are consistent in their style and composition because they will only own the securities that are included in the benchmark index. As a result, index funds have little risk of performing worse than their category benchmarks. Index funds appeal to investors who seek investment returns that are consistent with the returns of their targeted categories.

Index funds are cost-efficient because they do not require a lot of management labor. Index fund managers simply buy and hold shares of the securities that are included in the benchmark index. Active fund managers must research and monitor securities inside and outside of the index to determine which to buy and sell for their funds. The active fund managers ensure they are compensated for this additional work by charging higher expenses, thereby passing along extra costs to investors. In addition to higher fund expenses, investors may incur more tax costs with active funds. As active managers buy and sell multiple securities attempting to perform better than an index, they increase their funds' turnover ratios, which increases the frequency of realized capital gains. Index funds buy and hold the same securities as long as they are included in the index, so index funds typically have lower turnover ratios and fewer capital gains tax liabilities.

Index fund advocates follow a certain philosophy about investing. They believe active funds are inconvenient to analyze and monitor, inconsistent in composition and performance, and inefficient regarding costs. They believe the probability of an active fund performing better than a benchmark index does not warrant the acceptance of those disadvantages. They believe index funds are superior because they are convenient, consistent, low-cost investments, and maybe the biggest advantage of index funds is performance. Data from Standard & Poor's Index Versus Active scorecard shows index funds have historically performed better than a majority of their active fund peers.

When To Start Social Security Benefits

2011-10-24T00:00:00.000-05:00

People who are eligible for Social Security retirement benefits may start receiving benefits anytime between ages 62 and 70. However, people who start receiving benefits before their full retirement age, which is 65 to 67 depending on year of birth, will see their monthly benefits permanently reduced, and people who delay receiving benefits past their full retirement age will see their monthly benefits permanently increased. This trade-off causes many people to question when is the optimal age to start receiving benefits. The following are a few aspects to consider before deciding when to start receiving Social Security retirement benefits.

Life Expectancy
Assuming everyone lives to the same age, people who begin receiving Social Security benefits at younger ages will collect a lower monthly benefit for more years, and people who begin receiving Social Security benefits at older ages will collect a higher monthly benefit for fewer years. While we know not everyone has the same life expectancy, the Social Security Administration (SSA) attempts to predict what the average age of death will be for people depending on their gender and current age. You can find the average life expectancy for a person of any age on the SSA website. The SSA considers the average life expectancy age to be the break-even point for the total lifetime benefits a person will receive. So theoretically, a person will have received the same total lifetime benefits at his or her life expectancy age, regardless of which age he or she began receiving benefits. People who feel they will live more or less years than the average life expectancy should let that influence their decision of when to start receiving benefits. People who will die before the average person their age may want to start receiving benefits at an earlier age, and people who will live longer than the average person their age may want to delay receiving benefits until a later age.

Investment Return
Once a person starts collecting a Social Security retirement benefit, that monthly benefit amount is locked in for life with an increase only for cost-of-living adjustments when determined by the SSA. For every month a person starts receiving Social Security benefits before his or her full retirement age, the benefit amount is reduced by a certain percentage, and for every month a person delays receiving Social Security benefits after his or her full retirement age, the benefit amount is increased by a certain percentage. You can find the percentage adjustment for a person of any age on the SSA website. The percentage increase or decrease may be considered favorable or unfavorable compared to a person's expected investment return. If the percentage increase or decrease of the monthly benefit is less than a person's investment return, he or she may may want to start receiving benefits at an earlier age and invest the benefits for a return greater than the SSA adjustment. If the percentage increase or decrease is more than a person's investment return, he or she may want to delay receiving benefits until a later age because the SSA adjustment will provide a greater return than investing the benefits.

Employment Status
People who are still working and earning income do not usually benefit from starting to receive Social Security benefits before their full retirement age. Not only do they receive a reduced benefit by starting at the earlier age, but the SSA imposes an additional penalty by reducing their monthly benefit by $1 for every $2 of income they earn above $14,160 per year (limit adjusts for inflation). People who are working often have higher incomes and higher marginal tax rates before retirement than they will have after retirement. Social Security benefits are counted as part of taxable income, so some people may not want to receive benefits during their working years when they are paying income taxes at higher marginal rates. In some cases, starting to receive benefits while continuing to work may push them into higher marginal tax brackets. The effect of income taxes on Social Security benefits should be evaluated in conjunction with a person's after-tax investment return. If income taxes suppress a person's net investment return to less than the percentage adjustment for delaying Social Security benefits, receiving later may be preferable to receiving early.

We cannot definitively determine the optimal age to start receiving Social Security retirement benefits because the decision is often based on multiple unknowns. We must make assumptions about life expectancies, investment returns, and income taxes. However, we do know the aspects to consider in the evaluation, and we use this information to guide us to the best decision we can make at the time.

Saving For Children

2011-10-10T00:00:00.000-05:00

Personal finance experts emphasize the importance of starting to save at an early age. The power of compound interest can provide a huge financial advantage for people who begin saving for retirement several years sooner than their peers. Some of us have seen the calculations that show the difference between starting to save in your 20s versus your 30s and how the person who starts saving sooner has a larger account balance at retirement. Most people have reached their older years before they realize this benefit and then can only wish they had started saving sooner. While the benefit of starting to save early may have been missed by older people, they can still help their children benefit from a long time horizon. If starting to save just ten years sooner than your peers provides a large advantage, imagine the benefit of starting to save twenty or thirty years sooner. With some assistance from their families, children can benefit from the power of compound interest while also learning the valuable lesson of saving.

Assume you save $100 per month for your child from her birth to her age 18. If you invested the savings in a diversified stock market mutual fund, and it grows by 8% per year, the account balance would be $48,009 by her age 18. That would be a nice gift for college, but what if she leaves the money alone? If she does not touch the account for the next 47 years, no additions or withdrawals, and it continues to grow by 8% per year, the account balance would grow to $2,036,326 by her age 65. That nice gift for college turns into a nice nest egg for retirement.

In the above scenario, your child does not save any additional money to the account after her age 18. Now assume she continues saving $100 per month to the account after age 18, and it grows by 8% per year. In that case, the account balance would be $2,657,564 by her age 65. Although she continues to save for 47 additional years, the ending balance is only about 30% higher. That shows the true power of starting to save early. The first 18 years of saving produce a balance of $2,036,326, while the last 47 years of saving produce a balance of only $621,238. The reason is the earlier savings experience more years of compound interest growth.

Saving for your children's retirement may not be a priority, and you should not place that goal ahead of saving for your own retirement, but if you have the ability to invest for your children, they will thank you one day. Imagine if your parents had invested for you in the stock market back when you were a child and how much that investment might be worth today. You would be pleased, and your children would probably feel the same. Teach your children the concept of saving by getting them involved in the process. For example, if you want them to have an allowance of $10 per week, give them an allowance of $15 per week with the requirement they save $5 in an account so their net is still $10. This will teach them that they must always save a portion of the money they earn or receive. Children have the ability to learn the concept of saving at an early age, and parents who teach this to their children pass on a valuable life lesson.

Time And Risk

2011-09-21T00:00:00.000-05:00

Investors want to receive the highest possible return with the lowest possible risk. However, the risk/reward trade-off principle says we cannot increase our potential return without increasing our exposure to risk. Is that always true? The risk/reward principle is usually applicable for short-term investments, but when we consider long-term investments, we can maximize potential return with minimal exposure to risk.

Consider the risk/reward principle in comparing a stock portfolio and a bond portfolio. In any one year, an all-stock portfolio has a higher potential return and a higher probability of loss than does an all-bond portfolio. Therefore, stocks are considered the higher risk/reward investment over a short time period. The applicability of the risk/reward principle depends the time horizon considered. When we evaluate the stock portfolio over a longer time horizon, the potential return increases and the probability of loss decreases.

