Inheriting an IRA or Employer-Sponsored Retirement Plan

What is it?

When the account owner of a traditional individual retirement account (IRA) or employer-sponsored retirement plan dies, the remaining funds in the account pass to the named beneficiary (or beneficiaries). Unlike many other inherited assets, these IRA or plan funds typically pass directly to the beneficiary without having to go through probate. (Probate is the court-supervised process of administering a will and proving it to be valid.)

These funds are usually subject to federal income tax, unlike some other inherited assets. For federal income tax purposes, post-death distributions from an IRA or plan account are treated the same as distributions that the account owner took during his or her lifetime (state income tax may also apply). In both cases, the portion of a distribution that represents pretax or tax-deductible contributions and investment earnings is taxed, while the portion that represents after-tax or nondeductible contributions is not. The difference, of course, is that the beneficiary is the one who must pay the taxes after the account owner has died. For more information, see Income in Respect of a Decedent.

If you are an IRA or plan beneficiary, you might want to leave inherited funds in the account as long as you like. This would allow you to postpone taxable distributions indefinitely, while maximizing the tax-deferred growth potential of the funds. Unfortunately, you are not allowed to do this. You will generally be required to take distributions of the inherited funds at some point, possibly sooner than you would like. However, you may have more than one option for taking distributions, and the option you choose can be critical.

Caution: While the same general rules apply to inherited Roth IRAs, Roth IRAs are unique in that qualified distributions are free from federal income tax.

Caution: This discussion focuses on the general rules regarding options available to a beneficiary that inherits an IRA or employer-sponsored retirement plan. Your IRA or plan may specify the option(s) available to you.

Beneficiary designations
Primary, secondary, and final beneficiaries

Primary beneficiaries are the IRA owner’s or plan participant’s first choices to receive the funds. By contrast, secondary beneficiaries (also known as contingent beneficiaries) receive the funds only in the event that all of the primary beneficiaries die or disclaim (i.e., refuse to accept) the funds.
Designated beneficiaries

Designated beneficiaries get preferential income tax treatment after your death. Being named as a primary beneficiary is not necessarily the same as being a designated beneficiary. Designated beneficiaries are individuals (human beings) who (1) are named as beneficiaries in the IRA or plan documents, (2) do not share the same IRA or plan account with another beneficiary who is not an individual, and (3) are still beneficiaries as of the final beneficiary determination date (September 30 of the year following the year of the IRA owner’s or plan participant’s death–the “September 30 next-year date”). The distinction is important because designated beneficiaries generally have greater and more flexible post-death options.

Tip: Are you a designated beneficiary? The answer depends on who the beneficiaries are on the “September 30 next-year date”–not who the beneficiaries are on the date of death. If you inherited an IRA or plan because the owner or participant named you as sole primary beneficiary, you are almost certainly a designated beneficiary. If you are one of several primary beneficiaries for the same IRA or plan account, you are probably a designated beneficiary if all of the other primary beneficiaries are individuals. However, if any of the other primary beneficiaries are nonindividuals (a charity, for example), you may not be a designated beneficiary. Also, if the IRA or plan funds are coming to you through the owner’s or participant’s estate, you are probably not a designated beneficiary. If the funds are coming to you from a trust that is receiving the IRA or plan dollars, special rules will apply. Consult a tax or estate planning professional.

Final date for determining beneficiaries

Only beneficiaries remaining on September 30 of the year following the year of the IRA owner’s or plan participant’s death are considered as possible designated beneficiaries for purposes of post-death distributions from the IRA or plan account.

The September 30 next-year date does two things. First, it allows the IRA owner or plan participant to change beneficiaries any time during his or her lifetime. Second, it creates the opportunity for post-death planning. For example, if an IRA owner dies and the primary beneficiary does not need the money, the primary beneficiary could make a disclaimer up until the September 30 next-year date (note, however, that to be valid for estate and gift tax purposes, a qualified disclaimer–refusal to accept benefits–must be signed by a beneficiary and meet other requirements no later than nine months after a death. Therefore, even though designated beneficiaries are determined on September 30 of the year following the year of a death, a disclaimer may need to be signed much earlier to meet the nine-months-after-death rule). This might allow the funds to pass to a secondary beneficiary with a greater financial need.

Another possibility is that one or more primary beneficiaries could “cash out” their entire share of the inherited funds by the September 30 next-year date. If this is done by the September 30 next-year date, the “cashed out” beneficiaries are not considered as possible designated beneficiaries for purposes of calculating post-death distribution methods. For example, this strategy can be very effective in cases where the primary beneficiaries include both individuals and one or more charities. The charity (ineligible as a designated beneficiary) can take its entire share (income tax free) by the September 30 next-year date, leaving only the individuals as remaining beneficiaries who may qualify as designated beneficiaries.

Caution: 2002 final regulations clarify that a designated beneficiary who dies after the death of the IRA owner or plan participant, but prior to the September 30 next-year determination date, is still treated as a designated beneficiary for purposes of calculating post-death distributions from the IRA or plan account. As discussed above, this is in contrast to situations where a designated beneficiary makes a qualified disclaimer prior to the September 30 next-year date.

Factors that determine post-death distribution options

First, if you have inherited an employer-sponsored retirement plan account, the plan is generally allowed to specify the post-death distribution options available to you. These options may not be as flexible as the options permitted under the final IRS distribution rules. For example, depending on whether a plan participant died before or after his or her required beginning date, some plans may provide a different default payout method than the IRS rules. In such a case, you may not be able to elect another payout method as an alternative to the plan’s default method. Your first step should be to consult the retirement plan administrator regarding your post-death options as a beneficiary.

The other factor that determines post-death options is the type of beneficiary. Individual beneficiaries generally have more options and flexibility than nonindividual beneficiaries. For example, post-death options are severely limited if the IRA owner or plan participant dies with his or her estate as a beneficiary. This could occur if the estate is named as a beneficiary, or if there are no named beneficiaries (in which case the estate becomes the “default” beneficiary). The same limited options apply when one or more charities are named as beneficiary. Special rules apply when a trust is named as beneficiary. Under certain conditions, the underlying trust beneficiaries can be treated as the IRA or plan beneficiaries for distribution purposes.

For individuals who qualify as designated beneficiaries, the options available further depend on whether the beneficiary is a spouse or another individual. Depending on plan provisions and other factors, nonspousal individuals will typically have several post-death options. These options generally include using the life expectancy method, receiving a lump-sum distribution, taking distributions under the five-year rule, or disclaiming the funds. (See below for a description of each.) The life expectancy method is usually the default payout method, and often the most favorable method in terms of providing the longest possible payout period (thereby spreading out income taxes and maximizing tax-deferred growth).

A surviving spouse generally has all of the options available to other designated beneficiaries, plus two additional options. A surviving spouse beneficiary can elect to roll over inherited funds to his or her own IRA or plan account, providing income tax and estate planning benefits. A surviving spouse who is the sole beneficiary may also elect to leave the funds in an inherited IRA and treat that IRA as his or her own account. (This option does not apply to inherited retirement plans.) In most cases, it will be in a surviving spouse’s best interest to exercise one of the two additional options.

Tip: Nonspouse beneficiaries can not roll over inherited funds to their own IRA or plan. However, the Pension Protection Act of 2006 lets a nonspouse beneficiary make a direct rollover of certain death benefits from an employer-sponsored retirement plan to an inherited IRA. (See Nonspouse rollover to an inherited IRA–The Pension Protection Act of 2006, below.)

Tip: If a participant died before beginning to take required minimum distributions, a surviving spouse can generally wait until the year the participant would have reached age 70½ to begin taking distributions from the account.

Tip: Once a post-death payout method is in place, the IRA or plan beneficiary is usually allowed to take larger distributions than required (including, in most cases, a lump-sum distribution of the beneficiary’s entire share). However, if the beneficiary receives less than required in any year, a 50 percent federal penalty tax will apply to the undistributed required amount. This penalty tax would be in addition to regular income tax.

Post-death distribution options for designated beneficiaries

Remember, only individuals who meet certain requirements can be designated beneficiaries of an IRA or retirement plan account. The post-death distribution options available to designated beneficiaries generally include one or more of the following.
Life expectancy method

This method involves taking distributions over a beneficiary’s single life expectancy (or, in some cases, over the deceased account owner’s remaining single life expectancy). This is typically the “default” payout method for designated beneficiaries under the final rules, regardless of whether the IRA owner or plan participant died before or after the required beginning date for minimum distributions (unless plan provisions specify otherwise). The distributions must begin no later than December 31 of the year following the year of the IRA owner’s or plan participant’s death. For more information, see Life Expectancy Method.
Five-year rule

This method involves taking distributions in any amount and at any time within a five-year period. The five-year period ends on December 31 of the year during which the fifth anniversary of the IRA owner’s or plan participant’s death occurs. If there is no designated beneficiary and the death occurred before the required beginning date, the five-year rule is the default rule under the final regulations. In other cases, the life expectancy method is the default rule. However, a designated beneficiary can often still elect the five-year rule as an alternative payout method. From a tax standpoint, it is usually not as desirable as the life expectancy method. For more information, see Five-Year Rule.
Lump-sum distribution

This distribution method involves withdrawing a beneficiary’s entire interest in an inherited IRA or retirement plan account within one tax year. This can take the form of a single distribution of the entire interest, or multiple distributions spread over the one-year period. In most cases, any designated beneficiary can elect a lump-sum distribution of his or her share of an inherited IRA or plan account. However, other post-death payout options are typically available, and will usually be more attractive from a tax standpoint. A lump-sum distribution can have very undesirable tax consequences. For more information, see Lump-Sum Distribution.
Roll over the remaining interest

This special post-death option is available only to surviving spouses who are designated beneficiaries. It involves “rolling over” the surviving spouse’s interest in the inherited IRA or plan account to the spouse’s own IRA or plan. A surviving spouse can generally elect this option regardless of whether the IRA owner or plan participant had begun taking lifetime required minimum distributions (RMDs). Once in the spouse’s IRA or plan, the funds continue to grow tax deferred, and distributions need not begin until the spouse’s own required beginning date. Also, the spouse can name beneficiaries of his or her choice. For more information, see Roll Over the Remaining Interest.
Disclaim the inherited funds

Any designated beneficiary can opt to disclaim his or her share of the inherited IRA or plan account. Disclaiming simply means refusing to accept the inherited funds, allowing them to pass to another individual or entity (i.e., a secondary beneficiary). A qualified disclaimer must be completed within nine months of the date of death. This nine-month deadline usually occurs before the September 30 next-year date. Disclaiming sometimes makes sense for tax and/or personal reasons. For more information, see Disclaim the Inherited Funds.

