Blue Jeans Millionaire

Checking the Beneficiary Box, Part II

Richard — Fri, 10 Jul 2009 12:17:19 +0000

Step one was making sure that your current designations on your workplace retirement savings accounts were in order.

Step two involves some more sophisticated estate planning…

…a task that takes on an entirely new dimension when you have heirs spanning one or two generations.

Start with the idea that there are two kinds of retirement accounts:

Those that are funded by tax-deductible dollars (regular 401-k and regular IRA accounts)
Those that are funded by after tax dollars (Roth 401k and Roth IRAs)

The rule on the regular accounts is that the tax will be paid upon distribution. What you control is whether the distribution will be a lump sum, or taken as required minimum distributions based on the actuarial tables furnished by the IRS.

The advantages in drawing down just the minimum required is that your tax obligation is broken down into bite-size chunks each year…and more importantly, the corpus of your account can and should continue to be invested.

Think of it as a bucket that has a hole in the bottom (withdrawals), but that continues to steadily fill up from the spigot of compounded earnings.

When your heir(s) inherit, they will then draw down based on their life expectancy.

For example, your spouse can simply rollover your unused portion into their own IRA, and draw the minimum required for their life expectancy.

The opportunity to plan for dynastic wealth emerges when you designate someone a generation or two younger…your children or grandchildren…as the beneficiary. Simply because they have a much longer anticipated life span, and will therefore be taking smaller distributions.

This is not absent all possible peril. If a sixteen year old grandson is designated as beneficiary, he could blow it all on fast cars and women.

Or he could spend it all foolishly.

Better to set up a trust as beneficiary, so that an adult can dole out the funds in a more responsible manner.

The possibilities are magnified dramatically when we deal with Roth accounts.

They will still require lifetime amortization (for the heirs, not for the initial account holders), but there will be no taxation.

Think this through. I set up Roth IRAs for both of my kids when they were earning money from summer jobs as teenagers. They could continue to fund these accounts for another sixty years—maybe longer, with no required distribution.

And then they could name their future grandchildren as beneficiaries, under trust supervision by the middle generation…to run an additional 75 years, with regular draws that are never, ever taxable.

A way to fund expensive education and other life essential goals, to benefit both your children and grandchildren.

An elegant but simple plan, that requires some foresight and much patience.

Resulting in what the lawyers like to call control from the grave.

Checking the Beneficiary Box, Part I

Richard — Thu, 09 Jul 2009 12:12:08 +0000

What’s the least favorite topic wealth management clients want to discuss?

Their eventual, inevitable demise.

Predictably…many put their head in the sand and ignore this eventuality.

Which explains the huge percentage of families who have not done the most rudimentary of wills and life insurance protection.

But even for these laggards, your employer’s H.R. department will prod you to make some end of life decisions. Whether you like it or not.

I refer to the beneficiary designation you must check off when you participate in your workplace 401k and free life insurance program. Or your regular or Roth IRA.

This is estate planning on the cheap.

It only takes a quick stroke of the pen, but the consequences can be both long lasting and monumental in scope and outcome.

Here are some salient features you need to understand and utilize.

1. In most states, if you do not name your spouse as the designated beneficiary of your account, you must have the spouse’s signature allowing another designee.

This is to protect a marital interest from being carelessly or recklessly extinguished. It might be appropriate and acceptable if children from a prior marriage are named as primary beneficiaries…but this is something that must be explained and bargained for upfront

2. You will be asked to name both a primary beneficiary as well as a secondary.

Typically, if the spouse is the primary, the contingent beneficiaries would most likely be your children, the sum to be divided equally. In some cases, you can even designate your children “per stirpes” which means that their share would pass to their own heirs if they should predecease their parents.

I warned you, this discussion on death probabilities and outcomes can quickly turn very creepy.

3. Pitfalls. There are many. Here are the most common.

a. You may have named your parents as beneficiaries when you were single, without bothering to amend the designation to your spouse after marriage.

Payout goes to the named beneficiary, even if that is not who you intended at the time. The law recognizes the written selection, not the life changing events in the interim.

b. You may have named one child as beneficiary, to receive the full 100%, but later have other children who you would have wanted to get equal shares.

c. This is the biggie.

Naming your current spouse as beneficiary…not taking into account that you you may have a different spouse when the claim is filed. You would not believe how many ex spouses collect these bonus payments years after their marriage terminated.