Looking at the past 85 years of historical investment returns, from 1926 through 2010, we can see which time periods an all-stock portfolio performed better and which time periods an all-bond portfolio performed better. Considering all 5-year time periods from 1926 through 2010, stocks performed better than bonds in 70% of the 5-year periods. Considering all 15-year time periods, stocks performed better than bonds in 95% of the 15-year periods. Considering all 25-year time periods, stocks performed better than bonds in 100% of the 25-year periods.

The historical investment return data shows that as we extend the time horizon, the risk of a stock portfolio decreases because the probability of a higher return increases. That should be the focus for long-term investors. Do not worry about the daily volatility of a long-term investment. The ultimate goal of a long-term investment is to maximize return. In time periods of 25 years or longer, an all-stock portfolio has always produced a higher investment return than an all-bond portfolio. So if you are an investor with a long time horizon, investing in a stock portfolio should minimize your risk of inferior performance.

Overfunding Education with 529 Plans

2011-09-09T00:00:00.000-05:00

The idea of saving too much for college may not seem like a big concern considering college costs are increasing at about double the rate of inflation. However, for families that use only 529 plans to save for future college costs, saving too much could cost them more than saving just enough. A 529 plan is a type of tax-advantaged account designed specially for college education savings. 529 plan contributions are not deductible for federal income taxes, but money contributed to the plan can grow tax-free, and withdrawals are tax-free if the money is used for education expenses. If the money from a withdrawal is not used for education expenses, the earnings portion of the withdrawal is taxed at ordinary income tax rates plus an additional ten percent penalty tax. That potential tax is an important reason why families should not save too much in 529 plans. Families should instead consider splitting their college education savings between 529 plans and regular, taxable accounts. Let's compare these strategies with a couple of examples.

The Martinez family wants to save enough for their infant daughter to attend an expensive private school at a future estimated cost of $200,000 for four years. The Martinez family saves $100,000 in a 529 plan for their infant daughter which grows to $200,000 by the time she graduates from high school. Once their daughter reaches college age, she decides to attend a more affordable public school that will cost $100,000 over four years. The Martinez family has $200,000 in their daughter's 529 plan but will use only half of that amount for her public college education. Therefore, half of the earnings in her 529 plan ($50,000) will be subject to ordinary income taxes and a ten percent penalty tax. So if the Martinez family is in the 25% federal income tax bracket, they will owe $17,500 in taxes on the half of earnings ($50,000 x 25%) + ($50,000 x 10%).

The Rodriguez family also wants to save enough for their infant son to attend an expensive private school at a future estimated cost of $200,000 for four years. The Rodriguez family saves $50,000 in a 529 plan and $50,000 in a regular, taxable account. The $50,000 in the 529 plan grows to $100,000, and the $50,000 in the taxable account grows to $100,000 by the time he graduates from high school. Once their son reaches college age, he also decides to attend a more affordable public school that will cost $100,000 over four years. The Rodriguez family withdraws the entire $100,000 from the 529 plan to pay their son's education expenses, and therefore, pay no income taxes on the earnings portion of the 529 withdrawal. They do not use the other $100,000 in the taxable account for education, but the earnings in the taxable account ($50,000) will be subject only to capital gains taxes. So if the Rodriguez family is in the 15% long-term capital gains tax bracket, they will owe $7,500 in taxes on the earnings ($50,000 x 15%).

In comparison of the two above scenarios, both families saved the same amounts and paid the same amounts for education, but they did not pay the same amounts of income taxes. The Martinez family paid $10,000 more in taxes than the Rodriguez family because they used only a 529 plan for education savings rather than splitting education savings between a 529 plan and a taxable account. The ideal way to save for college education is to use a 529 plan to save for the minimum education costs and use a taxable account to save for potential costs above the minimum. This strategy will help prevent the overfunding of a 529 plan while still saving an adequate total amount for education expenses. The 529 plan is a great tool in saving for college education costs, but the 529 plan must be used in moderation. Otherwise, income tax penalties may defeat the potential tax benefits.

How Social Security Benefits Are Calculated

2011-08-18T00:00:00.002-05:00

Most of us have a basic understanding of how the Social Security retirement system works. We pay Social Security taxes during our working years and receive Social Security benefits during our retirement years. Your Social Security retirement benefit is based on the amount of income you earn over your lifetime, so generally, the more your earn, the more your benefit will be. But do you really know how much your benefit will be? Do you understand how the Social Security Administration calculates your retirement benefit? Knowing how Social Security benefits are calculated may help us improve the way we plan for retirement.

The first thing to know is to be eligible for Social Security retirement benefits, you need to work for at least 40 quarters (10 years) and earn more than a certain amount of income in each quarter. In 2011, your earnings must be at least $1,120 per quarter ($4,480 per year) for the work to count toward your 40 quarters of needed credit. In previous years, the minimum earnings amount was lower, but it has been increased over the years due to inflation. The amount of earnings that count toward your benefit are also limited to a maximum. In 2011, your earnings in excess of $106,800 per year are not subject to Social Security taxes and are not considered in your earnings history for the retirement benefit calculation. The maximum amount of earnings considered each year is also adjusted upward for inflation.

Now let's go through the formula the Social Security Administration (SSA) uses to calculate your retirement benefit once you become eligible. First, the SSA lists the amounts of all your past earnings per year that were subject to Social Security taxes. They do not include your earnings that were above the maximum earnings taxed in each year. Then, the SSA adjusts for inflation your earnings from past years so that your previous earnings amounts are stated in today's dollars. Next, the SSA selects your highest 35 years of earnings stated in today's dollars and adds together those 35 highest amounts. If you did not work for at least 35 years, you may have some zeros counted in your highest 35 years of earnings. You only have to work 10 years to qualify for a Social Security retirement benefit, but you will need to work at least 35 years in order to maximize your benefit.

Once the SSA has totaled your highest 35 years of indexed earnings, they divide the amount by 420, which is the number of months in 35 years. This provides your average monthly earnings in today's dollars. Then, the SSA breaks your average monthly earnings amount into three parts and multiplies each part by a different percentage. The percentages are fixed, but the dollar amounts of the bend points are adjusted each year for inflation and are stated here as of 2011. The first $749 of your average indexed monthly earnings is multiplied by 90%, the amount above $749 through $4,517 is multiplied by 32%, and the amount above $4,517 is multiplied by 15%. The SSA adds together the three results to determine your primary insurance amount, which is the estimated monthly retirement benefit you are eligible to receive at your full retirement age.

The amount of your Social Security retirement benefit can be lower or higher if you begin receiving a benefit sooner or later than your full retirement age. Your benefit can decrease or increase by approximately 8% per year for early or delayed receipt, but the exact percentage will depend on when your full retirement age is. Your full retirement age is somewhere between ages 65 and 67 depending on your year of birth. Once you start receiving a retirement benefit, your benefit will adjust upward in some years to account for cost of living increases. There are additional factors that can affect the amount of your Social Security benefit, so you may want to consult a financial planner before starting to collect benefits. Hopefully, knowing how Social Security retirement benefits are calculated will allow you to better plan for the benefits you expect to receive in retirement.

Source: Social Security Administration Actuarial Resources

Couples Money Management

2011-08-04T00:00:00.000-05:00

Couples who are married or cohabiting at some point have to decide how to manage their joint finances. There are multiple ways in which couples can successfully managed their joint finances, so each individual couple has to decide which money management style works best for them. This article reviews a few options for how couples may manage their money together.

