Life Insurance Beneficiary Mistakes

I’ve reviewed over two dozen life insurance policies this year.  Aside from the big problems I currently see in cash value policies, beneficiary designation is important because a mistake can be costly.  Perhaps because so much thought, energy, time and money is spent deciding upon the type of policy and coverage, the simple detail of beneficiary gets overlooked.

Estate as Beneficiary

If your policy has your estate as the beneficiary, and your will then directs who will receive your assets from your estate, the life insurance proceeds are now subject to federal and state estate taxes.  Currently, the first $5.25 million of estate assets are exempted from federal taxes, so if you die tomorrow with less than that in your name, you may not have to worry about paying a chunk of your death proceeds to the IRS rather than your heirs.

In reality, we don’t know what the exemption will be when you pass away, and you don’t know what you may be worth when that happens.  Having your estate as beneficiary means including the face amount in your total also means potential estate tax at the state level since state thresholds can start at $675,000, with most starting at $1 million.

Spouse as Beneficiary

While it’s more tax-efficient to put your spouse’s name on the beneficiary form, people often forget to name secondary beneficiaries.  Another costly mistake because if you and your spouse die at the same time with no secondary beneficiaries listed, then the proceeds go right back into your estate.  Even if you predecease, if your spouse dies without naming a proper beneficiary, what’s left of your life insurance payment could be subject to estate taxes.

Children as Beneficiaries

This can avoid the estate tax but you have to give up ownership of the policy. (Ownership transfer must have occurred more than three years prior to death to be excluded.)    Probably not the best option if your spouse needs those assets for income.  I reviewed one policy where the son was the beneficiary with the understanding that he would divide the money with his siblings.  Wrong!  If he receives the life insurance proceeds, it arrives tax-free.  But when he pays the money to his other brother and sister, those become taxable gifts.

Solutions

You have some basic ways to prevent life insurance proceeds from being included in your estate.  The easiest and most practical solution is never to own it in the first place.  The beneficiary should purchase and own the policy.  Consider an irrevocable life insurance trust.  You will assign the ownership of the policy to the trust, and gift the amount of the insurance premiums to the beneficiaries of that trust, with the provision that they use that money to buy the policy and keep it current.  While you will give up control over the policy and premiums, this trust technique will ensure that your policy avoids estate tax.  In addition, you can design the trust to support your spouse, and determine how, when and who gets the ultimate proceeds after his/ her lifetime.

At the very least, double check your policy’s beneficiary designation and make adjustments if necessary.

Download this Beneficiary Form Checklist to help organize your accounts and policies.

Beneficiary Checklist
Andy partners with individuals, families and entreprenuers to provide objective and comprehensive financial planning. Andy is a Fee-Only, Certified Financial Planner™ and Registered Investment Advisor.

 

Two Minute Tax Tips for Year End

Don’t Forget Your Contributions

If you turned 50 this year you are entitled to a catch up contribution of $5,500 for your 401(k). It is not too late to catch up for 2013. Also, anyone with compensation can contribute to an IRA. It’s the deductibility of the IRA contribution that is subject to income limits. If you are not eligible to do a deductible Traditional IRA then consider a Roth IRA. The Roth IRA contribution limits are significantly higher than deductible Traditional IRAs. If your Adjusted Gross Income (AGI) is below the amounts listed, you can make a full IRA contribution. If your AGI is too high, you still have an opportunity to contribute to a non-deductible IRA. There is no income limit for non-deductible IRA contributions and the assets inside the IRA will grow tax deferred.

 

Watch Your Capital Gains

Under the tax law there are now four long-term capital gains tax rates (0%, 15%, 18.8% and 23.8%). Old school advice was to tax-loss harvest to erase your gains. For 2013 and beyond, tax-loss harvesting may not be the best advice.  Depending upon your income bracket, if you wait until next year the long-term capital gains rate could increase 23.8% rather than 15%


Roth Conversion Considerations

Roth conversions don’t always carry a tax bill, and you can mitigate a tax bill by pairing tax strategies. For instance, you could increase your charitable deductions to match the amount of your Roth conversion. If a passive activity with suspended losses becomes unsuspended, that would be a great time to consider a Roth conversion. Remember, there are no income limits for Roth conversions. You have until October 15, 2014, to decide if a 2013 Roth conversion makes sense; this “out” is called a “recharacterization.”