Post-death distribution options for nondesignated beneficiaries

Charities and estates can be beneficiaries of an IRA or retirement plan account, but they cannot be designated beneficiaries because they are not individuals. In addition, individuals who are beneficiaries of an IRA or plan may not qualify as designated beneficiaries under certain conditions. The post-death distribution options available to nondesignated beneficiaries generally include one or more of the following.
Five-year rule

If an IRA owner or retirement plan participant dies before his or her required beginning date for lifetime RMDs, and there are no designated beneficiaries on the account, required post-death distributions generally must be taken according to the five-year rule. For more information, see Five-Year Rule.
Distributions over the account owner’s remaining life expectancy

If an IRA owner or retirement plan participant dies on or after his or her required beginning date for lifetime RMDs, and there are no designated beneficiaries on the account, required post-death distributions generally must be taken over the account owner’s remaining single life expectancy (calculated in the year of death according to IRS life expectancy tables, up to a maximum of 17 years). For more information, see Life Expectancy Method.
Lump-sum distribution

As an alternative to either of the above payout methods, a nondesignated beneficiary (just as a designated beneficiary) generally has the option of receiving a lump-sum distribution of the inherited IRA or plan funds. Again, though, this may not be advisable from a tax standpoint. For more information, see Lump-Sum Distribution.
Disclaim the inherited funds

As an alternative to any of the above payout methods, a nondesignated beneficiary (just as a designated beneficiary) generally has the option of disclaiming inherited IRA or retirement plan funds. For more information, see Disclaim the Inherited Funds.

Nonspouse rollover to an inherited IRA–The Pension Protection Act of 2006

A spouse beneficiary can roll over death benefits received from an employer-sponsored retirement plan to either the spouse’s own IRA, or to an IRA established in the deceased’s name with the spouse as beneficiary (an “inherited IRA”). In the past, neither of these options was available to nonspouse beneficiaries. While nonspouse beneficiaries still can not roll over inherited funds from an employer plan to their own IRA, the Pension Protection Act of 2006 lets a nonspouse beneficiary make a direct (trustee to trustee) rollover from a 401(k), 403(b), or governmental 457(b) plan to an inherited IRA, for distributions after 2006. If a nonspouse beneficiary elects a direct rollover, the amount directly rolled over is not includible in gross income in the year of the distribution.

The ability to make a rollover to an IRA is significant because employer plans often require faster payouts to nonspouse beneficiaries than the law requires, accelerating taxation for these individuals. IRAs on the other hand generally allow distributions to be spread over the maximum period permitted by law, permitting tax deferral for the longest period of time. The IRS has recently provided guidance on nonspouse rollovers from employer sponsored plans to IRAs. IRS Notice 2007-7 provides that:

• The IRA must be established in a manner that identifies it as an inherited IRA, and also identifies the deceased employee and the beneficiary, for example, “Tom Smith as beneficiary of John Smith.”
• An indirect rollover–where the beneficiary receives the distribution and then rolls the funds over to an IRA within 60 days–is not allowed
• A plan can make a direct rollover to an IRA on behalf of a trust where the trust is the deceased employee’s named beneficiary, provided the beneficiaries of the trust can be treated as designated beneficiaries under IRS required minimum distribution (RMD) rules, and the trust is identified as the IRA beneficiary.
• The nonspouse beneficiary can’t roll over RMDs to the inherited IRA.

The Notice provides complex rules for determining both the RMDs ineligible for rollover from the employer plan, and the RMDs required from the IRA after the rollover:

1. The employee dies before his or her required beginning date, and the 5 year rule applies. Under the 5-year rule, no amount has to be distributed by the retirement plan to the beneficiary until the end of the fifth calendar year following the year of the employee’s death. In that year, the entire remaining amount that the beneficiary is entitled to under the plan must be distributed. Notice 2007-7 provides that the beneficiary can directly roll over his or her entire benefit until the end of the fourth year. On or after January 1 of the fifth year following the year in which the employee died, no amount payable to the beneficiary is eligible for rollover. Most importantly, Notice 2007-7 provides that if the beneficiary was subject to the 5-year rule in the employer plan, the 5-year rule will continue to apply to for purposes of determining RMDs from the inherited IRA after the rollover.

However, even where the 5-year rule applies, a special rule allows a nonspouse beneficiary to determine the RMD under the employer plan using the life expectancy rule, roll the balance over to an inherited IRA, and continue to take RMDs from the IRA using the life expectancy rule–which provides the maximum tax deferral for the beneficiary. To use this special rule the rollover must occur no later than the end of the year following the year in which the employee dies.

Example(s): Sam, a participant in his employer’s 401(k) plan, dies on June 1, 2010. The 401(k) plan provides that beneficiaries must receive their entire balance from the plan under the five year rule. Therefore June, Sam’s beneficiary, must receive the entire balance no later than December 31, 2015. June would like to defer taxes on her inherited funds for as long as possible. If she makes a direct rollover to an inherited IRA by December 31, 2011, she will be able to use the life expectancy rule, rather than the 5-year rule, when calculating her RMDs from the IRA. Her rollover must be reduced by the amount of RMDs that would have been required under the employer plan using the life expectancy rule. If June fails to make her rollover by December 31, 2011, then she will still be able to make a rollover to an inherited IRA (no later than December 31, 2014), but will have to continue to use the five year rule when calculating her RMDs from the IRA. That is, she will still be required to receive all the funds in the inherited IRA no later than December 31, 2015.

2. The employee dies before his or her required beginning date, and the life expectancy rule applies. If the life expectancy rule applies, the amount ineligible for rollover includes all undistributed RMDs for the year in which the direct rollover occurs and any prior year. After the rollover, the life expectancy rule continues to apply in determining RMDs from the inherited IRA. RMDs are determined using the same applicable distribution period as would have been used under the employer plan if the direct rollover had not occurred.

3. The employee dies on or after his or her required beginning date. If an employee dies on or after his or her required beginning date, the amount ineligible for rollover includes all undistributed RMDs for the year in which the direct rollover occurs and any prior year, including years before the employee’s death. After the rollover, the life expectancy rule continues to apply in determining RMDs from the inherited IRA. The RMD under the IRA for any year after the employee’s death must be determined using the same applicable distribution period as would have been used under the employer plan if the direct rollover had not occurred.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of John Jastremski and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

Erik J. Larsen is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

Erik J. Larsen is a Representative with FSC Securities and may be reached at www.theretirementgroup