Everything Joint
One option is to open a joint checking account and deposit all income into and pay all expenses from the joint account. This method requires the couple to ignore potential disparities between their individual incomes and individual expenses. Due to that, the everything joint method works best when the disparity between incomes is so large that one partner is financially supporting the other partner. Having everything joint may also work well when the majority of all expenses are joint or when only one partner prefers to do all of the management.

Everything Separate
Another option is to maintain only separate checking accounts, and the partners individually pay their various joint expenses. This method works well when the partners have similar individual incomes or when they have just a few joint expenses. As an alternative to dividing up payments, one partner can pay all of the joint expenses and the other partner can reimburse the paying partner with his or her part of the joint expenses owed. The everything separate method will require both partners to be active in the management and accounting of expenses.

Joint and Separate
A couple may also combine the joint and separate methods by maintaining both types of accounts. With this option, the couple can deposit all income into the joint account and transfer an allowance to to their separate accounts for individual expenses, or the couple can deposit all income into their respective separate accounts and each transfer an allowance to the joint account for shared expenses. This method works well when the couple has different spending preferences. The couple uses their joint account only for expenditures that are agreed upon by both partners, and they use their individual accounts for expenditures which they do not need to consult with their partner. For this reason, the joint and separate method limits financial stress for many couples.

Once a couple decides how to manage their joint finances, they should also decide which financial responsibilities will be managed by each partner. Even though the responsibilities may be delegated, each partner should know how to manage all of the financial responsibilities in case he or she needs to perform the other partner’s responsibilities at some point. Almost any money management style can work successfully for a couple as long as both partners communicate, understand, and agree to a common practice.

CFP Board Registered Programs

2011-07-14T00:00:00.000-05:00

The Certified Financial Planner™ certification is the recognized standard of excellence for personal financial planning. Candidates for CFP® certification must meet four requirements to obtain certification: education, examination, experience, ethics. The education requirement can be satisfied by obtaining a bachelor's degree from an accredited college or university and completing a financial planning curriculum registered with the CFP Board.

Many universities in the United States offer an undergraduate degree program, a graduate degree program, or a certificate program that satisfies the CFP Board's education requirement. The following are universities located in the State of Texas that offer such programs.

Undergraduate Degree Programs

Angelo State University - San Angelo, Texas
B.B.A., Finance Major with Financial Planning Option

Baylor University - Waco, Texas
B.B.A., Financial Services & Planning

Stephen F. Austin State University - Nacogdoches, Texas
BBA in Finance

Texas Tech University - Lubbock, Texas
B.S. Agricultural Economics / Minor in Personal Financial Planning
B.S. Personal Financial Planning
Undergraduate Minor in Personal Financial Planning

University of North Texas - Denton, Texas
B.B.A., Finance, Financial Planning Track

University of Texas at Dallas - Richardson, Texas
Bachelor of Science, Finance Major, Personal Financial Planning track

University of the Incarnate Word - San Antonio, Texas
B.B.A. in Banking and Finance with a career path in Financial Planning

Graduate Degree Programs

Southern Methodist University - Dallas, Texas
Financial Planning Certificate Program in Plano

St. Mary's University - San Antonio, Texas
Master of Business Administration (MBA), Financial Planning Track

Texas Tech University - Lubbock, Texas
M.S. Personal Finance / M.S. Finance
M.S. Personal Financial Planning
M.S. Personal Financial Planning / MBA
M.S. Personal Financial Planning / JD

Certificate Programs

Rice University - Houston, Texas
Classroom-Based CFP® Certification Education Program

Southern Methodist University - Dallas, Texas
Financial Planning Certificate Program in Dallas

Texas A&M University - Commerce, Texas
Certificate in Financial Planning

Texas State University - San Marcos, Texas
Certificate in Financial Planning Program

Texas Tech University - Lubbock, Texas
Graduate Certificate in Personal Financial Planning

University of Dallas - Frisco, Texas
Financial Planning Certificate Program

University of North Texas - Denton, Texas
Certificate Program in Personal Financial Planning

University of Saint Thomas - Houston, Texas
CFP® Certification Education Program

University of Texas - Arlington, Texas
CFP® Certification Education Program

University of Texas - Austin, Texas
Financial Planning Certificate Program

University of Texas - San Antonio, Texas
CFP® Certification Education Program Online

The education requirement for CFP® certification can alternatively be met by obtaining certain other degrees or professional designations. Academic degrees and credentials that fulfill the educational requirement include: licensed attorney, Certified Public Accountant, Chartered Financial Analyst, Chartered Financial Consultant, Chartered Life Underwriter, Doctor of Business Administration, Ph.D. in business or economics.

Source: CFP Board, July 2011

Spend Less Strategies

2011-07-01T00:00:00.000-05:00

Wealth is accumulated when income exceeds expenses. Wealth accumulation can be accelerated by increasing the spread between income and expenses. Some people prefer to widen that spread by generating more income, while other people prefer to reduce their expenses. For those who prefer the latter, here are five simple strategies that can help you limit the amount you spend.

Buy only what you need.
This simple concept can be easily overlooked as people often lose touch with which expenses really are necessary. You may have been paying for some things so long that you forget about those expenses being discretionary. Almost every budget has discretionary expenses. These expenses can include things like dining in a restaurant, subscribing to premium television, or even upgrading your residence. Sometimes we may need an item, but we do not need the best version of that item. Sure, you need a place to live, but do you really need that huge house with the excellent view in the expensive neighborhood? Sometimes we can be confused with what we really need because we have people telling us we need things that we do not. If you want to lower your spending, try to classify which of your expenses are necessary and which are unnecessary and then reconsider if you want to keep paying for all of those unnecessary expenses. If you still have questions about whether you should be paying for an item or not, seek the guidance of an unbiased third party rather than relying only on the persuasion of a salesman.

Research and compare prices.
Impulsive purchases can cause people to buy things they should not buy and pay prices they should not pay. Shopping is a good way to discover what you want to buy, but that browsing should be complemented with research before making the purchase. If you see something you want, write down the product information, and then leave to do your research. Search the Internet for more detailed specifications and for product reviews. Read about the item in consumer buying guide magazines and websites. You may discover the item you wanted would not really serve your needs, or you may discover alternative items that could better serve your needs. If you complete your research and still want to buy, then compose a list of all stores that sell the item, including online stores, and record each seller's price for the item. This research can also provide you ammunition when buying from sellers who are negotiable or willing to match prices. Narrow down your list of sellers to the ones you feel comfortable buying from and then go with the seller who will give you the best price.

Buy used rather than new.
Used products often cost less than new products, so buying used can be a great way to lower costs. However, you want ensure the quality of the product does not greatly suffer as a result of being used. Products to consider buying used are ones that depreciate in value faster than they depreciate in quality. For example, new cars depreciate significantly as soon as the buyer drives them home. You also want to be able to easily evaluate the quality of the used product. For example, a used computer has more unforeseeable problems than a used dinning table. The lower price of a used item is sometimes due only to a reduced prestige for the item because it was previously owned rather than a result of actual deterioration of the item's quality. Sometimes the lower price is due to an inefficient secondary market; although, the Internet has helped provide a larger marketplace for resell of many used items. Many sellers are more interested in just disposing of their used items rather than recovering the costs they paid for the items. If you are willing to invest time and effort into shopping for used items, you can find some excellent deals.

