Summer 2001 Newsletter IN THIS ISSUE... Click on the Below Topics to Jump to That Area: You Still Need Estate Planning New Simplified Distribution Rules What Happened To Savings? 5 Tips To Increase Your Net Worth A Look At Convertible Bonds Getting To Know Us. YOU STILL NEED ESTATE PLANNING The Economic Growth and Tax Relief Reconciliation Act of 2001, signed into law on June 7, 2001, provides for the repeal of the estate and generation-skipping transfer tax in the year 2010. Until that time, the estate tax exclusion will increase from the current $675,000 to $1,000,000 in 2002, $1,500,000 in 2004, $2,000,000 in 2006, and $3,500,000 in 2009. In addition, the maximum estate and gift tax rates will be reduced from the current 55% to 50% in 2002, 49% in 2003, 48% in 2004, 47% in 2005, 46% in 2006, 45% in 2007, and to the top individual income tax rate in 2010 (for gift taxes only). The rule providing that inherited assets receive a step-up in basis to the market value at the date of the decedent’s death will be repealed when the estate tax is repealed. At that time, inherited property will generally have a basis equal to the lesser of the decedent’s adjusted basis or the property’s fair market value at the date of the decedent’s death. Even though the estate tax will be repealed in 2010, the gift tax on gifts made during your lifetime will remain. The lifetime gift exemption will increase to $1,000,000 in 2002 and will remain at that level. Since the estate tax won’t be eliminated for over eight years, you probably don’t want to undo any strategies already in place. In fact, your estate plan will need to consider strategies to deal with estate taxes in the event you die before 2010. Additionally, the Act contains a "sunset" provision stating that for tax years after 2010, the 2001 tax law will come back into effect unless further congressional action is taken. While reducing estate taxes is a major estate planning goal, keep in mind that you also want to ensure that your estate is distributed to your chosen heirs. Keep these points in mind: You still need a will to provide for the distribution of your estate and to name guardians for minor children. Also consider a durable power of attorney and a health care proxy. A durable power of attorney designates an individual to control your financial affairs if you become incapacitated, while a health care proxy delegates health care decisions to another person when you are unable to make these decisions. Continue an annual gift program, since it does not result in the payment of any gift taxes. You may gift up to $10,000 per year ($20,000 if the gift is split with your spouse) to an individual federal gift tax free. This amount is adjusted annually for inflation, in $1,000 increments. You can make gifts to any number of individuals, even those not related to you. Over a number of years, an annual gifting program can remove a substantial amount of assets from your estate. In additions, any future appreciation or income generated on those gifts is removed from your estate. Consider using your lifetime gift tax exclusion during your life. The amount is currently $675,000 for 2001, but is scheduled to increase to $1,000,000 in 2002. This strategy does not result in the payment of any gift taxes and reduces your taxable estate in the event that you die before 2010. When making gifts, look for opportunities to transfer assets that have the potential to appreciate in value, but have not already done so. Investigate trusts that will accomplish other estate planning goals. While many trusts are designed to help reduce estate taxes, there are other reasons to set up trusts, including to control asset distribution, to make gifts to charities, to provide for the possible incapacity of the creator, to protect heirs from others or themselves, to avoid probate, to allow a professional to manage assets, and to ensure that provisions are made for minors. The eventual repeal of the estate tax has not eliminated the need for estate planning. For a more detailed discussion of these issues or if you’d like help, please call us at (800) 878-4036. NEW SIMPLIFIED DISTRIBUTION RULES In January 2001, the Treasury Department released new proposed regulations concerning required minimum distributions from individual retirement accounts (IRAs) and employer-sponsored 401(k), 403(b), and 457 deferred-compensation plans. Although the rules are scheduled to become effective on January 1, 2002, the Treasury Department has indicated that they can be used retroactively to the beginning of 2001. However, if you prefer, you can still use the old rules for distributions made in 2001. The new rules simplify the calculation of required minimum distributions and give account owners more flexibility. To understand the significance of the new rules, you need to remember a couple of basic points about the old rules. Under the old rules, you needed to decide two things by April 1 of the year after you turned 70 ½ – who your beneficiary was and which of three methods you were going to use to calculate distributions. These two decisions significantly impacted the amount you were required to withdraw each year and, once made, were irrevocable. The new rules simplify distributions as follows: Once you reach age 70 ½, your minimum required distribution is calculated by taking your account balance as of the end of the preceding year divided by your distribution period (as noted in the following table):   Age Divisor Age Divisor 70 26.2 93 8.8 71 25.3 94 8.3 72 24.4 95 7.8 73 23.5 96 7.3 74 22.7 97 6.9 75 21.8 98 6.5 76 20.9 99 6.1 77 20.1 100 5.7 78 19.2 101 5.3 79 18.4 102 5.0 80 17.6 103 4.7 81 16.8 104 4.4 82 16.0 105 4.1 83 15.3 106 3.8 84 14.5 107 3.6 85 13.8 108 3.3 86 13.1 109 3.1 87 12.4 110 2.8 88 11.8 111 2.6 89 11.1 112 2.4 90 10.5 113 2.2 91 9.9 114 2.0 92 9.4 115+ 1.8 This table is used regardless of who your beneficiary is (one exception is noted in the next paragraph). These new distribution rules are expected to reduce the required minimum distribution amount for the vast majority of taxpayers. If your spouse is your sole beneficiary and is more than ten years younger than you, you can use either the above table or a table based on the actual joint life expectancy of you and your spouse. You can change beneficiaries at any time, with no impact on your minimum required distribution amount. For purposes of determining who receives your account balance after your death, you have until the end of the year following your death to make that determination. This could be accomplished by instructions you leave or by beneficiaries disclaiming their right to the balance. After your death, your beneficiary can make withdrawals based on his/her remaining life expectancy. This rule applies regardless of whether you died before or after your required distribution date. If you do not have a designated beneficiary and you die after you start making required minimum distributions, the balance is distributed over your remaining life expectancy at the time of your death. If you die without a designated beneficiary and before your required minimum distribution date, the balance must be paid out within five years of your death. Your IRA custodian must now report what your required minimum distribution should be each year to both you and the IRS. This makes it easier for the IRS to monitor whether you have withdrawn at least the minimum amount required. If you do not, you will owe the IRS a tax of 50% of the amount that should have been withdrawn.