WEEKLY ECONOMIC UPDATE
WEEKLY QUOTE   “It is every man’s obligation to put back into the world at least the equivalent of what he takes out of it.” - Albert Einstein     WEEKLY TIP   Succession planning isn’t just about an orderly ownership transition. It is also about tax efficiency. Waiting too long can mean paying more in insurance premiums, fees and taxes.     WEEKLY RIDDLE   You need to take a gallon of oil out of a barrel of oil. How can you do it using only a 3-gallon container and a 5-gallon container?     Last week’s riddle: It is a short and simple word, and something that everyone needs. Put an ‘r’ on the end and you have a new friend, but if the first letter goes away, you are sad. What is this word?     Last week’s answer: Love.	HOUSING MARKET COOLS DOWN IN February Nationally, home sales took a step back last month. Last week, the National Association of Realtors reported a 0.9% drop in residential resales in February. The federal government subsequently announced a 1.6% slip in new home purchases last month, although new home prices rose by over 8.0%. The year-over-year numbers are better: existing home sales have jumped 8.8% in the last 12 months, and new home sales have picked up by 11.4%. Housing starts were down 1.1% in February from January’s 4-year high, but building permits were up 5.1% for the month.1,2 INITIAL CLAIMS HIT A NEW 4-YEAR LOW According to the Labor Department, claims fell by 5,000 to a seasonally adjusted 348,000 for the week ending March 17. This is the smallest amount since March 2008.3   LEADING INDICATORS MOVE NORTH AGAIN The Conference Board’s monthly index rose 0.7% for February, with reduced jobless claims and the interest rate spread exerting the most influence. Eight of the index’s ten indicators were up for the month.3   BULLS PRESS PAUSE BUTTON Stocks pulled back for the week as anxieties over subpar foreign manufacturing indices inspired some profit-taking. A new concern surfaced Friday: Reuters said Iran’s oil exports had dropped 14% this month. The S&P 500 retreated 0.50% last week to 1,397.11 Friday. The DJIA lost 1.15% on the week to settle Friday at 13,080.73, while the NASDAQ advanced 0.41% in five days to wrap up Friday at 3,067.92. Gold ended the week at $1,662.40 an ounce, oil at $106.87 a barrel. Unleaded gasoline averaged $3.89 a gallon nationally in AAA’s newest price survey.4,5   THIS WEEK: Plenty of crucial data appears. On Monday, the National Association of Realtors tells us about February’s pending home sales, and Fed chairman Ben Bernanke speaks about the labor market at NABE’s annual conference. Tuesday, we get the January S&P/Case-Shiller Home Price Index, the Conference Board’s March consumer confidence poll and Q4 results from Lennar and Walgreens. Wednesday, February durable goods orders figures come out plus earnings from Family Dollar and Texas Industries. Thursday offers the government’s final take on Q4 GDP and earnings from Best Buy and Research in Motion. On Friday, February consumer spending data arrives plus the final University of Michigan consumer sentiment survey for March.   % CHANGE Y-T-D 1-YR CHG 5-YR AVG 10-YR AVG DJIA +7.06 +8.23 +0.96 +2.54 NASDAQ +17.76 +13.70 +5.06 +6.57 S&P 500 +11.09 +7.67 -0.54 +2.16 REAL YIELD 3/23 RATE 1 YR AGO 5 YRS AGO 10 YRS AGO 10 YR TIPS -0.11% 0.98% 2.19% 3.48%   Sources: msn.money.com, bigcharts.com, treasury.gov, treasurydirect.gov – 3/23/124,6,7,8 Indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends.
Please feel free to forward this article to family, friends or colleagues. If you would like us to add them to our distribution list, please reply with their address. We will contact them first and request their permission to add them to our list.
This material was prepared by Peter Montoya Inc, and does not necessarily represent the views of John Jastremski, Jeremy Keating, Erik J Larsen, Frank Esposito, Patrick Ray, Robert Welsch, Michael Reese, Brent Wolf, Andy Starostecki and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.
The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

 

Cash Reserve

What is a cash reserve?

A cash reserve is a pool of funds (and sometimes credit) that you hold in a readily available form to meet emergency and other highly urgent, short-term needs. Sometimes, it is referred to as an emergency or contingency fund.

Caution: Terminology is important here because contingencies often are not emergencies. Purchasing an expensive item that suddenly goes on sale or buying stock when its price suddenly drops might lead one to tap a so-called contingency fund, but these are certainly not emergencies.

The definition used here of a cash reserve is money set aside solely to cover critical, unexpected needs, such as a sudden loss of income. Consequently, it is not a fund for meeting anticipated expenses, large or small, such as real estate taxes, tuition, or a spontaneous vacation. Instead, a cash reserve protects you, your family, and your loved ones against unexpected financial crises.

Example(s): The manufacturer of a new computer you’ve been thinking about buying has just announced a substantial rebate on machines purchased within the next two months. While this might be an excellent opportunity to purchase the item at a reduced cost, it is not an emergency and therefore does not justify tapping your cash reserve. Maintaining sufficient savings elsewhere eliminates the temptation to tap emergency-designated funds for nonemergency needs.

Why is a cash reserve necessary?

A sound financial plan should ensure that you are protected when financial emergencies arise. In times of crisis, you do not want to shake pennies out of a piggy bank. Also, having a cash reserve may help prevent being forced to take on additional debt precisely when another financial challenge is the last thing you need. Consequently, the first step in the financial planning process should be to establish a cash reserve.

Determining how large a cash reserve should be

The amount of your cash reserve should be based on your own personal situation. While basic guidelines do exist, you should adjust them to reflect your unique circumstances. Some factors you should consider when determining a cash reserve goal include job security, the condition of your real estate, and the health of you and your dependents. Naturally, such factors change with time, so an annual review and adjustments are important elements of the planning process.
Three to six months of routine living expenses compose a typical cash reserve, but there are exceptions

Your should generally follow the 3-6 months rule: that is, your cash reserve should equal 3 to 6 months of ordinary living expenses. Occasionally, low job security or high income volatility might suggest having a reserve of up to 12 months of expenses. The actual number of months selected should reflect these and other significant risk factors, such as the adequacy of insurance coverage and the condition of any property you own.
Using credit provides a higher-risk secondary funds source

Credit available to you can be a secondary source of funds in a time of crisis. However, because borrowed money must be paid back (often at very high interest rates), using lenders as the primary source of your cash reserve can create more long-term financial problems than it solves. Credit as part of a cash reserve functions best when it’s part of a multi-tier cash reserve structure that includes multiple financial resources.
Taking stock of what you have

List the locations and amounts of your money that you can withdraw on an immediate (or nearly immediate) basis without incurring a loss. Typical sources include savings accounts, money market accounts, Treasury securities, and cash value life insurance. Be careful to exclude accounts set up to meet everyday needs or special objectives, such as education, vacations, or a new car. You can also include untapped credit resources, provided you count them separately from cash resources.
Are you missing the goal? If so, by how much?

This is almost as easy as subtracting what you have from what you need. If you elect to consider credit resources part of your cash reserve, the procedure is slightly more complex, since part of the total amount must be held as cash (noncredit) assets.

Example(s): Hal and Jane determine that their cash reserve should equal five months of living expenses, or $25,000 ($5,000 per month). Because their current cash reserve is only $15,000 in a non-tax sheltered money market account, they need to save or reallocate an additional 10,000 to meet their goal. The $15,000 amount is sufficient to cover at least three months of expenses. Therefore, they can cover the $10,000 difference partly or entirely with available credit.

Achieving your cash reserve goal

Your initial thought is probably that cutting spending and saving aggressively are the only options for establishing or increasing a cash reserve. However, you may already have assets that you could make part of your cash reserve. These could include savings bonds coming due, the cash value of a life insurance policy you plan to convert, or even an antique you no longer care about that you might sell. The discussion that follows explains methods that you can use to build your reserve fund to the desired level rapidly.
Identifying, converting, and reallocating current assets to build your cash reserve

You may be able to reposition current assets. Current or liquid assets are those that are cash or convertible to cash within a year. You can designate those already in cash form to be part of your cash reserve. Those not in cash form can be converted to cash when appropriate and added to your cash reserve.

Examples of current assets include:

• Certificates of deposit and savings bonds that will mature in 12 months (avoid paying an early redemption penalty by waiting until they mature)
• An antique, a painting, or a piece of jewelry
• Stock shares
• A valuable collection (stamps, antique dolls, rare books, etc.)
• Current savings for nonemergency contingencies, part of which might be reallocated to your cash reserve

Evaluate the approaches to systematic saving currently available to you

If you have not established a cash reserve or if the one you have falls short of your goal, there are several paths you can take to eliminate the shortfall. Automatic savings (e.g., using payroll deduction at work) is one of the best approaches. Systematic savings that are budgeted as a regular household expense can also help. Curtailing discretionary spending is still another wise choice. Exploring the pros and cons of your alternatives will help you create a savings plan that is best for your own situation.
Develop a cash reserve savings plan to achieve your goal as rapidly as is reasonably possible

Having reviewed the available savings options, select one or a combination of approaches to achieve your cash reserve goal. Because an adequate cash reserve serves as your protection against financial chaos, you should be as aggressive as reasonably possible in achieving your goal. Combining both spending reduction and savings can help you quickly reach your goal.

Structuring and maintaining a cash reserve

The most important attribute of a cash reserve is its availability in time of sudden need. However, this does not necessarily require you to keep the entire sum in a low-interest savings account. There are several excellent alternatives, each with its own unique advantages. For those with a larger cash reserve, a multi-tier structure of sources based on timeliness of access is often desirable. Because income and personal circumstances are subject to change, periodic review of the cash reserve total and its structure is advisable.
Stash the cash: deciding where and in what form to keep a cash reserve

A federally insured savings account is considered one of the safest places to put money being reserved for emergencies, but when interest rates are in the basement, there may be better alternatives. Money market deposit accounts at a bank and various types of term deposits, such as certificates of deposit (CDs), typically offer higher interest rates with little, if any, increased risk. Term deposits are effectively a loan to the institution and not intended for withdrawal prior to the expiration or maturity date. Financial institutions generally assess a substantial penalty for early withdrawal. Laddering maturity dates provides a means of minimizing the impact of this disadvantage.

Money market mutual funds are another good choice. However, you need to understand that a money market mutual fund, whether from a bank or fund company, is not federally insured. With a money market fund, it’s possible to lose money, although most money market funds will go to great lengths to avoid “breaking the buck”–that is, allowing a share’s value to fall below $1, thus costing investors at least part of their principal. Be sure to obtain and read a fund’s prospectus (available from the fund) so you can carefully consider its investment objectives, risks, expenses, and fees before investing.

