Financial Topics Newsletter Archive
SBT Investment Services, Inc. through its relationship with Infinex Investments, Inc., member SIPC/FINRA, offers a range of educational resources to help customers achieve their life goals. These include the personal attention of our Advisors, registered representatives of Infinex Investments, Inc., periodic educational forums, and topical articles in our Financial Newsletter.
We publish this online newsletter monthly and maintain an archive of past issues. If you have any questions about or would like to discuss an article, please contact one of our Advisors.
November 2007
In This Issue:
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Squeezed Between Competing Needs
At a time when baby boomer couples should be saving for their own retirements, many feel squeezed by competing financial needs. Having started families later than past generations, their children may just now be entering college or still living at home. At the same time, aging parents may need financial assistance. It is a dilemma that is likely to become more common.
Caring for Parents
As life expectancies continue to rise, it becomes increasingly likely that you may need to help an aging parent. Some financial precautions you should consider now include:
- Investigate long-term-care insurance for your parents. If they can’t afford the insurance, you may want to purchase it for them.
- Have your parents prepare a listing of their assets, liabilities, and income sources, including the location of important documents. This can save time if you need to take over their finances.
- Make sure your parents have legal documents in place so someone can take over their financial affairs if they become incapacitated. They may also want to delegate health care decisions.
- Understand the tax laws if you provide financial support to your parents. You may be able to claim them as dependents if you provide more than half their support. Additionally, you may be able to deduct medical expenses paid on their behalf.
- Find out of if your employer offers a flexible spending account for elder care. This may allow you to set aside pretax dollars to pay for up to $5,000 of elder-care expenses for a dependent parent.
Assisting Your Children
For many families, college costs are a significant financial cost. While you may want to pay all college costs for your children, it may not be feasible with competing needs to save for retirement and to assist parents. Some strategies to consider include:
- Shift some of the burden to your children, requiring them to work part-time during college or to take out student loans.
- Understand the financial aid system, investigating all financial aid sources. Search for scholarships that are not based on need. Apply to several different colleges, looking for the best financial aid package. Negotiate with your child’s preferred college to see if you can increase the financial aid package.
- Look for ways to reduce the cost of college. Your child can start at a community college, which is often cheaper than a four-year college, especially if the child commutes from home. Or consider a public university in your state, which will generally be more affordable than a private university.
Once your child graduates from college, don’t assume your financial responsibilities are over. Adult children may return home for a variety of reasons — they can’t find a well-paying job, they have too much debt to live alone, or they divorce and need financial support. If your child returns home, realize there are increased costs — additional food, phone bills, utilities, etc. Consider charging rent and imposing a deadline on how long he/she can stay.
Don’t Forget Yourself
When faced with the competing needs of children and aging parents, it’s easy to neglect your own need to save for retirement. But don’t feel guilty about your retirement needs. One of the best gifts you can give your children is the knowledge that you will be financially independent during retirement.
Consider the following:
- Calculate how much you need for retirement and how much to save on an annual basis to reach that goal. Don’t give up if that amount is beyond what you’re able to save now. Start out saving what you can, resolving to significantly increase your saving once your parents’ or children’s needs have passed. Also consider changing your retirement plans, perhaps delaying your retirement or reducing your financial needs.
- Take advantage of all retirement plans. Enroll in your company’s 401(k), 403(b), or other defined-contribution plan as soon as you’re eligible. Also consider investing in individual retirement accounts. All provide a tax-advantaged way to save for retirement.
- Reconsider your views about retirement. Instead of a time of total leisure, consider working at a less stressful job, starting your own business, or turning hobbies into paying jobs.
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Avoid Withdrawal Mistakes
- Not understanding all available options. Each retirement option, such as 401(k) plans, profit-sharing plans, and individual retirement accounts (IRAs), has different tax and plan rules regarding withdrawals. Review all your options to select the best choice for your circumstances. In many cases, your selection will be irrevocable.