For years, we have heard that our personal savings rate is dismally low. And in fact, as the graph below shows, the personal savings rate as a percentage of disposable income has been significantly declining since 1992, actually turning slightly negative in 2000. How concerned should we be by this trend?

While this measure of savings is the most widely quoted, it is often criticized since it reports the percentage of disposable income set aside for saving. It does not record any increases or decreases in total wealth, such as gains in investments and real estate.

Yet even studies that have attempted to take capital gains into account have shown significant declines in the personal savings rate. One study found that the personal savings rate, including capital gains, decreased from a little over 12% in 1993 to approximately 7% in 2000 (Source: AARP Research Study, March 2000).

So why has personal savings decreased so significantly? Several possible causes have been suggested:

• Steep increases in many services, such as medical services, education, recreation, and housing, have caused consumers to significantly increase their expenditures.
• Government transfer payments, such as Social Security, Medicare, and Medicaid benefits, act as a disincentive for individuals to save. Individuals realize that they can count on these benefits from the government, so feel less need to save on their own.
• The easy availability of credit has caused many consumers to borrow aggressively rather than to save.
• Significant increases in the stock market mean that many individuals have significant gains. Since consumers base their ability to make purchases on both their income and wealth, these gains have led them to increase their purchases and decrease savings.

Whatever the cause, this long-term trend is distributing since the baby boomer generation is the first generation that will have to finance a significant portion of its own retirement. Two major trends will cause this generation to need more in the way of personal savings:

• REDUCED THIRD-PARTY SUPPORT. Generous pensions and Social Security benefits will probably not be as readily available to the baby boomer generation. While the Social Security system is expected to survive, changes are widely anticipated. The trend in company-sponsored pension plans has been a significant increase in defined-contribution plans, where employees make contributions from their earnings, at the expense of defined-benefit plans, where the employer funds benefits.
• INCREASED LONGEVITY. Not only are we now living much longer than in the past, but this trend is expected to continue at an even faster pace in the future.

