Any financial planning process begins with a change in financial behavior and expectations. The degree of change varies based on financial priorities, but in the end, it’s about adopting new habits and abandoning others.

Before you take any of the following steps, it makes sense to talk to an expert who can help you see your whole financial picture. A CERTIFIED FINANCIAL PLANNER™ professional can examine all your sources of income and expenses and find the most efficient ways to cut expenses, pay off debt and boost the money you have for saving and investing.

In the meantime, here are some ideas:

Refinance if you can: Mortgage rates are still at historically low levels. You’ll need at least 10 percent equity (20% of equity will save you the PMI insurance cost) in your home and a credit score exceeding 720 to qualify for the best rates, but start negotiating with your current lender first and see how well you do.

Track your spending for a week: Either on paper or on the computer, write down every dollar you spend in the average week (and cut off credit card use during that week). At the end of that week, start marking out non-essential items just to see how much you could live without. Start with coffee and restaurant or carryout meals and work backward from there.

Make a budget: Once you’ve established how your income covers the essential expenses you must plan for, and a few inexpensive treats that should stay in, build a budget that includes specific amounts you can allocate toward debt. Keep a running total of your spending going forward, and revisit how that budget is working on a monthly basis until you start to see some positive results, and then you can review the performance of that budget a little less frequently.

Reset your entertainment expectations: Find ways to save money with friends – cook more meals at home or rent a movie instead of going out to see one. Also, get used to checking entertainment listings for free events that interest you.

If you can do it safely, take over home and auto maintenance yourself: The do-it-yourself movement is in a new phase with the economic downturn. For any home or auto maintenance chores you may have during the year, learn as much as you can about those tasks and estimate the cost of materials and your time before doing them yourself. Previous generations made do-it-yourself a necessity. See if that option is right for you and you might save considerable money doing it. Also, for bigger jobs, pair up with friends and family and you can help each other save money.

Set a new gift policy with your adult friends and family: Does everyone on your gift list over the age of 21 really need a present for birthdays and major holidays? Suggest to family and friends to have a gift drawing, a budget limit, a moratorium on gifts, or some other alternative where you trade off gifts for quality time. Even though the holidays are a few months away, it’s not too early to think about reining in the traditional holiday overspending.

Go debit: Debit cards wearing a bankcard logo are typically welcome at most stores where credit cards are accepted. This way, you pay cash without carrying cash. If you don’t have such a card, you can get one from your bank to replace your traditional ATM card, but remember to tell them to limit your buying power on the card to only what you have in your account. And use the overdraft protection to avoid fees.

Revamp your shopping list: Give this a shot: start a central weekly shopping list on a single piece of paper and add a dollar value for each. Write everything you think you need to buy on that single sheet, from groceries to clothes for the kids. That way, you’ll see all your proposed spending in front of you, and you can get a closer look at what your true priorities are. You’ll be surprised at all the “essentials” that are not really that essential that you can cross off before you spend.

Talk to your family about spending: When you’re talking to kids about budgeting and lowering your expenses, you have to walk a fine line between discipline and fear. But setting money priorities is part of growing up, and it’s essential to discuss and agree upon them as a family.

Buy used for yourself: Make someone else’s poor luck your good luck. If you need clothing, a car or a new watch to replace the old one that’s past fixing, it might be worthwhile to buy second-hand. The best places to find these gems are on the internet on places like craigslist. Plenty of people have unloaded items in relatively good shape to bring in cash during the recent downturn. You might do very well, and if anyone asks, don’t call it used; call it “vintage.”

October 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins, CFP, CLU, AEP, a local member of FPA.

One good thing that might come from all the attention on Michael Jackson’s estate is that it may motivate people to get their own affairs in order. In addition, there are lessons to be learned that readers can apply to their own situation.

Michael’s will, dated March 22, 2002 was probated in California on July 1, 2009. The will was actually relatively straightforward and devoid of the weirdness that we have come to expect from Michael Jackson. The will is a pour-over will which many estate attorneys, including me, often recommend for medium or large estates. The pour-over will basically says all money or property that had not already been transferred to the Michael Jackson Family Trust while Michael was alive should be transferred to the trust after his death.

The Michael Jackson Family Trust is a trust that Michael Jackson formed during his lifetime. If his attorneys were crossing their t’s and dotting their i’s, Michael most likely transferred the majority of his assets to this trust. The simplified terms (put in my words) of the trust are likely as follows.

Michael named himself as the first trustee and while he was alive, he could do anything he wanted with the property in the trust. He could spend the money, burn the money, buy property, buy an interest in royalties of the Beatles music, buy art, incur debt, whatever he wanted.

Note that Michael’s will, like virtually all wills, became a matter of public record. The exact terms of the Michael Jackson Family Trust, however, are not a matter of public record. That is an additional advantage of the trust for those preferring to keep their affairs private. In the state of California, though, some details of the trust become a matter of public record, so we know that the beneficiaries of the Michael Jackson Family Trust include Michael’s mother, Katherine, the singer’s children and a charitable trust.

Three co-executors of the will were named in 2002 including long-time Jackson attorney, John Branca, music executive, John McClain, and Jackson’s accountant, Barry Siegel. However, Barry Siegel resigned from his role as executor in 2003. It is now the responsibility of Branca and McClain to transfer any assets that were not already transferred to the Michael Jackson Family Trust to the trust. In addition, Branca and McClain will also serve as successor trustees of the Michael Jackson Family Trust.

So, one lesson is that someone even as screwy as Michael Jackson had a will. The pour-over will is an excellent method of keeping your affairs private. A bigger advantage for most readers, however, is that the configuration of a pour-over will with a family trust avoids probate. For most people avoiding probate, though not critical, is usually a good thing. Avoiding probate reduces fees that the state charges, reduces attorney’s fees and keeps the court out as much as possible.

The most interesting thing to me about Michael’s will is the contingent guardian of his minor children. His first choice was Katherine Jackson, his mother, a choice many parents make. In the event Katherine either isn’t able to serve as a guardian or declines to serve as a guardian, Michael’s next choice is singer, Diana Ross!