The solution is simple enough.

You must do an annual review and update of your designations. Even if your will is current and up to date, the beneficiary designation will override any such apportionment of your holdings.

In part II, we will explore options that could stretch out the payout to your beneficiary by many, many decades. An extreme version of controlling from the grave.

Why Does U.S. Lag Foreign Markets?

Richard — Wed, 08 Jul 2009 12:26:23 +0000

The first section I turn to in the Wall Street Journal every morning is page 4 of the Money and Investing Section.

This is a target-rich environment, that boils down essential market data from the global equity and commodity markets, allowing for ready comparisons.

As of the market close on July 2nd, here were two statistics that stood out.

Year to date return of the Wilshire 5000 index (the entire universe of U.S. stocks). Up 1.3%
Year to date return of the Dow Jones World index (excluding United States). Up 10.4%

A nominal difference of just 9%…but an eye popping order of magnitude difference of exactly 800%.

Why do you suppose global investors place such a premium on foreign markets….or such a markdown on the U.S. market?Let’s try these for starters…

1. We have a special responsibility in this country, as custodian and guardian of the world’s core reserve currency…the dollar.

Because global commodities are normally priced in dollars, the country that has the monopoly on printing that currency can simply run the printing presses overtime, as needed to paper over the gap between production and consumption.

This works…until the counterparties to the transaction wise up to the implications. If the prevailing wisdom decides that the dollar is damaged goods, then assets in this country are marked down, while assets abroad rise as a counterweight.

By spending with wild abandon, we have trashed the world’s confidence in our currency. And since Nixon severed the dollar from gold in 1971, the dollar is worth only what our trading partners say it is worth. There is no more objective anchor to its valuation.

2. We have a culture deeply steeped in regulatory excess and unbridled litigation.

With every crisis, the lawyers are even more deeply entrenched in the fabric of everyday life and commerce.

The recession of 2001 gave us Sarbanes Oxley…and has helped to displace New York from the financial center of the world. Savvy companies now go public in Europe or Asia to avoid this totally unnecessary hurdle. Capital always flows to friendlier climes.

The current recession will unleash a flood of regulatory “reforms” that will serve to further isolate and remove the U.S. from contention as leader of the free market global economy.

And acting as a shadow government, contingency-fueled trial lawyers will continue to erode trust and confidence in U.S. domiciled companies. Better to plant your flag anywhere else, where custom dictates that the loser pays all costs in litigation…introducing a note of rationality not found here.

3. We have concluded nearly three decades of laissez-faire expansion, heralded by the Reagan Revolution….and nurtured even during the Clinton years.

It would have been nice if it had lasted longer, but taking the long view, we had nearly fifty years of anti-capitalist sentiment dating from FDR’s election, preceded by sixty five years of extraordinary growth and expansion following the civil war.

These grand thematic patterns may last one or two generations.

Which is why global markets are spooked by what is happening here.

The turn in sentiment has only just begun.

This ugly turn may still have decades to run before it finally sputters out.

You can bank on it. Or not.

Richard — Tue, 07 Jul 2009 12:01:50 +0000

A riddle for our times.

Normally, banks make money by gathering in deposits — paying little or no interest to account holders — then re-lending the money to borrowers at a substantial markup.

Also known as “spread-lending”. And if the banks make loans to borrowers who pay back the money, life is easy and the bonus money keeps on flowing.

The conundrum facing banks today is that they have substantial sums to lend, but not enough borrowers who can qualify under the new rules and close scrutiny of their financials, now that liar’s loans are out of fashion.

Not to worry.

In 2006, the FDIC authored a study showing that three quarters of banks now automatically enroll depositors in overdraft protection programs….resulting in $2 billion in bank fees.

You may recall the conversation the last time you moved your account to earn your free toaster…where your friendly banker volunteered that you would never again face the embarrassment and humiliation of a bounced check.

With overdraft protection, the bank would make, in essence, a very short-term unsecured loan to cover any shortfall..most likely to be repaid from your regular paycheck after you also signed up for direct deposit.

What’s not to like? The typical fee per overdraft is a measly $33. You will spend more than that at a date night at the movies.

Let’s do the math.