Caution: An investment in the fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
Ladder maturities of term deposits for better accessibility and lower interest rate risk

Laddering refers to staggering the maturity dates of fixed-term investment vehicles (i.e., those that pledge to return your principal plus interest on a given date). Certificates of deposit (CDs) and U.S. Treasury securities (T bills) are examples of savings vehicles you might consider as a second tier of your cash reserve. If so, spreading the maturity dates of such vehicles over a short time period (e.g., two to five months) assures their availability to meet sudden financial needs that may extend beyond a few months. Laddering enables you to seek a higher level of interest while preserving some accessibility and flexibility to adjust to changing financial circumstances.
Build a multi-tier cash reserve when using term deposits or credit lines

If your cash reserve includes more than two or three months of living expenses, you can consider dividing it into two or three tiers. You then have the option of using a different form of savings or credit for each tier. This method allows you to consider savings vehicles that offer higher interest rates, although such money will not be available immediately without penalty. If you choose to include credit as part of a multi-tier account structure for your cash reserve, always use it as the final tier, because payback requirements and related interest charges make it the least desirable form of emergency protection. The following table illustrates this point:

TIER	DESCRIPTION	ACCOUNT TYPE
1	3-4 months living expenses immediately available	Ordinary or money market savings
2	4-6 months of living expenses	Money market savings, CDs, or Treasury bills
3	6-12 months of living expenses	CDs
4	Preapproved credit	Personal credit line

Review and adjust your cash reserve annually to reflect your changing circumstances

If anything is certain, it is that the personal and financial circumstances of you, your family, and your loved ones are very likely to change within the span of a year or two. A new child comes along, an aging parent becomes more dependent, a larger home or new car brings increased expenses, or maturing offspring leave the nest. Because your cash reserve is your first line of protection in a financial crisis, it is important to review it annually. If the amount and structure of your reserve no longer matches current needs, you should make the appropriate adjustments. An overly large reserve can mean that opportunities for better returns are being overlooked. In contrast, an undersized reserve increases the risk for financial chaos and stress in a time of sudden need.

 

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of John Jastremski, Jeremy Keating, Erik J Larsen, Frank Esposito, Patrick Ray, Robert Welsch, Brent Wolf, Andy Starostecki and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

 

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

 

The Retirement Group may be reached at www.theretirementgroup.com

 

 

Retirement Income Investing: Beyond Annuities

One of the challenges of investing during retirement is providing for annual income while balancing that need with other considerations, such as liquidity, how long you need your funds to last, your risk tolerance, and anticipated rates of return for various types of investments. Annuities may be seen as a full or partial solution, since they can offer stable income or guaranteed lifetime payments (subject to the claims-paying ability of the issuer). However, they’re not right for everyone. A well-thought-out asset allocation in retirement is essential. While income investments alone are unlikely to meet all your needs, it’s important to understand some of the most common non-annuity investments that can provide income as part of your overall investment strategy. Bonds: retirement’s traditional backbone A bond portfolio can help you address investment goals in multiple ways. Buying individual bonds (which are essentially IOUs) at their face values and holding them to maturity can provide a predictable income stream and the assurance that unless a bond issuer defaults, you’ll receive the principal when the bond matures. (Bear in mind that if a bond is callable, it may be redeemed early, and you would have to replace that income.) You also can buy bonds through mutual funds or exchange-traded funds (ETFs). Depending on your circumstances, funds may provide greater diversification at a lower cost than individual bonds. However, a bond fund has no specific maturity date and therefore behaves differently from an individual bond, though like an individual bond, its price typically moves in the opposite direction from interest rates. Consider the issuer Bonds are available from many types of issuers, including corporations, the U.S. Treasury, local and state governments, governmental agencies, and foreign governments. Each type is taxed differently. For example, the income from Treasury securities (unlike corporate bonds) is exempt from state and local taxes but not from federal taxes. Bonds issued by state and local governments, commonly called municipal bonds or munis, are just the opposite. Often a staple for retirees in a high tax bracket, munis generally are exempt from federal income tax (though specific issues may be taxable), but may be subject to state or local taxes. Largely because of that tax advantage, a tax-free bond typically yields less than a corporate bond with the same maturity. You’ll need to compare a muni’s tax-equivalent yield to know whether it makes sense on an after-tax basis. Think about bond maturities Bond prices can drop when interest rates and/or inflation rise, because their fixed income will buy less over time. Inflation affects prices of long-term bonds–those with maturities of 10 or more years–the most. One way to keep a bond portfolio flexible is to use so-called laddering: buying bonds with various maturities. As each matures, its proceeds can be reinvested. If bond yields are up, you benefit from higher rates; if yields are down, you have the option of choosing a different maturity or investment. Certificates of deposit/savings accounts Certificates of deposit (CDs), which offer a fixed interest rate for a specific time period, usually pay higher interest than a regular savings account, and you typically can have interest paid at regularly scheduled intervals. A CD can be rolled over to a new CD or another investment when it matures, though you may not get the same interest rate, and you’ll pay a penalty if you cash it in early. A high-yield savings account also pays interest, and, like a CD, is FDIC-insured up to $250,000. Stocks offering dividends Dividend-paying stocks, as well as mutual funds and ETFs that invest in them, also can provide income. Because dividends on common stock are subject to the company’s performance and a decision by its board of directors each quarter, they may not be as predictable as income from a bond. However, dividends on preferred stock are different; the rate is fixed and they’re paid before any dividend is available for common stockholders. That fixed payment means that prices of preferred stocks tend to behave somewhat like bonds. Preferred shares usually pay a higher dividend rate than common shares, and though most preferred stockholders do not have voting rights, their claims on the company’s assets will be satisfied before those of common stockholders if the company has financial difficulties. However, a company is often permitted to call in preferred shares at a predetermined future date, and preferred stockholders do not participate in a company’s growth as fully as common shareholders would. Pass-through securities/REITs Some investments are designed to act as a conduit for income from underlying assets. For example, mortgage-related securities represent an ownership interest in mortgage loans made by financial institutions. The most basic of these, known as pass-throughs, represent a direct ownership interest in a trust that consists of a pool of mortgages. Examples of pass-throughs include securities issued by the Government National Mortgage Association, the Federal Home Loan Mortgage Corporation, and the Federal National Mortgage Association. Certain types of investment trusts–for example, REITs that buy, develop, manage, or sell real estate–don’t owe taxes as long as they pay out at least 90% of their net income to investors. That payout has traditionally made them popular as an income vehicle and portfolio diversifier (though diversification alone does not guarantee a profit or ensure against a loss). There are many types of REITs, so be sure you understand how the one you choose functions before investing. Automated inflation fighting Some investments are designed to fight inflation for you. Treasury Inflation-Protected Securities (TIPS) pay a slightly lower fixed interest rate than regular Treasuries. However, your principal is automatically adjusted twice a year to match changes in the Consumer Price Index (CPI). Those adjusted amounts are used to calculate your interest payments. That inflation adjustment means that if you hold a TIPS until it matures, your repaid principal will likely be higher than when you bought it (the government guarantees it will not be less). However, you can still lose money if you sell a TIPS before maturity. Inflation rates change, and other interest rates can affect the value of a TIPS. If inflation is lower than expected, the total return on a TIPS could actually be less than that of a comparable non-indexed Treasury. Also, federal taxes on the interest and increases in your principal are owed yearly even though additions to principal aren’t paid until a TIPS matures. Inflation-linked CDs function much like TIPS, but you’ll generally owe federal, state, and local taxes each year. Some mutual funds are managed with an eye toward inflation. A mutual fund that invests in inflation-protected securities pays out not only the interest but also any annual inflation adjustments, which are taxable each year as short-term capital gains. Some funds target inflation by mixing TIPS with floating rate loans, commodity-linked notes, real estate-related investments, stocks, and bonds. Distribution funds Some mutual funds are designed to provide an income stream from year to year. Available as part of a series, each fund designates a percentage of your assets to be distributed each year as scheduled payments, usually monthly or quarterly. Some funds are designed to last over a specific time period and plan to distribute all your assets by the end of that time; others focus on capital preservation, make payments only from earnings, and have no end date. You may withdraw money at any time from a distribution fund; however, that may reduce future returns. Also, payments may vary, and there is no guarantee a fund will achieve the desired return. Many choices New ways to help you translate savings into income are constantly being created. These are only a few of the many possibilities, and there’s more to understand about each. This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of Erik Larsen and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867. The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process. Erik Larsen is a Representative with FSC Securities and may be reached at www.theretirementgroup

How Much Annual Income Can Your Retirement Portfolio Provide?

How Much Annual Income Can Your Retirement Portfolio Provide?

Your retirement lifestyle will depend not only on your assets and investment choices, but also on how quickly you draw down your retirement portfolio. The annual percentage that you take out of your portfolio, whether from returns or the principal itself, is known as your withdrawal rate. Figuring out an appropriate initial withdrawal rate is a key issue in retirement planning and presents many challenges.

Why is your withdrawal rate important?

Take out too much too soon, and you might run out of money in your later years. Take out too little, and you might not enjoy your retirement years as much as you could. Your withdrawal rate is especially important in the early years of your retirement; how your portfolio is structured then and how much you take out can have a significant impact on how long your savings will last.

Gains in life expectancy have been dramatic. According to the National Center for Health Statistics, people today can expect to live more than 30 years longer than they did a century ago. Individuals who reached age 65 in 1950 could anticipate living an average of 14 years more, to age 79; now a 65-year-old might expect to live for roughly an additional 19 years. Assuming rising inflation, your projected annual income in retirement will need to factor in those cost-of-living increases. That means you’ll need to think carefully about how to structure your portfolio to provide an appropriate withdrawal rate, especially in the early years of retirement.