Another lesson that parents of young children can learn is that Michael did the responsible thing of making a will and stating who he wanted to be the guardian of his children in the event of his death. Even if a parent of a young child or children has no money or no life insurance, they should still do a will to make known their choice of guardian in the event of their death.

You may question whether leaving his children to the care of his 79-year-old mother, Katherine Jackson, was wise. Another thing you may question is whether his contingent guardian (in case his Mother could or would not serve as guardian), 65-year-old singer, Diana Ross, was wise. For one thing, the will was dated July 7, 2002 when they were five years younger. The important thing, however, is that Michael presumably considered the matter and made his wishes known when he prepared his will. I wish all parents of young children would do the same.

If you are interested in reading Michael Jackson’s will, please click on the following link.

http://www.docstoc.com/docs/8016703/Michael-Jacksons-Will

Taking Things a Little Deeper: A Life Insurance Lesson

Certainly we will hear many things regarding Michael’s estate in the coming weeks, months and possibly years. Assets like Michael’s 50 percent interest in the Sony/ATV music catalog (including rights to thousands of hit songs by everyone from the Beatles to the Jonas Brothers) valued between $500 million to $1.5 billion certainly pique our attention. The fact that the estate is also burdened by his personal debts of an estimated $500 million will most likely also receive a lot of attention.

One lesson is that if you have assets that are hard to value and are not terribly liquid, you should consider life insurance. The life insurance proceeds, if set up correctly, would be free of income taxes and estate taxes. The proceeds could be used to pay debts of the estate and taxes on the estate. If Michael had sufficient life insurance, his interest in the royalties would not have to be sold in a fire sale to pay the taxes on that same asset—something that may happen now.

There is another lesson that will probably not be talked about by anyone except me. So, here is some unique wisdom. This advice is terribly relevant for millions of IRA and retirement plan owners today.

A 401(k) Lesson

Though not much is known about Michael Jackson’s estate planning, if he got good advice, it is a good bet that Michael had either a 401(k) plan or some type of retirement plan. Since he made a lot of money, he may have been limited in how much he was allowed to deduct on his federal and California taxes for the contribution to his 401(k). Even if he wasn’t allowed to deduct it, it still would have been wise for him to make the highest contribution allowed. After-tax dollars inside a retirement plan, incidentally, are conceptually the same as a nondeductible IRA. He may have had other retirement plans and possibly an IRA. For our discussion, let us assume that he had a 401(k) plan and the ultimate beneficiary of his 401(k) plan is a trust for the benefit of his children, the oldest of which is 12 years old. Because his children are likely to be taxed at the highest rates for the rest of their lives and because trusts in general have the highest tax rates of any entity, it is a good bet that the IRS will collect a lot of taxes on that money. The IRS will likely collect both estate taxes within nine months of his death and income taxes on those retirement funds, though hopefully they will have to wait for the income taxes.

It is a reasonable bet that the advisors involved will know enough to ensure that the distributions from the inherited 401(k) plan should be distributed over the children’s lifetimes. The impact of making small distributions over many years is to defer the payment of income tax due when the 401(k) plan or a portion of the 401(k) plan is distributed to the children.

It is an important lesson to IRA and retirement plan owners as well as beneficiaries to plan for the deferral (or putting off) of the income taxes on the inherited 401(k) or IRA as long as possible.
What the advisors to Michael’s family likely don’t know is that Michael’s children could make a Roth IRA conversion of the inherited 401(k) plan. Just like individuals making a Roth IRA conversion, his children could pay income tax on the inherited 401(k) plan now and have all future growth of the plan income tax-free.

In effect what they would be doing is paying tax on the seed and reaping the harvest tax-free. Interestingly enough, if Michael had made a trustee to trustee transfer (more commonly known as a rollover) from his 401(k) plan to an IRA, his children would not have the option of making a Roth IRA conversion of the inherited IRA.

Though he probably had a bigger balance, to make it more relevant to more readers, let’s assume Michael had $1 million in his 401(k) plan. The benefits to the children for making a conversion of the inherited 401(k) to an inherited Roth IRA could be measured in tens of millions of dollars over their lifetime (details available).

One of the lessons here is that beneficiaries of 401(k) plans have options upon the death of their loved one.  They should not blindly follow the advice of the person at the bank or even their attorney or financial advisor.  I would bet that the big shot attorneys Michael was dealing with do not know about making a Roth IRA conversion of an inherited 401(k).  True, this is a relatively new law, but it is so important, it pays for consumers to keep up.

A more relevant lesson for many more people is to question the old wisdom of automatically rolling over (technically doing a trustee to trustee transfer) of your 401(k) plan to an IRA.  Several potential benefits of keeping your money in your existing 401(k) plan or even creating your own one person 401(k) plan include:

1. Possibility of a good fixed-income account in your existing 401(k) often referred to as a GIC (Guaranteed Income Contract).  This would only apply to keeping money in your existing 401(k) plan.

2. The ability for the 401(k) owner to make a Roth IRA conversion of after-tax dollars inside the 401(k) to a Roth IRA without having to pay the tax.

3. The protection of ERISA (Employee Retirement Income Security Act) meaning a higher level of creditor protection than just an IRA.

4. As mentioned above, the ability of the heirs to make a Roth IRA conversion of the inherited 401(k) that they could not do with an inherited IRA.

Remember, if you already have the bulk of your retirement plan dollars in an IRA and still have earned income, you may be able to create your own one-person 401(k) plan and make a Roth IRA conversion of the after-tax dollars inside of your 401(k) or IRA tax-free.

I hope readers will learn from Michael’s estate and some of the weirdness will be overlooked by the lessons to be learned.

* * * * * * * * * * * * * * * *

James Lange is a nationally recognized IRA, Roth IRA, 401(k) and retirement plan distribution expert. He is the author of two best-selling editions of the book, Retire Secure! Pay Taxes Later (the 2nd edition was released in February 2009 by Wiley). Mr. Lange has been quoted 30 times in The Wall Street Journal and is a frequent contributor to numerous media outlets including Newsweek, Bottom Line, and Kiplinger’s Retirement Report. He also founded the Roth IRA Institute this year to “advise advisors” and launched his own radio show on KQV am 1410 in Pittsburgh. Audio archives are available at www.retiresecure.com.