Pay cash rather than finance.
When you buy an item on credit, you are borrowing money for the purchase, and if you have to pay any expenses to borrow the money, that increases your costs. If you want the lowest price possible, paying cash for an item will always result in a lower price than financing and paying interest. The most common reason people borrow money for a purchase is because they do not have the cash reserves on hand to pay for the item all at once. Therefore, they must pay more to borrow money so they can afford the purchase. When you borrow money to pay for an item, then really consider whether you can comfortably afford the item, and not just whether you can afford the monthly payment. When you finance the purchase of a depreciating asset, your debt on the item could be greater than the value of the item at some point in the future. In this case, you have paid interest costs that can never be recovered even if you sell the depreciated item. The one time you may financially benefit from financing a purchase is when the item appreciates in value and is sold in the future. In that case, you can use leverage to enhance your realized gain and potentially recover all the interest costs you had to pay.

Do it yourself when you have the resources.
When you pay other people for their goods or services, you are paying them for their ability and time to produce and provide those goods and services. When you have the ability and time to produce and provide the goods and services for yourself, you can eliminate the need to pay others for those items. This strategy has some limitations due to specialization of labor and economies of scale. You can learn how to make and do just about anything for yourself, but the resources you must invest may cause you to spend more than you would by paying other people to provide those goods and services. For example, you could go acquire all the education and equipment necessary to build an automobile for yourself, but you would probably spend less purchasing one already built by an automobile manufacturer. On the other hand, you can spend less with the do-it-yourself strategy when the education and equipment investment is low, and especially when the need is routine. For example, you could spend less by cleaning your home by yourself every week rather than paying for maid service to perform the same task. If you have sufficient time, knowledge, and maybe most importantly, the willingness to do things for yourself, this can be a great way to lower your expenses.

Intestate Succession

2011-04-15T00:00:00.002-05:00

A will is the legal instrument used to direct the disposition of a person's estate upon his or her death. If a person dies without a valid will, the intestacy law of the state in which that person resided will be applied in the disposition of his or her estate. This article discusses the intestacy law of the State of Texas. The intestacy laws are different from state to state, so please refer to a different source for intestacy laws outside of Texas. To determine how the estate will be distributed for a person who dies intestate in Texas, locate below the scenario of the deceased person and see the corresponding answer.

The following scenarios apply only to separate property owned solely by the deceased person. Scenarios regarding community property are covered later.

Married, With Children
- one third of personal estate to surviving spouse, and two thirds of personal estate to the deceased's children and their descendants
- one third of real estate to the surviving spouse for the remainder of his or her life, and two thirds of real estate to the deceased's children with the remaining one third of real estate also to the children after death of the surviving spouse

Married, Without Children
- all of the personal estate to the surviving spouse
- one half of the real estate to the surviving spouse, and one half of the real estate to the deceased's family as if the deceased was unmarried

Unmarried, With Children
- all to the deceased's children and their descendants

Unmarried, Without Children, With Both Father and Mother Surviving
- to the father and mother in equal portions

Unmarried, Without Children, With Either Father or Mother Deceased, With Brothers or Sisters
- one half to the surviving parent, and one half to the brothers and sisters and their descendants.

Unmarried, Without Children, With Either Father or Mother Deceased, Without Brothers or Sisters
- all to the surviving parent

Unmarried, Without Children, With Both Father and Mother Deceased, Without Brothers or Sisters, With All Grandparents Surviving
- one quarter to paternal grandfather, one quarter to paternal grandmother, one quarter to maternal grandfather, one quarter to maternal grandmother

Unmarried, Without Children, With Both Father and Mother Deceased, Without Brothers or Sisters, With One or More Grandparents Deceased
- one quarter to each surviving grandparent, and the remaining quarters to the descendants of each deceased grandparent

A married person can have separate property and community property. The following scenarios apply only to community property owned by the deceased with his or her spouse.

Married, With Surviving Children Who Are Not Descendants of the Surviving Spouse
- one half of the community estate to the surviving spouse, and the other half to all of the deceased's children and their descendants

Married, Without Surviving Children Who Are Not Descendants of the Surviving Spouse
- all of the community estate to the surviving spouse

Texas intestacy law provides for many inheritance scenarios depending on the familial status of the deceased person. If a person wishes for his or her estate to be distributed in a manner different than what the intestacy laws dictate, that person should have a legal will. Even if the person agrees with the intestacy laws for how he or she wants the estate to be distributed, the absence of a will can create additional costs and delays in disposition of the estate. Individuals should seek legal counsel services in the development of their wills to ensure proper disposition of their estates after death.

Law Source: Texas Statutes, Probate Code, Chapter 2, Section 38 and Section 45

Passive Investment Management

2011-03-04T12:00:00.000-06:00

Active management and passive management are two contrasting investment strategies. Active management is based on the idea investors can outperform the market through security selection and market timing. Passive management is based on the idea investors cannot consistently outperform the market. The passive strategy holds that efficient markets make excess gains too expensive to pursue, so investors should aim for average performance at minimal cost. Both investment strategies have valid arguments, but an evaluation of each method will show why the passive investment strategy is the more favorable option.

The active investment strategy presents some challenges. The first challenge is determining which securities to own. For example, when an investor wants to own a mutual fund in a particular category, the investor must select among hundreds or thousands of available funds in that category. The selection process is usually based on an evaluation of how mutual funds in that category have historically performed, and the investor will typically select an actively managed fund that has performed well in the past. The problem is past performance does not guarantee future results. The investor can select a actively managed mutual fund that has performed well in the past, but that fund could be among the worst performing funds in the future. Mutual fund managers cannot consistently beat the market, so consequently, investors risk underperforming the category with an actively managed fund.

The passive investment strategy does not require such an in-depth evaluation and comparison of different securities. When a passive investor wants to own a mutual fund in a particular category, the investor selects a low-cost, well-diversified index fund that represents that category. An index fund does not have as much risk of underperforming the category because an index fund should represent the same composition as the category. In each category, some securities will perform well and some will perform poorly, but when they all net against each other, the result will be average market performance. The passive investor is willing to accept average market performance rather than accept the risk of underperformance. Past performance of an index does not guarantee future results, but if an investor wants to perform as well as the category index, then an index fund will typically produce those results.

The second challenge of the active investment strategy is knowing when to own certain securities. The active investor wants to own more aggressive securities when the market will perform well and more conservative securities when the market will perform poorly. To determine how the market will perform, the investor must evaluate the current environment and make predictions for what will happen going forward. The problem is that investors' predictions and timing are not always right. Investors have a tendency to buy securities when they are performing well and sell securities when are performing poorly, when actually, they should do the opposite. Some investors know to buy low and sell high, but they must still make predictions for when the lows and highs will occur. The investors' predictions may be right sometimes, but in order to outperform the market, they must accurately predict the market a majority of the time.

The passive investment strategy does not attempt to time the market by buying and selling different securities based on market conditions. The passive investor would prefer to follow a buy-and-hold approach utilizing a diversified mix of index funds. First, investors determine their appropriate asset allocation based on their risk tolerance and time horizon. Then the investors select a mix of securities that represents their appropriate asset allocation and maintain that allocation through various market fluctuations by rebalancing occasionally. By rebalancing, the investors sell overperforming securities and buy underperforming securities, which is to follow the ideal principle of buying low and selling high. Passive investors maintain their current asset allocation through market fluctuations because if they are allocated appropriately, they are willing to accept the risks and rewards that come with that allocation.

The active investment strategy can outperform the passive investment strategy if an investor is fortunate enough with security selection and market timing, but the high costs of attempting to outperform make the active investment strategy impractical. The passive investor can buy and hold index funds with low expenses. The active investor will research and evaluate multiple securities and market conditions and select actively managed mutual funds with a higher expense ratios. Even with all of that effort and expense, active investors may still underperform passive investors, and even if the active investors perform as well as the passive investors, the additional costs incurred put active investors at a disadvantage. For active management to beat passive management, investors must consistently outperform the market average. Investors cannot consistently outperform the market, and in the times when they can outperform, the added costs negate excess gains. These are the reasons why the passive investment strategy frequently results in better performance.