- Not using reasonable estimates to calculate your withdrawal amounts. The amount you should withdraw annually can be calculated based on how much principal you want remaining at the end of your life, your life expectancy, your expected long-term rate of return, and your expected long-term inflation rate. If you don’t use conservative estimates, you run the risk of depleting your assets before you die. Even with conservative estimates, review these factors annually so you can adjust the withdrawal amount if necessary.
- Not withdrawing funds in a tax-efficient manner. Before beginning withdrawals, review all your retirement assets, including pension plans, IRAs, and taxable investments, to determine the most tax-efficient strategy for withdrawals. This can add years to the life of your retirement funds.
- Retiring early without considering the financial implications. Retiring even a few years earlier than planned can significantly impact the amount needed for retirement. Make sure you’ll have sufficient funds for your entire retirement before opting to retire early.
- Taking a lump-sum distribution in your name. When rolling over a lump-sum distribution from a 401(k) plan or other qualified plan, transfer the funds directly to your new account’s trustee. Otherwise, your former employer will withhold 20% for taxes when the funds go directly to you. You will then have to replace the 20% from your own funds within 60 days or the 20% withholding will be considered a distribution, subject to income taxes and possibly the 10% federal tax penalty.
- Not taking required minimum distributions. Once you reach age 70 ?, you must take required minimum distributions from traditional IRAs and other qualified plans or pay a 50% excise tax on the amount you should have withdrawn. If you are still working, you can delay withdrawals from qualified plans, but not from traditional IRAs, until you retire.
- Not selecting proper beneficiaries. The proper selection of beneficiaries can make a significant difference in the amount of taxes owed when you die.
- Not seeking advice. Determining how much to withdraw from your retirement investments and the best way to make those withdrawals can be complicated. Since the decisions are often irrevocable and can have a major impact on your retirement lifestyle, seek guidance first.
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Dealing with Stock Price Declines
When a stock’s price declines substantially, you might wonder what you should do. If you own the stock, should you sell before the stock declines more or purchase more shares at the lower price? If you are interested in the stock, should you purchase now or stay away from it? Before you decide, you need to assess the cause of the price decline. Typically, the stock’s price is reacting to one of three things:
- Market trends — When the overall market is weak, individual stock prices can also be affected. Compare the performance of a stock to the overall market to see if it is moving in line with the overall market. Some stocks may move to a greater extent than the overall market, while others may move to a lesser extent. Review the beta of the stock when making this comparison. Beta, which can be found in a number of published services, is a statistical measure of how stock market movements have historically impacted a stock’s price. If a stock’s price is just reacting to overall market conditions, you probably don’t want to sell for this reason. Whether you should purchase the stock will depend on your assessment of the future direction of the stock market.
- Industry factors — A stock’s price can also be affected by industry-wide factors. Those factors could include the cyclical nature of the industry’s sales, a structural change in the industry, a change in government regulation, industry liability issues, and competitor announcements. With these types of changes, you need to assess whether the industry’s changes are significant enough to cause you to sell the stock.
- Company-specific issues — These changes relate solely to the company in question and can include items like earnings, management, liability questions, government regulation, competition, and fraud. With these types of changes, you need to determine what is causing the stock price decline and then assess whether the change is temporary or permanent. For instance, an earnings shortfall might be a one-quarter event or it could signal a fundamental shift in demand for the company’s products. Reassess the company’s fundamentals to make sure you still believe its future prospects are good, looking at things like the management team and trends in sales and net income. If, after making this assessment, you believe the change is temporary and has not affected the company’s fundamentals, you probably will not want to sell the stock and may even want to add to your position.
Before you can decide whether you should sell your stock or buy additional shares, you need to assess what has caused the price change. You will then be in a better position to decide how to react.
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What Are Zero-Coupon Bonds?