James Lange is a tax attorney and CPA with a thriving retirement and estate planning practice in Pittsburgh, Pennsylvania.  He focuses on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, will and trust preparation, and intricate beneficiary designations for IRAs and other retirement plans.  Jim’s advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, and his articles are frequently published in Financial Planning, Kiplinger’s Retirement Report and The Tax Adviser.

It’s a few short weeks until cap and gown season begins, and for grandparents hoping to do something nice for their grandkids and something sensible for their estate, there are several options to explore.

Roth IRAs: The Roth option is a good one if you want to help them start a retirement fund of their own or if you want them to inherit a Roth where they can make tax-free withdrawals after your death.

Roth IRAs aren’t a useful alternative for very young kids because the rules state that all Roth holders have to have earned income to be able to make contributions. If they fit that description – as many kids working in high school do – either their parents or guardians can open the account and grandparents can make contributions to match the percentage of earnings kids put in their Roth IRA. Grandparents simply match that contribution.

Also, if you have a Roth IRA, you can benefit your grandchildren by naming them as your primary beneficiaries, and when they inherit it, they’ll be able to make tax-free withdrawals for a home, an education or any other purpose.

Parents or grandparents may want to consider setting up and funding a Roth IRA for their children or grandchildren as soon as the children or grandchildren have enough earned income from part-time or summer jobs. This will ensure that the five-year requirement is met when the individual for whom the Roth IRA is established is ready to make a withdrawal to buy a home, for example.

529 Plans: Another great tool for grandparents is the 529 college savings plan. Grandparents can fill out a plan enrollment form designating a grandchild as beneficiary, select the investments from the plan’s options, and make future contributions either by check or by automatic contribution. It’s also fine for grandparents to make their contributions directly to a 529 account already owned by the grandchild’s parents.

As a refresher, 529 college savings plans – named for the federal law that created them in 1996 – allows a parent to open a tax-deferred college savings plan with as little as $25 to start in some states. A 529 college savings plan is not the same thing as a 529 prepaid college tuition plan. Prepaid tuition plans are just that – tax-deferred savings plans that allow you to save for tuition for in-state schools (though some plans allow you to transfer out a portion of those assets to out-of-state schools). Also, it’s important to note that prepaid tuition plans are not an automatic guarantee a student will get into that college.

Since 2006, withdrawals from 529 plans have been permanently tax-free. In some states, contributions may also be deductible on state tax returns. All 50 states now have 529 plans college savings plans, and a majority of them provides additional incentives, such as a state-tax deduction to in-state residents who invest in their respective plan.

It’s a good idea to have your financial adviser or your CERTIFIED FINANCIAL PLANNERÔ professional help you sort through the details of various state plans. There are various services – including Morningstar Inc. – that now rank the offerings of each state’s plan. www.SavingforCollege.com and www.FinAid.org are leading sites to help educate you in how these plans work.

Grandparents can treat their contribution as complete gifts, which means they can apply the $12,000 per year gift tax annual exclusion or an accelerated contribution of up to $60,000, with a special five-year, gift-spreading election. Check with your tax adviser first.

Another great benefit is that a 529 plan owned by grandparents should not affect the grandchild’s eligibility to receive federal financial aid because a grandparent’s assets are not reportable on the free application for federal student aid, or FAFSA, and the tax-free withdrawals from a grandparent-owned 529 plan are not counted as student income or student resources.

Coverdell Education Savings Accounts: For grandchildren heading to private school who are under the age of 18, most grandparents – check your eligibility with a tax professional first – can contribute up to 2,000 dollars annually per grandchild to a Coverdale Educational Savings Account. Coverdell earnings accumulate free of federal income taxes, and can be taken to pay for private elementary, secondary or college. Yet, your income is a factor. You can make a Coverdell contribution as long as your modified adjusted gross income is between 95,000 and 110,000 dollars if you’re single or between 190,000 and 220,000 dollars if you’re a married and filing jointly. Yet, if you exceed either of these requirements, you can ask the parent of the adult child to open up the account and make the contribution, though you will have to give up control over the account.

Make a direct gift of your grandchild’s tuition: Under current tax law, you can make gifts of any amount to cover your grandchild’s tuition. Yet, you’re going to need to pay the college directly and you need to be aware that it won’t dent your federal estate tax exemption (3.5 million dollars in 2009), but it will cut the overall amount of your taxable estate. You can, however, go ahead and make additional gifts per grandchild of $13,000 to help with other college expenses.

June 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins,CFP,CLU,AEP, a local member of FPA.

What is it?

Marriage is an important step in anyone’s life and brings many challenges with it. One of those challenges is the management of your finances as a couple. The money decisions that you make now as a couple can have a lasting impact on your financial future together. Careful planning of your finances can ensure that together, you achieve financial success.

Budgeting your money

In general

When you were single, you managed your finances in a way that was comfortable for you and that you understood–no one had to approve or disapprove of your financial decisions. Now that you are married, however, both you and your spouse have to agree on a system for budgeting your money and paying your bills.

Discuss financial situations

You and your spouse must discuss your respective financial situations and expectations, and take stock of your individual assets (what you own) and liabilities (what you owe). Revealing your financial situation is an important step when budgeting as a couple. If either of you has a financial problem, it is best to identify it now and begin solving it together. This is the time to address questions such as what do each of you earn, and what additional sources of income do you have? What do you own? Will both of you work now that you are married? Who will hold title to property acquired before and after the wedding? In addition, be sure to disclose all of your financial commitments. If you pay child support, let your partner know the amounts. If you have to repay student loans, discuss that as well.

The worksheets that follow will assist you in determining your current financial situation.

After you discuss your financial situations, you should discuss your financial goals. You can start by each making a list of your short- and long-term financial goals. Short-term goals are those that can take anywhere from three to five years (e.g., saving for a down payment on a home or a new car). Long-term goals are those that take more than five years to achieve (e.g., saving for a child’s college education or retirement). When you have each determined your individual financial goals, you should review your goals together to achieve common objectives. You can then focus your energy on those common objectives and strive to attain those goals (short- and long-term) together.