Mortgage Point Comparison

2011-02-15T19:00:00.000-06:00

Mortgage loan costs are important to understand when financing the purchase of real estate. Mortgage lenders commonly charge borrowers a variety of different fees, collectively known as closing costs, to obtain a mortgage loan. Some of these are standard, fixed fees charged by a lender on all mortgage loans. One fee that has some variability in how it is applied is the discount point.

Discount points, also known as an origination fees or points, are initial interest charges prepaid by a borrower to lower the interest rate on a mortgage. One point will cost the borrower one percent (1%) of the loan amount and typically lowers the interest rate by one-eighth percent (0.125%). For example, if the mortgage interest rate is 5.50% without any points paid, and the borrower pays two points, the lender will decrease the interest rate to 5.25%.

Should a borrower pay points to lower the interest rate on a mortgage loan? Paying zero points minimizes the initial cost to obtain the loan but results in a higher repayment cost going forward. Paying some points will increase the initial cost to obtain the loan but reduces the repayment cost going forward. The decision of whether a borrower should pay one or more discount points can be evaluated by conducting a break-even analysis.

Some professionals will try to present the break-even analysis in the following manner. A borrower wants to obtain a $200,000 mortgage loan. The interest rate without paying any points is 5.125%. Paying one point will add $2,000 to the borrower's closing costs and will lower the interest rate to 5.0%. Due to the lower interest rate, the scheduled monthly payment will be reduced by $15.33 per month. At a savings rate of $15.33 per month, the borrower will save a total of $2,000 in monthly payments over a period of 131 months, or almost 12 years. If the borrower plans to keep the mortgage 131 months or longer, then paying the one point would save the borrower money. If the borrower plans to keep the mortgage less than 131 months, then paying the one point would not save the borrower money. This break-even comparison seems easy enough, right? The problem is this evaluation is oversimplified. This method of comparison is inadequate and presented here only to demonstrate what not to do.

To accurately determine whether a point should be paid, the break-even analysis should consider the difference in monthly interest costs, not the difference in monthly payment costs. Revisiting the previous scenario, by lowering the interest rate from 5.125% to 5.0%, the interest portion of the monthly payment will be reduced by $20.83 in month one. The interest portion of the monthly payments decreases slightly each month, so loan amortization tables must be referenced to compare the difference in interest paid each month. Comparing the cumulative monthly interest that would be paid with each loan shows the borrower will save a total of $2,000 in monthly interest payments over a period of 98 months, or about 8 years. If the borrower plans to keep the mortgage 98 months or longer, then paying the one point would save the borrower money. If the borrower plans to keep the mortgage less than 98 months, then paying the one point would not save the borrower money. As you can see, this break-even point is much sooner than the 131 months that was calculated previously.

Why should we compare the difference in monthly interest payments rather than total monthly payments? The total monthly payment is comprised of two parts: principal and interest. The borrower benefits by reducing the portion of the payment that goes towards interest because that means more of the monthly payment goes towards principal. The more principal the borrowers pays, the more the outstanding loan balance is reduced. When the borrower sells the real estate, having a lower outstanding loan balance to pay off results in the borrower keeping more of the sales proceeds. We compare the difference in monthly interest payments because the borrower should not be concerned with only the monthly payment savings but also the total gain realized when the real estate is sold. A lower interest rate on the mortgage loan provides a lower monthly payment and a faster accumulation of equity in the real estate. Borrowers should consider both of these important factors when evaluating whether to pay points on a mortgage loan.

Resources: Glossary of Mortgage Terms

Estate Tax Law Changes

2011-01-11T00:00:00.000-06:00

The future of federal estate tax law was a mystery until Congress recently passed the "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010." This legislation included, among many tax law items, changes to the estate tax law for years 2010, 2011, and 2012. The following is a summary of the new changes in the federal estate tax law.

Under previous tax laws, the estate tax was fully repealed for 2010, but the new legislation retroactively reinstated an estate tax for 2010. For 2010, the estate tax exemption amount is $5 million. The amount of an estate that exceeds the exemption amount is taxed at 35%. Retroactively applying an estate tax law may seem unfair to many estates of individuals who died during 2010; however, the estates of individuals who died during 2010 have a choice in which rules they want to follow. They can be subject to the new estate tax law for 2010 or elect to follow the previous rules assuming a full repeal of the estate tax in 2010. The basis of inherited assets is treated differently under each scenario and may influence which rules a decedent's estate elects to follow.

Under the new estate tax law for 2010, the basis of inherited assets is the full market value at the decedent's death. Under the 2010 repeal of the estate tax, the basis of inherited assets is limited to the lesser of the decedent's basis or the full market value at the decedent's death. Estates of less than $5 million will probably want to assume an estate tax during 2010. They can still avoid paying estate tax with the $5 million exemption, and their heirs can receive a full fair market basis in the inherited assets. Estates of more than $5 million may want to elect the repeal of estate tax for 2010. Their heirs will not receive a step-up of basis, but future capital gains they may have can be taxed at the long-term capital gains rate of 15% rather than the current estate tax rate of 35%.

For 2011 and 2012, the estate tax exemption is $5 million (adjusted for inflation in 2012), and the amount of an estate that exceeds the exemption is taxed at 35%. One main difference in the estate tax law for years 2011 and 2012 compared to previous years is the portability of the estate tax exemption between spouses. In previous years, any unused portion of a deceased spouse's exemption amount could not be used by the surviving spouse, but for 2011 and 2012, any unused portion of a deceased spouse's exemption is added to the exemption amount available to the surviving spouse. For example, if a husband dies and leaves everything to his wife, then he uses none of his $5 million available estate tax exemption. His wife would then have an available estate tax exemption of $10 million, which is the $5 million unused by her husband plus the $5 million of her own exemption.

The "Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010" did not address changes in the federal estate tax law for years beyond 2012. Starting in 2013, absent further legislation, the estate tax exemption amount will revert to $1 million, and the maximum estate tax rate will be 55%. The portability of the estate tax exemption between spouses will also disappear starting in 2013. Congress could pass additional legislation before 2013 that extends the recent changes in the estate tax law, but to assume that now would be pure speculation. Until we have legislation that makes the federal estate tax law permanent, the future of estate tax law will always be a mystery.

Supporting Documents: Text of Legislation; Technical Explanation; Summary

Concurrent Ownership of Property

2010-12-14T00:00:00.003-06:00

Ownership of property can take several different forms, such as sole ownership by one person or concurrent ownership by two or more persons. Within the category of concurrent ownership, there are various arrangements by which people can own property together. The form of concurrent ownership may depend on facts such as how and when the property was acquired and whether the co-owners are spouses or non-spouses. People who own property together should be concerned with the form of ownership because it can affect their rights with the property during their lives and the disposition of the property after their deaths. This article will discuss different forms of concurrent ownership and characteristics of each.

Individuals who are not married to each other (non-spouses) may own property together in one of two forms: Tenancy In Common or Joint Tenancy. Tenancy In Common can be thought of as the default form of co-ownership. When two or more individuals acquire property together, they will be regarded as Tenants In Common if no statement to the contrary is documented in the ownership title. Each of the Tenants In Common owns a percentage share of the property, and those percentages can be equal or unequal, as determined by the percentage contributed by each to acquire the property. Each of the Tenants In Common has the right to access, utilize, sell, and even encumber with debt their portion of the property. When one of the Tenants In Common dies, that owner's share of the property will be included in his or her estate and go through probate. The surviving Tenants In Common do not have an automatic right to inherit the deceased owner's share of the property. The deceased owner's share will be inherited by the beneficiary designated in the deceased owner's will, which may or may not be the surviving Tenants In Common, or by the state laws of intestate if the owner dies without a will.