You find yourself with too much month at the end of the money, and your Netflix account is due, and it auto debits your checking account. You thought you had sufficient funds, but maybe you forgot to deduct the prior month’s overdraft fees.

So the bank charges you $33 to make your $25 debit clear the account. And your regular paycheck deposits one week later, repaying your short term loan.

$33 is 132% of $25. Per week.

But for one week, you need to multiply the APR by 52 to get the annual rate.

Which would be 6,864%. Annualized.

Makes sense.

I can think of two professions noted for wearing pin stripe suits.

Gangsters. And Bankers.

Only the gangsters have to work much harder for their money.

This would be laughable if not so widespread and pervasive a behavior pattern.

It’s the butcher’s bill we must pay for our indulgence with innumeracy and our unwillingness to practice essential financial hygiene.

Bulls. Bears. Dead Cats. And now….Deer.

Richard — Mon, 06 Jul 2009 12:59:55 +0000

Now that we’ve mastered the alphabet, a brief history of Wall Street’s zoological taxonomy…

Allegedly, bull markets got their name from the habit of the bull in tossing its victim upward after impaling them on its horns. Your basic- losing matador, winning bull - metaphor.

While bear markets were named for the ursine habit of forcing their victims downward as they were first mauled…then eaten.

I know. It sounds so gruesome.

But anyone still standing after the debacle of two bear markets in the first decade of the new century understands this imagery all too well.

We now need to add a third animal to the mix. Not another predator like the other two, but the most timid of prey. Deer.

Specifically, the deer in the headlights, frozen by indecision and inaction.

The uncomfortable truth is that we all have had our deer in the headlights moment sometime in the past year…and may still be in the cross hairs.

What we must understand is that not making a decision is decisionmaking by default. Not cleaning up the mess, taking your tax losses and going forward is a negative action decision…not likely to produce acceptable results.

Every day you stare at your losers..and stand pat…you have, in essence, made the decision once again to buy and own those dogs.

We may be in a bull trap market…a huge dead cat bounce (animal #4 in our financial zoo—another predator, of course)…that will prove that we are in a long term secular bear market. We experienced similar long term, secular bear markets from 1900-1921, from 1929-1942, and from 1966-1982.

Or it may be the real thing. We have likewise had long term, secular bull markets from 1921-1929, from 1942-1966, and from 1982 to 2000.

This is not an exact science, and it is only wholly explainable when examined in retrospect.

The good news is that a nimble investor (not a locked in, buy and hold forever type) who closely monitors their holdings, can surf the peaks and valleys that are interspersed amongst the long term secular trends.

As many did in the five year bull market from 2002-2007.

The key is to be both opportunistic and optimistic.

And to get out of the glare from that car barreling down the road while you stand your ground, trying to make up your mind.

That’s how you end up as road kill.

The Alphabet Recovery

Richard — Thu, 02 Jul 2009 12:23:54 +0000

Sometimes it helps to reduce complex outcomes to more easily grasped symbols.

Which is how we ended up with the latest shorthand…letters of the alphabet used as symbols to describe the shape of eventual economic recovery.

The rules are simple enough. A downward sloping trajectory refers to a contraction in economic output…ditto…in reverse…for the upward sloping sign.

1. The classic symbol for a recovery is the letter “V”.

This is distinguished by the vertiginous drop in production, which then touches bottom and reverses course on a dime, and skyrockets right back to where it was before the recession hit.

This is found in short, mild recessions that quickly evaporate. No such luck this time.

2. If anything, we are more likely to have a “U” shaped recovery.

This is where it takes time to build a base at the bottom before clawing our way back to prosperity…a feature of lingering recessions.

3. Unless, that is…we end up with the dreaded “L”

If we continue to print money with abandon and total lack of restraint, while propping up Zombie banks and dinosaur industrials, we could end up like Japan in their lost two decades beginning in 1989.

This gives rise to the dreaded “L” shaped recovery. A steep drop, followed by a long leveling off at the bottom. We went through this in the thirties. History could repeat itself.

4. Then there are the “M” and “W”shapes.

Things get complicated when you have back to back expansions and recoveries, as we did in the decade 1999-2009. The tech stock bubble of 2000 became the tech stock debacle of 2000-2002. Followed by a five year bull market, and then the savage 2007-2009 bear market after the debt and real estate bubble burst.

It would look like an “M” if you had recovery, decline, recovery, decline.