Decide on the type of bank account(s) you will keep

Decide whether you and your spouse will have separate bank accounts or a joint account. Advantages to consolidating your checking funds into one account include easier record-keeping, reduced maintenance fees, less paperwork when you apply for a loan, and simplified money management. If you do choose to keep separate accounts, consider opening a joint checking account for household expenses.

Caution: When sharing a checking account, be sure to keep track of how much money is in the account at all times since both of you will be writing checks that draw from the same account.

Prepare an annual budget

The first step in developing a financial future together as a couple is to prepare an annual budget. The budget will be a detailed listing of all your income and expenses over the period of a year. You may want to designate one spouse to be in charge of managing the budget, or you can take turns keeping records and paying bills.

Tip: Make sure that you develop a record-keeping system that both you and your spouse understand. Also, keep your records in a joint filing system so that you can easily locate important documents.

• Begin with your sources of income–list salaries and wages, alimony and child support, interest, and any other form of income that you and your spouse may have.
• List your expenses. It may be helpful to review several months’ worth of entries in each of your checkbooks to be sure that you include everything. Put all the expenses that are paid monthly into one category, and put all other expenses (every other month, quarterly, semiannually, annually) into another. Some common expenses are:

Savings	Major purchases
Rent or mortgage payments	Insurance
Student loan payments	Car repairs
Groceries	Clothing
Pet care	Tax payments
Utilities	Medical expenses
Car payments	Gifts
Credit card payments	Automobile gas
Alimony/child support	Child day care
Household items	Entertainment/dining out
Personal care/grooming

• Estimate your expenses for each category. How much money do you spend on these items on a monthly basis and on an annual basis? Try to come up with a realistic amount for what you think you will spend in a year’s time. Add another category to the irregular expenses list, and call it Contingencies. This can be a catchall category for expenses that you might not anticipate or budget for. The amount to budget for contingencies should be about 5 percent of your total budget.
• Add your sources of cash and uses of cash on an annual basis. Hopefully, you get a positive number, meaning that you are spending less than you are earning. If not, review your expense list to determine where you can cut your spending. Consider using computer spreadsheets or programs like Quicken for assistance.

Create a cash flow system

After you have developed a budget, you should create a system for managing your monthly inflow and outflow of cash. It is a good idea for both you and your spouse to become involved in this process–at least at first–so that both of you have a clear understanding of the costs of running the family and household.

Cash flow systems like the one described below are simple and painless to operate. Once they are established, you will find that making financial decisions becomes much easier because you have done your homework.

• Separate your regular monthly expenses from irregular expenses (every other month, quarterly, semiannually, annually) by using a different bank account for each. Otherwise, you may be tempted to use money that has been earmarked for something else. You should limit the number of checking accounts that you have in order to avoid confusion.
• Each time you get paid, deposit some money into an account for irregular expenses. The amount of money you deposit should be equal to the total amount needed for the irregular expenses, divided by the number of paychecks you each receive annually. In so doing, you will have the money for the outlay when it arises. The rest of your pay should go into your checking account, to be used for regular monthly expenses and savings.
• One variation to this system of cash flow management is to establish one or two additional bank accounts for one or both of you for personal spending money. Allocate the budgeted amount for personal expenses (e.g., lunches, haircuts, gifts) to this account. This way, you are free to spend the money in this account in any way you like without having to worry about meeting regular monthly expenses. However, all of these bank accounts may have fees.

Saving and investing your money

In general

At some point in your married life, you will almost certainly encounter some large expenditures, such as a new home, your own business, or a college education for your children. Chances are, you won’t be able to meet these expenditures from your current income. You and your spouse must discipline yourselves to set aside a portion of your current income for saving and investing your money to ensure its steady growth or, at the very least, protect it against loss.

Save a percentage of your earnings

When figuring out your budget, savings should be considered one of your monthly expenses. Think of savings as a fixed payment (like a car payment) that must be made every month. If you don’t and you wait until the end of the month to save whatever you have not spent, you’ll find that nothing ever seems to go into your savings account. A good rule of thumb is for you and your spouse to save 4 to 9 percent of your combined gross earnings while you are in your 20s and then double that savings percentage as you reach your 30s and 40s. In some cases, a dual-income couple may be able to live off one spouse’s salary and save the other salary.

Example(s): Mary and Richard, a married couple in their 20s, earn a combined annual gross income of $60,000. Together, Mary and Richard save 5 percent of their combined gross income each year, or $3,000.

As another example, Christine and Tom, a married couple in their 30s, earn a combined annual gross income of $80,000. Together, Christine and Tom save 10 percent of their combined gross income each year, or $8,000.

Build an emergency cash reserve

The savings that you accumulate can serve as an emergency cash reserve. Ideally, you should have in savings an amount that is comfortable for you to fall back on in case of an emergency, such as a job loss. A common formula used for calculating a safe emergency fund amount is to multiply your total monthly expenses by 6. When determining how much cash should be in your emergency fund, a major factor is your comfort level. If you and your spouse feel secure with your jobs and are confident that if you lost your current jobs you would be able to find a new one fairly quickly, an emergency fund of three times your monthly expenses should be sufficient. However, if either of you has an unpredictable income, you may want to have an emergency fund that is equal to 12 times your monthly expenses.

Example(s): Christine and Tom, a married couple in their 30s, plan to build up an emergency cash reserve. Both Christine and Tom are attorneys and feel quite secure with their present jobs. Christine and Tom have monthly expenses of $3,000 and plan to build up an emergency cash reserve that is equal to 3 times their monthly expenses, or $9,000 ($3,000 x 3).

As another example, Mary and Richard, a married couple in their 20s, plan to build up an emergency cash reserve. Both Mary and Richard are employed as freelance writers and feel that their incomes are at times unpredictable. Mary and Richard have monthly expenses of $1,500 and plan to build up an emergency cash reserve that is equal to 12 times their monthly expenses, or $18,000 ($1,500 x 12).