Andy partners with individuals, families and entreprenuers to provide objective and comprehensive financial planning. Andy is a Fee-Only, Certified Financial Planner™ and Registered Investment Advisor.

 

Use Your IRA for Charitable Giving

Yes, but you need to be over 70-1/2 and do it before the end of the year.  If you don’t need the income and have charitable contributions to make, don’t overlook this great way to kill two birds with one stone, called a Qualified Charitable Distribution (QCD).

The charitable IRA rollover is an ideal way to make a charitable contribution and fulfill the Required Minimum Distribution (RMD) for 2013. Not having to report the RMD as income is a huge tax benefit that is much better that taking a charitable tax deduction. The value here lies in your adjustable gross income (AGI). If money goes out of your IRA into your checking account and then you write a check to charity, you get a tax deduction, but the IRA distribution goes into your gross income. The deduction for the charitable gift reduces your taxable income, but not your adjusted gross income.

Several taxes are calculated from your AGI: Medicare premiums, medical expenses, taxability of social security benefits, phase-outs of personal deductions, and the surtax on investment income. When you make the gift directly from your IRA, these taxes are bypassed all together. All of those things are affected by adjusted gross income and you just bypass it by making a gift directly.

This technique helps not only high-income individuals, but also lower income individuals. If you are in a lower income tax bracket, you may benefit because it can reduce the taxation of your social security benefits. You may be able to use the standard deduction even though you’re getting the itemized deduction effectively by making a charitable gift.

Someone who has already taken his RMD for a particular year cannot use a QCD later in the year to fulfill his RMD requirement for that year; he cannot roll the already-taken RMD back into the IRA (to enable him to use a QCD instead) because RMD’s are not eligible rollover distributions.

 

Charitable Reminder

Contributions are deductible in the year made. Thus, donations charged to a credit card before the end of 2013 count for 2013. This is true even if the credit card bill isn’t paid until 2014. Also, checks count for 2013 as long as they are mailed in 2013.

Always consider gifting appreciated securities instead of cash, which is very tax inefficient. Gifting stock with a fair market value of $3,000 with a cost of $1,000 could save $300 in tax ($2,000 x 15%), plus you still receive a charitable deduction.

Andy partners with individuals, families and entreprenuers to provide objective and comprehensive financial planning. Andy is a Fee-Only, Certified Financial Planner™ and Registered Investment Advisor.

 

How Plan Sponsors Can Avoid Problems

Avoid problems with your 401k with sage advice from the Oracle – Ary Rosenbaum:  http://www.jdsupra.com/legalnews/the-hidden-dangers-for-the-401k-plan-s-26704/

Mr. Employer, follow these effective guidelines:

  1. Offer your employees investment education so they can understand the right investments based on their risk profile, age and financial situation.  Not only does this increase participation, but also helps you avoid lawsuits.
  2. Hiring a bad financial advisor is worse than hiring no advisor.  A good advisor should help you manage the fiduciary landscape.
  3. Understand all the plan fees.  This includes hidden fees.

For clear, easy to understand articles on all 401k concepts, check out Ary’s site:  http://www.jdsupra.com/profile/Ary_Rosenbaum_docs/

 

 

 

Target Date Fund Fees Subject of Lawsuit

Stay out of Target Date-Rape Funds folks.  The layering of fees is expensive and deceptive.  American Chemicals and Equipment is suing Prinicpal over some questionable accounting used to disclose fund fees.  Howbout $120 million in “acquired fund fees” for 2012.  http://news.morningstar.com/articlenet/article.aspx?id=612469

Take a look at the disclosed fund fees for John Hancock Target Date 2035.  6 share classes with fees ranging from .71 to 4.13.  These are just the disclosed fees.  John Hancock Target Date Fund Fees – Same Fund, different sharesJohn Hancock Fees

Andy partners with individuals, families and entreprenuers to provide objective and comprehensive financial planning. Andy is a Fee-Only, Certified Financial Planner™ and Registered Investment Advisor.

 

Smart Money Moving into Navistar?