Joint Tenancy can be thought of as the alternative form of co-ownership. If two or more individuals wish to own property as Joint Tenants, they must be explicitly documented as such in the title. To form a Joint Tenancy, all of the owners must have acquired the the property at the same time, hold the same title to the property, own equal shares of the property, and have equal rights to possess the property. If any one of these four requirements fails to be true during the life of a Joint Tenancy, then the ownership will convert to a Tenancy In Common. As with the Tenancy In Common, each of the Joint Tenants has the right to access, utilize, sell, and encumber the property. The main difference in the Joint Tenancy form of ownership is the provision for a deceased owner's share of the property to bypass probate and be automatically inherited by the surviving Joint Tenants, in which case the ownership is named Joint Tenants With Right Of Survivorship. In some states, such as Texas, the words Joint Tenants With Right Of Survivorship must be written in the title. If the ownership is recorded only as Joint Tenants and the words With Right Of Survivorship are missing, then the right of survivorship will not be assumed, and the deceased owner's share will be included in his or her estate.

Individuals who are married to each other (spouses) may have an additional form of ownership available. Tenancy By The Entirety is a form of co-ownership between spouses available in only about half of the states. This form of ownership is very similar to Joint Tenancy. Tenancy By The Entirety includes the four requirements for Joint Tenancy with an additional fifth requirement of marriage between the owners. Unlike with Joint Tenancy, one spouse cannot unilaterally terminate the Tenancy By The Entirety by breaking one of the requirements, such as selling his or her half of the property. Tenancy By The Entirety can provide the same benefit of Joint Tenancy With Right Of Survivorship by allowing the deceased spouse's share of the property to bypass probate and be automatically inherited by the surviving spouse.

Community Property is another form of co-ownership between spouses available in only some states: Alaska, Arizona, California, Louisiana, Idaho, Nevada, New Mexico, Texas, Washington, and Wisconsin. Community Property is defined as any property accumulated by either spouse during marriage except for gifts and inheritances. Each spouse owns a one-half, undivided interest in all Community Property, regardless of his or her individual contributions to acquire or maintain the property. Spouses can own Community Property as either Tenants In Common or as Joint Tenants. The mere fact that a property is classified as Community Property does not dictate how the property will be disposed of after the death of a spouse. The laws of Community Property define the rights of each owner while both spouses are still living, but the disposition of Community Property after one spouse's death will depend on whether the spouses were Tenants In Common or Joint Tenants With Right Of Survivorship.

These are the most common forms of concurrent ownership between individuals. One form of ownership does not stand out as the best because each form has different characteristics that may achieve the goals of different people. You may want to seek legal counsel for more guidance on which form of concurrent ownership would best achieve your goals. Content from this article should not be interpreted as legal advice. Content from this article should be regarded as general and generic because each legal jurisdiction can have variations in the interpretation and application of property laws and probate laws. You should consult with an attorney for more information regarding property laws and probate laws before making any changes to ownership registrations or other legal documents.

Currency Exchange

2010-11-16T00:00:00.002-06:00

If you have ever traveled in a foreign country, you have probably had to exchange your U.S. Dollars for a foreign currency. How much foreign currency your Dollars will buy depends on the value of the Dollar at that time. You can check currency conversion rates to find what quantity of a foreign currency is currently equal to one Dollar. However, you should not expect the currency conversion rates to represent exactly what you will receive in a currency exchange. Businesses that exchange currency make money on these transactions by building a fee into their exchange rates. The way these businesses charge you can make it difficult to detect how much that currency exchange is actually costing you. This article will show how to calculate the true cost of currency exchange. For illustration purposes, let's evaluate conversions between the U.S. Dollar and the Mexican Peso.

The currency conversion rate changes daily, but let's say 1 Dollar currently equals 12.5 Pesos. You have Dollars and want to buy Pesos, so you go to a currency exchange business. They sell you 12 Pesos per 1 Dollar. One Dollar is actually worth 12.5 Pesos, but for each Dollar you convert, the currency exchange business keeps 0.5 Pesos and only gives you 12 Pesos. The 0.5 Pesos per Dollar that they keep is the exchange fee they are charging you. You can calculate the exchange cost in Dollars by reversing the conversion rate. One Dollar divided by 12.5 Pesos equals 0.08 Dollars per Peso. You are paying an exchange fee of 0.04 Dollars for each Dollar you convert to Pesos.

You now have Pesos and want to buy back your Dollars at the currency exchange business. Get ready to pay another exchange fee. They sell you 1 Dollar per 13 Pesos. One dollar is actually worth 12.5 Pesos, but for each Dollar you buy, the currency exchange business charges you 13 Pesos and keeps the extra 0.5 Pesos as their exchange fee. Based on the reversed conversion rate of 0.08 Dollars per Peso, you are paying an exchange fee of 0.04 Dollars for each Dollar you buy. Since you only received 12 Pesos for each Dollar you sold and had to pay 13 Pesos for each Dollar you bought, the double conversion cost you 1 Peso, or 0.08 Dollars, per Dollar converted.

Paying currency exchange fees can be difficult to accept because we know exactly how much currency is worth, and psychologically, we do not like to pay more for things than they are worth. However, we should recognize that currency exchange businesses are trying to earn a profit just like any other business. They have to charge exchange fees to compensate for the services they provide, but this does not mean you should just accept any fee they try to charge. Competition can exist among currency exchange businesses, so you should shop around for the best exchange rate and negotiate the best deal you can.

Retirement Plan Improvement

2010-10-08T00:00:00.002-05:00

Retirement planning is avoided by some people because they fear their financial future may appear unfavorable. However, people who worry about being financially prepared for retirement are very likely the people who would benefit most from retirement planning. They can benefit because planning will show them what actions they can take to make their financial future appear more favorable. If you are ever unsatisfied with the results of your retirement plan, do not get discouraged because there may be adjustments that can be made to improve those results. Let’s review a few strategies that can greatly improve your retirement plan projections.

Saving more money is one obvious way to improve your plan. This means you have to reduce your current lifestyle expenditures, but that may be to your advantage in more than one way. If you can reduce your lifestyle expenditures before retirement, you may discover that your expected retirement need is actually less than previously forecasted. Also consider that some expenditures may disappear in retirement, such as supporting children, paying a mortgage loan, and spending on job-related expenses. If you reduce the expected level of retirement expenditures, then you will likely need less accumulated savings for retirement. So although you will save more money before retirement, the necessary amount of savings may not be as high as you think.

Delaying retirement is another way to improve your plan results. Retiring at an older age may provide more years to save and may reduce the number of years of your retirement need. Of course, we cannot know the exact number of years of retirement need since age of death is unknown. With the delayed retirement option, you can benefit your plan without having to increase annual savings or decrease annual spending, before or after retirement. An in-between option can be to include some income from a part-time job after retirement. This extra income may not allow you to totally delay retirement need withdrawals, but it can reduce the amount of withdrawals needed during your early years of retirement, providing your investments more time to grow.

Downsizing your estate can also improve your plan results. Selling assets outside of your investment portfolio can provide additional cash flow into your retirement plan. For many families, a home is their most valuable non-investment asset. Once the children have left home and less living space is needed, you may want to sell your current home, purchase a smaller home, and use the net proceeds for retirement funding. For married couples, a reevaluation of estate needs may be necessary after one spouse dies. Also consider how much inheritance you want to leave to your heirs upon your death. If estate preservation is not a goal, then you may consider liquidating everything you have of value in order to fund your retirement.