Investing your money

When you have established an emergency cash reserve, you can begin to invest your money to target your financial goals. There are three fundamental types of investments: cash and cash alternatives, bonds, and equities. Cash and cash alternatives are relatively low-risk investments that can be readily converted into currency, such as money market accounts. Bonds, sometimes called debt instruments, are essentially IOUs; when you invest in a bond, you’re lending money to the bond’s issuer–usually a corporation or governmental body–which pays interest on that loan. Because bonds make regular payments of interest, they are also known as income investments. Equities, or stocks, give you a share of ownership in a company. You have the opportunity to share in the company’s profits and potential growth, which is why they’re often viewed as growth investments. However, equities involve greater risk than either cash or income investments. With equities, there is no guarantee you will receive any income or that your shares will ever increase in value, and you can lose your entire investment. In addition to these three basic types of investments–also known as asset classes–there are so-called alternative investments, such as real estate, commodities, and precious metals.

No matter what your investment goal, your overall objective is to maximize returns without taking on more risk than you can bear. You’ll need to choose investments that are consistent with your financial goals and time horizon. A financial professional can help you construct an investment portfolio that takes these factors into account.

Establishing good credit

In general

Establishing good credit is an important step in the path towards a solid financial future. A good credit history can enable you to make credit purchases for items that you might not otherwise be able to afford. Most creditors will require a good credit history before extending credit to you. If you do not have a credit history, it is important to establish one as soon as possible. If you have a poor credit history, you should take steps toward improving it right away.

Individual or joint credit

Married couples can either apply for credit individually or jointly. One of the benefits of applying for joint credit is that both you and your spouse’s income, expenses, and financial stability are considered when a creditor evaluates your overall financial picture. However, applying for separate credit has its advantages. If you and your spouse ever run into financial problems (e.g., illness or job layoff), separate credit allows one spouse to risk damaging his or her credit history while preserving the other spouse’s good credit. In addition, separate credit can also protect you and your spouse from each other. If you and your spouse cosign a loan or apply for a credit card, you are both responsible for 100 percent repayment of the debt. In other words, if your spouse does not pay his or her share, you can get stuck with paying the whole amount. On the other hand, if your spouse takes out a loan or applies for a credit card on his or her own, generally your spouse is solely responsible for the debt.

Tip: While the general rule is that spouses are not responsible for each other’s debts, there are exceptions. Many states will hold both spouses responsible for a debt incurred by one spouse if the debt constituted a family expense (e.g., child care or groceries). In addition, in some community property states, both spouses may be responsible for one spouse’s debts, since both spouses have equal rights to each other’s incomes. You may want to discuss your state’s laws with an attorney if you live in a community property state.

Forefield Inc. does not provide legal, tax, or investment advice. All content provided by Forefield is protected by copyright. Forefield is not responsible for any modifications made to its materials, or for the accuracy of information provided by other sources.

The purpose of life insurance is to provide a sum of money (the death benefit) at the death of the insured. When you use life insurance as part of your college-funding plan, you can provide funding for your child’s college education in two ways. The first and perhaps obvious use is the death benefit, which can be used to pay for your child’s college education should you die prematurely. Statistically speaking, you probably will be alive to see your child through college, in which case you can still use life insurance as part of your education-funding plan. When you choose a cash value life insurance policy, you have a second way of reaching your college-funding goal. When you pay premiums on a cash value policy, some of your money is applied towards the policy cash value, making it sort of a savings account within the life insurance policy. Cash values accumulate and can be used during your lifetime via withdrawals and/or policy loans. This discussion assumes that you will live beyond the time your child enters college, and it will focus on the potential benefits of using cash value life insurance in your plan for funding your child’s college tuition.

When can it be used?

You have a need for insurance

Life insurance can be an important tool in your savings plan for your child’s college education. However, it is not appropriate that you buy life insurance solely for funding college tuition. You should only consider life insurance for this purpose when you also have a need for life insurance protection. Need is determined by several factors. If you work and produce an income that your family depends on, there is likely an insurance need. Even if you don’t work outside the home but are responsible for the care of your children, there may be an insurance need. The worksheet How Much Insurance Do You Need? will give you a guideline to help you and your financial planner determine appropriate levels of life insurance coverage.

Tip: If you already have insurance, review your existing coverage every few years. Changes in your life (such as salary increases, marriage or divorce, the birth or adoption of a child, or purchase of a residence) may indicate a need for a change in coverage.

You have a long time before tuition funds are needed

Insurance companies often charge the policy expenses such as fees and commissions in the earlier years of the policy. Because of this expense front-loading, several years could pass before your policy cash values begin to accumulate to sizable amounts. It is generally recommended that cash value insurance be considered for purchase when you intend to hold it for a long period of time, usually at least 10 or 15 years.

Tip: Check your existing policies. If you already have life insurance with cash values (remember that policy you bought 10 years ago?), you may have a head start on your funding plan for your child’s college education.

Strengths

Your family is provided with life insurance protection

Unlike other investments or a savings account, life insurance provides your family with a death benefit (i.e., a sum of cash paid after your death). Generally, the amount of the death benefit is significantly larger than the total premiums paid for the policy. If you should die before your child enters college, tuition can be paid from the policy death benefit. Should you live (which is much more likely), you can use policy cash values to pay for some or all of your child’s tuition. Your family still receives the benefit of life insurance as long as the policy remains in force.

Policy cash values grow tax deferred

The portion of your premium payment that is applied to cash value is invested either by the insurance company or at your direction, depending on the type of policy. Positive investment returns increase the cash value. You are not subject to taxes on the growth in cash value until you withdraw the cash values or cancel (surrender) the policy. It is possible that you may be able to withdraw cash values and not be subject to income tax on the withdrawal. For more information, see the section on tax implications.

Diverse investment choices are available for cash values

The cash values in your life insurance policy are invested in investment vehicles that traditionally have the potential to earn higher returns than an ordinary savings account at a bank. The investment options (normally called subaccounts) usually include bonds or stocks. You can buy a life insurance policy that lets you select the specific investments, or you can leave the investment choices up to the professional investment managers with the insurance company. In either case, you have the potential for higher returns (but also greater potential for loss) than if you made deposits to a traditional passbook savings account.

Tip: Read the fine print concerning the underlying investments for the insurance policy you are interested in. Shop around until you find a policy with cash value investments you are comfortable with.

Caution: Variable life and variable universal life insurance policies are offered by prospectus, which you can obtain from your financial professional or the insurance company. The prospectus contains detailed information about investment objectives, risks, charges, and expenses. You should read the prospectus and consider this information carefully before purchasing a variable life or variable universal life insurance policy.