On an individual level, the decline in the personal savings rate should serve as a wake-up call to assess your progress toward your retirement goals.

To achieve your financial goals, you need to find ways to increase your net worth, which can be accomplished by increasing your assets and/or decreasing your debts. These five basic tips can help:

• SET EXCITING FINANCIAL GOALS. Putting money aside for a distant goal, rather than spending that money now, is a difficult thing for most people to do. So set exciting goals that will motivate you to achieve them. Then quantify your ultimate goal as well as interim goals so you’ll have a way to track your progress.
• SPEND LESS THAN YOU EARN. The amount of money left over for saving is a direct result of your lifestyle. Your lifestyle decisions will impact you now and in the future, since you will typically want to continue the same lifestyle after retirement. To get a grip on your spending, take time to analyze your expenses and to set a budget. Try reducing nonessential expenditures. Another strategy is to find ways to spend less money for the same things.
• SAVE IT BEFORE YOU SEE IT. If you have to find the money for saving every month, you’ll likely find that there isn’t much left after all the bills are paid. Typically, a better strategy is to set up an automatic savings program where money is automatically deducted from your bank account every month and deposited directly into an investment account. Another good alternative is to sign up for your company’s 401(k) plan, having funds withdrawn every paycheck. (Remember that an automatic investing plan, such as dollar cost averaging, does not assure a profit or protect against a loss in declining markets. Since such a strategy involves periodic investment, consider your financial ability and willingness to continue purchases through periods of low price levels.)

• DON’T LET DEBT SABOTAGE YOUR GOALS. If a significant portion of your income is going to pay interest on your loans, that leaves less available for saving. Strive to eliminate all your debts except your mortgage.
• INVEST, DON’T JUST SAVE. Your ultimate nest egg is basically a function of two factors — how much you save and how much you earn on those savings. Become comfortable with various investment alternatives, so that you’ll feel comfortable investing in more aggressive alternatives that offer potentially higher rates of return.

Convertible bonds are a hybrid investment, combining features of both bonds and stocks. Like all bonds, convertibles pay a fixed interest rate for the bond’s life, with the principal returned at the end of the bond’s term. However, convertible bonds can also be exchanged for a specific number of shares of the issuing company’s common stock.

The bond’s interest payments are typically higher than the dividends paid on the common stock, although the interest rate is usually lower than that on nonconvertible bonds. However, the ability to convert to common shares allows investors to participate in share price increases without as much exposure to share price decreases. Convertibles do not decline as much as the common shares because the bond retains a market value equal to comparable bonds paying the same yield.

When issued, the value of the convertible bonds exceeds the price of the common shares by an amount known as the conversion premium, which changes as the stock price changes. If the stock is selling below the conversion equivalent, there is no financial incentive to convert the bond, so the bond’s price will be primarily determined by factors affecting bonds. Once the stock’s price rises enough to provide a profit converting the bond, the stock’s value will significantly affect the convertible’s market value.

Most convertibles can be called back by the issuer at a specific price. These call provisions are typically used by the issuer to force investors to convert the bond to common stock, so that the debt obligation can be eliminated.

Since they are a hybrid investment, convertible bonds can be difficult investments to evaluate. You should consider bond and stock pricing, current interest rates, the probability of a bond call, the convertible’s yield advantage over common stock, the fixed-income value of the convertible, and the volatility of the underlying stock. Please call us at (800) 878-4036 if you’d like to discuss convertible bonds in more detail.

You may not be aware of all our services, so we are including a basic list:

• Fee-based money management
• Investment review
• Asset allocation models

• Screening and selection of life, disability, and long-term health care
• Insurance needs modeling and projections

• Helping coordinate trusts, strategies, and insurance

• Retirement modeling and projections
• Comprehensive financial planning

• Pension plan asset management
• Employee benefits coordination
• Buy-sell and other owner issues

We offer knowledge and experience with the services listed above. In addition, we would be happy to meet with any of your family, friends, or colleagues who need help in any of these areas. If you have questions about any of these services or would like more detailed information, please do not hesitate to call us at (800) 878-4036.