Financial Topics Newsletter Archive

December 2006

In This Issue:

• Protecting Your Earning Power
• Coping with Long-Term-Care Costs
• When Should You Sell?
• An Annual 401(k) Plan Review
• Stick with Your Strategy

Protecting Your Earning Power

You probably have life insurance to protect your family’s lifestyle in case you die prematurely. But have you considered how your family would cope if you were unable to work for a lengthy period due to illness or injury?

Only 28% of workers have some form of disability insurance (Source: SmartMoney, July 2005). Many people ignore disability coverage, hoping they won’t be affected by a disabling injury or illness. However, the Society of Actuaries indicates that an adult has a one-in-seven chance of dying before age 65, but a one-in-three chance of being disabled for at least three months.

Consider disability insurance if your current assets won’t support you until age 65. To see if this is the case, review your available options. Determine how much you need monthly to pay essential expenses and what income sources you could count on if you couldn’t work. Review the following questions to determine if you have adequate coverage in this area:

Will Social Security provide disability benefits? The criteria for benefits are very strict — you must be unable to work at any job, expect to be completely disabled for at least one year, and have contributed to the Social Security system for a sufficient length of time. Approximately 37% of those who apply qualify. Even if you do qualify, benefits tend to be modest. As of June 2006, the average disability benefit was $943 (Source: Social Security Administration, 2006). Your annual Social Security Statement indicates what disability benefits you can expect.

Does your employer provide disability insurance? Many companies provide short-term disability insurance, which covers 100% of your salary for three to six months. Long-term disability insurance is typically less common and less generous than short-term plans. Policies frequently have strict definitions of disability, pay no more than 60% of your base salary (bonuses and profit sharing generally aren’t included in benefit calculations), pay benefits for only two to five years, and don’t provide cost-of-living adjustments.

Do you want to use other personal assets? You can access individual retirement accounts, annuities, or 401(k) plans without penalty if you are disabled. But first decide whether you want to risk depleting your retirement fund or children’s college fund due to a disability.

How much of your income should disability insurance replace? You should ensure that your available resources and benefits from disability insurance equal at least 60% of your pretax income. Many insurers limit coverage from all disability policies to 60% to 70% of your salary to provide an incentive to return to work. Make sure the total of your employer-provided insurance and individual coverage does not exceed the maximum that will be paid, or you could end up paying for coverage you won’t receive. Insurers typically require documentation of income and may limit the maximum monthly benefit.

Are there any significant differences between employer-provided insurance and individual policies? You typically have no choice regarding the benefits offered by your employer, while an individual policy can be tailored to your needs. The most significant difference, though, is the tax treatment of any benefits. If premiums are paid by your employer, benefits are taxable. If you pay the premiums, benefits are tax free. This will have a significant impact on the amount available to pay your bills. It may make sense to reimburse your employer for the cost of this insurance so any benefits will be tax free.

What provisions should you look for in a disability policy? There are several provisions you should pay special attention to, including:

• The definition of disability — There are three basic types of coverage — own occupation, any occupation, and income replacement. Own occupation pays benefits when you can’t work at your specific occupation. Many professionals, such as doctors and lawyers, opt for this coverage. However, due to substantial claims, this coverage is now more difficult to obtain. You may only be able to find own-occupation coverage for a specified period, with the policy then converting to any-occupation coverage. Any-occupation coverage means you must be unable to work at any occupation your training and education would be suited for. Income replacement policies pay the difference between what you were earning before the disability and what you are earning now.
   
• Noncancelable or guaranteed renewable — Noncancelable means you can renew the policy every year at the same premium. Guaranteed renewable means you can renew the policy every year, but the premium can increase as long as it is not done so in a discriminatory manner. Either provision will ensure the policy won’t be canceled due to medical problems.
  
• Waiting period before benefits begin — If you have other resources to rely on for the short term, such as sick leave, personal savings, or short-term disability coverage, you can increase the waiting period to reduce premiums. Waiting periods can range from one week to two years, but the most common option is a 90-day delay in benefits.
  
• Length of benefits — Disability insurance is designed to protect your financial situation in the event of a serious disability, so coverage should last for the long term. You can obtain lifetime benefits, but you may only need benefits until age 65, when presumably you could collect Social Security and other retirement benefits.