Cash values can be withdrawn

When the time to pay college tuition arrives (or you need the money for any other purpose), you might withdraw some or all of the cash value from your policy, much like a withdrawal from a bank account. The amount you can withdraw is generally limited to a percentage of the cash value and varies by policy and company. You may be able to withdraw from your cash values and still keep your insurance in effect to provide a death benefit at your death.

Tip: It’s a good idea to leave enough cash value in the policy to maintain the policy and cover the policy fees.

Caution: Cash value withdrawals may reduce the death benefit.

Cash values can be borrowed against

Cash values can be borrowed against using a policy loan. Policy loans are allowed under the terms of your insurance contract and are not affected by your current financial position. In other words, you don’t have to undergo a credit check or a bank loan approval process for a policy loan. When you take a policy loan, the check you receive comes out of the general funds of the insurance company, not your cash value. Your policy cash value serves as the loan collateral. The interest rate for a policy loan is known in advance and may be lower than that on a bank loan.

Tip: Some policies allow borrowings at an interest rate only slightly higher than the rate being credited to cash values. With some policies, the loan interest rate charged equals the rate credited to cash values, for a zero net cost loan.

Caution: If either your dividends or the increases in cash value are reduced, this is also part of your cost to borrow.

Caution: If you die with an outstanding policy loan against your account, your death benefit is reduced by the amount of the outstanding loan balance.

Caution: Interest accrues on the unpaid loan balance. If you choose not to repay the loan, the accruing interest could erode your cash values and result in a policy lapse with some types of policy.

You can combine withdrawals with policy loans

Cash value withdrawals and policy loans are not exclusive events. You can use a combination of withdrawals and loans to maximize the tax-free cash withdrawal benefits. You might choose to make cash value withdrawals up to the amount of your policy basis and then take a policy loan. In insurance terms, this is referred to as “surrender to basis and switch to loan.”

Example(s): Let’s say you have a son you are putting through college. You own a cash value policy that you bought just after he was born, and you are considering accessing your cash values to pay this year’s tuition. The first thing you might do is to make a tax-free withdrawal of cash value from the policy equivalent to the amount of premiums you have paid into the policy. After you withdraw to your basis, you take a policy loan.

Insurance policy can be gifted to your child

As the owner of a life insurance policy, you may be able to transfer ownership to someone else by gift. As part of your overall financial and estate planning, you may choose to gift the policy to your child. To attain the maximum allowable tax benefit from your policy, you may want to withdraw cash value equivalent to your basis in the policy before you make the gift.

Example(s): Let’s say you have a daughter you are putting through college. You own a cash value policy that you bought when she was very young. She doesn’t have an income because her “job” at present is that of an unpaid archaeologist working on a project in France. You are considering making a gift of your cash value insurance policy to your daughter. Before you make the gift, you may be able to make a tax-free withdrawal of cash value from the policy equivalent to the amount of premiums you have paid into the policy. In insurance terms, this is referred to as a withdrawal to basis. After you complete the withdrawal to basis, you gift the policy to your daughter. As the new owner, she can now withdraw from the cash value. Her withdrawals will be taxed at her income tax rate, which presently is considerably lower than your rate. Another option is for her to take a policy loan against the remaining cash value.

Caution: Depending on the amount of the cash value gifted, part of it may be considered a taxable gift. Also, you may need to continue the gift with additional gifts of the premiums in order to keep the policy in force. Otherwise, your low-income college student may not be able to make the premium payments, and the policy could lapse.

Life insurance values are not included in federal methodology for financial aid

Under the federal financial aid formula, assets are grouped into two categories: assessable and nonassessable. Life insurance policies fall into the nonassessable category. In other words, the value of your cash value life insurance is not counted as income or assets in the financial need calculation. The amount of federal financial aid your child is eligible for is not reduced because you have life insurance containing cash value.

Although life insurance values are not included in the federal methodology, many colleges and universities do look at these values when assessing financial need and assistance at the school level.

Tradeoffs

You must be insurable

In order to get life insurance, you must be considered insurable by an insurance company. Insurability can be affected by such factors as medical history, age, or participation in dangerous hobbies such as auto racing. Life insurance is not available to people in extremely poor health, although few people are actually refused insurance.

Tip: Even if you have a history of health problems, you may still be able to buy a rated policy. The premiums are higher than for a preferred policy (whose favorable premiums reflect the fact that the applicant is less likely to die than a standard applicant), but your need for insurance protection may make it worth the expense.

Premiums represent financial obligation

Once you buy a life insurance policy, there is often an ongoing expense: the premiums. In the early years of the policy, the premiums represent a contractual obligation. Obviously, when you pay premiums, you have less cash available for other purposes.

Tip: In the later years of the policy, you may be able to reduce the amount of premiums you pay. This depends on the type of policy, so check out the details of your policy. With some policies, you can reduce your death benefit when your need for insurance is reduced (e.g., when your child has completed college). The death benefit reduction would be accompanied by a reduction in your premiums. Check the policy for details.

Amount of insurance must be justifiable

When you buy life insurance, you purchase a policy with a stated death benefit, also called the face amount. An appropriate death benefit is calculated beginning with your current income and your economic life (i.e., what you can be expected to earn during your working lifetime). There are several ways to calculate a life insurance need, but in the end, the death benefit must be justifiable in order to satisfy the insurance company’s financial underwriting process.  As a result of this death benefit limitation, your cash value potential is also limited. For instance, a 30-year-old person with an income of $30,000 would not be eligible to buy the same amount of insurance as a 50-year-old person with an income of $1 million.

Your cash value contributions may be limited

Because life insurance contracts receive favorable income tax treatment, the government has restricted the amount of money that can be paid into policies that are treated as life insurance contracts for tax purposes. There are specific rules that define a life insurance contract for tax purposes. These rules limit the amount of cash you can put into a policy that is treated as a life insurance contract.