Or a “W” if you started with decline, and ended in ultimate recovery.

This volatility unnerves investors, shaking their confidence in the future.

5. My prediction? Not exactly a letter, but the symbol for Square Root: √

A deep decline, followed by a partial rapid recovery, leading into a prolonged period of stasis, as we suffer from the debauchery of indiscriminate deficit spending.

Stagflation. That seventies show. Again.

Kudos to Kudlow

Richard — Wed, 01 Jul 2009 12:51:50 +0000

Not all of television is a vast wasteland.

Winston Churchill once famously described the Balkans as an area that produced more history than they could consume locally. World War I being a case in point.

Which basically sums up my impression of the magnitude and pace of change that began with the Bear Stearns bailout in March of 2008.

Other than the global depression of the thirties, I cannot think of a time when the economic landscape has been so convulsed by the forces of change…and the sheer volume and velocity of government intervention.

I absorb as much as I can from print media and online sources, but find myself fatigued and overwhelmed at the effort.

Like trying to get a drink from a fire-hose.

So I’ve gotten into the habit of having Larry Kudlow explain it all to me on his CNBC cable business show, The Kudlow Report, broadcast 7-8 PM Eastern.

Be careful not to tune in during the prior hour, or you will be exposed to Jim Cramer, and risk being in range the next time he tosses a chair in your direction.

Fox has a new business cable channel, but its a distant second in my book. I’ve never been able to warm up to Bloomberg’s cable business channel. Too tame and bloodless for my taste.

Kudlow is a veteran, both of Washington and Wall Street…

…and he has assembled perhaps the best team of television journalists to help sift and sort the major emerging business and financial themes of the day.

What surprised me at first was the range and depth of technical discussion, involving the intricacies of how the Federal Reserve functions, along with the other regulatory apparatus of the federal government.

Of course, with a business pedigree, his tilt is towards economic freedom and less intervention, but he is careful to give the opposing viewpoint equal time during panel discussions.

Steve Moore from the Wall Street Journal is paired against Robert Reich, former Clinton labor secretary, to make the gladiatorial combat more equitable.

Senators from both sides of the aisle fight for air time on his show, and his guests run the gamut from idealistic libertarians to unvarnished socialists.

My endorsement of the show is not wholly unqualified.

Sometimes the discussion degenerates into shouting matches, and it’s a sad spectacle to see such academically and financially-pedigreed panelists reduced to such tawdry mudslinging and wrestle-mania braggadocio.

Maybe that just proves how much out of step I am with modern society.

I can remember when libraries expected patrons to be quiet. When movie audiences were hushed during the feature.

And only Marine drill sergeants could casually sprinkle profanity into everyday conversation.

Tax Reform You Can Believe In, Part II

Richard — Tue, 30 Jun 2009 12:23:39 +0000

Now that we’ve solved the dilemma of funding universal health care, let’s move on to remedy another gaping hole in the tax collecting bucket.

The real estate lobby has enshrined residential real estate as the most sacred and untouchable of all exemptions and deductions.

Some actually make sense to me. Of course, real estate taxes should be deductible, otherwise it would represent an intolerable burden of uneven taxation.

And the current $8,000 tax credit for first time buyers is the only example of bailout spending I have seen that is targeted to achieve the biggest bang for the buck, and is matched to sync up with the trough of the recession.

But then come the truly excessive giveaways.

Most egregious of all, is the deduction for home mortgage interest. Which is truly welfare for the rich.

Let’s do the math:

The average single family home price nationally has fallen to approximately $160,000. Assuming high leverage (a new FHA loan, for example), plan on a new mortgage of $150,000, at 5.5%. That would be $8,250 in interest the first year, a number that steadily decreases as the mortgage amortizes, and principal payments steadily increase.

Yet the standard deduction for a married couple filing jointly is $11,400 in 2009. So the interest deduction is wasted…even a renting couple can claim the full $11,400.

It’s a different story for the jumbo loan on the McMansion.

They could easily rack up $30,000 or more in deductible interest, a subsidy born in large measure by the moderate income families who could not benefit from deductions in excess of the standard deduction.

Which is why we are grossly over-housed as a nation. Housing is, after all, a consumption expenditure, that does nothing to increase savings or productivity.