Current Life Expectancy Estimates
	Men	Women
At birth	75.7	80.6
At age 65	82.3	85

Source: National Vital Statistics Report, Vol. 59, No. 4, March 2011

Conventional wisdom

So what withdrawal rate should you expect from your retirement savings? The answer: it all depends. A seminal study on withdrawal rates for tax-deferred retirement accounts (William P. Bengen, “Determining Withdrawal Rates Using Historical Data,” Journal of Financial Planning, October 1994) looked at the annual performance of hypothetical portfolios that are continually rebalanced to achieve a 50-50 mix of large-cap (S&P 500 Index) common stocks and intermediate-term Treasury notes. The study took into account the potential impact of major financial events such as the early Depression years, the stock decline of 1937-1941, and the 1973-1974 recession. It found that a withdrawal rate of slightly more than 4% would have provided inflation-adjusted income for at least 30 years. More recently, Bengen used similar assumptions to show that a higher initial withdrawal rate–closer to 5%–might be possible during the early, active years of retirement if withdrawals in later years grow more slowly than inflation.

Other studies have shown that broader portfolio diversification and rebalancing strategies also can have a significant impact on initial withdrawal rates. In an October 2004 study (“Decision Rules and Portfolio Management for Retirees: Is the ‘Safe’ Initial Withdrawal Rate Too Safe?,”Journal of Financial Planning) Jonathan Guyton found that adding asset classes such as international stocks and real estate helped increase portfolio longevity (although these may entail special risks). Another strategy that Guyton used in modeling initial withdrawal rates was to freeze the withdrawal amount during years of poor portfolio performance. By applying so-called decision rules that take into account portfolio performance from year to year, Guyton found it was possible to have “safe” initial withdrawal rates above 5%.

A still more flexible approach to withdrawal rates builds on Guyton’s methodology (“Using Decision Rules to Create Retirement Withdrawal Profiles,” Journal of Financial Planning, August 2007). William J. Klinger suggests that a withdrawal rate can be fine-tuned from year to year, using Guyton’s methods but basing the initial rate on one of three retirement profiles. For example, one person might withdraw uniform inflation-adjusted amounts throughout his or her retirement. Another might choose to spend more money early in retirement and less later; still another might plan to increase withdrawals as he or she ages. This model also requires estimating the odds that the portfolio will last throughout retirement. One retiree might be comfortable with a 95% chance that his or her strategy will permit the portfolio to last throughout retirement; another might need assurance that the portfolio has a 99% chance of lifetime success. The study suggests that this more complex model might permit a higher initial withdrawal rate, but also means the annual income provided is likely to vary moreover the years.

Don’t forget that all these studies were based on historical data about the performance of various types of investments, and that past results don’t guarantee future performance. Given market performance in recent years, many experts are suggesting being more conservative in estimating future returns.

Inflation is a major consideration

For many people, even a 5% withdrawal rate seems low. To better understand why suggested initial withdrawal rates aren’t higher, it’s essential to think about how inflation can affect your retirement income.

Here’s a hypothetical illustration; to keep it simple, it does not account for the impact of any taxes. If a $1 million portfolio is invested in a money market account yielding 5%, it provides $50,000 of annual income. But if annual inflation pushes prices up by 3%, more income–$51,500–would be needed next year to preserve purchasing power. Since the account provides only $50,000 income, an additional $1,500 must be withdrawn from the principal to meet expenses. That principal reduction, in turn, reduces the portfolio’s ability to produce income the following year. In a straight linear model, principal reductions accelerate, ultimately resulting in a zero portfolio balance after 25 to 27 years, depending on the timing of the withdrawals.

Volatility and portfolio longevity

When setting an initial withdrawal rate, it’s important to take a portfolio’s ups and downs into account–and the need for a relatively predictable income stream in retirement isn’t the only reason. According to several studies in the late 1990s by Philip L. Cooley, Carl M. Hubbard, and Daniel T. Walz, the more dramatic a portfolio’s fluctuations, the greater the odds that the portfolio might not last as long as needed. If it becomes necessary during market downturns to sell some securities in order to continue to meet a fixed withdrawal rate, selling at an inopportune time could affect a portfolio’s ability to generate future income.

Making your portfolio either more aggressive or more conservative will affect its lifespan. A more aggressive portfolio may produce higher returns but might also be subject to a higher degree of loss. A more conservative portfolio might produce steadier returns at a lower rate, but could lose purchasing power to inflation.

Calculating an appropriate withdrawal rate

Your withdrawal rate needs to take into account many factors, including (but not limited to) your asset allocation, projected inflation rate, expected rate of return, annual income targets, investment horizon, and comfort with uncertainty. The higher your withdrawal rate, the more you’ll have to consider whether it is sustainable over the long term.

Ultimately, however, there is no standard rule of thumb; every individual has unique retirement goals, means, and circumstances that come into play.

 

This material was prepared by Peter Montoya Inc, and does not necessarily represent the views of Erik Larsen, The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

Erik Larsen is a Representative with FSC Securities and may be reached at www.theretirementgroup.com.

Should You Pay Off Your Mortgage or Invest?

This material was prepared by Peter Montoya Inc, and does not necessarily represent the views of Erik Larsen, The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

Erik Larsen is a Representative with FSC Securities and may be reached at www.theretirementgroup.com.

Owning a home outright is a dream that many Americans share. Having a mortgage can be a huge burden, and paying it off may be the first item on your financial to-do list. But competing with the desire to own your home free and clear is your need to invest for retirement, your child’s college education, or some other goal. Putting extra cash toward one of these goals may mean sacrificing another. So how do you choose?

Evaluating the opportunity cost

Deciding between prepaying your mortgage and investing your extra cash isn’t easy, because each option has advantages and disadvantages. But you can start by weighing what you’ll gain financially by choosing one option against what you’ll give up. In economic terms, this is known as evaluating the opportunity cost.

Here’s an example. Let’s assume that you have a $300,000 balance and 20 years remaining on your 30-year mortgage, and you’re paying 6.25% interest. If you were to put an extra $400 toward your mortgage each month, you would save approximately $62,000 in interest, and pay off your loan almost 6 years early.

By making extra payments and saving all of that interest, you’ll clearly be gaining a lot of financial ground. But before you opt to prepay your mortgage, you still have to consider what you might be giving up by doing so–the opportunity to potentially profit even more from investing.

To determine if you would come out ahead if you invested your extra cash, start by looking at the after-tax rate of return you can expect from prepaying your mortgage. This is generally less than the interest rate you’re paying on your mortgage, once you take into account any tax deduction you receive for mortgage interest. Once you’ve calculated that figure, compare it to the after-tax return you could receive by investing your extra cash.

For example, the after-tax cost of a 6.25% mortgage would be approximately 4.5% if you were in the 28% tax bracket and were able to deduct mortgage interest on your federal income tax return (the after-tax cost might be even lower if you were also able to deduct mortgage interest on your state income tax return). Could you receive a higher after-tax rate of return if you invested your money instead of prepaying your mortgage?

Keep in mind that the rate of return you’ll receive is directly related to the investments you choose. Investments with the potential for higher returns may expose you to more risk, so take this into account when making your decision.

Other points to consider

While evaluating the opportunity cost is important, you’ll also need to weigh many other factors. The following list of questions may help you decide which option is best for you.

• What’s your mortgage interest rate? The lower the rate on your mortgage, the greater the potential to receive a better return through investing.
• Does your mortgage have a prepayment penalty? Most mortgages don’t, but check before making extra payments.
• How long do you plan to stay in your home? The main benefit of prepaying your mortgage is the amount of interest you save over the long term; if you plan to move soon, there’s less value in putting more money toward your mortgage.
• Will you have the discipline to invest your extra cash rather than spend it? If not, you might be better off making extra mortgage payments.
• Do you have an emergency account to cover unexpected expenses? It doesn’t make sense to make extra mortgage payments now if you’ll be forced to borrow money at a higher interest rate later. And keep in mind that if your financial circumstances change–if you lose your job or suffer a disability, for example–you may have more trouble borrowing against your home equity.
• How comfortable are you with debt? If you worry endlessly about it, give the emotional benefits of paying off your mortgage extra consideration.
• Are you saddled with high balances on credit cards or personal loans? If so, it’s often better to pay off those debts first. The interest rate on consumer debt isn’t tax deductible, and is often far higher than either your mortgage interest rate or the rate of return you’re likely to receive on your investments.
• Are you currently paying mortgage insurance? If you are, putting extra toward your mortgage until you’ve gained at least 20% equity in your home may make sense.
• How will prepaying your mortgage affect your overall tax situation? For example, prepaying your mortgage (thus reducing your mortgage interest) could affect your ability to itemize deductions (this is especially true in the early years of your mortgage, when you’re likely to be paying more in interest).
• Have you saved enough for retirement? If you haven’t, consider contributing the maximum allowable each year to tax-advantaged retirement accounts before prepaying your mortgage. This is especially important if you are receiving a generous employer match. For example, if you save 6% of your income, an employer match of 50% of what you contribute (i.e., 3% of your income) could potentially add thousands of extra dollars to your retirement account each year. Prepaying your mortgage may not be the savviest financial move if it means forgoing that match or shortchanging your retirement fund.
• How much time do you have before you reach retirement or until your children go off to college? The longer your timeframe, the more time you have to potentially grow your money by investing. Alternatively, if paying off your mortgage before reaching a financial goal will make you feel much more secure, factor that into your decision.