There may be a death benefit restriction

If the cash value in a policy is too high relative to the policy death benefit, cash value increases will be taxed instead of being allowed to grow tax deferred. The excess cash value must be distributed to you. The cash value might become too high relative to the death benefit if the underlying investment experiences high returns or if the death benefit is reduced. In addition, the size of the policy you are eligible to buy is limited by your age and income under the financial underwriting requirement that the amount of insurance be justifiable.

You may be subject to modified endowment contract (MEC) rules

The modified endowment contract (MEC) rules were established to prevent people from using life insurance policies as tax-free investments for large sums of money. The MEC rules limit the amounts you can pay into a policy during the first seven years of the policy’s life. If you exceed the limits, the policy is permanently classified as a MEC and is subject to special tax rules. Under these rules, policy loans are generally taxable, and withdrawals are not only taxable but may also be subject to a 10 percent penalty tax.

Underlying investments subject to fees, potential losses

The underlying investments in a cash value policy may be subject to losses, depending on the performance of the investment and the markets. Just as investment gains are added to your cash value, losses may be deducted, depending on the specific policy. Investments are also subject to management and administrative fees.

Tip: Read your contract and prospectus concerning the underlying investments and any associated fees before you choose a policy.

What factors should you consider when choosing a policy?

When planning for college expenses, parents are often concerned with four areas: tax benefits, financial aid, control issues, and investment costs. Generally, all types of cash value life insurance will provide you with the same benefits in the areas of tax benefits and financial aid. The major difference between various policy types occurs in the areas of control and costs. The following types of life insurance all contain cash value and may be used for funding your child’s college education.

• Whole life
• Variable life
• Universal life
• Variable universal life

Tax benefits

The following tax characteristics are common to all types of cash value life insurance.

• Cash value grows tax deferred
• Cash value withdrawals to basis are not taxable
• Policy loan proceeds are not subject to income tax
• Death benefit is generally received by beneficiary free from income tax

Financial aid

Some assets, like cash value life insurance, may be treated differently depending on who is doing the financial analysis, the government or a college.

• Federal financial aid methodology doesn’t include policy cash values in parents’ total assets when determining a child’s financial need
• Individual colleges may consider policy cash values when determining a child’s financial need

Control issues

In all cases, when you own a cash value life insurance policy, you control the policy. You can decide if withdrawals are to be taken when allowed under your policy or if you want to take a policy loan. You choose the policy beneficiary who will receive the death benefit when you die. However, between the various types of cash value policies, there are differing levels of control over the cash value investments and premium payments. These may be key factors in choosing the appropriate life insurance type for saving for your child’s college education while also protecting your family’s income at your death.

Control over cash values

You have two options concerning your policy cash values. You can choose from investments offered by the policy, assume the investment risk, and monitor the performance of your cash values, or you can leave that to the insurance company’s fund manager.

Control over premium payments

All life insurance policies require some payment of premium. However, depending on the policy you choose, you may be able to control the timing and amount of your premium payments. You might want to pay a fixed amount that is due on a specified date that you can budget for indefinitely. On the other hand, you may want the flexibility to decide if you will occasionally pay a larger or smaller premium or skip a payment altogether. You may want to pay your premium in an up-front lump sum, thereby eliminating future payments.

Investment costs: Premiums

When you buy life insurance, you incur a direct cost–the premiums you pay for the policy. Premiums generally include the cost of the insurance protection as well as certain administrative expenses, risk charges, and processing costs. With universal life and variable universal life policies, the expenses are itemized in the policy prospectus. With whole life and variable life, the expenses and charges may be bundled (i.e., you can’t easily determine and compare charges for individual items).

Tip: Often the expenses are front-loaded; that is, the expenses and charges are deducted directly from each premium payment, with the balance of the premium payment being credited to the cash value account.

The significance of premium differences

It may be tempting to compare different policies based solely on the premium amount. This method may not be reliable, however. Many policies receive dividends from the insurance company that are based on the company’s investment returns or expense experience. Even if a policy seems to have a high premium, if the policy also receives high dividends, its cash values accumulate rapidly. Moreover, if it receives high interest credits, it may actually be less costly than a policy with a lower stated premium.

Tip: Check with your financial planner. There are several different formulas for comparing policy costs. The policy with the lowest premium may not actually be the least expensive.

Fees, penalties, and charges

In addition to premiums, there may be other fees, penalties, and charges related to your policy. If you withdraw cash value or take a policy loan, the insurance company may charge a processing fee. If you take a cash withdrawal or a policy loan, there are costs you incur in the form of foregone interest on the amount of the withdrawal or loan, not to mention the interest that accrues on the loan amount. If you choose to cancel the policy, there may be surrender charges involved, which will vary depending on how early or late in the life of the policy the cancellation occurs. Some policies carry a 15- to 20-year surrender schedule.

Tip: If you already own life insurance, check your policy and consult your agent about fees and interest charges if you are considering a cash withdrawal or policy loan.

Tip: If you are in the process of buying a policy, compare several policies before you make your choice. Fees and processing charges can vary by company and policy type.

What are the tax implications?

Income Tax

Premium payments not deductible

Life insurance premium payments are not tax-deductible expenses.

Cash withdrawals may not be taxable

Life insurance policy cash value withdrawals are considered a nontaxable recovery of your policy basis until the entire policy basis has been withdrawn. There are special rules for policies that are classified as a modified endowment contract (MEC), which are not discussed here.

Example(s): Say you own a life insurance policy (non-MEC) with a cash value of $15,000. Your basis in the policy equals $12,500. You plan to take a withdrawal of $7,000 now to pay for part of your son’s tuition. You won’t have to pay tax on this withdrawal amount because it will be considered a return of your basis.

Caution: Withdrawals in excess of your basis are treated as taxable distributions of interest or gain.

Caution: Cash value withdrawals that occur in the first 15 years of the policy and are accompanied by a reduction in the face amount may be treated as ordinary income to the extent that the cash value of the policy exceeds the policy basis.

Policy loans generally not taxable

When you take out a loan against your life insurance policy (except a modified endowment contract (MEC), the amount you receive is not considered taxable income. This rule applies even when the loan is larger than the amount of premiums you have paid in (except in the case of a MEC).