Retirement is a reality of life, so retirement planning should not be avoided. You may fear unfavorable plan results, but we have just reviewed a few strategies that can improve those results. Retirement planning will help you better prepare for the future by showing you what steps to take today. Do not delay planning because the sooner you start, the more options you have, and the better prepared you can be.

Long-Term Care Insurance Policy Features

2010-09-18T00:00:00.000-05:00

Long-term care is the provision of medical or non-medical assistance to people experiencing a prolonged illness or disability. Long-term care is most frequently needed by elderly individuals, but long-term care can potentially be needed by anyone starting at any age. The costs of long-term care over an extended period of time can be astronomical, so planning for a way to pay for long-term care is important. Many people turn to long-term care insurance to protect against the risk of having to pay for all of the care themselves. People with long-term care insurance receive benefits to help pay for the cost of their care if they ever reach certain health conditions defined in their policies. Long-term care insurance policies have several features which may be unfamiliar to individuals evaluating this type of insurance for the first time. This article will explain the most common features of a long-term care insurance policy.

Type of Care: Long-term care insurance policies may offer options of where the care is provided. Home-based care is provided in your home, which may include skilled medical care or possibly just homemaker services. Adult day care is provided at a facility away from your home during the day, and then an informal care-giver cares for you at home in the evenings. Assisted living care is provided at a facility where you live in a community with others needing long-term care. Nursing home care is also provided at a facility where you live but includes more skilled medical care assistance. You should consider which type of care you want to prepare for and make sure your policy covers that type of care.

Benefit Triggers: To become eligible for long-term care insurance benefits, tax-qualified policies require you to be unable to perform at least two of the six activities of daily living. The six activities of daily living are eating, bathing, dressing, transferring into and out of a bed and a chair, getting to and from the toilet, and control of bowel and bladder function. You may also qualify for benefits if you develop a severe cognitive impairment, such as Alzheimer’s Disease. If you want a policy with more liberal benefit triggers, you may have to evaluate policies that are non-tax-qualified. The disadvantages of non-tax-qualified policies are that premiums are not tax-deductible and benefits may be taxable income.

Elimination Period: Once you reach the benefit triggers defined in your policy, you must wait a number of days before the insurance policy begins paying you benefits. During this waiting period, you must pay out-of-pocket for all of the long-term care you receive. Most policies have an elimination period that ranges between 30 and 180 days. Tax-qualified policies require an elimination period of at least 90 days. After you have been receiving long-term care for a number of days equal to the elimination period, your policy will then begin paying benefits.

Benefit Amount: The benefit amount is usually expressed as a maximum daily benefit. The insurance policy will pay up to a certain dollar amount each day for your long-term care. The daily benefit amount may differ depending on the type and location of care. Benefit amounts commonly range between $100 to $300 per day. The benefit amount may not cover 100% of your daily long-term care expenses, in which case you may still have to pay some costs out-of-pocket. You should evaluate the cost of long-term care in the area where you want to live and decide how much of that cost you are willing to pay versus have the insurance pay.

Benefit Period: The benefit period is usually expressed as the maximum number of years your policy will pay benefits once you begin receiving long-term care. The benefit period may also be expressed as a maximum dollar amount, in which the policy will pay your daily benefit amount until the maximum dollar amount is reached. The benefit period options can range anywhere from one year to a lifetime. A very long benefit period may not be necessary for most people because the average individual utilizes long-term care for less than five years.

Inflation Option: Long-term care insurance policies also offer an option to increase your benefit amount over time to help protect against the rising cost of long-term care. A simple inflation adjustment will increase your benefit amount each year by a percentage of the initial benefit amount. A compound inflation adjustment will increase your benefit amount each year by a percentage of the previous year’s benefit amount. The compound inflation adjustment is much more likely to keep pace with actual inflation.

Nonforfeiture Option: You may elect the option to receive some long-term care benefits even if you decide to cancel your policy. If this option is selected, the insurance policy will provide long-term care benefits until your total long-term care cost equals the dollar amount of premiums you paid into the policy. As an alternative, the policy might provide your daily benefit amount for a shortened benefit period, such as 30 days.

Premium Waiver Option: When you are insured by a long-term care policy, you are normally required to continue paying premiums even after your begin receiving long-term care benefits. If the premium waiver option is selected, you can stop paying for the policy once you start receiving benefits. The premium waiver may not apply for all types of long-term care received, so be sure to determine when this feature would actually apply.

Long-term care insurance policies may have additional options and features not listed here, so fully investigate any policies you are considering before becoming insured. The features of a long-term care insurance policy will directly impact the cost of the policy. Obviously, the more favorable your policy features are, the more expensive your premiums will be. You have to find the right mix of features you desire in a policy at a premium cost you are comfortable with. Remember the purpose of any insurance is to protect against the risk of incurring costs that you could not pay for by yourself. Some people may have enough assets to pay for a potential need for long-term care without any assistance. For the rest of the population, insurance may be the best option to help pay for long-term care.

Sources: Texas Long-Term Care Partnership, Texas Department of Insurance

College Cost Inflation

2010-09-01T00:00:00.000-05:00

The cost of attending college is becoming more expensive. Because of inflation, the cost of most goods and services normally increases over time, but college education costs have historically increased more rapidly than most other goods and services. Saving for future college expenses has become an essential part of the financial planning process for many families. Education planning requires a projection of future college costs and a savings plan that will prepare families for those future costs.

To help project future costs of goods and services, we evaluate historical inflation rates. The U.S. Consumer Price Index (CPI) is commonly used as a measure of inflation in the United States. CPI measures the change in average price of a defined basket of goods and services purchased by U.S. consumers. Based on the CPI, the average annual inflation rate over the past 20 years (1990 through 2009) was 2.8%. The average inflation rate during the 1990s was 3.0% per year and during the 2000s was 2.6% per year.

We also need an inflation measure specific to college expenses. A not-for-profit organization named College Board conducts an annual survey of colleges around the country and compiles data lists regarding the average cost of college. One of the College Board lists shows the historical average cost of tuition, fees, room and board at public and private four-year universities. Based on the College Board data, the average annual increase in college cost over the past 20 years (school years 1990-1991 through 2009-2010) was 6.0% at public institutions and 5.4% at private institutions.

As you can see from the data, the cost of college has been rising at about double the rate of inflation. What does this mean for families? Assume a family with a newborn child earns $100,000 annual income. 18 years from now, they want to send their child to a college that currently costs $15,000 per year, or 15% of their income. Assume their income inflates by 3% annually, and the college cost inflates by 6% annually. After 18 years, their income inflates to about $170,000 per year and the college cost inflates to about $43,000 per year. The family planned on sending their child to a college that costs 15% of their income, but after 18 years, the college now costs 25% of their income, which may be more than their budget can handle.

How can families prepare for future college expenses? Paying for all college expenses as they are incurred is too stressful on most families budgets, so a better alternative is to save for college expenses in the years before those expenses are expected to be incurred. Education planning can help families establish a savings strategy that achieves their goals for college education funding. As the cost of attending college increases, so does the significance of the education planning process. We cannot control the rising cost of college, but we can control how we plan and prepare for it.

Sources: Bureau of Labor Statistics, College Board

Investment Return Calculations

2010-08-16T00:00:00.000-05:00

Investment returns should be evaluated and compared in reference to a specified length of time. A 7% total return is not meaningful performance data without knowing the length of time it took to earn the 7%. Likewise, comparing a 7% total return over three years versus a 7% total return over five years will not provide a fair comparison. To help people better evaluate and compare total investment returns over various time periods, they are often calculated as annual returns. Let's examine how total returns and annual returns are calculated.