The middle ground

If you need to invest for an important goal, but you also want the satisfaction of paying down your mortgage, there’s no reason you can’t do both. It’s as simple as allocating part of your available cash toward one goal, and putting the rest toward the other. Even small adjustments can make a difference. For example, you could potentially shave years off your mortgage by consistently making biweekly, instead of monthly, mortgage payments, or by putting any year-end bonuses or tax refunds toward your mortgage principal.

And remember, no matter what you decide now, you can always reprioritize your goals later to keep up with changes to your circumstances, market conditions, and interest rates.

 

 

 

The Split Annuity: Current Income Plus Future Savings

Financial planning in retirement usually has two primary goals: create a steady, dependable stream of income and preserve retirement savings. One idea which may assist in achieving these retirement objectives is the split annuity concept.

What is a split annuity?

An annuity is a contract purchased from an insurance company that can be used to accumulate money on a tax-deferred basis for retirement and/or to convert retirement assets into a stream of income. A split annuity isn’t really one annuity, but a combination of two or more annuities funded with a single sum of money. A portion of the money is placed in an immediate annuity that makes a fixed payment to you for a fixed period of time, such as ten years. The balance of the money is invested in a fixed-interest deferred annuity, which accrues sufficient interest to equal the beginning sum used to fund both annuities by the time the immediate annuity payments stop. The amount of income you receive depends on the amount of money paid into each annuity, and the terms and interest rates applicable to each contract.

Example of Split Annuity $100,000 investment
Immediate Annuity	Deferred Annuity
$41,457 generates annual payments of $5,136.76 for 10 years	$58,543 at 5.50% per year will grow to $100,000 by the end of 10 years
This example assumes a total initial investment of $100,000. This is a hypothetical illustration and does not reflect actual annuity products or performance. Withdrawals from an annuity prior to age 59½ may result in a 10% penalty tax imposed by the IRS. Guarantees are subject to the claims-paying ability of the issuer.

Split annuity benefits

Fixed income –The immediate annuity makes fixed payments to you for a fixed period of time, regardless of changing interest rates or stock market fluctuations.

Possible tax-advantaged payments –The tax code treats payments received as an annuity as being divided into two parts: a nontaxable portion that represents the return of premiums paid into the annuity, and a taxable portion that corresponds to the earnings in the annuity. As a result, only a portion (i.e., the earnings) of each payment is included in your gross income. The remainder is a return of principal and not taxed.

Tax-deferred accumulations –The earnings on a fixed-interest deferred annuity (i.e., the interest earned on your money) are tax deferred until withdrawn. Unlike most taxable investments, you pay no taxes on your annuity earnings until you begin to take payments or receive income. Income tax deferral allows your money to potentially grow faster than in a taxable account, because earnings that otherwise would be subject to taxes are available for growth.

Flexibility –The fixed-interest deferred annuity can provide a new income stream at its maturity. Also, most fixed-interest deferred annuities allow you to withdraw a portion of the annuity’s cash value without penalty. This option provides you with access to additional money should you need it in addition to the immediate annuity payments.

Return of principal –At the end of the immediate annuity payout period, the fixed-interest deferred annuity is worth the original amount of your investment in both annuities. At that time, you can use the money from the fixed-interest deferred annuity however you wish, including another split annuity.

Split annuity limitations

Surrender or early withdrawal charges –The fixed-interest deferred annuity usually has early withdrawal or surrender charges. This assessment is often a percentage of a withdrawal exceeding any applicable penalty-free amount allowed in the annuity contract. Most fixed-interest deferred annuities include some exceptions to the withdrawal charge, including withdrawals due to disability, loss of employment, long-term care, and death of the annuity owner.

Fixed annuity payments –While knowing that you will receive a fixed payment for a fixed period of time may be comforting, it may also prove inconvenient if you need or want more income. Typically, immediate annuity payments are fixed once they’ve begun, although there are some exceptions (such as inflation adjustments and commuted payment options) that allow for withdrawals from the balance of the immediate annuity in addition to the fixed payments.

Lower deferred annuity interest rates –The appeal of the split annuity idea is knowing that at the end of the immediate annuity payout period, the fixed-interest deferred annuity will have earned enough interest to equal the principal amount used to fund both annuities. The growth of the fixed-interest deferred annuity portion of the split annuity is based on the interest rate paid by the annuity issuer. The immediate annuity payments are based, in part, on the amount apportioned to the immediate annuity. The more money allocated to the immediate annuity, the larger the income payments. If more money is allocated to the fixed-interest deferred annuity because of lower interest rates, then less money is allocated to the immediate annuity, decreasing the payments to you.

Split annuity uses

While the split annuity concept is not the only alternative for pursuing a particular financial objective, it may be useful in a number of situations.

Dependable income and savings–Many people, especially retirees, want a dependable income coupled with preservation of retirement funds. The split annuity concept may offer a means to both objectives. Not only does the immediate annuity pay a fixed income for a fixed period of time, but a portion of each payment received from the immediate annuity may not be subject to income tax because it is considered a return of premium. Immediate annuity payments are fixed and don’t fluctuate during the payout period, regardless of changing interest rates. Moreover, the deferred annuity part of the concept offers a fixed interest rate on that portion of the money allocated to it. Most deferred annuities also allow for a portion of the account value to be withdrawn without penalty, so if you need more money in addition to the immediate annuity payments, you can withdraw it from the deferred annuity.

For retirement plan income –Say your only retirement income is Social Security. You have savings but you’re concerned that if you take out too much, you may run out too soon. The split annuity can provide a steady source of income without exhausting your principal. It’s also flexible enough that if you need more income, you can take some from the fixed-interest deferred annuity (subject to early withdrawal penalties). At the end of the fixed income period, you can reevaluate your finances and determine whether you need more, less, or the same income, and adjust accordingly.

Bridge the gap between retirement and Social Security –You have some savings in the bank and you want to retire, but you don’t want to (or are too young to) apply for Social Security retirement benefits. The income payments from the immediate annuity part of the split annuity concept may provide the income you want between retirement and Social Security. The fixed-interest deferred annuity preserves your principal by earning interest on the money you apportion to it. When you’re ready to begin receiving Social Security retirement benefits, the fixed interest deferred annuity will have earned enough interest to equal your original principal investment.

The split annuity can help

With company pensions vanishing and the cost of living rising, you likely will have to rely on your own savings to provide the majority of your retirement income. The split annuity concept can be a useful part of your retirement income plan by supplying fixed income while preserving funds for later use.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of Erik J. Larsen and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

Erik J. Larsen is a Representative with FSC Securities and may be reached at www.theretirementgroup.com.

First-Time Homebuyer Tax Credit

Introduction

The first-time homebuyer tax credit was originally established by the Housing and Economic Recovery Act of 2008. The credit was subsequently extended and modified by the American Recovery and Reinvestment Act of 2009 and the Worker, Homeownership, and Business Assistance Act of 2009.

Home purchases made April 9, 2008 through December 31, 2008

A temporary refundable credit equal to 10-percent of the purchase price of a principal residence, up to $7,500 ($3,750 if married filing separately) was available to first-time homebuyers who purchased a home on or after April 9, 2008, and before January 1, 2009. Generally, to qualify as a first-time homebuyer, you (and your spouse if you were married), could not have owned any other principal residence during the three-year period ending on the date of purchase.

The credit was phased out for individuals with higher incomes. Specifically, the credit was reduced for individuals with modified adjusted gross income (MAGI) exceeding $75,000, and was eliminated for individuals with MAGI equal to or exceeding $95,000. For married individuals filing a joint federal income tax return, the credit was reduced if MAGI exceeded $150,000, and was eliminated for those with a MAGI of $170,000 or more.

The credit at this time was effectively an interest-free loan. Individuals who claimed the credit for purchases made during this period of time are required to pay back the credit over fifteen years in equal installments. The fifteen year repayment period begins two years after the credit was claimed. So, if an individual claimed a $7,500 credit on his or her 2008 federal income tax return, he or she would start paying $500 a year back, beginning with his or her 2010 return.

Caution:  If an individual claimed the credit for a home purchase made during this period of time, and sells the home during the fifteen year repayment period, or the home ceases to be the principal residence of the individual during the fifteen-year repayment period, repayment of the credit is accelerated. Repayment is generally not accelerated if the home remains the principal residence of the individual’s spouse.

Tip:  If the principal residence is sold during the fifteen-year repayment period, then the remaining credit amount would be due from the gain on the home sale. If there is insufficient gain, then the remaining credit payback is forgiven. Also, if an individual dies during the repayment period, the balance is forgiven.

Caution:  Although the repayment amount is limited to the gain realized upon the sale of the home, if the home is sold during the payback period, that gain is determined by reducing the basis in the home by the amount of the remaining unpaid credit.

Caution:  The tax credit could not be combined with the mortgage revenue bond (MRB) homebuyer program or the DC first-time homebuyer credit.

Tip:  The credit could also be applied against the alternative minimum tax (AMT).

Home purchases made on or after January 1, 2009 and before November 7, 2009

A temporary refundable credit equal to 10-percent of the purchase price of a principal residence, up to $8,000 ($4,000 if married filing separately) was available to first-time homebuyers who purchased a home on or after January 1, 2009, and before November 7, 2009. Generally, to qualify you (and your spouse if you were married), could not have owned any other principal residence during the three-year period ending on the date of purchase.