Hedge fund gurus Mark Rachesky and Carl Icahn both bought truck loads (pardon my pun) of shares in the company Navistar (NAV).  Rachesky’s hedge fund, MHR Fund now owns 15.8% of the company’s shares and Icahn 16.5%.  Both of these seasoned investors are well know for taking ownership stakes in a company to increase shareholder returns.  One to watch.

Andy partners with individuals, families and entreprenuers to provide objective and comprehensive financial planning. Andy is a Fee-Only, Certified Financial Planner™ and Registered Investment Advisor.

 

 

ING Sued Over 401k Revenue Sharing

district court in Connecticut ruled ING Life Ins. and Annuity Co. (“ILIAC”) a fiduciary related to its revenue sharing practices and scheduled a four week trial to begin anytime after September 3.

The lawsuit, Healthcare Strategies v. ING Life Insurance and Annuity Co., could have huge ramifications.  This class action suit covers all ING plans where they have maintained a contractual relationship based on a group annuity contract or group funding agreement and for which, since February 23, 2005.

Here are the allegations:

(1) ILIAC has included certain mutual funds as investment options based on the funds’ revenue sharing payments to ILIAC rather than the funds’ potential to benefit the plans,
(2) ILIAC’s receipt of revenue sharing payments constitute prohibited transactions under ERISA 406(b)(1) & (3),
(3) The fees charged by ILIAC to the plans do not bear a meaningful relationship to the cost of the services provided, and they thus constitute excessive compensation to ILIAC, and
(4) By taking as its compensation the spread between the guaranteed payment and the investment performance of assets in fixed accounts and guaranteed accumulation accounts, ILIAC has retained excessive compensation and engaged in self-dealing.

Insurance companies hoping that the door was closed on the industry standard of revenue sharing and claiming no fiduciary responsibility are probably more than a little nervouse. Especially after a recent settlement where the advisor failed to disclose $500,000 worth of revenue sharing: http://www.dol.gov/ebsa/newsroom/2013/13-1530-PHI.html

Hello Mr. Employer!  Does your plan engage in revenue sharing?  You had better know because it puts you at risk too, aside from steadily bleeding your plan.

Thank you Thomas E. Clark, Jr for your heads up blog post over at http://blog.fraplantools.com/the-roller-coaster-continues-court-finds-ing-a-fiduciary-over-revenue-sharing-practices-schedules-trial-for-september/

 

College Funding Alternative

529 Savings plans are popular as evidenced by an average account balance of $17,174 and total plan assets closing in on $200 billion.  Their appeal is due to high contribution limits, tax-free-growth and withdrawal (must meet federal requirements).   Grandparents needing to gift money can contribute up to $14,000 a year without triggering gift taxes, and even make five years worth of contributions to move money out of their estate into to fund the grandchildren’s college.

While these benefits look good on the surface,  I don’t often recommend them for a several reasons.  First, 529 plan assets can reduce your child’s financial aid benefit because money in their account will count up to 5.54% of the student’s savings on the financial aid worksheets used by colleges and universities.  The assets are treated as an asset of the parents, regardless of whether they are owned by the parent or a child. If a 529 plan is owned by a grandparent, most financial aid offices will include this as student income, even when the distributions are not reportable for federal income taxes.

Second, the investment choices are limited to state sponsored plans.  When looking at investment options and performance of these plans compared with other options, the tax-free growth appeal looses its luster.  Third, the funds can only be used for qualified higher education expenses including tuition, room and board, books, supplies and equipment.

A Simple Alternative

Given the average price tag for a public university degree currently sits at $37,800 and rising, you may find a smarter alternative within the 4 million words of the Internal Revenue Code.  Section 2503(e) provides that gifts made to an education provider, on behalf of children, grandchildren or any beneficiary, don’t count as taxable gifts.  Rather than funding a 529 plan, you could pay the child or grandchild’s tuition directly.  You avoid gift taxes, aren’t limited with investment options, and the money is NOT counted against the student’s need for financial aid by the university’s endowment fund.

Often, the best plans are simple.  So when considering education funding options, remember the time tested acronym K.I.S.S.