Assume a $10,000 investment grows to $12,000 over a five year period. To calculate the total return over the period, divide the ending value by the beginning value and then subtract one. [ (12,000/10,000) - 1 = 0.20 = 20% ] It might seem like a 20% return over five years would equate to a 4% annual return. [ 20% / 5 = 4% ] However, calculating annual return this way ignores the benefit of compound interest. Compound interest occurs when investment earnings are added to the principal investment so that future investment growth applies to both the initial investment and accumulated earnings. If we assume the investment earns 4% per year on both the initial investment and the accumulated earnings, the total return after five years would be more than 20%. Therefore, simply dividing the total return by the number of years of the investment period is not the correct way to calculate annual return.

To calculate annual return on both the initial investment and the accumulated earnings over the period, divide the ending value by the beginning value to derive the total return, raise the total return to the power of one divided by the number of years of the investment period, and then subtract one. [ Annual Return = (ending value / beginning value)^(1 / number of years) - 1 ] When we know the annual return but not the total return, we can calculate total return by adding one to the annual return rate and raising it to the power of the number of years of the investment period. [ Total Return = (1 + annual return)^(number of years) ]

Let's return to the example where a $10,000 investment grows to $12,000 over a five year period. The annual return is calculated as [ (12,000/10,000)^(1/5) - 1 = 0.0371 = 3.71% ]. Using the annual return number of 3.71%, we can calculate the total return over five years as [ (1+0.0371)^(5) - 1 = 0.1998 = 19.98% ] which when rounded, is the 20% total return we initially calculated. The same formulas apply even if the investment period is less than one year. Assume the $10,000 investment grows to $12,000 over a nine month period. Nine months is 75% of one year, so the annual return is calculated as [ (12,000/10,000)^(1/0.75) - 1 = 0.2752 = 27.52% ].

In the formulas, when we raise a number to the power of a number, that means we multiply a number times itself for the number of times of the power. [ example: four raised to the power of three = 4^3 = 4*4*4 = 64 ] This part of the formula can get complicated, so a calculator is highly recommended for performing investment return calculations. Investment return itself is not difficult to derive with the use of a calculator. Knowing and using the correct formulas is the key to successfully calculating investment returns. Recognizing the difference between total return and annual return is essential to evaluating and comparing various investment returns.

Hedging with Futures Contracts

2010-08-04T00:00:00.000-05:00

A futures contract is an agreement between two parties to buy or sell a specified asset at a future time and price. The quantity and quality of the asset and the future price and time of the transaction are all agreed upon when the futures contract is made. To complete the contract, the seller must deliver the asset at the future time and the buyer must accept the asset and pay the seller the previously agreed upon price. A majority of the time, futures contracts are never completed. Rather, the buyer and/or seller purchase the opposite position of a different futures contract, allowing them to reverse out of their original position.

Futures contracts can be made on different types of assets, including commodities such as metals, fuels, crops, and livestock. Producers of commodities commonly use futures contracts to reduce their risks from fluctuating commodity prices. They hedge against the price risk by purchasing futures contracts in a position opposite to their current position. A long position benefits from a price increase, and a short position benefits from a price decrease. Producers have a long position in the product they are selling, so they may enter into a short hedge if they want to reduce the price risk of a product they are selling. Producers have a short position in any product they need for production, so they may enter into a long hedge if they want to reduce the price risk of a raw material they use in production. Let’s cover a couple of examples to show how futures contracts can be used as a hedge. For the sake of simplicity, these examples ignore transaction costs and taxes.

Long Position, Short Hedge: The price of cattle is currently 90 cents per pound. Mr. Rancher needs to sell his cattle six months from now but is unsure what the future price of cattle will be. He wants to lock-in a future price, so he looks for someone who will buy his cattle six months from now at 90 cents per pound. Mr. Butcher offers to buy Mr. Rancher’s cattle six months from now at a price of 90 cents per pound, so they agree to a futures contract. After six months pass, the price of cattle may be either higher or lower than 90 cents per pound. Let’s evaluate what happens under each scenario.

Price Increase: Six months pass, and the price of cattle increases to 95 cents per pound. To complete the contract, Mr. Rancher would deliver the cattle to Mr. Butcher for 90 cents per pound, thereby selling for 5 cents less than the market rate but still getting the 90 cents per pound previously locked-in. However, Mr. Rancher could reverse out of his futures contract position by purchasing a contract to buy cattle currently at 95 cents per pound and using that contract to cover his obligation to sell cattle at 90 cents per pound. Mr. Rancher incurs a 5 cent loss on his futures contract and then sells his cattle at the current market price of 95 cents per pound, so his net revenue would be 90 cents per pound, his previously locked-in price.

Price Decrease: Six months pass, and the price of cattle decreases to 85 cents per pound. To complete the contract, Mr. Rancher would deliver the cattle to Mr. Butcher for 90 cents per pound, thereby selling for 5 cents more than the market rate but still getting the 90 cents per pound previously locked-in. However, Mr. Rancher could reverse out of his futures contract position by purchasing a contract to buy cattle currently at 85 cents per pound and using that contract to cover his obligation to sell cattle at 90 cents per pound. Mr. Rancher earns a 5 cent gain on his futures contract and then sells his cattle at the current market price of 85 cents per pound, so his net revenue would be 90 cents per pound, his previously locked-in price.

Short Position, Long Hedge: The price of hay feed is currently 15 cents per pound. Mr. Rancher needs to buy hay to feed his cattle over the next several months but is unsure what the future price of hay will be. He wants to lock-in a future price, so he looks for someone who will sell him hay three months from now at 15 cents per pound. Mr. Farmer offers to sell Mr. Rancher hay three months from now at a price of 15 cents per pound, so they agree to a futures contract. After three months pass, the price of hay may be either higher or lower than the 15 cents per pound. Let’s evaluate what happens under each scenario.

Price Increase: Three months pass, and the price of hay increases to 20 cents per pound. To complete the contract, Mr. Farmer would deliver the hay to Mr. Rancher for 15 cents per pound, and Mr. Rancher would buy for 5 cents less than the market rate, paying just the 15 cents per pound previously locked-in. However, Mr. Rancher could reverse out of his futures contract by selling to someone else his contract to buy hay at 15 cents per pound and then purchasing hay at the current market rate of 20 cents per pound. Mr. Rancher earns a 5 cent gain on his futures contract and then buys hay at the current market price of 20 cents per pound, so his net cost would be 15 cents per pound, his previously locked-in price.

Price Decrease: Three months pass, and the price of hay decreases to 10 cents per pound. To complete the contract, Mr. Farmer would deliver the hay to Mr. Rancher for 15 cents per pound, and Mr. Rancher would buy for 5 cents more than the market rate, paying the 15 cents per pound previously locked-in. However, Mr. Rancher could reverse out of his futures contract by selling to someone else his contract to buy hay at 15 cents per pound and then purchasing hay at the current market rate of 10 cents per pound. Mr. Rancher incurs a 5 cent loss on his futures contract and then buys hay at the current market price of 10 cents per pound, so his net cost would be 15 cents per pound, his previously locked-in price.

As you can see, in both the long position and the short position, the use of a futures contract can lock-in a price. The hedge can reduce price risk, but it may not eliminate price risk. Mr. Rancher needs to accurately predict the quantity, quality, and timing of the cattle he will sell and the hay feed he will need in order to achieve a perfect hedge. It should be noted that Mr. Rancher has locked-in a price only because he has hedged opposite to his current position. Futures investors who are not producers or users of the underlying assets are not trying to reduce price risk; they are trying to realize an investment gain. Futures contracts are still subject to gains and losses even if the futures investor owns or uses the underlying assets. Futures contracts are complex financial products subject to investment risk. However, futures contracts can be very a useful tool for commodity producers and consumers who are completely exposed to price risk.