Zero-coupon bonds do not pay interest during the bond’s life. Since most investors purchase bonds to receive periodic interest income, this may seem like a contradiction. However, some investors desire the fixed return without the periodic receipt of interest payments. Zero-coupon bonds were designed to meet that need.
What are the major characteristics of zero-coupon bonds? Zero-coupon bonds are sold at a deep discount from face value. Since the bonds do not pay interest during the bond’s life, your return results from the bond’s price gradually increasing from the discounted value to the face value at maturity. Maturity dates range from six months to 30 years.
The bond’s interest rate is locked in at purchase, but no interest is paid until maturity. Instead of receiving semiannual interest payments, your principal earns the stated interest rate compounded over the bond’s life. When the bond matures, you will receive both the principal and interest — the bond’s face value.
What types of zero-coupon bonds exist? You can purchase corporate, U.S. Treasury, or municipal zero-coupon bonds. Since you don’t receive any of your investment until maturity, choose a zero-coupon bond with a high credit rating. U.S. Treasury zeros are the safest zeros, since the payment of principal and interest is guaranteed by the U.S. government if held to maturity. However, many corporate and municipal zero-coupon bonds are issued with high credit ratings.
What are the advantages of zero-coupon bonds? Zeros have several unique features that may be attractive to investors:
- Your principal earns the stated interest rate compounded over the entire period the bonds are outstanding.
- You can purchase zero-coupon bonds to mature at a specific time for the amount needed, providing a convenient way to fund known expenses.
- For a relatively small initial investment, you can purchase a bond that will pay a much larger amount at a later date.
- How are zero-coupon bonds taxed? The yearly growth in the value of the zero, called accretion, is considered interest income for tax purposes, even though you don’t actually receive the money. You can avoid these taxes by purchasing zero-coupon municipal bonds, whose accretion is not taxable. Or you can purchase zeros for tax-sheltered accounts, such as 401(k) plans or individual retirement accounts. Then, taxes will be deferred until the money is withdrawn.
- How do interest rate changes impact the value of zero-coupon bonds? Like other fixed-income securities, a zero-coupon bond’s price moves up when interest rates fall and down when interest rates rise. However, zeros are affected much more dramatically by movements in interest rates. A general rule of thumb is that a 1% movement in interest rates will adjust a zero-coupon bond’s market value by approximately 1% for every year left to maturity. By holding the bond to maturity, however, you will receive the entire face value. Because of the possibility of large fluctuations, it is generally recommended that you hold zero-coupon bonds until maturity.
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Clean Up Your Portfolio
Before year-end, get all your information together, thoroughly analyze it, and clean up your portfolio. Some points to consider during this review include:
- Take another look at your asset allocation plan. Do this before you review your actual investments, so you aren’t influenced by your current allocation. Don’t just assume your original allocation is still appropriate. You may now realize that your risk tolerance is lower or higher than you originally thought. Asset allocation does not assure a profit or protect against loss in a declining market.
- Find your most recent statements. List each investment and its current value. Total your investments by category — cash, bonds, and stocks. Then compare those percentages to your asset allocation plan. If you haven’t done this review in a while, you’re likely to find your current allocation is off from your desired allocation. You then need to devise strategies to get your allocation back in line.
- Get rid of small accounts. It’s not unusual to find you have several small accounts. Perhaps you have a bank savings account with several hundred dollars in it that you don’t use anymore. Or you may have a small investment account that you received as a gift. You still have to look at the statements every month and make sure any income is included on your tax return. Take all those small accounts, cash them out, and consolidate the funds in one account.
- Look for ways to simplify your investments. Do you have a variety of individual retirement accounts (IRAs) that can be consolidated in one IRA? Do you own similar stocks or other investments that aren’t adding much in the way of diversification to your portfolio? While you want to be properly diversified, minimize the number of accounts and investments you own so your investments are easier to monitor.
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Copyright © 2008. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.
FR2007-0420-0124
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