 

Andrew M. Brown, CFP®
Certified Financial PlannerTM
Fee-Only Registered Investment Advisor

Sources: http://money.cnn.com/2013/03/12/pf/college/college-savings/index.html

http://www.savingforcollege.com/tutorial101/the_real_cost_of_higher_education.php

4 Key Questions to Protect Your Coupon Income

4 Key Questions to Protect Your Coupon Income

If you, or anyone on your behalf, buys individual bonds in your account, know the markup game.  A markup is when a broker-dealer buys a bond at a low price and resells it at a higher price.  This difference, called the spread, could mean significant reductions in your income, especially since brokerage firms are legally allowed to charge undisclosed markups ranging upward of 5%.  Consider that a 2% markup will eat up a year’s worth of income.  Since the SEC doesn’t require that a broker disclose the markup, you need information.

  1. Ask your bond broker about how much sales credit he/she will receive on a prospective purchase.
  2. Ask if the bond is being recommended on its own merits or if the brokerage house owns it?
  3. Ask the broker if there are any incentive tied to the recommendation.
  4. Find out the bond’s CUSIP number, and lookup the price range where the bond should be trading.  Go to: http://emma.msrb.org/

 

Since all bonds traded in the muni market will have a markup at either the wholesale or retail level, determining the impact of these markups on your income should benefit your pocket book.  Of more importance though, is that you understand the type of bond, credit quality, coupon rate and maturity when making your decision.

 

Sources

Broker Markups: A Bond Investor’s Worst Enemy: http://www.forbes.com/2009/02/26/munis-spreads-markups-personal-finance_investing_ideas_bond_brokers.html

How Expensive Are Your Bonds: http://www.cbsnews.com/8301-505123_162-57475603/how-expensive-are-your-bonds/

How Bonds are Bought and Sold: http://www.municipalbonds.com/education/read/150/how-bonds-are-sold-your-transaction-costs

Broker Markups Taking a Big Bite Out of Muni Bond Payouts: http://www.investmentnews.com/article/20100825/FREE/100829963

Municipal Bondholders Blindsided by Greed

Municipal bonds have traditionally attracted conservative investors looking for federal tax exempt income.  While municipal bonds carry the risk of default, investors rely on rating agencies to grade the issuer’s credit with ratings from AAA to junk bonds.  Just like we have credit scores, so do municipalities, and these credit scores let us know what we are getting into.  Also, some bonds carry insurance that guarantees repayment of your money if the bond doesn’t.

Bond investors rely on the credit ratings and insurance guarantees in determining the risk when making decisions.  But how do you know about fraud risk, as in the case of the Jefferson County mess in Alabama?  Jefferson County serves another example of Wall Street’s greed and continued financial shenanigans to make money.

In Jefferson County, JP Morgan & Chase paid $8.2 million to bribe officials so the company could obtain $5 billion in municipal bond offerings and swap agreement transactions.  JP Morgan hoodwinked officials into a financing deal that has now resulted in the largest U.S. municipal bond bankruptcy in history.  JPMorgan agreed to a $722 million settlement with the Securities and Exchange Commission without admitting or denying any allegations.

Matt Taibbi eloquently summarized this scandal in his Rolling Stone article:

“The destruction of Jefferson County reveals the basic battle plan of these modern barbarians, the way that banks like JP Morgan and Goldman Sachs have systematically set out to pillage towns and cities from Pittsburgh to Athens. These guys aren’t number-crunching whizzes making smart investments; what they do is find suckers in some municipal-finance department, corner them in complex lose-lose deals and flay them alive.” “And even if the regulators manage to catch up with them billions of dollars later, the banks just pay a small fine and move on to the next scam. This isn’t capitalism. It’s nomadic thievery.”

Municipal bond investors looking to avoid being blindsided by another scheme should consider a diversified portfolio using municipal bond Exchange Traded Funds (ETF), a no-load mutual fund who’s manager has at least a 10 year track record, or a separately managed account.  For larger portfolios, a separately managed account usually makes more sense because you’ll have a professional institutional bond manager, who should be completely separate from your custodian, buy the bonds in your account, and the portfolio is tailored for your needs.

 

Sources

http://www.rollingstone.com/politics/news/looting-main-street-20100331

J.P. Morgan agreed to pay $75 million in penalties and forfeit $647 million in fees to settle SEC claims.

http://www.businessinsider.com/the-incredible-story-of-the-jefferson-county-bankruptcy-one-of-the-greatest-financial-ripoffs-of-all-time-2011-10