Coping with Long-Term-Care Costs

Life expectancies have increased significantly and are expected to continue to increase in the future. As people age, they are more likely to develop conditions that limit their ability to live independently. However, it is estimated that only 5% of people between the ages of 45 and 64 have purchased long-term-care insurance (Source: Employee Benefit News, January 1, 2006).

How likely is it that you’ll need long-term-care insurance? It is estimated that 69% of individuals age 65 and older will need some type of long-term care, with 37% entering a nursing home (Source: The Wall Street Journal, February 22, 2006). Those entering a nursing home face an average stay of 2-1/2 years, with an average annual cost of $74,000 (Source: Investment News, October 10, 2005).

Who needs long-term-care insurance? If your assets, not including your home, equal at least $2 million, you can probably fund long-term-care costs with those assets, although you may not want to deplete your assets for this care. Those with very few assets will probably be covered by Medicaid. It is the people between these two extremes who should consider long-term-care insurance. This coverage may be especially important for women, who tend to outlive their husbands.

If you’re considering long-term-care insurance, review these points:

• Purchase the insurance at a relatively young age. You should probably purchase the insurance by the time you are in your 50s or early 60s. After that, the premiums get much more expensive. Also, if you develop a serious health condition, you may not be able to purchase the insurance.
• Check for inflation provisions. Since you may not receive benefits for many years and costs for long-term care have been increasing significantly in recent years, check inflation protection in your policy. Another option is to make sure your policy contains an annual renewal option, so you can buy additional coverage in the future.
• Obtain insurance from a stable insurance company. You want to obtain insurance from a company that is sure to be around for the long term.
• Make sure the policy terms are reasonable. Many people choose a benefit period of three years to cover the average nursing home stay. However, due to the substantial costs associated with long-term care, you may want to select a longer period. Benefits should be paid in as many situations as possible, including skilled care, intermediate care, custodial care, home health care, and adult day care. Review the waiting period carefully to ensure a good balance between premium costs and out-of-pocket costs.
• Review carefully the level of assistance needed to qualify for benefits. Typically, benefits are paid when you are unable to perform two of six activities of daily living, including bathing, eating, using the bathroom, moving back and forth from a chair to a bed, and remaining continent. Typically, benefits are also triggered when a cognitive impairment, such as Alzheimer’s disease, requires substantial supervision.
• Determine how benefits are paid. Some policies pay a set daily amount, regardless of your actual costs. Other policies will only pay your actual out-of-pocket expenses up to a daily limit or reasonable and customary costs. Find out how you prove you’re entitled to benefits. Some plans require an in-house doctor to review your health, while others allow your own doctor’s review.
• Consider sharing a policy with your spouse. Some companies now offer policies that allow spouses to share the policy, with a variety of options available.
• Check the policy’s tax status. A qualified policy allows you to deduct a certain percentage of the premium, depending on your age, as a medical expense on your tax return. Medical expenses are deductible to the extent they exceed 7.5% of your adjusted gross income. Also, payouts from qualified policies are received free from federal income taxes.

When Should You Sell?

It’s always difficult to determine the proper time to sell a stock. What if you sell and the stock price increases dramatically? Or what if you hold onto the stock and its price declines? To help you decide when to sell, consider these signals:

• The price of a stock with a large loss isn’t moving. Investors hate selling a stock with a loss, often wanting to hold on until they at least break even. However, just because the stock’s price was much higher in the past doesn’t mean it will hit that price anytime soon. You may want to sell and reinvest in another stock with better prospects. To help make that decision, forget what you paid for the stock. Instead, analyze it at its current price, deciding whether you would purchase it now at that price.
• The stock has hit your target sell price. When you purchase a stock, set both high and low target sales prices. While you don’t have to sell when the stock hits those prices, you should at least review it at that time. You might want to set rigid rules for selling a stock when it declines by a certain percentage of your purchase price, to ensure you don’t incur substantial losses. Many investors find it emotionally difficult to sell a stock at a loss, so this rule takes the emotion out of that decision. Keep in mind that capital losses can be offset against capital gains, and an excess of $3,000 can be deducted against ordinary income. Any remaining capital losses can be carried forward indefinitely.
• Your stock’s performance is lagging the market or its industry. Compare your stock’s performance to that of other stocks in the same industry and to the overall market. Keep in mind that your stock’s performance will vary over time, depending on the stage of the market cycle and how your stock’s industry is performing in that cycle. Consider selling a stock that has lagged in performance for an extended period.
• The stock’s fundamentals have changed. The world is constantly changing and the market leaders of today may not be the market leaders of tomorrow. Thus, watch your stocks so you can spot when fundamentals may be shifting.
• The stock is subject to negative news stories. You shouldn’t sell a stock at the first sign of trouble, since it’s not unusual for a stock to go through a difficult period. But if the news is continuing and involves significant events like management shakeups, major competitors stealing market share, unwelcome mergers and acquisitions, or top executives selling large blocks of stock, it’s time to reevaluate the stock.
• The stock’s price has run up too much, too quickly. While this is a good thing, the price could have risen so significantly that you may not think it has the potential to increase much more in the future. At that point, you may want to sell and purchase another stock with better prospects.

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An Annual 401(k) Plan Review

At least annually, you should thoroughly review your 401(k) plan. Some items to consider include:

• Have your goals or objectives changed? Most people use their 401(k) plan to fund retirement, although it can also be used for other things. Take time to reassess your goals and objectives, which can impact how much you contribute and how you invest those contributions. Calculate how much you’ll need at retirement as well as how much you should save annually to meet that goal.
• Are you contributing as much as you can to the plan? Look for ways to increase your contribution rate. One strategy is to allocate any salary increases to your 401(k) plan immediately, before you get used to the money and find ways to spend it. At a minimum, make sure you are contributing enough to take full advantage of any matching contributions made by your employer. In 2006, the maximum contribution to a 401(k) plan is $15,000 plus an additional $5,000 catch-up contribution, if permitted by the plan, for individuals age 50 and older.
• Are the assets in your 401(k) plan properly allocated? Some of the more common mistakes made when investing 401(k) assets include allocating too much to conservative investments, not diversifying among several investment vehicles, and investing too much in an employer’s stock. Saving for retirement typically encompasses a long time frame, so make investment choices that reflect that time period. For many, that means that a significant portion of their assets should be invested in growth vehicles.
• Do your investments need to be rebalanced? Use this review to ensure your allocation still makes sense. Also review the performance of individual investments, comparing the performance to appropriate benchmarks. You shouldn’t select your investments once and then just ignore the plan. Review your allocation annually to make sure it is close to your desired allocation. If not, adjust your holdings to get your allocation back in line. Selling investments within your 401(k) plan does not generate tax liabilities, so you can make these changes without any tax ramifications.
• Are you satisfied with the features of your 401(k) plan? If there are aspects of your plan you’re not happy with, such as too few investment choices or no employer matching, take this opportunity to let your employer know.

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What Are ADRs?

American depositary receipts (ADRs) are the form in which foreign stocks trade on U.S. stock exchanges. An ADR is a negotiable certificate issued by a U.S. bank (the depositary), representing shares of a foreign stock. The original foreign stock certificates are owned by the bank and held in the issuer’s country. Each ADR can represent a multiple or fraction of the original foreign stock. This ratio is set by the depositary so the ADR’s price falls within a range considered typical for U.S. stocks.

For an investor, ADRs can offer advantages over purchasing individual stocks on foreign stock exchanges:

• ADRs are traded on U.S. stock exchanges. Thus, you don’t need to become familiar with foreign stock markets or deal with delays that can occur in foreign markets.
• All stock transactions are executed in U.S. dollars, including purchases, sales, and dividends. Prices are quoted in U.S. dollars and include both changes in the stock price and currency fluctuations.
• Financial reporting tends to be more complete. If the ADR is sponsored, reports will be prepared in English. However, financial reports are based on accounting rules in effect in the company’s home country, which can differ substantially from U.S. accounting principles.

• Research the ADR carefully before investing. You are investing in a company in a foreign country, so you should become familiar with the economics of that country.
• Only consider ADRs if you are investing for the long term. If you are trying to take advantage of short-term exchange rate movements, there are other investment vehicles more suited for that purpose.

Copyright^�©2006. 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.

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