The error is compounded, when we allow up to $1 million in acquisition indebtedness to qualify for the interest deduction on not just the primary home, but also the second, vacation home.

They say we have the governance we deserve in a democracy, which is pretty depressing as philosophies go.

I suppose that means we have the tax code we deserve in a flawed democracy, cravenly beholden to powerful special interest groups and lobbies.

We are both addicted to and addled by our love affair with consumption.

Eating too much food, consuming too much energy, driving extravagantly wasteful urban assault vehicles, and living in housing several orders of magnitude larger than what would be prudent.

And being goaded and prodded by tax incentives to facilitate such overconsumption.

To assuage our guilt.

Why not? It’s deductible…right?

Tax Reform You Can Believe In, Part I

Richard — Mon, 29 Jun 2009 12:15:11 +0000

Health care will become a universal entitlement sometime this year.

The only question now…is how to pay for it.

My proposal is hardly original. It was, in fact, a cornerstone of the McCain campaign last year.

And that would be to tax health care benefits paid to employees by their employers.

Since fairness is the dominant theme in this era of “eat the rich” rampant populism, the question arises…how is it fair that such a large chunk of employee compensation escapes the clutches of the tax collector?

This..in an era when the Feds are trying to figure out how to tax personal use phone calls on company provided phones…and your local grocery store will soon be tasked to put a tax on high calorie sodas and snack foods.

Of course, it is a relic of World War II wage and price controls, allowing a de-facto wage increase to sneak in under the radar in the guise of a non wage benefit.

Not only would taxing health care benefits help pay for much, if not most of the cost of bringing coverage to the uninsured, it would also rationalize health care spending going forward.

First, because employees will be flummoxed when they learn that their employer has been footing nearly $1,000 per month for an employee with spousal and minor children coverage. All employees see, or even comprehend, is their monthly contribution, as well as the deductibles and copays.

It might then dawn on many such workers that they would be better off with a stripped down, catastrophic coverage plan (very high deductible) costing maybe a third of what the gold-plated plan offered, and then transferring the savings to higher wage income.

Which leads to another blinding moment of insight.

It will then become clear that what we carelessly call health insurance is in fact an amalgam of insurance with prepaid health care.

Nothing will cut the Gordian knot of health care reform unless we can involve consumers in the bargaining and negotiating involved to rein in our runaway spending.

We do not ask our employers to pay our auto or homeowners insurance…and have learned through trial and error, by increasing deductibles or reducing the scope of coverage, how to control such expenditures.

I am convinced that much of the stonewalling by the insurance carriers opposed to reform is their desire to continue the rickety machinery of third party payment, so as to obscure the true cost of their services.

Of course, the government will fail the test if it also continues the third party payment model, as it currently does with Medicare, where it blindly pays for services without regard to successful outcomes.

We will know we have succeeded in health care reform, when all medical service providers aggressively price and market their services in a competitive marketplace, as is now the case with Lasik eye surgery and cosmetic surgery…submarkets that compete for discretionary consumer spending…and which are not distorted by the third party payment diversion.

Don’t hold your breath while waiting for such logic to prevail.

10 Things Financial Planners Won’t Tell You, Part II

Richard — Fri, 26 Jun 2009 12:08:22 +0000

This is a continuation of yesterday’s post, which is a reprint of an article its entirety from the June 16, 2009 issue of Smart Money.

(Copyright: Smart Money Magazine)

6. “Once I’ve done the plan, I’m outta here…”

Financial planners like to give you the sense that they’ll be with you every step of the way through important financial decisions. But in reality, many clients find that a once-attentive planner becomes increasingly elusive as time wears on. When Kratz worked for a financial advisory firm several years ago, he says he adopted more than 1,000 clients who had been discarded by colleagues, usually because they no longer produced adequate income to keep their planners interested. “Typically, the first year was an intense relationship, but clients complained that they stopped hearing from the adviser after that,” he says. The reason? The commissions had dried up - a lot of products, especially insurance products, are based on one year of commissions before they drop off, says Kratz.

To avoid a shutout, ask prospective financial planners at the interview stage how often you should expect to be in touch. A good reply, says Coupeville, Wash., Certified Financial Planner Kathleen Cotton, is about four times in the first three months to hammer out a plan, then at least once or twice a year after that.

7. “…especially if you’re not so well-to-do.”