The income phaseout ranges for the credit remain the same as the amounts that applied to qualifying 2008 purchases: Specifically, the credit is reduced for individuals with modified adjusted gross income (MAGI) exceeding $75,000, and is eliminated for individuals with MAGI equal to or exceeding $95,000. For married individuals filing a joint federal income tax return, the credit is reduced if MAGI exceeds $150,000, and is eliminated for those with a MAGI of $170,000 or more.

While any credit claimed as a result of a qualifying purchase in 2008 had to be paid back over a fifteen year period, there is no such requirement for qualifying purchases made on or after January 1, 2009. However, if the home ceases to be an individual’s principal residence within thirty-six months of the purchase, the individual must pay the credit back. If married at the time of purchase, the home must remain the principal residence of either spouse for the thirty-six month period to avoid repayment. If repayment is required, it is reported and paid on the federal income tax return for the year in which the home ceased being a principal residence.

Tip:  The credit can be applied against the alternative minimum tax (AMT).

Caution:  No District of Columbia first-time homebuyer credit is allowed with respect to the purchase of a residence after December 31, 2008, if the first-time homebuyer tax credit described here is allowable to such individual (or the individual’s spouse) with respect to such purchase.

Home purchases on or after November 7, 2009 and before October 1, 2010

A refundable credit equal to 10-percent of the purchase price of a principal residence, up to $8,000 ($4,000 if married filing separately) is available to first-time homebuyers who purchased a home on or after November 7, 2009 and before May 1, 2010. Homes purchased on or after May 1, 2010 and before October 1, 2010 can qualify for the credit if a binding written contract to complete the purchase was entered into prior to May 1, 2010. Generally, to qualify you (and your spouse if you were married), could not have owned any other principal residence during the three-year period ending on the date of purchase.

A refundable credit equal to 10-percent of the purchase price of a principal residence, up to $6,500 ($3,250 if married filing separately) is available to individuals who have maintained the same principal residence for at least five consecutive years in the eight year period ending at the time the new home is purchased during the time period described above.

For purchases during this time period, the credit is phased out for individuals with modified adjusted gross income (MAGI) exceeding $125,000, and is eliminated for individuals with MAGI equal to or exceeding $145,000. For married individuals filing a joint federal income tax return, the credit is reduced if MAGI exceeds $225,000, and is eliminated for those with a MAGI of $245,000 or more. The credit is not available for any home with a purchase price exceeding $800,000.

Additionally:

• The credit is not allowed unless the individual claiming the credit is eighteen years of age as of the date of purchase. An individual who is married is treated as meeting the age requirement if the individual or the individual’s spouse meets the age requirement.
• The credit is not allowed if the principal residence is acquired from a person who is closely related to the individual or the spouse of the individual.
• No credit is allowed if the individual is a dependent of another taxpayer.
• No credit is allowed unless the individual attaches to the relevant tax return a properly executed copy of the settlement statement used to complete the purchase.
• The credit is not available to nonresident aliens

Caution:  If the home ceases to be an individual’s principal residence within thirty-six months of the purchase, the individual must pay the credit back. If married at the time of purchase, the home must remain the principal residence of either spouse for the thirty-six month period to avoid repayment. If repayment is required, it is reported and paid on the federal income tax return for the year in which the home ceased being a principal residence.

Caution:  No District of Columbia first-time homebuyer credit is allowed to any taxpayer with respect to the purchase of a residence after December 31, 2008, if the first-time homebuyer tax credit described here is allowable to such taxpayer (or the taxpayer’s spouse) with respect to such purchase.

Tip:  The credit can be applied against the alternative minimum tax (AMT).

Special rules apply to members of the uniformed services

Special rules apply to an individual who receives government orders (or whose spouse receives such orders) for qualified official extended duty service. If such an individual disposes of a principal residence after December 31, 2008 (or no longer uses the home as a principal residence) in connection with the government orders, no recapture of the first-time homebuyer credit applies by reason of the disposition of the residence. Any 15-year recapture with respect to a home acquired before January 1, 2009, ceases to apply in the taxable year the disposition occurs.

In addition, the qualifying time period for the first-time homebuyer credit is extended for one year. Specifically, In the case of any individual (and, if married, the individual’s spouse) who serves on qualified official extended duty service outside of the United States for at least 90 days during the period January 1, 2009 through April 30, 2010, the qualifying time period for the first-time homebuyer credit is extended for one year, through April 30, 2011 (through June 30, 2011, in the case of an individual who enters into a written binding contract before May 1, 2011, to close on the purchase of a principal residence before July 1, 2011).

Tip:  Qualified official extended duty service means service on official extended duty as a member of the uniformed services, a member of the Foreign Service of the United States, or an employee of the intelligence community.

Tip:  Qualified official extended duty is any period of extended duty while serving at a place of duty at least 50 miles away from the taxpayer’s principal residence or under orders compelling residence in government furnished quarters. Extended duty is defined as any period of duty pursuant to a call or order to such duty for a period in excess of 90 days or for an indefinite period.

Tip:  The uniformed services include: (1) the Armed Forces (the Army, Navy, Air Force, Marine Corps, and Coast Guard); (2) the commissioned corps of the National Oceanic and Atmospheric Administration; and (3) the commissioned corps of the Public Health Service. The term “member of the Foreign Service of the United States” includes: (1) chiefs of mission; (2) ambassadors at large; (3) members of the Senior Foreign Service; (4) Foreign Service officers; and (5) Foreign Service personnel.

Tip:  The term “employee of the intelligence community” means an employee of the Office of the Director of National Intelligence, the Central Intelligence Agency, the National Security Agency, the Defense Intelligence Agency, the National Geospatial-Intelligence Agency, or the National Reconnaissance Office. The term also includes employment with: (1) any other office within the Department of Defense for the collection of specialized national intelligence through reconnaissance programs; (2) any of the intelligence elements of the Army, the Navy, the Air Force, the Marine Corps, the Federal Bureau of Investigation, the Department of the Treasury, the Department of Energy, and the Coast Guard; (3) the Bureau of Intelligence and Research of the Department of State; and (4) the elements of the Department of Homeland Security concerned with the analyses of foreign intelligence information.

Electing to treat purchase as if made in prior year

If an individual purchases a principal residence in 2009 and qualifies for the first-time homebuyer credit, he or she can elect to treat the purchase as if it occurred on December 31, 2008, claiming the credit on his or her 2008 federal income tax return (amending the return to claim the credit if necessary). Similarly, individuals who purchase a principal residence in 2010 can elect to treat the purchase as occurring on December 31, 2009 for purposes of the first-time homebuyer credit.

Tip:  For individuals who purchase a principal residence in 2010 but elect to treat the purchase as if it occurred on December 31, 2009, 2009 modified adjusted gross income (MAGI) is used to determine whether the credit is reduced or eliminated.

Allocating the credit between individuals who aren’t married

The first-time homebuyer credit can be allocated when two or more unmarried individuals purchase a principal residence. IRS Notice 2009-12 explains that when two or more individuals purchase a qualifying principal residence and otherwise satisfy all requirements, the first-time homebuyer tax credit can be allocated among the individuals using any reasonable method, provided the method does not allocate any portion of the credit to an individual who is not eligible to claim that portion. Reasonable methods include allocating the credit based on individuals’ contributions toward the purchase price, and allocating the credit based on individuals’ ownership interests.

Caution:  The total first-time homebuyer tax credit allowed for all individuals cannot exceed $8,000 ($6,500 if qualification for the credit is based on prior ownership of a principal residence for a period of at least five years).

Summary of general rules (table)

Summary of general rules for first-time homebuyer tax credit
When was the home purchased?	4/9/08 through 12/31/08	1/1/09 through 11/6/09	11/7/09 through 4/30/10 (through 9/30/10 if binding written contract before 5/1/10)
Maximum credit	$7,500 ($3,750 if married filing separately)	$8,000 ($4,000 if married filing separately)	$8,000 ($4,000 if married filing separately)
Reduced credit available to existing homeowners?	No	No	Yes– homeowners who have maintained the same principal residence for 5 of 8 years ending on the purchase date eligible for maximum $6,500 credit ($3,250 if married filing separately)
Does credit have to be paid back?	Yes–generally over 15 years in equal installments	No, provided the home remains your principal residence for 36 months	No, provided the home remains your principal residence for 36 months
Credit claimed on tax return for what year?	2008	Can elect to treat purchase as if it occurred on 12/31/08, claiming credit on 2008 return; otherwise claimed on 2009 return.	Purchase in 2009 can be treated as if it occurred on 12/31/08; otherwise claimed on 2009 return. Purchase in 2010 can be treated as if it occurred on 12/31/09; otherwise claimed on 2010 return.
Income phase out	$75,000 to $95,000 ($150,000 to $170,000 if married filing jointly)	$75,000 to $95,000 ($150,000 to $170,000 if married filing jointly)	$125,000 to $145,000 ($225,000 to $245,000 if married filing jointly)
Maximum purchase price	No maximum	No maximum	$800,000

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of Erik J. Larsen and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

Erik J. Larsen is a Representative with FSC Securities and may be reached at www.theretirementgroup.com.

Home Mortgage Interest Deductions

What is a home mortgage interest deduction?

If you itemize deductions, you can generally deduct “qualified residence interest” you pay on certain home mortgages taken in connection with your primary residence and a second residence. (You cannot deduct mortgage interest with respect to a third residence.) This deduction generally applies only to interest on mortgages to buy, build, or improve your primary or secondary residence or to home equity loans used for any purpose.