Example(s): Say you own a life insurance policy (non-MEC) with cash value of $20,000. Your basis in the policy is $17,000. You decide to take a policy loan to pay your daughter’s tuition. Under the terms of your policy, you are allowed to take a loan for an amount up to 90 percent of the policy cash value–in this case, $18,000 ($20,000 x.90). You are not subject to tax on the amount of the loan, even though the loan is larger than your basis.

Policy loan interest not deductible

Interest you pay on a policy loan is generally not a deductible expense (under certain circumstances, interest on loans used for business or investment purposes may be deductible).

Policy cancellation may be taxable

If you cancel (surrender) your policy for cash, the gain on the policy is subject to federal income tax. The gain on a canceled policy is the difference between (1) the net cash value and any loan forgiveness amounts, and (2) your policy basis.

Caution: If you surrender your policy while there is an outstanding policy loan, there could be additional tax consequences.

Death benefits generally not subject to federal income tax

Policy death benefits are generally not subject to federal income tax.
Gift Tax

Policy proceeds not considered gift to beneficiary

When the proceeds of your life insurance policy are paid to a beneficiary other than yourself (as the owner-insured) or your estate, they are not treated as a gift for gift tax purposes.

Policy premium payments generally not subject to gift tax

When you are the owner of a policy on your own life, with another party as the beneficiary, premium payments made by you are not considered a gift to the beneficiary for gift tax purposes. If, however, someone else pays the premiums on a policy you own, the premium payments are considered a gift to you and may be subject to federal gift tax if the annual premiums exceed the annual gift tax exclusion.
Estate Tax

Policy proceeds included in estate value in some cases

The proceeds of a life insurance policy are included in the value of your estate if you held any incidents of ownership at any time during the three years before your death or if the proceeds are payable to you or your estate. Some examples of incidents of ownership include the right to change the beneficiary, to take out policy loans, or to surrender the policy for cash.

Policy proceeds often exempt from state inheritance tax

In many states, life insurance proceeds are exempt from state inheritance taxes.

April 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins,CFP , a local member of FPA.

It’s a few short weeks until cap and gown season begins, and for grandparents hoping to do something nice for their grandkids and something sensible for their estate, there are several options to explore.

Roth IRAs: The Roth option is a good one if you want to help them start a retirement fund of their own or if you want them to inherit a Roth where they can make tax-free withdrawals after your death.

Roth IRAs aren’t a useful alternative for very young kids because the rules state that all Roth holders have to have earned income to be able to make contributions. If they fit that description – as many kids working in high school do – either their parents or guardians can open the account and grandparents can make contributions to match the percentage of earnings kids put in their Roth IRA. Grandparents simply match that contribution.

Also, if you have a Roth IRA, you can benefit your grandchildren by naming them as your primary beneficiaries, and when they inherit it, they’ll be able to make tax-free withdrawals for a home, an education or any other purpose.

Parents or grandparents may want to consider setting up and funding a Roth IRA for their children or grandchildren as soon as the children or grandchildren have enough earned income from part-time or summer jobs. This will ensure that the five-year requirement is met when the individual for whom the Roth IRA is established is ready to make a withdrawal to buy a home, for example.

529 Plans: Another great tool for grandparents is the 529 college savings plan. Grandparents can fill out a plan enrollment form designating a grandchild as beneficiary, select the investments from the plan’s options, and make future contributions either by check or by automatic contribution.  It’s also fine for grandparents to make their contributions directly to a 529 account already owned by the grandchild’s parents.

As a refresher, 529 college savings plans – named for the federal law that created them in 1996 – allows a parent to open a tax-deferred college savings plan with as little as $25 to start in some states.  A 529 college savings plan is not the same thing as a 529 prepaid college tuition plan. Prepaid tuition plans are just that – tax-deferred savings plans that allow you to save for tuition for in-state schools (though some plans allow you to transfer out a portion of those assets to out-of-state schools). Also, it’s important to note that prepaid tuition plans are not an automatic guarantee a student will get into that college.

Since 2006, withdrawals from 529 plans have been permanently tax-free. In some states, contributions may also be deductible on state tax returns. All 50 states now have 529 plans college savings plans, and a majority of them provides additional incentives, such as a state-tax deduction to in-state residents who invest in their respective plan.

It’s a good idea to have your financial adviser or your CERTIFIED FINANCIAL PLANNER (TM) professional help you sort through the details of various state plans. There are various services – including Morningstar Inc. – that now rank the offerings of each state’s plan.  www.SavingforCollege.com and www.FinAid.org are leading sites to help educate you in how these plans work.

Grandparents can treat their contribution as complete gifts, which means they can apply the $12,000 per year gift tax annual exclusion or an accelerated contribution of up to $60,000, with a special five-year, gift-spreading election. Check with your tax adviser first.

Another great benefit is that a 529 plan owned by grandparents should not affect the grandchild’s eligibility to receive federal financial aid because a grandparent’s assets are not reportable on the free application for federal student aid, or FAFSA, and the tax-free withdrawals from a grandparent-owned 529 plan are not counted as student income or student resources.

Coverdell Education Savings Accounts: For grandchildren heading to private school who are under the age of 18, most grandparents – check your eligibility with a tax professional first – can contribute up to 2,000 dollars annually per grandchild to a Coverdale Educational Savings Account.  Coverdell earnings accumulate free of federal income taxes, and can be taken to pay for private elementary, secondary or college. Yet, your income is a factor. You can make a Coverdell contribution as long as your modified adjusted gross income is between 95,000 and 110,000 dollars if you’re single or between 190,000 and 220,000 dollars if you’re a married and filing jointly.  Yet, if you exceed either of these requirements, you can ask the parent of the adult child to open up the account and make the contribution, though you will have to give up control over the account.

Make a direct gift of your grandchild’s tuition: Under current tax law, you can make gifts of any amount to cover your grandchild’s tuition. Yet, you’re going to need to pay the college directly and you need to be aware that it won’t dent your federal estate tax exemption (3.5 million dollars in 2009), but it will cut the overall amount of your taxable estate.  You can, however, go ahead and make additional gifts per grandchild of $13,000 to help with other college expenses.

April 2009 — This column is produced by the Financial Planning Association, the membership organization for the financial planning community, and is provided by Martin V Higgins,CFP , a local member of FPA.