The past decade has seen a big push among planners to target high-net-worth clients, and many planners today have a minimum asset requirement—typically $100,000. Considering that, according to the 2004 Census by the U.S. Census Bureau, American households have a median net worth of about $44,000, that leaves a lot of folks out in the cold.

Luckily, middle-class clients do have some alternatives. The Garrett Planning Network (www.garrettplanningnetwork .com) is a ring of 260 planners across the nation who work primarily with the $100,000-and-under income set, charging hourly fees for periodic advice. Similarly, John Sestina has his own network of 20 planners scattered around the U.S.; he says they can even handle some clients entirely over the phone (www.sestina.com). “There’s a large influx of middle-class retirees that have assets that need to be put somewhere, so more and more companies are trying to tap into this market,” says Percy E. Bolton, committee member of the Certified Financial Planner Board of Standards and founder of Pasadena, Calif.–based Percy E. Bolton Associates. “There are two waves of change today—the planners that are going after the super-rich and those that are going after the middle- and upper-middle-class clients.”

8. “Confused? That’s the point.”

Many clients meet with planners only to leave with more questions than answers. “It’s like going to the doctor—you think you understand when you’re there, but then you walk out and think, What was it they said?” says Madeline Moore, a Portland, Ore.–based financial planner. Unfortunately, this confusion is often used to manipulate you.

Sherry Fabricant and her husband, of Plano, Tex., started investing $120,000 with a financial planner at an area brokerage firm at the end of 1997. The planner told them that withdrawal of funds before a five-year period would incur a sliding fee (5 percent of assets in the first year, 4 in the second, and so on). However, not only did the planner put them in high-fee funds without their understanding but he didn’t explain that with any additional investment transaction, the five-year restriction would begin anew. “Recently, we made a huge sell and a huge purchase,” says Fabricant, “and it wasn’t explained that our five years would then start over.”

How can you protect yourself? Ask plenty of questions and write down the responses, and if you don’t get straight answers, move on. “Remember, they work for you,” says Sestina. “So if you never understand what they’re saying, fire them.”

9. “In fact, I don’t even understand your plan.”

There’s a plethora of computer software today designed to help financial planners with clients’ asset allocation, cash flow, retirement planning, and so on. These tools make for quick results, but they can also cause problems—especially when planners don’t understand how the software works.

When Scott Dauenhauer worked at one major brokerage firm, he and his colleagues churned out boilerplate documents that, he says, all looked alike and usually had glaring mistakes— everything from a wrong age (which can render the entire plan wrong) to a misunderstanding of the client’s goals. The danger was that most of his fellow advisers had little training in planning, “so you have a document that’s probably wrong and an adviser who can’t tell you why,” Dauenhauer says.

Cotton suggests that you quiz your planner about any computer-generated plan to make sure he really understands it. You could ask, say, whether the software assumes a flat rate of return on investments or how it deals with taxation issues. You can also test your CFP’s plan against the free service at Financeware.com, which analyzes plans using real stock market returns—and is therefore more realistic than the flat rate used by most planners’ programs.

10. “Good luck busting me for malpractice.”

Since the financial-planning industry is so loosely organized, it’s not surprising that there are no firm regulations regarding consumer grievances. The CFP Board enforces a code of ethics, “but given the limitations of a voluntary certification program, it’s kind of after-the-fact enforcement,” says Roper. So what can you do if you get cheated? If your planner, like most, holds a securities license, you go to FINRA, the Financial Industry Regulatory Authority. But be prepared to wait. Although the majority of arbitration cases are settled in around six months, if your case goes to a hearing, it could take up to 16 months to get a decision.

Even then, there’s no guarantee you’ll get a favorable outcome: In 2007, only 37 percent of investors who had a hearing recovered any money. Also, since arbitration can cost between $15,000 and $50,000, it makes sense only if you’ve lost more than $30,000. If you’re out less than that, start by writing a formal letter of complaint to the supervising manager, then write one to FINRA, the Securities and Exchange Commission, or your state securities regulator. You’re unlikely to get any money back, says Eccleston, but the adviser might face disciplinary action. Even better: Protect yourself in advance by checking out a prospective financial planner’s record. The SEC lists client complaints and regulatory violations on its website (www.adviserinfo.sec.gov), where you can also get details on both SEC- and state-registered planners.