The extent to which you may deduct the interest on your home loan depends on several factors, including the manner in which the loan proceeds are used, the amount of the loan(s), the type of loan, and whether your loan was taken prior to October 14, 1987.

Tip:  For 2007 through 2011 only, premiums paid or accrued for qualified mortgage insurance is treated as deductible mortgage interest. Qualified mortgage insurance means mortgage insurance provided by the VA, FHA, and Rural Housing Authority as well as private mortgage insurance (PMI). The amount of the deduction is phased out if your AGI exceeds $100,000 ($50,000 if married filing separately). This provision does not apply with respect to any mortgage contract issued before January 1, 2007 or after December 31, 2011.

What is qualified residence interest?

Qualified residence interest consists of any interest you pay in a given tax year for acquisition indebtedness or home equity indebtedness on your “qualified residence.”

A qualified residence is your principal residence and/or a second residence that meets certain requirements. A second residence you rent to others during the year can be considered a qualified residence for tax purposes only if you (or close relatives) use it for personal purposes for the greater of 14 days during the year or 10 percent of the number of days it is rented during the year.

Definition of home acquisition indebtedness

Acquisition indebtedness is a loan that meets certain dollar limitations and is incurred in buying, building, or substantially improving your qualified residence. In addition, the loan must be secured by a mortgage on that residence.

Example(s): Assume John buys his first home for $250,000, taking out a mortgage of $200,000. The $200,000 mortgage is considered acquisition indebtedness.

Tip:  An improvement must add value to your home (and be added to your home’s basis for tax purposes). Proceeds used to pay for repairs do not qualify.
Amount of home acquisition debt

Home acquisition debt on your primary residence and a second residence totaling up to $1 million ($500,000 if you’re married and file separately) qualifies for interest deductibility. However, these dollar amounts are reduced by the total amount of any outstanding “pre-October 13, 1987″ indebtedness that you may have.

For IRS purposes, all loans taken on and secured by your primary residence and one second residence prior to October 14, 1987 (no matter how the proceeds are used) are considered “grandfathered” home acquisition debt. All interest paid on such grandfathered debt is deductible, even if the total debt exceeds $1 million (or $500,000 if you’re married and file separately).

Tip:  Because the IRS has complex rules for tracing the use of borrowed funds, you should keep detailed records of loans taken to buy, build, or improve a residence so you can (if necessary) prove that the proceeds qualify as a home acquisition loan.

Definition of home equity indebtedness

Home equity indebtedness refers to debt secured by your main or second home that exceeds the acquisition indebtedness. Home equity debt is limited to the lesser of:

1. The fair market value (FMV) of the home minus total acquisition indebtedness on that home, or
2. $100,000 ($50,000 if married filing separately) for main and second homes combined

Interest on home equity loans that meet these limits and qualifications is deductible no matter what the loan proceeds are used for, except when the proceeds are used to purchase tax-exempt vehicles (investments or properties), such as tax-exempt bonds.

Example(s): Suppose you bought a home in 1980 for $180,000, taking out a mortgage of $130,000 to buy the home. The $130,000 is considered home acquisition debt. A few years later, when the fair market value of the home has increased to $195,000 and the principal balance on the original $130,000 acquisition loan has been paid down to $110,000, you take out a home equity loan of $90,000. You may deduct interest paid on $85,000 of the $90,000 home equity loan. Why? Interest cannot be deducted on the home equity debt that exceeds the difference between the fair market value of the residence ($195,000) and the principal owed on the acquisition debt on the residence ($110,000) at the time the home equity loan is taken.

Caution:  Refinancing of an acquisition debt is considered acquisition debt to the extent it does not exceed the principal outstanding on the loan immediately before the refinancing.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of Erik J. Larsen and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

Erik J. Larsen is a Representative with FSC Securities and may be reached at www.theretirementgroup.com.

Strategies for Cash Alternatives

Introduction

Cash alternatives, often used to fund a cash reserve, can be a useful financial tool for investors because they provide a low-risk place to hold money until it is needed for a future purpose.

Convenience is the principal benefit of cash alternatives. They typically pay a relatively low rate of interest, so their primary risk is opportunity cost. There are several strategies to help you get the most out of your cash alternative investments. For example, you can:

• Diversify the investment vehicles you use and ladder maturity dates. This can help you maximize liquidity, create a more steady flow of income, or defer recognition of taxable income from one year to the next.
• Evaluate both taxable and tax-exempt investments in light of your tax bracket and other income to maximize your after-tax returns
• If you have specific goals, consider concentrating your money in an appropriate cash alternative vehicle. For example, Series EE bonds may be a good vehicle for funds earmarked for a child’s college education.

There are various types of cash alternatives. When selecting your investment vehicles, you should balance liquidity needs with potential returns. If you already have a comfortable level of cash reserves, it might be wiser to place part of your money in cash alternatives that offer higher interest rates, even if they impose penalties for early withdrawals. On the other hand, if your cash reserves are relatively small, there may be a greater likelihood that you’ll need to make an early withdrawal, and you might be better off accepting a lower rate to avoid penalties.

Strategies for tax planning

Here are some factors to consider when doing tax planning for cash and cash alternatives, and deciding how much emphasis to give taxable versus tax-exempt instruments:

• Evaluate the effect your proposed investment might have on your other tax items. For example, taxable interest income increases your adjusted gross income (AGI), which can reduce allowable itemized deductions if you are in a high income tax bracket and subject to the itemized deduction phaseout.
• If you receive Social Security benefits, be aware that tax-exempt interest is included in the income calculation that is used to determine the taxable amount of such benefits. Thus, tax-exempt interest can increase your tax liability.
• If you do not generate sufficient taxable income, you may lose the benefit of your itemized or standard deductions and personal exemptions. You may want to generate enough taxable income to benefit from these deductions (assuming the rate you earn on your taxable investments exceeds that of your tax-exempt investments).

Strategies for maximizing liquidity and deferring income

Laddering is a method of investing or depositing money so as to avoid having large sums come in all at once–with little or nothing in between–by investing in more than one vehicle and staggering maturity dates.

For example, you might invest in certificates of deposit (CDs) with various maturity dates so they will come due at different times. Alternatively, consider combining your CD investments with other cash alternatives in order to obtain higher interest rates. Or, you could use a multi-tiered investment approach by combining a number of different cash alternative vehicles with a personal line of credit.

One of the greatest benefits of laddering cash alternative investments is that it minimizes interest-rate risk. Interest rates rise and fall in response to many factors, which makes them very difficult to predict. Shorter-term investments, such as money market funds and short-term CDs, are among the most sensitive to the ups and downs of interest rates. If you combine longer and shorter maturities, you don’t have to guess which way rates are headed next. Your risks are spread out. Laddering can also be used to help reduce the likelihood that you will have to face early withdrawal penalties if you need to draw money out to meet unexpected needs.

When choosing among specific cash alternative investments, it’s important to weigh the benefits and tradeoffs of each vehicle. There are several major factors to consider:

1. The financial strength of the issuer
2. The maturity date of the instrument
3. Any early withdrawal penalties
4. The yield to maturity
5. The liquidity relative to other cash alternatives (some types have no guaranteed liquidity)

Although the companies that issue commercial paper are of the highest quality, an unforeseen development could weaken the issuer financially, potentially reducing your prospects of being repaid when the instrument matures. Ratings provided by independent ratings services provide a helpful, independent assessment of the credit quality of the issuer. However, ratings are not continually updated and time can change a company’s outlook quickly.

The maturity date tells you how long you must wait before your principal will be repaid. Longer maturity periods typically involve higher risk and higher potential returns. An early withdrawal penalty is the amount you forfeit if you need to withdraw your money before the maturity date.

Finally, the yield to maturity is the amount of interest (and possible gain in principal amount) you receive if you hold the instrument until it matures.

Strategies that help you work towards specific goals

If you have a specific investment goal in mind, such as saving for your child’s college education, it may be wise to concentrate in one form of cash alternative, such as Series EE government savings bonds.

Also, bear in mind that changing allocations as your goals or time horizons change often involves becoming more conservative. For example, cash alternatives may be a good choice as you near the specific event for which you are saving. As a rule, your ability to accept risk decreases as your time horizon gets shorter. Say your child will be starting college in two years. If you started saving 15 years ago and have been investing in long-term vehicles, now may be a good time to shift those funds to more conservative, more liquid investments.

This material was prepared by Broadridge Investor Communication Solutions, Inc., and does not necessarily represent the views of Erik J. Larsen and The Retirement Group or FSC Financial Corp. This information should not be construed as investment advice. Neither the named Representatives nor Broker/Dealer gives tax or legal advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. The publisher is not engaged in rendering legal, accounting or other professional services. If other expert assistance is needed, the reader is advised to engage the services of a competent professional. Please consult your Financial Advisor for further information or call 800-900-5867.

The Retirement Group is not affiliated with nor endorsed by fidelity.com, netbenefits.fidelity.com, hewitt.com, resources.hewitt.com, access.att.com, ING Retirement, AT&T, Qwest, Chevron, Hughes, Northrop Grumman, Raytheon, ExxonMobil, Glaxosmithkline, Merck, Pfizer, Verizon, Bank of America, Alcatel-Lucent or by your employer. We are an independent financial advisory group that specializes in transition planning and lump sum distribution. Please call our office at 800-900-5867 if you have additional questions or need help in the retirement planning process.

Erik J. Larsen is a Representative with FSC Securities and may be reached at www.theretirementgroup.com.